R. R. Donnelley & Sons Company
Q2 2013 Earnings Call Transcript

Published: 30 Jul 2013

[Operator:]

Welcome to the R.R. Donnelley Second Quarter 2013 Results Conference Call. My name is Adrianna, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I would now like to turn the call over to Dave Gardella. Dave, you may begin.

[David A. Gardella:]

Thank you, Adrianna. Good morning, everyone, and thank you for joining us for R.R. Donnelley's Second Quarter 2013 Results Conference Call. Yesterday afternoon, we released our earnings reports, 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 is 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 to 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, Dan Leib, Dan Knotts and Andrew Coxhead. I'll now turn the call over to Tom.

[Thomas J. Quinlan:]

Thank you, Dave, and good morning, everyone. I will begin with a brief summary of our performance during the second quarter and then turn it over to Dan Leib, who will take you through the quarter in detail. Following Dan Leib's comments, I will revisit the strategy we've outlined previously, and highlight a few examples of how we are executing on the strategy and creating unique value-added solutions for our customers. During the second quarter, we continue to see sequential improvement in our revenue trends that began in the latter half of 2012. Revenue grew 1.7% during the second quarter as compared to the same period a year ago, aided in part by acquisitions and an increase in logistics volume. Net sales from services increased 28.8%, while net sales from products decreased 2.5% over the same period last year. Second quarter operating cash flow of $153.7 million represented an increase of nearly $92 million compared to the second quarter of last year. We are pleased to report that second quarter revenue was in line with our expectations, and we are reiterating our full-year guidance. We also remain committed to our long-term targeted gross leverage range of 2.25x to 2.75x. Now Dan Leib will provide more detail as he takes you through the numbers. Dan?

[Daniel N. Leib:]

