R. R. Donnelley & Sons Company
Q3 2010 Earnings Call Transcript

Published: 3 Nov 2010

[Operator:]

Good morning, my name is Shaira, and I will be your conference operator today. At this time, I would like to welcome everyone to the RR Donnelley Third Quarter 2010 Results Conference Call. [Operator Instructions] Thank you. Mr. Gardella, you may begin your conference.

[Dave Gardella:]

Thank you, Shaira. Good morning, everyone, and thank you for joining us for RR Donnelley's third quarter 2010 results conference call. Earlier this morning, we released our earnings report, a copy of which can be found in the Investors section of our website at rrdonnelley.com. During this call, we'll refer to forward-looking statements that are subject to uncertainty. For a complete discussion, please refer to the cautionary statement included in our earnings release and further detailed in our annual report on Form 10-K and other filings with the SEC. Further, we will discuss non-GAAP and pro forma financial information. We believe the presentation of non-GAAP and pro forma results provide you with useful supplementary information concerning the company's ongoing operations and are an appropriate way for you to evaluate the company's performance. They are, however, provided for informational purposes only. Please refer to the press release and related footnotes for GAAP information and a reconciliation of GAAP and non-GAAP information. We also posted to our website in the Investors section a description as well as reconciliation of non-GAAP measures to which we will refer on this call. We're joined this morning by Tom Quinlan, Miles McHugh, and Drew Coxhead. I'll now turn the call over to Tom.

[Thomas Quinlan:]

Thank you, Dave. Good morning, everyone. You've heard us the phrase One RR Donnelley to describe the strategic framework that guides our approach to winning and expanding customer relationships, driving cost savings, integrating acquisitions and maximizing the value of our product development initiatives. During the third quarter, our revenues increased 1% compared to the same period a year ago. We believe that the momentum we have established through our One RR Donnelley strategy is better reflected by the increase that we experienced when we exclude the negative impact of changes in foreign exchange rates, lower paper sales due to the mix of paper selected by our customers, and the one-time effect of the $12.5 million fee we received in third quarter 2009 for the transition of a customer's contract. Collectively, these items negatively impacted our revenue growth in the quarter by just over 200 basis points. Before Miles takes you through the quarter in detail, I will address three of the interrelated benefits associated with our One RR Donnelley strategy. First, we are demonstrating a continuing ability to move from transactional to contractual customer relationships. Second, we are seeing customers embrace the unique ability RR Donnelley has developed to provide end-to-end solutions for them. And third, the digital initiatives that we are implementing are not just offering an alternative to conventional print production, they are helping to open the door to entirely new opportunities with customers. I'll begin with a shift from transactional to contractual relationships, which is driven by the intersection of customers' goals and our ability to meet their emerging needs. The economic downturn that began in 2008 knocked down a lot of silos within organizations and increased their desire to put together programs that would maximize their procurement efficiencies. As an accelerating rate, we have seen parts of our customers' organizations being brought together for the first time to look for a single supplier that can meet all of their diverse needs. This plays directly into one of RR Donnelley's greatest strengths

[Miles McHugh:]

