Annual Report — [x] Reg. S-K Item 405 — Form 10-K
Filing Table of Contents
Document/Exhibit Description Pages Size
1: 10-K405 Annual Report -- [x] Reg. S-K Item 405 45 250K
2: EX-3.(II)(A) By-Laws 19 75K
3: EX-3.(II)(B) Amend. to By-Laws Adopted 1-28-99 1 7K
4: EX-4.(D) Five-Year Credit Agmt. Dtd. 12-11-1998 112 414K
5: EX-4.(E) 364-Day Credit Agmt. 112 420K
6: EX-12 Comp. of Ratio of Earnings 1 6K
7: EX-21 Subsidiaries 2 12K
8: EX-23 Consent of Accountants 1 7K
9: EX-27 Financial Data Schedule 2 7K
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------ ----------
Commission file number 1-4694
R. R. DONNELLEY & SONS COMPANY
(Exact name of registrant as specified in its charter)
Delaware 36-1004130
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
77 West Wacker Drive,
Chicago, Illinois 60601
(Address of principal executive (ZIP Code)
offices)
Registrant's telephone number--(312) 326-8000
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class Name of each exchange on which registered
----------------------------- ----------------------------------------------
Common (Par Value $1.25) New York, Chicago and Pacific Stock Exchanges
Preferred Stock Purchase Rights New York, Chicago and Pacific Stock Exchanges
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to the
filing requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information state-
ments incorporated by reference in Part III of this Form 10-K or any amendment
to this Form 10-K. [X]
As of January 31, 1999, 133,657,005 shares of common stock were outstanding,
and the aggregate market value of the shares of common stock (based on the
closing price of these shares on the New York Stock Exchange--Composite Trans-
actions on January 31, 1999) held by nonaffiliates was $4,795,177,263.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement dated February 18,
1999, are incorporated by reference into Part III of this Form 10-K.
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TABLE OF CONTENTS
[Download Table]
Form 10-K
Item No. Name of Item Page
--------- ------------ ----
Part I
Item 1. Business................................................. 3
Item 2. Properties............................................... 6
Item 3. Legal Proceedings........................................ 6
Item 4. Submission of Matters to a Vote of Security Holders...... 6
Executive Officers and Other Principal Officers of R.R.
Donnelley & Sons Company................................ 7
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters..................................... 8
Item 6. Selected Financial Data.................................. 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 8
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk.................................................... 17
Item 8. Financial Statements and Supplementary Data.............. 17
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..................... 17
Part III
Item 10. Directors and Executive Officers of the Registrant....... 17
Item 11. Executive Compensation................................... 17
Item 12. Security Ownership of Certain Beneficial Owners and
Management.............................................. 17
Item 13. Certain Relationships and Related Transactions........... 17
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K................................................ 18
Signatures............................................... 19
Index to Financial Statements and Financial Statement
Item 14(a). Schedules............................................... F-1
Index to Exhibits........................................ E-1
2
PART I
ITEM 1. BUSINESS
Industry and Company Overview
R.R. Donnelley & Sons Company is the largest commercial printer in North
America. Our company is a leading provider of printing and related services to
the merchandising, magazine, book, directory, financial and healthcare
markets. We use our superior skills, scale and technology to deliver solutions
that effectively meet our customers' needs. Our common stock (DNY: NYSE) has
been publicly traded since 1956. Today, the company has approximately 31,000
employees working in our core printing operations on four continents. We have
49 manufacturing plants with a broad range of capabilities to serve our
customers' needs. While 91% of our revenue is generated in the United States,
we have extended our core competencies into selected international markets.
Commercial printing in the United States is a large and fragmented industry,
and includes more than 50,000 firms that employ more than one million people
and generate approximately $150 billion in annual revenue.
The segment of commercial printing that we serve generates approximately $80
billion in annual revenue. Within this segment, we have leadership positions
in all five of our end markets:
. Merchandise Media ($1.3 billion, or 26% of 1998 consolidated net sales),
serving the consumer and business-to-business catalog, retail insert and
direct mail markets;
. Magazine Publishing Services ($1.2 billion, or 23% of 1998 consolidated
net sales), serving the consumer, trade and specialty magazine markets;
. Telecommunications ($822 million, or 16% of 1998 consolidated net sales),
serving the global directory needs of telecommunications providers;
. Book Publishing Services ($742 million, or 15% of 1998 consolidated net
sales), serving the trade, children's, religious and educational book
markets; and
. Financial Services ($532 million, or 11% of 1998 consolidated net sales),
serving the communication needs of the financial markets and healthcare
industry.
