R. R. Donnelley & Sons Company
Q4 2016 Earnings Call Transcript

Published: 28 Feb 2017

[Operator:]

[Call starts Abruptly]…is addressed more detail in our fourth quarter press release. A copy of which is posted on the Investors section of our website at rrdonnelley.com. This information will also be furnished to the SEC and the Form 8-K we filed today. Throughout this call, we will refer to forward-looking statements including comments on our financial outlook and strategy, all of which involve risks and uncertainties. Therefore, our actual results could differ materially from our current expectations. For a complete discussion on the factors that could cause our actual results to differ materially, please refer to the cautionary statement included in our earnings release and further detailed in our annual report on Form 10-K, our quarterly reports on Form 10-Q and other filings with the SEC. Further, we will discuss non-GAAP financial information. We believe the presentation of non-GAAP results provides investors with useful supplementary information concerning the Company's ongoing operations and is an appropriate way you to evaluate the Company’s performance. They are however provided for informational purposes only, any reference to non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release and our website. I now will turn the call over to Dan.

[Dan Knotts:]

Great. Thanks, Brian. Good morning, everyone, and thank you for joining us on our call today. I'd like to begin by saying that we're pleased with our results for the fourth quarter of 2016, as we grew both our net sales and our non-GAAP income from operations for the second consecutive quarter. Our results for the fourth quarter similar to our third quarter results reflect continued improvement in our performance trend from the first half of 2016. Our strong performance continues to be driven by our differentiability to provide cost effective products and services as well as comprehensive communication solutions that enable our clients around the world to effectively create, manage and execute their marketing and business communications. Further, we continue executing on our strategy to optimize our core, accelerate our strategy offerings, broaden our existing client relationships and scale our multi-channel communication services. Underlying our strategic growth initiatives is our ongoing focus on adjusting our cost structure to match our sales performance while also maintaining a disciplined approach to capital allocation. As an industry leader serving a large fragmented an evolving market, we're well positioned to meet growing client demand for innovation solutions that improve communication effectiveness, reduced complexity, and decreased costs. The choices companies have to make to effectively communicate with their intended audiences are becoming critical and growing investments. As our clients gain experience communicating in a multi-channel world, they're recognizing that how these communications are managed, optimized and delivered across the right channels, makes those communications more effective and more impactful; and while many companies have learned how to effectively communicate using individual channels print or digital or social, very few have mastered a fully integrated approach using multiple channels. Companies are increasingly challenged to manage their content and delivered across a complex maze of channels all while reducing their cost. Siloed processes, numerous suppliers and rapidly evolving technology impact both current and future communications as brands are pressured to deliver meaningful customer experiences, and the stakes are high for them to get it right. Research from Aberdeen Group shows the Company's strong omni-channel customer engagement efforts retain on average 89% of their customers compared to just 33% for companies with weak omni-channel customer engagement. Yet most companies are challenged to put to all together. Effective, impactful communications are at the heart of every successful organization in or at the core of what we do. With our unmatched portfolio of products and services, specialized expertise and innovative technology, we're confident in our ability to effectively serve the expanding and complex needs of our clients. We’re utilizing each of our offering individually to extend our market position through new client acquisition. We’re providing combinations of our offerings to create bundled solutions, as we expand our relationships with our more than 52,000 existing clients; and we continue to scale our multinational capabilities including content management, digital services and workflow automation to further expand our long-term strategic relationships with our clients by transforming the way they connect, interact and engage with their customers. Every day, we're providing individual products, bundled offering and integrated communications solutions across virtually all market segments to help our clients create those meaningful connections with their target audiences. I'd now like to share a few examples of how we're creating value for our clients worldwide. To further expand our marketing communications capabilities in the third quarter of 2016, we acquired Precision Dialogue an insight driven omni-channel customer engagement firm. We used these new capabilities to develop an innovative