Thank you, Tom. As with prior quarters, the focus of my comments will be on certain non-GAAP results and measures. Please refer to the support schedules of our earnings release for a reconciliation of our GAAP and non-GAAP results. We are pleased with our second quarter results and encouraged by the continuing improvement in operational trends. Year-over-year, revenue increased by $43 million or 1.7%. As detailed in our earnings release, our organic revenue declined 0.8% from the second quarter of 2012. This is the third consecutive quarter in which we've seen a sequential improvement in trend with a 40 basis point sequential improvement from the 1.2% organic decline in the first quarter of 2013 and 130 basis point improvement from the organic decline in the fourth quarter of 2012, and is the lowest quarterly organic decline we've experienced in nearly 2 years. I will discuss in more detail when I talk about each of the segments' year-over-year performance. In addition, free cash flow in the quarter improved $94 million from the same period a year ago, reducing our net debt in the quarter by $70 million. Second quarter gross margin was 23.3%, 20 basis points lower than the second quarter of 2012. The impact of pass-through postage revenue related to the Presort Solutions business that we acquired in late 2012 accounted for more than all of the decline, with a nearly 50 basis point negative impact on gross margin in the second quarter. I should note that this business is performing very well. But due to a significant amount of pass-through postage revenue, which accounts for approximately 94% of its revenue, it has lower gross margins than our consolidated average. Higher volume and favorable product mix, as well as lower benefits-related expense offset price reduction. SG&A expense in the quarter as a percentage of revenue was 11.4% or 50 basis points higher than the second quarter of 2012, primarily due to lower pension income, which accounted for 30 basis points and higher investment in IT-related initiatives. Second quarter adjusted EBITDA of $304.1 million compared to $319.3 million in the second quarter of 2012. Adjusted EBITDA margin in the second quarter of 2013 of 11.8% was 80 basis points lower than in the second quarter of 2012. The increase in pass-through postage revenue and lower pension income each separately accounted for approximately 20 and 30 basis points of the decline respectively. Additionally, price erosion and wage and other cost inflation in the International segment, primarily in Latin America and Asia, more than offset lower benefits-related expense, higher volume and a favorable product mix. Changes in foreign exchange rates did not have a material impact on the quarter-over-quarter consolidated margin comparison. With respect to operating margin, the reduction in capital intensity of our business continue to result in reduced levels of depreciation and amortization, narrowing the year-over-year decline in the non-GAAP operating margin to 30 basis points, from 7.8% in the second quarter of 2012 to 7.5% in the second quarter of 2013. Our non-GAAP effective tax rate in the quarter was 34.2%, 30 basis points higher than the second quarter of 2012. From a segment perspective, revenue in our U.S. Print and Related Services segment of $1.9 billion grew 2.4% from the second quarter of last year due primarily to the impact of 2012 acquisition. On an organic basis, sales declined 0.4% due to price erosion, which more than offset volume growth. The 0.4% decline is the best quarterly performance we've seen in the U.S. segment since 2010. On an organic basis, our logistics offering grew by 14.3%, consistent with the trend we've experienced over the past 14 quarters. The logistics business reported overall revenue growth of 49%, aided by 2 acquisitions in 2012. Double-digit volume growth helped premedia return to its several quarter trend of organic growth, following its first quarter decline. A trend in books and directories and financial print continues to improve, with financial print benefiting from strong capital market activity relative to the second quarter of 2012, while the book offering continues to see stabilization and improvement. Although we saw higher catalog and retail insert unit volume, overall, our magazines, catalogs and retail inserts offering, as well as our forms and labels offering remain consistent with their recent trends due to price erosion and lower overall volume. Non-GAAP operating margin for the segment of 10.3% declined 10 basis points from the second quarter of 2012. Accounting for approximately 30 basis points of decline was the impact of the Presort Solutions pass-through postage revenue. Additionally, lower depreciation and amortization, productivity improvements and lower benefits-related expense more than offset continued price erosion and a lower recovery on byproducts. Second quarter 2013 revenue in our International segment of $680.8 million declined by $1.8 million or 0.3% from the second quarter of 2012. Organic net sales declined 2% as volume declined in business process outsourcing, particularly in low margin-sourced volume, and global turnkey more than offset volume growth in all other international reporting units. Organic growth in Europe and Canada marked an improvement in trend, while Asia continued on its trend of higher volume, more than offsetting price erosion. This quarter marks the sixth consecutive quarter of organic growth for Asia. For the International segment, the non-GAAP operating margin of 6.5% declined 20 basis points from 6.7% in the second quarter of 2012, inclusive of an approximate 30 basis point unfavorable impact from changes in foreign exchange rates. Favorable product mix offset inflationary pressure and price erosion. Our second quarter 2013 non-GAAP unallocated corporate expenses were $45.9 million or $7 million higher than the second quarter of 2012, primarily due to lower pension income and increased investment in IT. Free cash flow in the quarter was $107.3 million, an increase of nearly $94 million from the second quarter of last year. Driving the improvement was the lower use of working capital and lower required contributions to our pension and other postretirement plans in the second quarter of 2013 compared to the same quarter last year, partially offset by higher cash tax payments. We continue to show improvement in our controllable working capital rate, which we define as accounts receivables plus inventory less accounts payables as a percentage of our trailing 3-month annualized net sales. A portion of the improvement in working capital in the second quarter was driven by billing efficiencies in our financial print offering, smoothing the seasonality that we have seen historically in that offering. At June 30, 2013, our trailing 3-month working capital rate was 13.2% or 170 basis points lower than the same time last year. We expect our year-end working capital rate improvement to narrow as the year progresses, but remain favorable. As previously noted, we are reiterating our full year guidance for free cash flow to be in the range of $400 million to $500 million. Total debt as of June 30, 2013, was $3.5 billion, down approximately $20 million from the first quarter and $246 million lower than a year ago. Further, we had no borrowings outstanding under our revolving credit agreement and no term debt maturing until April of 2014. From 2014 to 2017, our average term debt maturity is $282 million with the highest maturity of $315 million not due until January 2017. As of June 30, 2013, our term debt is 81% fixed at an average interest rate of 7.6%. Our net available liquidity as of that date was $1.3 billion. And our gross leverage was 2.9x compared to 3x of a year ago at June 30, 2012. Since March 31, 2013, we have decreased our net debt by $70 million. As noted in our press release, we continue to target gross leverage in the range of 2.25x to 2.75x on a long-term sustainable basis. The recent rise in interest rates has had a positive impact on the funded status of most of our major pension and postretirement plans. Given our major plans are frozen and closed, we do not accrue service costs resulting in the plans' benefit obligation and funded status being sensitive to discount rate changes. At June 30, the weighted average discount rate of our major pension and OPEB plans has increased approximately 80 basis points from the end of 2012, reducing our obligation by approximately $425 million. Our pension contribution for this year is set at $23 million. And we continue to estimate our 2014 contribution at $85 million. We review our actuarial assumptions annually as of December 31. And we have not made any remeasurements of obligation or funded status in the interim period. Before I turn it back to Tom, let me share our full-year guidance for 2013. This guidance remains unchanged from what we provided in April, and is also summarized in our press release. We expect revenue in the range of $10.1 billion to $10.3 billion. We expect our non-GAAP adjusted EBITDA margin to be in the range of 11.2% to 11.4%. As we discussed in our last call, there are 3 items that impact the year-over-year comparability by a total of 60 basis points. First, lower pension income in 2013 is expected to negatively impact our margin by approximately 20 basis points. Second, the customer rebate adjustment in 2012 favorably impacted the full year 2012 margin by approximately 20 basis points. And third, the pass-through nature of postage revenue related to the Presort Solutions acquisition completed in December '13 -- December 2012 is expected to reduce our overall margins by approximately 20 basis points in 2013. Depreciation and amortization expense is expected to be in the range of $450 million to $460 million. Interest expense is estimated to be in the range of $250 million to $255 million. Our full-year non-GAAP tax rate is expected to be in the range of 33% to 35%. We project the full year fully diluted weighted average share count to be in the range of 183 to 185 million shares. From a cash flow perspective, we continue to expect capital expenditures in the range of $200 million to $225 million, and free cash flow in the range of $400 million to $500 million. We continue to expect free cash flow to be inclusive of approximately $23 million in cash contributions to our pension and postretirement plan. As it relates to the back half of the year, I would like to provide some additional color specific to timing and our expectations. In last year's third quarter, you'll recall we disclosed some significant positive expense reductions, which will impact our year-over-year comparisons in the upcoming quarter. In particular, third quarter last year included a significant reversal of variable compensation expense that benefited last year by approximately $30 million. Consistent with the first and second quarters, we expect lower pension income in the third quarter of this year by nearly $7 million compared to the third quarter of last year. And as we mentioned on our third quarter call last year, we benefited from reductions in both our LIFO and Workers' Compensation reserves, totaling approximately $10 million. Also, we expect our third quarter non-GAAP tax rate to be higher than the full year rate and to be in the range of 35% to 37%. And with that, I will turn it back to Tom.