In addition to our U.S. operations, we operate in Mexico, South America,
Europe and China. For reporting purposes, revenues from our international
facilities primarily serving the directory market are reported within
Telecommunications. Revenues from our two Mexico facilities that primarily
serve the magazine market are reported within Magazine Publishing Services.
Our third Mexico facility serves the book market and is reported within Book
Publishing Services. Revenues from other international facilities serving more
than one market are included in "Other." The "Other" classification also
includes net sales from R.R. Donnelley Logistics Services (DLS), our logistics
and distribution operation. DLS serves our print services customers and others
by consolidating and sorting mail so that it is delivered to the postal system
closer to the final destination, resulting in reduced postage costs and
improved on-time delivery. Additionally, DLS delivers magazine newsstand,
newspaper inserts and financial services products. Finally, revenue from
Stream International Inc., which provides technical and help-line computer
support to its customers, is included in "Other."
While our printing plants are geographically diverse, the supporting
technologies and knowledge base are shared. Our 49 plants have a range of
production capabilities to serve the five basic commercial print markets
outlined earlier. We manufacture products for these markets with the
operational goal of optimizing the efficiency of our common manufacturing
platform. As a result, most plants produce work for customers in two or three
of our end markets.
Commercial printing remains a competitive industry. Consolidation among our
customers and in the printing industry has put pressure on prices and
increased competition among printers. We expect these industry trends to
continue. We will manage these trends by leveraging our market-leading
position, streamlining our costs and enhancing the value we deliver to our
customers.
3
A significant portion of our sales are under contract with customers, with
the remainder on a single-order basis. For some customers, we print and
provide related services for different publications under different
contracts. Contracts with our larger customers normally run for a period of
years (usually three to five years, but longer in the case of contracts
requiring significant capital investment) or for an indefinite period subject
to termination on specified notice by either party. These sales contracts
generally provide for price adjustments to reflect price changes for
materials, wages and utilities. No single customer has a relationship with the
company that accounted for 10% or more of our sales in 1998.
In each of the fiscal years ended December 31, 1998, 1997 and 1996,
international operations represented less than 9% of consolidated net sales,
less than 6% of earnings from operations (excluding 1997 and 1996
restructuring charges) and less than 15% of consolidated assets.
The various markets of the commercial printing industry in which we are
involved are highly competitive. While we have contracts with many of our
customers as discussed above, there are many competing companies and renewal
of these contracts is dependent, in part, on our ability to continue to
differentiate ourself from the competition. Differentiation results, in part,
from our broad range of value-added services, which include: conventional and
digital preproduction, computerized printing, Selectronic(R) imaging and
gathering, and sophisticated pool shipping and distribution services for
printed products; information content repackaging into multiple formats,
including print, magnetic and optical media; and graphic design and editorial
services. Although we believe we are the largest commercial printer in the
United States, we estimate that our revenues represent approximately 6% of
total sales of the portion of the commercial print industry which we serve.
While our plants are well located for the global, national or regional
distribution of our products, competitors in some areas of the United States
have a competitive advantage in some instances due to such factors as freight
rates, wage scales and customer preference for local services. In addition to
location, other important competitive factors are price and quality, as well
as the range of available services.
The primary raw materials we use are paper and ink. In 1998, we spent
approximately $1.9 billion on raw materials. We are a large purchaser of paper
and our focus is to improve materials performance and total cost management
for our customers, which we believe is a competitive advantage. We negotiate
with leading suppliers to maximize our purchasing efficiencies, but we do not
rely on any one supplier. We have existing paper supply contracts (at
prevailing market prices) to cover substantially all of our requirements
through 1999; and management believes extensions and renewals of these
purchase contracts will provide adequate paper supplies in the future. Ink and
ink materials are currently available in sufficient amounts, and we believe
that we will have adequate supplies in the future. We also coordinate
purchasing activity at both the local plant and corporate levels to increase
economies of scale.
Our overriding principles in the environmental arena are to create
sustainable compliance and an injury-free workplace. Our estimated capital
expenditures for environmental controls to comply with federal, state and
local provisions, as well as expenditures, if any, for our share of costs to
clean hazardous waste sites that have received our waste, will not have a
material effect upon our earnings or our competitive position.