solution for large national retailer faced with data base and efficiencies, no real-time data, infrequent reporting, limited data analytics and underperforming market programs. We rebuilt the client's data base to become the real-time engine for their marketing initiatives with RRD performing all of their data analytics, managing all of their marketing campaign development and executing all of their campaigns across multiple channels, including integrating their direct mail with digital web and mobile. The results have been significant. Our integrated offering through the combination of print and digital communication delivered a tremendous improvement in their return on investment as compared to the prior efforts. We monitor performance by channel, by campaign type and even by local store, which enable us to optimize the program for the client overtime. Our ability to develop insight driven communications strategies that guide marketing initiatives and lead to improved client engagement to a true one-to-one dialog further enhances our marketing communications offering. In the complex and fast moving world of secured business communications, a growing number of our clients are searching for more comprehensive, effective and modernized offering to replace their legacy, homegrown and aging data management applications. To solve that challenge, we've developed a hosted client communication management platform that provides highly automated workflow tools to manage the entire communications process, from content creation, composition and approvals to production delivery and optimization. We provide these services while ensuring the highest level of security and compliance throughout the process. Whether the individual technologies are housed at R.R. Donnelley or at the clients' location, the workflow is seamless and provides significant value well beyond traditional prints and mail business applications. In the UK, we work with businesses to develop effective communications solutions that improved the customer experience and allow our clients to focus on what they do best. We were recently selected to manage the omni-channel business communications services for Shoulders, a global asset management company. We have a team of 40 individuals working in a creative studio in Shoulders' London headquarter to deliver graphic design, brand governance and business presentations for delivery across all media channels. Additionally, we provide reprographics, mail room, and records of management services onsite, improved procurement in warehousing from a nearby R.R. Donnelley facility. From creative design to digital and print production to multi-channel delivery, we're providing Shoulders with an integrated end-to-end communications management service. We also continue to extend our relationships with our existing clients while accelerating our strategic growth offerings. Our packing solutions team which specialized in the consumer electronics, medical devices, pharmaceutical, health and beauty, and wine and spirits market was selected by a longstanding telecommunications client to manage a complex new product launch; because of our extensive capabilities our packaging solutions team managed the entire project from packaging design through print production, including in-box materials, labels and retail packaging. The structured design was supported by our Santa Clara, California office who works seamlessly with our China new product development team to manage this complex solution. And like many of other clients, the success of this project has led to additional opportunities with this client. From a market vertical perspective, in the healthcare industry, we're providing the expertise in economies of scale to execute our clients' non-core processes more effectively and more efficiently. Our solutions integrate seamlessly into their communication workflows with industry leading capabilities enabling our clients in this highly regulated industry to focus on their most critical market differentiators. In 2016, we became among the first companies to have successfully leveraged and incorporated the HITRUST Common Security Framework Program into the annual SOC2 audit process. HITRUST Common Security Framework is an information security framework created to meet the specific needs of the healthcare industry. The completed SOC2 report a test to R.R. Donnelley's compliance with HITRUST controls in three of the AICPA Trust Principles. We're proud of this accomplishment, as just one example of how we prioritize the importance of our data security for all of our clients. Additionally, our sustained commitment to innovation continues to produce marketable intellectual property and create significant value for our customers. Our approach leverages the combination of organic development, external partnerships and new technology investments to expand our patented capabilities within area such as Variable Print and RFID technology, print electronics and ease of codings, commercial and direct mail applications and technology associated with high speed color digital presses. These accomplishments driven by our focus strategy enable us to continue to provide differential value for our clients as a leading provider of effective, marketing and business communications. With that, I will now turn it over to Terry Peterson. Terry?

[Terry Peterson:]

