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R.R. Donnelley & Sons Co. reported second-quarter 2014 non-GAAP earnings of 42 cents per share which were down 6.7% on a year-over-year basis.

Quarter Details

Revenues were up 12.9% year over year to $2.90 billion primarily boosted by the acquisitions of Consolidated Graphics and Esselte operations. Sales on an organic basis increased 0.8% from the year-ago quarter.

Publishing and Retail Services revenues declined 3.6% from the year-ago quarter to $625.9 million in the reported quarter. Of the total decline, 60 basis points (bps) were related to the negative impact of lower pass-through paper sales, which lowered organic sales by 3% year over year. The company witnessed volume declines in books and directories. Pricing pressure in magazines, catalogs and retail inserts also led to the revenue decline.

Variable Print revenues were $957.4 million, up 52.9% from the year-ago quarter. This year-over-year increase was primarily due to the Consolidated Graphics and Esselte acquisitions. On an organic basis, revenues were up 3.2% year over year primarily due to higher volumes.

The Strategic Services segment registered revenues of $687.5 million, up 4.1% from the year-ago quarter. Quarterly organic growth was 3.8% due to organic growth in Logistics (up 10.7% year over year) and sourcing (up 20.6% year over year).

International sales in the second quarter were $631.7 million, down 0.6% from the year-ago quarter. Organic net sales were down 2% in the quarter due to pricing pressures.

Gross margin was 22.9%, down 37 bps from the year-ago quarter primarily due to price erosion and higher wages and other related costs. Moreover, increase in transportation costs and unfavorable product mix were responsible for the margin decline.

Operating expenses increased to $460.7 million from $405.1 million in the year-ago quarter. This year-over-year increase was mainly on account of a rise in selling, general & administrative expenses.

Adjusted non-GAAP operating profit increased 5.5% from the year-ago quarter to $203.7 million. However, operating margin declined 49 bps from the year-ago quarter.

Non-GAAP net earnings for the quarter were $84.6 million or 42 cents per share compared with $83.6 million or 45 cents per share reported in the year-ago quarter. Year-over-year increase in share count led to the earnings decline.

R.R. Donnelley exited the quarter with $288.9 million in cash and cash equivalents versus $308.4 million in the previous quarter. Long-term debt (including current portion) stood at $3.83 billion. Free cash flow for the company was $92.8 million.

Guidance

R.R. Donnelley reiterated its fiscal 2014 guidance. The company expects revenues in the range of $11.5 to $11.8 billion.

Adjusted earnings before interest, tax, depreciation and amortization (EBITDA) are expected in the range of 10.5% to 11.0% for fiscal 2014.  Interest expense is likely to be between $275.0 million and $285.0 million.

Capital expenditure is expected in the range of $225.0 to $250.0 million and free cash flow in the range of $400 to $500 million.

Management expects its service offerings to drive growth, going forward.

Recommendation

R.R. Donnelley reported modest second-quarter results. The strategic acquisitions made by the company positively impacted its top-line performance. Donnelley’s new client wins such as ZAGG Inc (ZAGG - Snapshot Report) and existing clients such as Williams-Sonoma (WSM - Analyst Report) and Office Depot Inc. (ODP - Analyst Report) help the company generate incremental revenues.

Nonetheless, we expect R.R. Donnelley to remain under pressure in the near term due to continuing pricing pressure, volatility in raw material prices and increasing competition. Moreover, the increasing adoption of the e-book readers remains a major concern for its legacy printing business.

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