Thanks, Tom. For four consecutive quarters now, our GAAP earnings per diluted share outperformed the prior year. Our third quarter 2010 GAAP earnings per diluted share of $0.25 exceeded third quarter 2009 by $0.19 or 317%. On a non-GAAP basis, we delivered $0.44 of earnings per share, a $0.10 decline from the third quarter of 2009. I mentioned on our last earnings call that the third quarter would be a difficult year-over-year comparison for us as last year's third quarter results included a few favorable items that were not going to be occurring again in Q3 of this year. I will discuss these items in more detail a bit later. I'm very pleased with our continued revenue growth. Third quarter sales grew 1.0% to $2.5 billion in the third quarter of 2010 compared to the same period last year. As Tom mentioned earlier, we realized this growth in spite of the unfavorable impacts of changes in foreign exchange rates, lower paper sales and the fees we received in the third quarter of 2009 for the transition of a customer contract. In aggregate, these three items negatively impacted our year-over-year sales growth by over 200 basis points. Adjusting for these items, the remaining growth was driven by increased volume across the platform, partially offset by continued price erosion. As we look ahead to the fourth quarter, we again expect to see modest revenue growth even with the expected continuation of unfavorable foreign exchange rates through the end of the year. GAAP income from operations was $148.7 million in the quarter, $55.3 million higher than in the third quarter of 2009. Included in these amounts were $48.7 million of restructuring and impairment charges and $2.6 million of acquisition-related expenses in the third quarter of 2010, compared to $131.7 million of restructuring and impairment charges and $0.1 million of acquisition-related expenses in the third quarter of 2009. A full reconciliation of our GAAP to non-GAAP earnings is included in our earnings release. Non-GAAP operating income in the current quarter was $200.0 million, down $25.2 million from third quarter of 2009. Three key items caused this decrease. First, we had a year-over-year increase of $16.1 million in our LIFO inventory provision. You may recall that we recorded a benefit of $13.1 million in the third quarter last year. That compares to a $3.0 million expense in this year's third quarter. Second, the one-time customer contract transition fee that we received in the third quarter of 2009 added $12.2 million to operating income last year. And third, we had an $11.9 million increase in our pension and postretirement benefits expense in 2010 versus 2009, an increase which is consistent with the increases seen in the first and second quarters. Collectively, these three factors negatively impacted the change in non-GAAP operating income by over $40 million. On the other hand, volume growth and increased recovery on print-related by-products and lower depreciation and amortization expense, partially offset by price erosion consistent with historical levels were the primary factors that helped us narrow the year-over-year decline in non-GAAP operating income. Our non-GAAP effective tax rate in the quarter was 35.7% compared to 31.3% in the third quarter of 2009. This increase was primarily caused by the write-off of certain tax assets in Latin America in the third quarter of this year. Now I'll discuss our operating results by segment. Third quarter sales in our U.S. Print and Related Services segment grew 2.0% over the third quarter of 2009 to $1.9 billion. As in the second quarter, we continue to realize a shift in the mix of paper used by our customers, which negatively impacted revenue growth by approximately 93 basis points. This impact was primarily reflected in our magazine catalog and retail inserts and book and directory reporting units. Volume increased year-over-year to nearly all of our offerings, most notably in our logistics, financial print and premedia offerings, while the unfavorable pricing environment in line with historical trends continue to put pressure on our sales growth. Sales in our International segment totaled $626.7 million in the third quarter, down 1.8% or $11.6 million from the same period last year. Unfavorable changes in foreign exchange rates and the $12.5 million fee we received for the transition of a customer contract in the third quarter last year negatively impacted revenue growth by approximately 510 basis points. We saw higher volume in Asia, Europe and Latin America, partially offset by lower volume in Business Process Outsourcing, Global Turnkey and Canada. The volume decline in our Business Process Outsourcing unit was due to the termination of a significant long-term customer contract last year. Price erosion, most notably in Asia and Europe, partially offset the volume gains. Our non-GAAP unallocated corporate expenses of $39.9 million increased by $41.6 million from the third quarter of 2009. As I noted earlier, our LIFO inventory provision in the quarter was $16.1 million higher than last year as we recognized the $13.1 million benefit in 2009 compared to a $3.0 million expense in the current quarter. Additionally, higher pension and other benefits-related expenses, including healthcare as well as higher provision for bad debt, comprised the balance of the increase over 2009. Capital spending was $50.4 million in the third quarter compared to $40.8 million in the third quarter of 2009. Interest expense in the quarter, of $57.6 million was $2.0 million favorable to the third quarter of 2009 due primarily to lower average borrowings and the favorable impact of our interest rate swaps. Additionally, in the third quarter of 2009, we recognized interest expense related to the acceleration of unamortized discounts related to the debt repurchases we made that quarter. We continue to maintain our favorable debt maturity profile. As of September 30, 2010, our debt was $3.4 billion with no maturities in the next 15 months. Our total debt is approximately 81% fixed at an average interest rate of 7.4%. Cash on hand at September 30, 2010, was $732 million, of which just over half is in the U.S. We continue to expect the Bowne acquisition to close this year and plan on using much of this U.S. cash, along with drawings on our revolving credit facility, to fund the purchase price. With just two months left in the year, we have some updates to our full year 2010 guidance. Consistent with our previous guidance, these expectations all exclude the impact of the pending Bowne acquisition. We expect year-over-year top line growth in the range of 0.5% to 1.0% as we expect to continue to be constrained by foreign exchange rates and lower paper sales for the balance of the year. We continue to expect our non-GAAP operating margin to be in the range of 7.3% to 7.5%. Depreciation and amortization expense is estimated at approximately $535 million for the year. Both our CapEx and interest expense are expected to be approximately $225 million. Our non-GAAP tax rate is expected to be in the range of 30% to 32%. This estimate could continue to be impacted by business trends affecting different countries in which we do business or by changes in tax laws. We continue to expect the fully diluted share base to be approximately 210 million shares. And lastly, we expect our operating cash flow, less CapEx, to be approximately $600 million. And with that, I'll return you to Tom.