Thank you, Dan. The highly focus of my comments will be on certain non-GAAP results and measures. Please refer to described schedules in our earnings release and on our website for a reconciliation of GAAP to non-GAAP results. References and comparisons of income statement amounts to prior periods will be on a continuing operations basis after giving effect to the spin-offs of LSC and Donnelly Financial as active October 1, 2016. Overall, we're pleased with our fourth quarter operating results as the net sales and profit trends continue to improve versus the first half of the year and as compared to the prior year. Fourth quarter 2016 net sales of $1.88 billion grew $67 million or 3.7% as compared to the fourth quarter of 2015. This increase was primarily due to the $80.4 million of net sales, previously recognized by reporting units that are now part of LSC and Donnelley Financial, and the previously announced acquisition of Precision Dialogue, which contributed $14 million of net sales in the quarter. Partially offsetting these increases were changes in foreign exchange rates, which negatively impacted fourth quarter net sales by $16.1 million and a $6.3 million negative impact from several small acquisition earlier in the year. Adjusted for these factors consolidated net organic sales declined 0.4% as volume growth in the international and Strategic Services segment was more than offset by $15.5 million of lower postage pass-through sales in a Strategic Services segment, price erosion across all three segments and volume decline in the Variable Print segment. Non-GAAP gross profit for the fourth quarter of 2016 was $363.9 million, down $9.7 million versus $373.6 million in the fourth quarter of 2015. Continued cost reductions from productivity improvements were more than offset by price pressure in most product categories, unfavorable product mix and a one-time charge in the logistics reporting units within the Strategic Services segment. As a percentage of net sales, non-GAAP gross profit was 19.4% in the fourth quarter, down 1.2 percentage points, from 20.6% reported in 2015. Fourth quarter 2015 non-GAAP SG&A, up $211.4 million decrease $5.7 million from $217.1 million recorded in last year's quarter primarily due to cost reduction initiatives and allocation differences resulting from this spin off, partially offset by increased expenses associated with higher net sales. Fourth quarter non-GAAP SG&A as a percentage of net sales was 11.3%, an improvement of 0.7 percentage point from 12% reported in the fourth quarter of 2015. Fourth quarter 2016 non-GAAP income from operations was $101.8 million, up $1.2 million or 1.2% from last year as lower SG&A and depreciation and amortization expense more than offset lower gross profit. As a percentage of net sales, non-GAAP income from operations of 5.4% was down slightly as compared to 5.6% recorded last year. Non-GAAP adjusted EBITDA of $152.5 million or 8.1% of net sale was down slightly from $156.5 million or 8.6% of net sales reported in 2015. On a GAAP basis, we recorded a loss per diluted share for the fourth quarter of $6.98 which included a $7.42 per share charge for the impairment of good will and intangibles in our commercial and digital print and statement printing reporting units, both within our Variable Print segments, and a net $0.07 per share spin-off related transaction expenses and other items. Excluding these items, our fourth quarter non-GAAP diluted earnings per share was $0.51 compared to $0.53 in the fourth quarter of 2015. The slight reduction was due to higher income from operations and non-operating income and lower interest expense which were more than offset by a significantly higher effective tax rate in the fourth quarter of 2016 primarily due to a charge to record a valuation allowance on certain state deferred tax assets. Next, I will discuss fourth quarter 2016 net sales and non-GAAP income from operations for each of our segments in more detail. Fourth quarter 2016 net sales in our Variable Print segment were $833.6 million, which is down $6.4 million or 0.8% from fourth quarter of the prior year. Volume increases in our commercial and digital print and labels reporting units and growth from digital prints and inserting operations of Precision Dialogue were more than offset by volume declines primarily with our direct mail and foreign reporting units and modest price erosion throughout the segment. Variable Print generated non-GAAP income from operations of $64.7 million, up slightly from $64.3 million reported in the fourth quarter of 2015. Increases from productivity improvements, the Precision Dialogue acquisition and lower depreciation and amortization expense were partially offset by modest price erosion and net volume declines. Non-GAAP adjusted EBITDA was $95.7 million down slightly from $97.1 million