[Thomas J. Quinlan:]

Thank you, Dan. Before we move to questions, I would like to review the strategy that we have outlined previously and have been actively implementing. As I move through that overview, I will point to some of the examples that illustrate our strategy and action. We continue to believe that our ongoing focus on our strategic initiatives will allow us to maintain our position as the profitable leader of our industry. The first core tenet of our strategy is to win every order in every contract that we can. Being the largest player in the United States, with only approximately 5% share of the market, there is significant opportunity for growth. And we will work to increase our share by selling more to our existing customers and by earning business with new customers. We want to be our customer's first choice as a world-class communications management service provider in every industry that we serve. The key element of this strategic tenet is our well-defined and multifaceted selling approach. We will take our extensive offering to the marketplace with an integrated sales effort comprised of 4 coordinated sales approaches. The first selling approach is to target and win transactional sales opportunities. The infrastructure behind our well-established One RR Donnelley business model, combined with our operating scale and the breadth of our product and service offering, ideally positions us to gain share through transactional sales. We are in front of our customers each and every day, and we will continue to work to seize all opportunities to meet their communication needs. The second aspect of our go-to-market approach is to provide end-to-end solutions to what we call our enterprise accounts. These accounts have the highest demand for our products and services based upon a complex communications requirement. Each of these accounts is managed under the direction and guidance of a senior business leader and offers a tremendous opportunity for us to leverage that bold spectrum of our industry-leading platform and meet their global print management requirements with our sourcing expertise. The third way that we approach our customers is through our supply chain management capabilities. Our global sourcing expertise, our IT systems and our leading logistics resources allow us to develop and execute complex supply chain programs for our customers. Let's take an example from the cellular phone industry. Roughly 1.7 billion cellular phones were shipped globally in 2012 And the average smartphone user supplements that with additional phone accessories. We provide fully integrated lifecycle management for such consumer-electronics products, from product development to product sourcing to assembly and kitting and ultimately to distribution. These groups add value to our customers who are servicing this sizable market with expanded capabilities that include the supply chain management of skins and design covers, chargers, hands-free car kits, headsets, connection leads, screen protectors, memory cards and more. We simplify this management and work to reduce costs through a global platform that employs our Asia direct-to-distribution model. Using this approach, we assemble, package and label the product in Asia for in-region distribution through bulk air or sea freight to major ports in Europe and United States, all with end-to-end order tracking for visibility and control. The fourth of our go-to-market approach involves providing our customers with comprehensive communication solutions specialized to their industry and unique to their communications requirements for their customers, investors, suppliers and employees. In addition to leveraging our extensive product and service offering, we are providing industry-specific integrated workflow solutions to drive meaningful supply chain efficiencies for our customers. As we have already identified, we selected the retail segment as our initial industry vertical for delivering these integrated workflow communication solutions. As an example of our progress in creating a comprehensive segment solution, let me provide you a project overview for one major retailer who chose to leverage our strategic end-to-end solutions for their entire in-store marketing requirements to ensure that successful launch into an important new market. In a very aggressive timeframe, we are supporting this retailer in the opening of approximately 125 new stores by providing highly specialized print and communication management services that includes retail inserts, creative and premedia services and the management of in-store signage that includes production, kitting and distribution services. Their in-store marketing workflow processes are enhanced through the utilization of our Rollout Management System, a workflow solution designed to plan and create all signage kits based on individual stores' planograms. We work with this retailer to quickly and efficiently plan their in-store marketing rollouts for each new store, dramatically reducing the volume of waste that is common in retail science projects of this scope and magnitude, and optimizing brand consistency across all communications. Our solution includes leveraging and enhancing our existing capabilities to manage the large format items, kitting complexity and volume, which retailers require. In addition, we utilize an experienced team of professionals with detailed knowledge of in-store marketing who will be integral to our future expansion of this solution. Our skilled premedia photo studio provides product shots for everything from fashion to food. We produce and warehouse more than 3,000 unique in-store marketing signs and kitted nearly 2,000 specialty items. In total, over 5,000 items are kitted for each store, which amounts to 2 full-sized tractor-trailer loads per location. To date, we have rolled out about half of the stores in weights, delivering the products to each location in time for their grand opening. Our in-store marketing offering represents a new industry solution for retailers, and is the first of many integrated work flow solutions that will bring our products and services together in a way that solves the communication challenges our customers are facing. We will use this 4-pronged go-to-market approach to support our strategy to win new business and increase share. As the second element of our overall strategy, we will leverage our unmatched operating expertise, procurement scale and customer relationships. As I've said before, the core of what we do is to help our customers communicate more effectively. In doing so, we will work with organizations worldwide to create, manage, produce, distribute and process content. No other organization can offer comparable portfolio of capabilities and do so with the kind of scale that we bring to customers across a broad range of industries. And we're doing so in many places around the world. Our second quarter results include year-over-year revenue growth, excluding the impact of foreign exchange rates, up 10% in Asia, 9% in Latin America and 5% in Canada. The third facet of our strategy is to build on our relationships with customers to sell more services that diversify our revenue base. During 2012, RR Donnelley generated nearly $1.4 billion in service revenue. During the second quarter of 2013, 17% of revenues came from selling services compared to 13.4% in the same period last year. This constitutes revenues from areas such as logistics, supply chain management, business process outsourcing, multichannel marketing, translation services, web and mobile site design and more. Let me share further evidence of our progress. RR Donnelley is the largest producer of digital photography in the United States. And our premedia-based photo studios took more than 1.2 million photographs for customers last year. We work with a major airline in Europe to generate and send 4.5 million e-mails on their behalf 6 times a year, digitally print their mileage awards statements and distribute hundreds of thousands of hard copy and electronic newsletters. And add it to the over 400 million words we already translate each year, we recently expanded our role with one of our customers with a contract to provide nearly $8 million in translation services per year. We are and will continue to be the best in the world at delivering services like these, which deliver exceptional standalone value and complement our product and service offering. And we're going to continue to focusing on diversifying our revenue base. The fourth element of our strategy is to continue to develop and acquire technologies that serve important needs for our customers. The way in which people access and receive information is changing. And we'll see that every day as each of us text, email, read information on tablet devices, access a website via printed NFC tags while shopping and much more. These emerging technologies are changing our customers' need to communicate with their audiences. This means that we need to continue to meet their current requirements while developing and acquiring additional products and services that transform their communications going forward. The fifth and final component of our strategy is a continued focus on operational efficiency, productivity and cost management. We have a disciplined planning process that involves looking at operational excellence and cost control every day. We will continue to make tough decisions in order to ensure that our cost structure remains synchronized with revenue opportunities in each segment. As part of our operational effectiveness, we continue to pursue our goal of 100% safety 100% of the time. Employee safety is the first and most important measure of operational excellence. I would like to take this opportunity to congratulate our employees around the world for their many safety milestones that they continue to achieve. Operator, could you please open it up for questions?