[Thomas Quinlan:]

Thank you, Miles. That was great. I'd like to make three quick points before we take your questions. First, as Miles just mentioned, we continue to expect the Bowne acquisition to close during the fourth quarter and we are ready to move quickly to add its respected capabilities to the RR Donnelley portfolio and to use our One RR Donnelley strategy to expand on the relationships that Bowne has built with clients. Second, all of us at RR Donnelley would like to thank Jack Potter, who retires as the longest-serving Postmaster General since 1814 for his energetic and innovative leadership at the USPS. We'd also like to welcome Patrick Donahoe as he assumes the supporting role. We look forward to working with him. Mail is crucial to driving 360-degree communications that continue to prove their effectiveness to marketers and other communicators everyday. Third, although technology plays an important role in our growth strategy, our employees never lose sight of the importance of craftsmanship and quality in establishing and maintaining customer relationships. During the quarter, we again, brought home more than our share of print industry awards, and several of our facilities achieved safety milestones. We continue to regard safety as the first and most important indicator of operational excellence. And now operator, please open it up for questions.

[Operator:]

[Operator Instructions] Your first question is from the line of Charles Strauzer with CJS Securities.

[Charles Strauzer:]

This is for Miles, just on the tax rate, obviously you had the write-off there, what was the kind if after-tax impact of a higher tax rate in the quarter?

[Miles McHugh:]

The biggest driver was a discrete item in the quarter for the write-off of a tax asset, certain tax assets in Latin America, and the impact of that was about a little under $0.03 a share.

[Charles Strauzer:]

And then Tom, kind of give broadly a little bit more expansion if you can on when you look at the organic growth opportunities for next year, just maybe give us a little bit more on that if you could.

[Thomas Quinlan:]