in the fourth quarter of 2015. Strategic Services generated fourth quarter 2016 net sales of $497.3 million which is an increase of $80.7 million or 19.4%, as compared to last year's fourth quarter. Net sales in the quarter benefitted from $76.7 million of net sales previously recognized by reporting units that are now part of LSC and Donnelly Financial. In addition volume increases in our logistics and sourcing reporting units and net sales from Precision Dialogue data analytics services offerings also benefitted the current quarter. Partially offsetting these increases were lower postage pass-through sales of $15.5 million, volume declines within digital and creative solutions and modest price declines in the segment. Changes in fuel surcharges which have negatively impacted our growth over the last two years did not have a significant impact year-over-year in the fourth quarter. Non-GAAP income from operations in Strategic Services of $1.6 million was down $10.7 million in the quarter primarily due to a one-time charge of $8.4 million in our logistics reporting unit and modest price declines which were partially offset by net volume increases including those from the recent acquisition of Precision Dialogue. Non-GAAP adjusted EBITDA was $7 million down from $16.9 million in 2015. Fourth quarter 2016 net sales in our international segment were $545.4 million, which is a decrease of $7.3 million or 1.3% from $552.7 million reported in the fourth quarter of 2015. Significant volume increases in our Asia and Latin America reporting units and net sales previously recognized by reporting unit that is now part of LSC were more than offset by the negative impact of changes in foreign exchange rates, volume declines in the global turnkey solutions, business process outsourcing and Canada reporting units pervious mild dispositions and price pressure in the segment. Non-GAAP income from operations and international was $51.8 million, which is an increase of $2.8 million or 5.7% versus $49 million reported in the fourth quarter of the prior year. Favorable mix, higher productivity and lower depreciation and amortization expense were partially offset by modest price erosion. Non-GAAP adjusted EBITDA was $66.1 million, down from $67.1 million for the 2015 period. Fourth quarter 2016 non-GAAP unallocated corporate expenses were $16.3 million, which is an improvement of $8.7 million from the fourth quarter of 2015 primarily due to cost reduction activities and allocation differences resulting from the spin-offs. Net cash provided by operating activities during the fourth quarter of 2016 was a $117.4 million, down from $447.8 million generated in the prior year period. As a reminder, the prior period includes cash provided by LSC and Donnelley Financial operations and has not been restated. The 2016 quarter also included spin-off related cash payments of $29.7 million, capital expenditures were $24.2 million during the current quarter. Before we discuss the balance sheet and 2017 guidance, I would like to briefly summarize our results for the full year from continuing operations. Full year 2016 net sales of $6.9 billion decline $41.6 million or 0.6% compared to 2015. 2016 results included a $123.2 million for net sales previously recognized by reporting units that are now part of LSC and Donnelley Financial and $22.4 million from the third quarter acquisition of Precision Dialogue. Changes in foreign exchange rates negatively impacted net sales during the year by $71.3 million and several smaller dispositions in 2015 and 2016 reduced year-over-year net sales by $37.3 million. Adjusting for these items, full year 2016 net organic sales declined 1.2%. A net volume increase primarily driven by our Strategic Services in international segments was more than offset by modest price erosion across all three segments, $29.9 million of lower fuel surcharges and $28.8 million of lower hostage pass-through sales both of which incurred in our Strategic Services segment. Our full year 2016 non-GAAP income from operations was $284.1 million compared to $300.5 million in 2015. Notable items contributing to the 2016 decline include the one-time charge in logistics and an $8 million pretax charge for legal settlements reported earlier in the year. These items along with price pressure and unfavorable mix were partially offset by lower depreciation and amortization expense, cost reduction activities and growth from the Precision Dialogue acquisition. Non-GAAP operating margin for the full year of 4.1% with 20 basis points lower than the 4.3% reported in 2015. Full year 2016 non-GAAP adjusted EBITDA was $488.3 million, down from $533 million reported last year. Our full year 2016 non-GAAP diluted earnings per share was $0.69 compared to $0.97 in 2015 due to a significantly higher effective tax rate in 2016 primarily