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R.R. Donnelley & Sons Co. reported first quarter 2013 non-GAAP earnings of 37 cents per share, comfortably exceeding the Zacks Consensus Estimate by 4 cents. However, earnings per share (“EPS”) declined 15.9% year over year, primarily due to margin contractions.

Quarter Details

Revenues for the quarter were up 0.5% year over year to $2.54 billion. Donnelley’s product revenues during the quarter were down 3% year over year to $2.13 billion while service revenues increased 24.5% from the year-ago quarter to $408.8 million.

U.S. Print and related services revenues inched down 0.5% from the year-ago quarter to $1.9 billion due to significant lower volumes along with continued pricing pressure across the segment offerings. Donnelley’s logistics business recorded robust revenue growth of 46.3% on a year-over-year basis, primarily driven by higher volumes.

International sales increased 3.5% year over year to $666.0 million in the quarter. The year-over-year growth was primarily driven by increase in volume in Asia and Global Turnkey. Moreover, Donnelley also witnessed higher volume in Europe. However, pricing pressure and low volumes in Canada were the headwinds during the quarter.

Donnelley’s gross margin for the quarter contracted 100 basis points on a year-over-year basis to 22% on certain customer rebate adjustments in 2012 and impact of pass-through postage revenue.

During the quarter, selling, general & administrative expenses were down 0.7% year over year and was attributed to the decline in employee-related costs.

Non-GAAP operating margin also declined 40 bps on a year-over-year basis to 6.8% due to certain customer rebate adjustment, price pressure and unfavorable product mix. Donnelley reported non-GAAP net income of $68.1 million versus $78.8 million in the year-ago quarter.

Balance Sheet and Cash Flow

Donnelley exited the quarter with $302.9 million in cash versus $430.7 million in the previous quarter. Long-term debt was $3.51 billion versus $3.42 at the end of previous quarter. Donnelley had $95.8 million in cash used in operations during the quarter.

Guidance

Donnelley reiterated its fiscal 2013 guidance. For fiscal 2013, Donnelley expects revenues to be in the range of $10.1 billion to $10.3 billion. The guidance assumes approximately $100.0 million negative impact from foreign exchange rates and lower paper sales.

Adjusted earnings before interest, tax, depreciation and amortization (“EBITDA”) are expected to be in the range of 11.2% to 11.4% for fiscal 2013. Depreciation and amortization is expected to be in the range of $450.0 to $460.0 million, while interest expense is likely to be in the range of $250.0 to $255.0 million.

Capital expenditure is expected to be in the range of $200 million to $225 million and free cash flow in the range of $400 million to $500 million. Long-term gross leverage is projected to be in the range of 2.25X to 2.75X.

Recommendation

We believe that Donnelley will achieve growth in fiscal 2013 due to its strong product pipeline. Donnelley’s near field communication (“NFC”) capability will boost its top-line growth going forward. Moreover, an improving macro-economic condition in the domestic market and cost cutting initiatives will boost profitability in the near term. Donnelley’s improving liquidity position is also a positive catalyst in our view.

Moreover, Donnelley’s continued focus on acquisitions will extend its offerings beyond the traditional market. Donnelley’s multi-million dollar contract wins from various companies such as Metro Inc., Chrysler and Office Depot Inc. (ODP - Analyst Report) are the other positive catalysts.

However, we expect Donnelley to remain under pressure in the near term due to continuing pricing pressure, volatility in raw material prices, and increasing competition from Quad/Graphics, Inc. and Dai Nippon Printing Co. Ltd. Moreover the increasing adoption of the e-book reader from the likes of Amazon (AMZN - Analyst Report) is a major concern for its legacy printing business.

Currently, Donnelley has a Zacks Rank #4 (Sell).

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