Sure. I think, Charlie, if anything this quarter and the second quarter, we're demonstrating that this platform is solid and strong and can benefit during a slow economic recovery that we're experiencing. We're not dependent upon any one thing. We're not dependent upon ad pages, the financial market, even consumer confidence. We've got multiple sales channels that are starting to hit on all cylinders. We have targeted sales specialists. We have global print management, which I will talk about more in 2011. That is gaining traction, more traction every day. And something I talked about today regarding CustomPoint. Just to give you an idea how we're penetrating our customers' organizations. And this is how we're taking transactional business into a contractual business. Our CustomPoint rollout management system, they are proprietary to RR Donnelley. I think we look at the most recent trend reports that show our customers placing almost 90% more orders with us through our own systems, than through commercially available systems. When customers use our systems, it creates sticky relationships and creates a switching barrier. And to give you an idea what that means, I mean, we're dealing with the top apparel company. You know, two of the top six of the automotive retailers. The number one beverage company, eight of the top some 15 commercial banks, some of the top 10 managed care companies, three medical companies and equipment companies. Obviously, the top Pharmaceutical companies and some of the top specialty retailers. When we're able to do this, the vast majority of orders that come to us electronically are for printing, but they're also for added value services such as inventory management, complex kitting and distribution and variable digital printing. So when you take that into account and then you look at the rollout management system that we've felt designed for retailers, there has the complex task of re-merchandising stores. We're able to identify store profile information, house it in a database then automatically create kitting and fulfillment orders based on those store profiles. So if a store is getting window posters, we know exactly the number that matches the number of display windows that they have. And this system applies not only to retail, but it applies to retail banks, insurance company and any other brick and mortars that are out there. And it is a great example of why we feel that we can take these capabilities and move across the One RR Donnelley platform to look for other industry variables. So as we sit here -- obviously, a long winded answer for you, but as we sit here, we see that we've got the ability to continue to penetrate customers in all their verticals and provide them a solution that no other person, no other company out there, we think, can provide them.

[Charles Strauzer:]

And Tom, when you look at then, you look at your push to kind of move more towards contractual and you talked about transactional versus contractual and things like that, and when you start to do some of the C-level executives out there, what is their reaction to it, are you getting more traction in C-level suites? And you're trying to say you're de-emphasizing longer run more or am I just misunderstanding a little bit?

[Thomas Quinlan:]

First of, no, we're not deemphasizing anything in our industry. But let me go back to the C-level comments. Our mission since day one has been how can we reduce your total overall cost of ownership and improve your return on investment? What we built here has allowed people to take advantage of that. And the C-level suites, I think, the Prudential is a very good example of obviously long-term agreement with the company that is not something that they take lightly and is a significant part of their business. And I think more and more companies, both Fortune 1000 companies, as well as publishers, are starting to embrace what we're able to bring to the table because it makes life easier for them. In its simplest form, we can reduce your cost, we can help you with your customers and we make it easier for you that you can just deal you have sort of one person to go ahead and talk to from that standpoint. From the de-emphasizing the long-run business, my goodness, I mean, if you look at most of our announcements, a lot of your announcements this year have been in that area where we be there one new business or we've got renewals that have taken place. Definitely competitive business, but there is opportunities there for us to help our publishers. Our publishers are becoming multimedia channels themselves, multimedia providers. So what can we do from that standpoint to help them? I think if you look at magazines, I think there's -- our numbers show that there's been 176 new launches in the first nine months of 2010, that's versus 259 in 2009. But I still think those are oppressive numbers given the extremely challenging print advertising environment that's out there. There's been 127 closures versus 383 closures last year, so that bodes well. In online titles only, there's been 26 this year versus 64 last year. So we believe publishers are using social media sites to help build relationships and engage their audiences. And social media can significantly enhance existing products and drive new revenues, which is good for the publishers, which means it's also good for us because if they are financially strong, so will we. So the way we are evolving print to be more interactive with our customers and end-users is just one of the ways that will we look to improve our customers' return on their investment and then applies to all products and services, not just magazines plus the catalogs retail inserts. We understand that consumers have a lot of media choices out there. We have to make sure the products and services that we have add value, remain vibrant, timely and critical part of consumer's decision-making process or information-gathering process, whatever it may be, and we're doing just that as I indicated in the many examples that we talked about earlier in the speech, and just to keep going on this point to beat it up a little bit. We are still obviously, as I talked about with the USPS this morning, we're are still very active there, which not only impacts the Fortune 1000 companies but obviously has a big impact on publishers. This is one of the reason why the Postal Regulatory Commission's decision to deny the request of UPSP for accident rate increase was so significant. It would have been an added cost to our customers that, again, we also would have to found a way to mitigate. We continue to assist the post office in reducing their cost. I think our technology advancements, when you think about Co-pal, co-tray, Co-mail, our significant influence in the development and implication in the intelligent mail bar code all lead to our customers in reducing their cost. And again, if those themes keep applying. So, no, we're not deemphasizing anything on this platform and nor do I ever see us doing that.