[Operator:]

[Operator Instructions] And our first question comes from Charles Strauzer from CJS.

[Charles Strauzer:]

Just that how did you say that service revenue was 17% of revenue in the quarter?

[Daniel N. Leib:]

I did.

[Charles Strauzer:]

Very good. And then if you could maybe, I don't know if Dan has these numbers, but maybe can you expand a little bit more on the kind of the growth rates by various kind of performing segments like logistics and services and financial? And if that you have any kind of growth rates, that'd be great.

[Daniel N. Leib:]

Yes, sure. So if we -- and these are organic growth rates. And then obviously when we put the Q out there, we will have to report it by reporting unit. But logistics' organic growth was 14%, which continues -- they've been in the low double digits for a number of quarters now consecutively. But we did see book directory, which is one reporting unit. The book business performs substantially better than the trends. So book directory as a unit organically was down 2.4%, and consistent with what we did in Q1 a lot better that what we saw in Q4. The variable print unit was down 0.6%, but we did see some very nice growth in the statement printing business in the quarter. Our premedia business was up organically, roughly 15%. And then when you go internationally, had organic revenue growth in Canada, Europe and Asia in the mid-single digits. And then Latin America was close to 9%. So pretty very good widespread growth. And on the downside the BPO or outsourcing business, we had a couple of low-margin outsource-related contracts that we had much lower growth in that BPO operations. That was down roughly organically 20% or so.

[Thomas J. Quinlan:]

And Charlie, just to stay with logistics for a second. I mean, I heard a number of you talking about FedEx and UPS with us. I mean, those are apples and oranges you're trying to compare. I mean, we've seen slight declines in the transportation market that were definitely out there. But as Dan talked about, the Donnelley logistics service worldwide -- it continues to grow. Shippers are looking for greater efficiency and cost control in freight transportation, management across all different modes. I think mailers across all products continue to sell postage-saving solutions often driven by consolidation and USPS work share strategies. All of those are available from RR Donnelley. And I think that the e-commerce growth continues to drive parcel delivery. Growth at e-tailers look for assistance and options and parcel delivery, yes, particularly across borders. So when you think about our co-mail, our list service revenue, our International mail services, Donnelley worldwide, the expedited courier, third-party mail, we're having some real -- we had some real good days there and expect that to continue, especially where the economy's going.