from a charge to record a valuation allowance on certain state deferred tax assets and lower income from operations partially offset by lower interest expense due to lower average borrowings outstanding. Turning now to the balance sheet, as of December 31, 2016, we had total cash on hand of $317.5 million and total debt outstanding of $2.39 billion, including a $185 million drawn against our credit facility. Remaining availability on the credit facility was $403 million as of December 31st. During the fourth quarter, we retired $222 million of our long-term note by drawing on our credit facility, which has since been partially repaid. Now that we've completed the spin-off transactions, our gross leverage at December 31st is 4.89 times, which is higher than our targeted gross leverage range of 2.25 to 2.75 times. We do expect our leverage to be reduced in 2017, as we plan to reduce our long-term debt by disposing of our 19.25% equity positions in both LSC and Donnelly Financial and cash provided by operating activities. At year end, our pension and other postretirement benefit plans were underfunded by $234 million, which is significantly improved from the $680 million unfunded level at the end of 2015, which included underfunded obligations that were subsequently transferred to LSC and Donnelly Financial. Required contributions in 2017 under all pension and other post retirement benefit plans are expected to be approximately $17 million. Looking ahead to 2017, we expect net sales to range from $6.8 billion to $7.0 billion. Non-GAAP income from operations is expected to range from $275 million to $300 million; and fully diluted non-GAAP earnings per shares expected to range from $0.90 to a $1.20. There are several key factors that impact our outlook for next year including the following. Invariable trends, we expect that the increase in net sales from the digital prints and inserting operations of the recent Precision Dialogue acquisition and volume increases in commercial and digital prints, direct mail and labels will be slightly more than offset by secular volume reductions in forms and statement printing and modest price erosion across most product categories. In our Strategic Services segment, we expect continued volume growth in our logistics reporting unit including a small increase in fuel surcharges, increased net sales from Precision Dialogue data analytics services offerings, plus additional net sales previously recognized by reporting units that are now part of LSC and Donnelly Financial. We expect these factors will be partially offset by lower postage pass-through sales and modest price erosion. In the international segment, we expect increased volume in our global outsourcing and Asia reporting units, and additional net sales previously recognized by reporting units that is now part of LSC to be partially offset by modest price erosion, difficult economic conditions across Latin America and effective changes in foreign exchange rates. We expect to normalize our variable compensation expense in 2017, which will result in significant increase in expense. We expect pension and other post retirement benefits income of $15 million which is $7 million lower than 2016 primarily due to reduction in our overhead income. We plan to continue our strong focus on cost reduction in order to offset the impact of various item including inflation and price erosion in each of our segments. Depreciation and amortization expense is expected to be in the range of $200 million to $205 million, we expect interest expense to be between $175 million and $180 million and our full year non-GAAP effective tax rate is anticipated to be between 32% and 33%, which is down significantly from the 2016 rate since we do not expect to one-time items recorded in 2016 to repeat. Shifting to our 2017 cash flow, we expect cash flow from operations to range from 220 million to 270 million, and capital expenditures are expected to be between $100 million and $115 million. Before we open up the call for questions, I’d like to review our ongoing capital priorities. Although, I stated earlier that we plan to lower our debt leverage in 2017 and beyond, we will continue to make strategic investment is our business including both organic investments and acquisitions that help us de-lever overtime and accelerate achieving our strategic goals. We also continuously evaluate our portfolio for strategic opportunities to optimize shareholders value, and we remain committed to our quarterly dividend, although our board does review our dividend recommendation each quarter. Finally, we do not expect to repurchase share in the perceivable future. And now, operator, let’s open up the line for questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question of line comes from Charles Strauzer from CJS Securities. Please go ahead.