[Operator:]

Your next question is from the line of Sachin Shah from Capstone.

[Sachin Shah:]

You mentioned you continuously believe the deal is going to be closing by the end of the year. Any kind of update as far as the FTC is concerned, as far as your process, any indication for you not to believe it's going to be closing by the end of the year?

[Thomas Quinlan:]

No, as I said in my prepared remarks that we expect it to close in the fourth quarter. Miles also indicated that as well, and that's our expectation.

[Sachin Shah:]

Any kind of update from them?

[Thomas Quinlan:]

Basically on what I just said is the statement. We expect this, the Bowne deal, to be approved and closed -- approved by the FTC and closed in the fourth quarter.

[Operator:]

Your next question is from the line of Craig Hubber for Access 342.

[Craig Huber -:]

A few housekeeping things if I could. Your incentive compensation expense, can you tell us if you would, how much that was up year-over-year? It was a big swing factor.

[Miles McHugh:]

Yes, year-over-year, we're up -- we're actually down. It's favorable $5 million versus this quarter last year.

[Craig Huber -:]

Was it pretty leveled, the absolute dollar the first three quarters?

[Miles McHugh:]

It was a little bit under $30 million in the first quarter, a little but higher in the second quarter, about $44 million, and now it's about a little, say, about $35 million or so this quarter.

[Craig Huber -:]

And then the tax rate I have some more question as before, but you talked about, I think, a 30% or 32% tax rate for the year. I think the midpoint of that, it sort of implies on a 27% tax rate in the fourth quarter. Does that sound reasonable to you. And my other question along those lines is why is it roughly over the last five years your fourth quarter tax rate is so much lower than it is the first nine months of each year?

[Miles McHugh:]

It is good. The first question is, it is reasonable for the fourth quarter tax rate that way. Tax rates throughout the year, each quarter you try to project and get to where you'll be for the full year's tax rate. So that's why you see the volatility in the quarters. And then for the fourth quarter impact, some of the past years, there's no real driver to that various discrete items that you can incur that aren't spread throughout the full year's rate can occur in any quarter, variety of things such as the statute of limitations running out on certain things and other changes can have impacts on a quarter-to-quarter basis.

[Craig Huber -:]

You basically is trueing it up enough in the fourth quarter, you're saying.

[Miles McHugh:]

You really true it up every quarter and as you get to where think you'll be for the full year's rate.

[Craig Huber -:]

Can you give us a preliminary sense of where your 2011 CapEx maybe versus this 225 you talk about this year?

[Miles McHugh:]

I mean, look, we're obviously pulling together our forecast for 2011 now, but directionally speaking, I think, in the same ballpark as a percentage of revenue is fair. I would also tell you that I do think that our platform that we built with our digital presses is going to really start to pay benefit for us there. And you know, and everyone knows, that we're a group that doesn't build it and hopefully somebody will buy it and hopefully somebody comes. If we're going to go ahead and purchase something, we've got revenue, that's going to generate off that piece of equipment. So I think as you build your model, we would look at it, and we'll come back to you obviously in February next year with more detail.

[Craig Huber -:]

And Tom, as we think about 2011, if I was, say, economy -- real GDP in the U.S. is going to grow, say, 2% next year, if you add 1%, 2% for inflation, do you think in that sort of environment, you could grow your top line 3.5%, 4%, organically?