[Charles Strauzer:]

And talk a little bit, too, about financial services, any kind of numbers there behind the growth there?

[Daniel N. Leib:]

Yes. it's in natural need offering [ph]. Then we will follow up. Yes, in the financial services business for us in the second quarter performed very well. As Dan mentioned from a price IPO standpoint on a year-over-year basis, the significant uptick for the quarter from a filings standpoint, a bit of a mixed bag on that front. But in general, financial services activity continues to be very strong. We're pushing very hard with our active disclosure, the fiber to work tool for XBRL tagging and gaining significant traction there as well. So very, very pleased with how our financial services business performed in the quarter.

[Charles Strauzer:]

Great. And then, Tom, if you could expand a little bit more on some of the things you talked about on the call and also last night on CNBC. You mentioned a lot about where the business is going and that the pieces of that are growing within Donnelly. Can you give a little bit more color around the size of those businesses today and the kind of the general profitability characteristics around those?

[Thomas J. Quinlan:]

We'll talk of that, Charlie, without going into too much detail. It was just primarily around about what we're doing as trying to be a global provider of integrated communications. I mean, it's become more of a solutions sell regardless of the product or services that anyone is offering in today's market, but we are. RR Donnelley is providing solutions. We know our customers. They're transitioning to allow their customers to engage in their brand. Our customers' customers are smarter and feel empowered because of this as they're looking at it. The brand experience is not only about the product, the price, placement, promotion. The brand experience now includes all of that. And it includes personalization, presence, persuasion, permission and convenience. We see our -- we see the consumers are interacting with brands with increased speed and frequency. And their opinions are reaching a wide audience. Companies are determining how much to spend across different marketing vehicles. These decisions are paramount to improving their company's return at their investment, as we've talked about a lot. We're providing solutions for companies via both physical and electronic distribution of that content. People know us for who we are, trusted partner, reliable, good stewards, financially sound. They don't know us as much as for what we do. And that's changing. And I think as we talked about here, our customers' needs are evolving. We're being innovative. We're being more visible in the marketplace, as you heard, to what we talked about as far as how the market's changed. We want to win business each and every day, the enterprise accounts, as we think about it, the supply chain management, the vertical segments. We started out in retail because we have a strong foundation there, and are having success. We're developing communication solutions now in health care, financial services and telecom. And those verticals alone represent probably about another $25 billion of opportunity that's out in the marketplace. These verticals present, for us, RR Donnelley, a portfolio of opportunities with completely different characteristics, near-term opportunities with mature communication needs and longer-term opportunities in emerging areas. You think about financial services, they are going to want to have one single view of their customer. No matter what part of their financial service organization that customer's in, they're going to have to have that out there. The health care, with the Affordable Health Care Act that's coming on, that's taking place, they're going to have to acquire customers and exchanges versus employers. That's going to open up opportunities for us. They're going to have to have to deepen their engagement with existing customers and patients via targeted communications. Telecom, they're going to have to have the bundles that we all -- get sent to us by them. The offers that they get, those are going to have to become even more personalized and more frequent. So as we look at it, every vertical that we touch, personalization's going to move the day. The products and services that we have is going to just continue to build on that. These services that we're offering are going to drive print. So as I mentioned last night I was asked is what about print? Print is going to be here. And print is going to continue to expand because our customers are going to continue to have to reach out to their customers in every possible fashion that they can, whether it's through an electronic transmission or through physical.

[Operator:]

And our next question comes from Scott Wipperman from Goldman Sachs.

[Scott Wipperman:]

Just following up on the end market numbers that you guys provided there. I guess I'm just trying to determine, I mean do you view this as sustainable for the remainder of the year, from the volume growth that you've seen? I'd be curious if there was any onetime wins or things that helps volume growth. Or I mean how should we thinking about it if you think things are bottoming and start to pick up here for the second half? And I have a few follow-ups.

[Thomas J. Quinlan:]

No. I would tell you the thing that does make us excited is, this is what Dan Knotts' team, with George Zengo and everybody's put together here is something that is more than sustainable. There isn't any grand slams that we fit in the quarter by itself. I think there's grand slams who fit in the quarter that we will see take -- that we will benefit from over the course of the next couple of quarters. But there's nothing that I would tell you that was sort of an outlier either on a good basis as we're looking at it. I think the way we're going to market, we'll make it simpler for our people to go to market. And everybody understands we put the accountability back into the place. People are empowered to go make decisions. And they're doing that. And the biggest thing that we've got going on is still, in this crazy economy on a global basis, our sales reps can offer cost savings and improve their return on what people are looking to make investments in. So again, that's a great formula for us as we look out.

[Daniel L. Knotts:]

I would just add, Scott, that the -- they mentioned performance has been widespread amongst the products from a trend perspective. And if you look at the guidance, it contemplates a pretty similar level of performance to what we've experienced in the front half of the year, notwithstanding my comments on the Q3, Q4 swap given some of the onetime items.