[Charles Strauzer:]

Can we first -- let's have discussion on the guidance and just wanted to talk about the assumptions you're building in on the revenue range. And then also the implied EBITDA margins don’t appear at least from the first place to show any real year-over-year improvements. Can you talk about the puts and takes there as well?

[Terry Peterson:]

Yes, I mean Charles. I just start to acculturate the number of those assumptions in the prepared remarks, but we're expecting revenue ranging at $200 million range. We do expect that to be down slightly to up slightly depending upon which into the range you’re on there. Though, we're getting benefits coming through and you can see it in our corporate segments most notably we're getting benefits, net benefits from the net allocation differences with last year to going into this year. We saw that about $9 million in the current quarter. We do have some other cost increases that have to be taken into consideration. One of which is a significant increase in our compensation expense, as we normalize some of the compensation program coming off of the lower results for the 2016 period. So, that is certainly something that has to be factored in as you really kind of look to the 2017 EBITDA as well as operating income results.

[Charles Strauzer:]

And I guess what I was saying is the assumptions in the revenue guidance, what are you factoring in terms of like the economic improvement versus non-economic improvement things that’s driving that range?

[Dan Knotts:]

Charles, it's Dan. I'll jump in here. I think in terms of economic improvement, we're assuming for 2017 environment that was very similar to what we saw in 2016. It was a bit of a tale of two stories for those who've been following us and the first half volumes that were coming through multitude of platforms were not nearly as strong as what we saw or what we saw were improving towards the back half of the year. So, if we look at the collective mix across the entire year of a softer first half and improving back half, we also saw, as we have completed that towards the end of the year, some softness in a couple of individual product lines. So, there's a quite a bit of volatility that still exist across the different product offerings that we have, as we headed into 2016 -- or 2017 sorry. But essentially, a short answer to your question is economic environment looks a lot like 2016 is our assumption.

[Charles Strauzer:]

And then just kind of going back to the margin question obviously your Strategic Services, the margins even if you accept the $8.4 million one-time charge where still margin is down, EBITDA margin was down sequentially from Q3. And what other things you're doing there to kind of improve those margins? And can you be more aggressive on the cost front to kind of help put that in right direction?

[Terry Peterson:]

Yes, I would say there's two things there, Charlie, the first one is the mix of work that is running through the units within Strategic Services and an increased focus on the more profitable side of that mix is directly on our radar screen as we head into 2017, and the second piece of that is as we know that we have to continue to focus on leveraging that cost structure, reducing that cost structure in certain areas as well to get those margins heading back in the right direction and both of those are firmly on our radar screen.

[Dan Knotts:]

And Charlie too, I mentioned a couple of times in my prepared remarks. Here we have these sales that used to be reported in reporting units that are part of LSC and DFS today. So that revenue that we're recognizing today that is increased revenue in that segment, that's all outsourced business to us, we still send that business over to LSC primarily, and they actually do the production on it. So, it's an outsourced piece of business for us. So, those revenues that are coming into that mix and created some of the growth, those are lower margin revenues or sales for us because of the outsourced nature of those activities.

[Charles Strauzer:]

And then on the international segment, you mentioned volume declines in global turnkey and BPO. Can you give a little more color there is to kind of the trends that you're seeing and the visibility on that, as you see if there is changes those declines might start to be?

[Dan Knotts:]

So, Charles, it's Dan again. I think on the starting with the global turnkey side, as most are aware, there's a lot of large complex customers that make up the global turnkey business, and as their volumes have volatility then from a quarter to quarter basis that flows directly through to us obviously. So, in terms of what we're seeing there and our outlook there, we’re aggressively pursuing new opportunities to expand and diversify the global turnkey, our global turnkey operating in critical component of the future of that particular business. From a BPO standpoint, I would say comparable approach to that as well. The dynamics within that business, I don’t think there are opportunities that remain in that business to continue improve upon the top line for that business. It has large customers, it has there volume fluctuates that directly impacts us as well. But relative to any systemic issue problem there relative to the customers we're serving, we think we have opportunities to grow that business or get that business that would make trajectory back in our line.

[Operator:]

And at this time, I see we have no further questions.

[Dan Knotts:]

Okay. Thank you. There is no other questions, so we're going to go ahead and conclude the call. I would like to thank everyone on the call for spending time with us today. With the successful completion of our first standalone quarter as the new RRD, we continue to remain confident and optimistic about our future as a leading provider of integrated multichannel marketing and business communication services. And I will also like to take the time to thank the dedicated and talented employees of RRD for your tremendous passion, deep commitment and significant contributions throughout 2016. With that, I'll turn back over to Brian for some final housekeeping.

[Brian Feeney:]

Thanks, Dan. As a reminder, a replay of R.R. Donnelley’s fourth quarter 2016 results call will be posted on the Investor's section of our website at rrdonnelley.com. Thank you for joining us. And that concludes the R.R. Donnelley fourth quarter 2016 earnings call.

[Operator:]

Thank you ladies and gentleman. This concludes today's conference. Thank you for participating. You may now disconnect.