[Thomas Quinlan:]

I do want to go there with any numbers, but what I would tell you is I to believe that the momentum that we have on profitable top line is really starting to come together. And if you take a look at what we've done the last two quarters, we have turned this place or evolve the supply chain to make it integrated communication more cost efficient, powerful and more targeted. And that going in on the sales call is so powerful that we should continue to see the benefits of it in spite of electronic substitutions, in spite of e-readers, they came about because we, sort of as in the supply chain, it was inefficient. We are making supply chain more efficient. We are making it such that at a cost point, we're compressing the publisher's cost there whatever it is, magazines, books, it does it matter. Catalogs, you go back to a time when the Internet was going to go ahead and knockout the catalog, and I'd say that's probably every quarter. Obviously, it didn't and it became another sales channel for the catalog. We truly believe for publishers that the multichannel approach will continue and the printed product will be there. We needed to evolve it so it is less expensive, it is as vibrant and as added value as it's ever been and it gets to the person that's looking forward to their customer on a timely basis.

[Operator:]

Your next question is from the line of Dan Leben from Robert W. Baird.

[Daniel Leben:]

First, just on the geographies, you mentioned volumes before companies, the geographies, can you give us a little more details there?

[Miles McHugh:]

Sure. For the quarter, we saw as kind of I mentioned a little bit are logistics business, financial prints and premedia were all up logistics and financial print double-digit growth. And we had variable print was also absolutely. Magazine catalog, retail inserts in the book and directory, they sold down a little under 2%. That was then impacted by the paper sales that we talked about more heavily to longer run print portions but otherwise, premedia still continues to bode well for us. And that's kind of the domestics snapshot. Internationally, I mentioned we're seeing good growth out of Asia, some also in Latin America, although it was about flat compared to last year. And then some of the decline was the Business Process Outsourcing business, which had the customer contract termination last year.

[Miles McHugh:]

And then as you think about it, too. I mean, our non-GAAP operating margin, the guidance that we gave you this morning somewhere between 7.3 and 7.5. If you go back and look at our segments and you go back and look at 2010, 2009, we are probably up close to 100 basis points, we believe, for 2010 at the end of the year compared to 2009 in each one of those segments, which we're pretty proud of. Obviously, we've got headwinds at us when you think of LIFO and pension. But in spite of those two things coming after us, we've done a great job, I think, of converting from a margin standpoint and having that type of increase in 2010.

[Daniel Leben:]

And then you mentioned the paper prices are pretty volatile and with an upward trajectory. Could talk a little bit about some of those drivers as it relates to both the paper sales as well as the margin impact on the business?

[Miles McHugh:]

Long story short, the markets are tighter across most grades, except obviously for newsprints. As you know, supply has been severely downsized and even with a economy, the mills we're able to raise prices multiple times this year in 2010. So that's what we're seeing out there with that particular commodity.

[Daniel Leben:]

And then you mentioned the bad debt provision, Miles. How far was that up year-over-year?

[Miles McHugh:]

I'll get you that number in a second here.

[Daniel Leben:]

In terms of the ProteusJet, obviously some very interesting growth impact. Help us understand longer-term how big of a kind of percentage of a mix this could be in terms of the impacts on growth as well as the margin profiles related to those projects?

[Thomas Quinlan:]

We obviously believe and again, when I talked about global print management you'll hear more about that in 2011, this stuff tells into that. We believe we've obviously got the network now of digital presses integrated that can go ahead and print for our customers in many locations, the product that they're looking to get their customers in a timely fashion. We do believe that, that is going to be even more important for us over the next couple of years as we continue to evolve print. The versioning of text data, the personalization of those items, the ability to take electronic -- iPad, computer whatever it may be, BlackBerry device, whatever those devices are that you go in to look at and then send to you a personalized collateral material full-color, glossy. Advertisers still like that because they know they've sent it to you. They know you don't have to them reach out to them. And as we better and our customers get better in managing data, the ability to on-the-fly get things to people within a 24-hour period, we believe, is going to be very, very significant to this business in the future.