[Scott Wipperman:]

Got it, that's great. And then, I guess, 2 related questions. So first is on the $20 million debt reduction. I'm assuming that means that you guys bought back some bonds in the quarter. So I was just hoping you could clarify which tranches. And then second related, I think the original goal was to get down to the high end of the leverage target by year end. So that -- if that is still the goal, one, if you could confirm that based off the midpoint of your EBITDA guidance. But I would imply we're going to see some -- a decent amount of more debt reduction in the second half. And so, I guess, can you just remind us what the priorities would be on that? Are you guys more focused on interest savings, smoothing out the maturity profile? How should we be thinking about that?

[Thomas J. Quinlan:]

I'll take the second one. Dan will come back to you on the first one. I think one of the things that I think the team's done a great job at and our advisers, too, is just being able to go ahead and give us a runway as it relates to debt maturities. That's not going to come up and hit us or whack us on the side of the head. We've made the towers pretty even as you think about our cash flow. If you think about the last 9 years, we've averaged over $500 million in free cash flow from operations after CapEx. And if you look at our debt maturities, they're going to take place on a go-forward basis. We're well within those boundaries for the next couple of years. So I think the way we deploy capital we're going to continue to deploy. Over the last 9 years, Scott, we've paid out almost $2 billion of dividends. We made $1.7 billion of interest payments. We bought back $1.3 billion worth of stock. We've done an excess of $4 billion acquisitions. We're going to continue to manage, deploy capital as we have in the past with a complete guideline being within the 2.4 to 2.75 range. We'll continue to look to do acquisitions. We'll continue to look to make this place stronger where we can. But again, please understand it's with that guidance of being within that range -- leverage range.

[Daniel N. Leib:]

Just to answer the first part of your question. So we didn't pay down any term debt maturities. It was largely capital lease and amortization-type items. If you look at the net debt down $70 million, as you referred to the 20. And then to Tom's point on the priorities for capital deployment. If we look at our guidance, and relative to the target long-term of 2.25 to 2.75, as you mentioned on the last call, within our guidance, and our cash flow obviously tilted towards the back half of the year remains that way less so this year than last year, but would allow us to get there and do a very small amount of M&A.

[Scott Wipperman:]

So just to be clear though, so the target or the goal still is to get down to the high end of that range by year-end?

[Thomas J. Quinlan:]

Yes, on a sustainable basis. We haven't time-dimensionalized it. But the comment is we can get there within the current guidance. But it is to be there on a sustainable basis.

[Operator:]

And our next question comes from Jamie Clement from Sidoti.

[James Clement:]

Just a question, a clarification. I was jotting down notes, and I'm not sure I got this right. Your comment about books and directories as you were going through some of your products and services lines, was your -- the 2% number that you gave out, was that just the 2% in -- that wasn't in the whole category, that was just -- were you just saying in the books business? Or is that...

[Daniel N. Leib:]

That's the whole category on an organic basis. And so what you see -- what you'll see in the Q that gets filed, the number will be higher due to less paper being provided and things like that. So in organic, we scrub out paper and also M&A to the extent that there is any -- so and then on the book side, the directory side obviously performed substantially different than the book side. The book side was relatively flat.

[Thomas J. Quinlan:]

And Jamie just staying there for a second with those 2 product lines. I mean, as you've probably seen announcements over across the last couple of months, we've become a trusted partner in that area as well, and relied along to bring solutions for the customers. If you think about what we're doing there with the book product, I would say that all indications by the experts out there that e-books are sort of leveling off. You know they're not going away. We're still playing in that part. But the physical books are still out there. But we become more players, too, on the distribution warehousing side. And as you go back in time, we were a printer. We became print services, now a communication services provider. Us being able to handle those warehouses given the footprint that we have in the United States is going to help those publishers reduce their costs, and allow them to focus on what their core competency is. So we're not -- we like our opportunities there because of what we can do for our customers in the publishing market there. As it relates to directories, they're going to take a different form. They're not going to be what we've all seen in the past. But we're working with a number of those publishers as well now to make it more localized, make it more current, I'll say, as they go and have it out there as being a piece that people will want to receive more frequently. Dan Knotts, if you have anything there?

[Daniel L. Knotts:]

Yes. I will just add that as we look at the book side about the 1-color consumer trade and the 4-color education side for the quarter, very, very happy with the volumes that we saw there. The significant relationships we have with our clients position us very well to capture our share of that volume. The other thing, as Tom mentioned that's critically important is as we look at the digital evolution that's occurred, particularly on the one color side. The infrastructure that still remains out within the industry represents a great opportunity on the book fulfillment and distribution side. And as we opened up our new facility last year in Plainfield in support of our customers, very well-positioned there. In addition to that, as we look at the investments that we made over the last 18 months in our digital side for both the 1-color and 4-color digital production, we now have the full gamut of 1-color and 4-color digital plus traditional offset plus fulfillment distribution. So we feel very good about that offering and our overall position in the book space.

