Donnelly's Earnings Surge in 1Q

Zacks

R.R. Donnelley & Sons Co. (RRD) reported earnings of 44 cents per share (excluding restructuring and impairment charges, acquisition expenses and loss on debt extinguishment) in the first quarter of 2012, which were ahead of the Zacks Consensus Estimate of 37 cents. Earnings surged 33.3% year over year, primarily driven by stringent cost savings during the quarter.

Quarter Details

Revenue declined 2.3% year over year to $2.52 billion, in line with the Zacks Consensus Estimate. Segment-wise, revenue from Product, which comprises around 87.0% of revenues, decreased 3.1% from the year-ago quarter to $2.20 billion. Services, which comprised 13.0% of the revenue, increased 3.6% year over year to $328.4 million.

U.S. print and related services revenue was down 2.3% from the previous-year quarter to $1.88 billion, due to a decrease in books and directories and financial print volumes along with continued pricing pressure across the segment. This offset the volume increases in logistics and office products. International sales remained flat year over year at $643.5 million during the quarter.

Non-GAAP gross profit was down 8.2% year over year to $580.0 million. Gross margin slipped significantly to 23.0% from 24.3% in the year-ago quarter. This was due to pricing pressure and unfavorable product mix.

Selling general & administrative (SG&A) expense increased 13.3% year over year to $283.2 million. As a percentage of total revenue, SG&A expense was 11.2% in the reported quarter versus 12.6% in the year-ago quarter. The improvement was primarily attributed to higher productivity and variable cost control.

Operating income on a non-GAAP basis improved 7.0% year over year to $171.7 million in the quarter. Operating margin increased to 6.8% from 6.2% in the year-ago period. Net income increased 15.0% year over year to $78.8 million, while margin crept up to 3.1% from 2.7% reported in the year ago quarter.

R.R. Donnelley exited the quarter with $415.0 million of cash versus $449.7 million in the previous quarter. Long-term debt was $3.76 billion at the end of the quarter. Cash outflow from operations was $52.0 million at the end of the quarter.

Outlook

R.R. Donnelley expects fiscal 2012 non-GAAP earnings in the range of $1.84 to $1.92 per share, slightly above the Zacks Consensus Estimate of $1.83. Moreover, non-GAAP effective tax rate for 2012 is expected in the range of 29.0% to 32.0%. For fiscal 2012, free cash flow is expected to be at least $500.0 million.

Recommendation

We remain Neutral on the company over the long term (6-12 months) despite its increasing volumes and new customer wins. We believe that strong alliances and customer wins including those of AT&T Inc. (T) and Verizon Communications Inc. (VZ) and Office Depot Inc. (ODP) will create value for the company over the long term.

However, we expect Donnelley to remain under pressure due to weak macroeconomic conditions prevailing in most of its current as well as prospective markets. Moreover, higher pension expenses, continuing pricing pressure, volatility in raw material prices and a highly leveraged balance sheet are significant headwinds going forward.

Currently, Donnelley has a Zacks #3 Rank, which implies a Hold rating in the short term (1-3 months).

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