[Miles McHugh:]

And then to back to your question on the bad debt expense, it was about $8 million lower last year than it was this year because last year, we had a reduction in our reserves as the economy continue to improve last year quite a bit.

[Daniel Leben:]

And then just in the margin impact from Proteus and Digital initiatives, are those equal margins to the traditional printing businesses or are they slightly lower?

[Miles McHugh:]

As we go through it, we feel positive about that or else we wouldn't be spending as much time as we're going through with that. So we feel good about what that particular technology is going to be able to do in the industry and obviously for us.

[Operator:]

Your next question is from the line of Scott Wipperman from Goldman Sachs.

[Scott Wipperman:]

I wondered if you could talk about margins for a second, just working on the assumption that we're going to see revenue growth next year? I was hoping you could give us a sense of where you see operating margins. Do you think we can get some expansion and then is there may be a longer-term target that we should be thinking about?

[Thomas Quinlan:]

obviously we're going to come back to you in a couple of months here to talk about margins, but what I would tell you is that it is placed correctly. So as new revenue comes in, we believe we've got the resources, both from a employee standpoint and from a capability standpoint with equipment, to go ahead and take on a new work. So again, here are the key decisions that we took in 2008, 2009. We probably could have shattered many facilities over the last 18 to 24 months. We didn't unlike some other people in our industry, we're prepared for when this comes back and we truly believe when economy comes back, it's going to be a good day for us. And going back to my earlier comment, is not just about -- we're not dependent upon any one particular area. If financial credit card solicitations start to come back, direct mail starts to come back, we can be there for that. Non-for-profit start to do things, great. More magazine launches, more special editions, our commercial print facilities, we believe that they're started to hit their stride too. So obviously we believe we can improve our margins. I won't give you a number today. We'll talk about that in a couple of months, but we do think there's a lot of upside here if in fact the economy does come back and if it doesn't, we're going to be as we demonstrated these last two quarters, we're going to be okay.

[Scott Wipperman:]

And then just quickly, Miles, free cash flow $600 million versus, I think, the previous range of guidance was $600 million to $650 million. Just wondering what was driving to come in at the $600 million number?

[Miles McHugh:]

We have the king of the higher end of the CapEx range at 225. So that's a big part of it, as well as we've got the sales growth, this a little bit of working capital impact there.

[Operator:]

Your next question is from the line of Kevin Christiano from Bank of America.

[Kevin Christiano:]

Just going back to the Bowne transaction, as the review of the deal nears completion, would you say that it was -- the scrutiny was more intense or less intense than you expected and if it was more intense, how does this impact your future acquisition strategy? I know it's early to talk about other acquisitions, but maybe if you could talk a little bit about the process?

[Thomas Quinlan:]

I would tell you a couple of things. Obviously, for years, we don't comment on acquisitions and I certainly haven't commented on anything that takes place now at the FTC and Washington. But what I would tell you is that obviously our industry is decentralized, is fragmented. As you keep hearing from me, unfortunately, I wouldn't say we have pricing power anywhere. As we continue to go through and look at opportunities, we'll continue to do that. we look to do deals because they can help customers, help us get further entwined with customers. We look to take out costs from properties that we look to acquire and obviously, we look for capacity. And those will be the three drivers we'll continue to look at deals for as we go around and see what properties are out there.

[Operator:]

Your next question is from the line of Hale Holden from Barclays Capital.

[Hale Holden:]

Can you help us frame out the decision not to increase both the rates. I mean, certainly a positive as we go into the fourth quarter direct mailing for you, but what does that mean sort of -- how do you advise clients for what may come next? Is there more dramatic shoe to drop? It seems like the postal service has some real issues that they have to fix, so how do you kind of fit within that matrix?