[James Clement:]

And I'm not sure which Dan the follow-up question should go to, but as we talk about the third quarter, one of the swings in your third quarter can be the education market. Any comment -- we've heard some conflicting things out of some publishers, not a lot out of publishers in terms of what the K-12 market may be looking like this year. But as we think about year-over-year comparisons, anything you'd like to add at this point about the third quarter in the education market?

[Daniel L. Knotts:]

There isn't really -- we're hearing obviously a lot of the same things...

[James Clement:]

Which is a whole lot of nothing. Nobody's really committing to anything either way.

[Daniel L. Knotts:]

Right. So we don't -- we're not banking on a significant change or uplift from that.

[Thomas J. Quinlan:]

What I would tell you is as the states get better, financially taken care of and their positions improve, at some point, these states have to adopt a new curriculum. It's been years since there's been heavy adoptions. We're positioned well to take care of that. If it doesn't happen this year, we'd like to think it would happen in 2014.

[Daniel L. Knotts:]

And more broadly outside of the book side. As we mentioned, there was a number of onetime items impacting favorably last year's Q3 so...

[Thomas J. Quinlan:]

Right.

[James Clement:]

And, Tom, of course, sixth graders tend to use their math textbooks as a second base sometimes. So they'll need to be replaced for that reason, too.

[Thomas J. Quinlan:]

Very true.

[James Clement:]

Tom, last question. Just you went through your products and services. You're in a unique position that you serve just about every industry that's out there. Can you give us a sense -- I don't know how many you want to give us, 2 or 3 in terms of the industries that you serve that you think are kind of coming out of this at a faster pace and maybe 2 or 3 of the industries that you think are kind of lagging a bit?

[Thomas J. Quinlan:]

Well, I would tell you from a vertical standpoint, what we've talked about from retail to the health care to financial and telecom, those are pretty good places to be in. You could live your life just in those verticals alone with the opportunities that are there. So we think that each one of those are going to play a role in -- as we continue to bounce along from an economic standpoint. If there is any tailwinds behind us, that's just going to be the more, the better for us. But the fact that we are doing certain things that we're doing now and showing people how they can have better communications with their customer, we think that bodes well. Change is not easy, but when we can take -- go from 80 vendors down to 1, the amount of efficiencies that get into your organization and the cost savings that take place, it's going to be tough to go ahead and turn your back on those.

[James Clement:]

Okay. And actually, I forgot, one final question, if I may. You've -- if you just take the first half and you multiply it by 2, you're about 15%, I think, below the low end of your CapEx guidance. Is that by design or you actually think you'll hit $200 million?

[Daniel N. Leib:]

I think that the $200 million to $225 million is the right range. CapEx spending's always a little bit lumpy. And so as we look at the good projects out there, that's the right range for us.

[Operator:]

Our next question comes from Kannan Venkateshwar from Barclays.

[Kannan Venkateshwar:]

So I have 3 questions from my side. The first is the working capital improvements we've seen, now that's basically been consistent over the last few quarters. So is there something more structural in the sense that as your revenue mix is moving more towards services, is that benefiting you from a working capital perspective? That's one. Second is from -- a lot of the secularly declining segments like books, for example, the trend seems to be improving organically. Is that more a function of market share gains? Or is it more that these trends that you're seeing on the secular declines themselves are changing? And I have a question on pensions, which I'll follow up with.

[Thomas J. Quinlan:]

Dan Leib will lead off and Dan Knotts will follow up with your second question.

[Daniel N. Leib:]

So on working capital, if you look at in this quarter, particular in this year really a very good improvement on DSO. And that has been a focus of the company over the past 2 years. We've talked about it on these calls going back over that time period. And it really is the focus of the entire organization to make sure that we're getting paid within terms, and then conversely that we're paying within terms. So that is not -- we don't view that as a mix of business. As we mentioned in this quarter in particular, we did have a large pickup as the seasonality and the financial business is much less this year than it has been over the past couple of years. Part of that integration of acquisitions and harmonizing of process and some of that's just very good management focus by the team there. And so we would expect some of that to moderate towards the back half of the year given that some of it is just timing and billing efficiencies. But we do expect to have a working capital benefit over prior year.

[Daniel L. Knotts:]

And then relative to your second question, the short answer is it's a combination of both. We continue to win in the marketplace new opportunities, win new contracts pulling into our platform. The other part of that is with the contractual positions we have with customers in those market segments. We go as they go and from a volume standpoint, take book as example back to 1-color and the 4-color side as the general lift that they see -- that we see coming back in the quarter on that front has added to those overall results. But it can't be pinned to one or the other. It's absolutely a combination of us winning in the marketplace, as well as the underlying business performance of these customers that we have our contracts with.