[Thomas Quinlan:]

The midterm elections yesterday, Congress getting back into session, shortly. It is a big issue that faces the country of the United States. There's probably about 7.5 million people workers that are associated with so many shape or form with the United States Postal Service. We can't hide it, it can't go away on its own. There's issues where there may be over funding on their contributions to their plan. There's issues where there's underfunding maybe on their healthcare. All these things have to be decided and pulled together by our legislative body quickly. I do think though the post office from the standpoint of a strong post office has always demonstrated that you've got strong commerce. And I do think our post office, with what we have there, will continue to be strong. We just want to measure as we go through things with them that they maintain the rates that are fair in all deliveries, that the service level remains high, and reward the people who are helping the Postal Service have cost avoidance, which we believe obviously we're in that ballpark, have the latest technology, operate efficiently, that takes place all the debates that will go on with Congress will go on, but there are two big issues out there that we see that the civil service retirement system benefits in that retiree health-care prepayment, those are big dollars. They'll be taking money from one pocket and another, so it's not as if United States also has a benefit coming. It's just it's going to move who's got the shortfall. But again, we think they're doing everything they possibly can and obviously we think history is showing you that societies that have had strong distribution networks have also had strong commerce as well.

[Unidentified Analyst:]

And then secondly, just as a follow-up to Kevin's M&A question, both of the rating agencies have kind of predicated your investment grade ratings on no further debt or cash financed M&A after bound 12 to 18 months. How do we sort of drive that with the need to further consolidate the industry?

[Thomas Quinlan:]

I think those are also fluid statements by them as well. As we start -- as we've demonstrated here today, were starting to see some more and more good things take place as this year has gone on. We've obviously had close relationships with all the agencies and it depends on properties that are out there, what takes place at that particular time, that particular moment. I would like you to take away the comment that I made of why we do transactions. I think we've shown you over the years that this management team has been together, that we prudently use our capital and I don't see us getting away from that at all and this company generates a tremendous amount of operating cash flow after CapEx. So we're going to continue to strive to do that.

[Operator:]

Your next question is from the line of Jennie Yuen [ph] from PIMCO.

[Unidentified Analyst:]

What is your pension contributions or what are they going to be for 2010 in total and then what will they be in 2011?

[Miles McHugh:]

Both '10 and '11. For '10, it's in the $20 million to $30 million range is where we anticipate and not much more than that, if anything next year, may be a little less. It wouldn't be until 2012 depending on where market returns are over the intervening period that contributions could be significantly higher.

[Unidentified Analyst:]

You guys were talking about contractual relationship at the beginning of the call. Just curious as to what percentage of your revenue are contractual now and like how long those contracts last, are they one year, three years, maybe some general terms on those?

[Thomas Quinlan:]

I would say we don't disclose what the break it is, but I will tell you that as you start to see more and more announcements by us of multiyear deals with customers, those type of transactions will be contractual-based because of what the value is that we're able to bring towards them regarding our different services, both us as the supplier and them as the customer, would want to make sure that it's a contractual basis because we are so interwound with their operations at that particular point. As I talked about, CustomPoint, the rollout management system, the different sales specialist that we have on the channels, you'll start to see more and more of that take place.

[Unidentified Analyst:]

How do you get paid, I mean is it monthly, yearly?

[Thomas Quinlan:]

Are you talking about on the invoicing?

[Unidentified Analyst:]

Yes, on the contract.

[Miles McHugh:]

We have terms and conditions in the contracts. Normal Ts and Cs that you would see. Nothing out of the norm there.

[Unidentified Analyst:]

I'm just wondering if you'd have any sort of deferred revenues build up or anything like that.

[Miles McHugh:]

No, nothing that would be of materiality.

[Thomas Quinlan:]

We appreciate everyone's time and support with us. We've got 57 days left to go on the year. We're going to go after and continue to after there. We are excited about transforming RR Donnelley from a printing company to an integrated communications provider, we're going to continue to do that, and hope everyone has a nice day. And again, thank you.

[Operator:]

This concludes today's RR Donnelley Third Quarter 2010 Results Conference Call. You may now disconnect.