[Thomas J. Quinlan:]

And Kan, before you go to your pension question, just to tell you how diverse and how the range of customers we serve -- just to give you an example, we've got a customer called Scanther. It's a startup company. They're based in Austin, Texas. They developed a mobile website in a box that incorporates QR codes, near-field communications and customized web-based management tool to allow small businesses to set up a mobile connection to their patrons. In order to bring their product to market effectively, they needed somebody to -- who could go ahead and touch all aspects of the production cycle, from the acrylic signs to the variable image codes that are printed, the NFC encoded synchronized across multiple products, from kitting to distribution. Our suites of products and capabilities, combined with our logistics expertise and relationships with key resellers of Scanther product allowed us to be a one-stop shop for them. So that they could -- producing, distributing and enabling this really good product to come to life and to be -- make their vision a reality. So there's somebody that's -- they may not be in a Fortune 100 today, but there's somebody that we think has good -- a good track that they're on to go ahead and really improve their business. So as you think about us, we're running the gamut of sizes of companies that we're trying to bring these solutions to.

[Kannan Venkateshwar:]

Okay. And on pensions, I guess as the trend and rates continues this year. You'll have a guidance of $85 million for next year in terms of contributions. Will that number change downwards if you see -- if the benefit that you've seen so far continues?

[Daniel N. Leib:]

We will certainly update as the year progresses. There is smoothing that goes on relative to funding requirements. And as we've talked on prior calls, the adjustments that were made to the Highway Bill last year had the positive impact. So we'll make adjustments or make updates of it, I should say. As we looked at it relative to these moves, we feel like there hasn't been much of a change off of that $85 million or so.

[Kannan Venkateshwar:]

Okay. And one last question, which is on -- now going forward into 2014, when we look at your situation, I mean you have a lot of cash in the balance sheet. And again, on the trends on the industry, it should help you on the pension side and so on. So there could actually be a point over the next couple of years when you're free -- you might have excess free cash flow outside of debt payments given that you've termed out all your near-term maturities. How should we think about what happens to that cash?

[Daniel N. Leib:]

I think the same way we talked originally a question that was asked this morning as far as how we deploy capital, we'll look to directly send it back to shareholders. We'll make sure that we've got acquisition. If there's acquisition opportunities, we'll take advantage of that. We'll reinvest back in the business. So I think if anything the consistency that you've seen from this team is going to remain, especially when it relates to that. And as you talk about interest rates, obviously, 80 basis points increase that we've seen had the impact that it's had in half a year, I don't think there's too many people out there that feel rates are going to go the other way. So we got penalized for what was taking place with our defined benefit plan because of operation twist. Whereas hopefully, we'll be at least rewarded as interest rates start to go the other way.

[Daniel L. Knotts:]

I would just add. The guardrails of 2.25 to 2.75 is the starting point and then from there, obviously, the consistency in capital deployment.

[Operator:]

And our next question comes from Westcott Rochette from S&P Capital IQ.

[Westcott Rochette:]

I have a question about the enterprise. I would imagine that, that would be a long sales cycle in terms of going to clients, telling them about your new services, kind of reintroducing them to additional services that you can offer. Can you just talk about how you feel, where you are in that kind of sales cycle overall and how you see that kind of progressing, and what visibility that gives you over kind of the next year or so?

[Daniel N. Leib:]

Yes. I think from an enterprise account standpoint, the approach that we take to that is trying to build the whole premise behind enterprise account is building a comprehensive bundle or suite of our products and services to benefit our customers in executing their communication requirements, whether it's to their shareholders, to their employees, to their suppliers and ultimately to their customers. The sales cycle is really dependent upon each of those individual enterprise accounts. There's terrific opportunities for us on a product and service basis, individual basis, to sell them in the short term as those needs continue to evolve within those enterprise accounts. We have a very focused approach on that with a specific number of accounts identified. Those accounts report into members of our senior leadership team. And we're actively pursuing any and all opportunities within those enterprise accounts as they evolve. And then also pushing forward with the new products and services that we have available to help those customers execute their communications.

[Westcott Rochette:]

Okay, that makes sense. So can you give a rough kind of ballpark of roughly how many accounts would fall into enterprise?

[Thomas J. Quinlan:]

What I would tell you is that its customers that are buying essentially that can utilize all of our products and services. As you think about the report card that we sort of look at, it says how many customers are utilizing our products and services, you'll find those customers probably using 8, 9, 10 products of services as people that would fall into that account and fall into that group.

[Operator:]

And our next question comes from Jamie Clement from Sidoti.

[James Clement:]

Dan, a follow-up question. I think you gave the number, but I believe it's the discount rates up roughly what, 80 basis points? So that gives you a benefit on the liability side of what -- I think you gave a number, right?

[Daniel N. Leib:]

Approximately, that's correct. Approximately $425 million.

[James Clement:]

Okay. Now on the asset return side, did you make a comment on that at all?

[Daniel N. Leib:]

I didn't. We -- as we look at some preliminary numbers and make some estimates of some others, it's probably another $100 million or so. And so $525 million off of net pension and OPEB together would put us at $875 million or so pretax for both pension and OPEB.

[Thomas J. Quinlan:]

9 Everyone, thank you, appreciate you joining, appreciate the support. And hope everybody has a great day. Take care.

[Operator:]

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