As of December 31, 1998, we had 31,000 employees in our core printing
operations, of whom more than 9,400 had been our employees for 10 to 24 years
and more than 3,300 for 25 years or longer. As of December 31, 1998, we
employed approximately 26,700 people in the United States, approximately
1,335, or 5%, of whom were covered by collective bargaining agreements. In
addition, we employed approximately 4,300 people in our foreign operations,
27% of whom were covered by collective bargaining agreements.
We announced two small strategic acquisitions in 1998. In October, we
purchased Ediciones Eclipse S.A. de C.V., a Mexico City-based printer of
retail inserts. In December, we purchased GTE's St. Petersburg, Florida,
directory-printing plant. In addition, we increased our investment in two
other international operations. In July, we purchased additional outstanding
shares of Editorial Lord Cochrane S.A., the largest printer in Chile, to
increase our ownership position to 78% from 55%. In November, we purchased the
interests of our partner in our Poland operation, the Polish-American Printing
Company, to take 100% ownership.
4
Stream, CS&T, and MMI
In April 1995, our Global Software Services business merged with Corporate
Software, Inc. to form Stream International Holdings, Inc. (SIH). We owned
approximately 80% of SIH, which included three business units:
. Stream International--technical and help-line support,
. Corporate Software & Technology--licensing and fulfillment, customized
documentation, license administration and user training, and
. Modus Media International--software replication, documentation, and
kitting and assembly.
In December 1997, SIH was reorganized into three separate businesses. Our
interest was restructured so that we currently own 87% of the common stock of
Stream International Inc., 86% of the common stock of Corporate Software &
Technology Holdings, Inc. (CS&T) and non-voting, preferred stock of Modus
Media International Holdings, Inc. (MMI). As a result of the restructuring of
our interests in the businesses and our intention to dispose of our interest
in CS&T in 1998, we had reclassified our interests in CS&T and MMI as
discontinued operations.
We now expect to sell our interest in CS&T in 1999. Because the sale of CS&T
did not occur in 1998 as originally intended, we have eliminated the
discontinued operations presentation and restated prior years' financial
results to include previously discontinued operations in our earnings from
operations. The "Loss from operations of businesses held for sale" on the
income statement includes our pre-tax operating losses and pre-tax
restructuring and impairment charges related to these previously discontinued
operations. In 1998, the "Loss from operations of businesses held for sale"
reflects an $80 million impairment charge (with no associated tax benefit)
related to the write-down of CS&T goodwill. In 1997, operating results of CS&T
and MMI are reflected through the December restructuring. Also, in 1997, we
recorded a $100 million ($60 million after-tax) provision to adjust the
carrying values of CS&T and MMI to their estimated net realizable values. In
1996, the $123 million loss ($86 million after-tax) reflects a small operating
loss from CS&T and MMI and two restructuring charges totaling $119 million
($61 million after-tax) related to the repositioning of MMI and CS&T's
worldwide operations and the restructuring of their software, printing,
kitting and fulfillment operations.
The financial results of Stream International Inc. are reported in our
consolidated results. The net assets of CS&T are included as "Net assets of
businesses held for sale" in the year-end balance sheet presentation. The non-
voting preferred stock in MMI is included in other non-current assets.
Special Note Regarding Forward-Looking Statements. Our Annual Report to
Shareholders and this Form 10-K are among certain communications that contain
forward-looking statements, including statements regarding our financial
position, results of operations, market position, product development,
regulatory matters and Year 2000 compliance. Our expectation to be Year 2000
compliant in a timely manner and at the costs described could be adversely
affected by several factors, including our ability to attract and retain
trained personnel or third-party suppliers in this area, the costs to do so,
and the ability to identify and correct systems or applications that require
remediation. Our failure to achieve Year 2000 compliance or the failure of our
key suppliers, vendors or customers to achieve Year 2000 compliance in a
timely manner could have a material adverse effect on the company.
In addition, when used in such communications, the words "believes,"
"anticipates," "expects" and similar expressions are intended to identify
forward-looking statements. These forward-looking statements are based on our
estimates, assumptions, projections and current expectations and are subject
to a number of risks and uncertainties. Actual results in the future could
differ materially from those described in the forward-looking statements as a
result of many factors outside our control, including competition with other
printers based on pricing and other factors, fluctuations in the cost of paper
and other raw materials we use, changes in postal rates, seasonal fluctuations
in overall demand for printing, changes in customer demand, changes in the
advertising and printing markets, changes in the capital markets that affect
demand for commercial printing, the financial condition of our customers, the
general condition of the United States economy, changes in the rules
5
and regulations to which we are subject, including environmental regulation,
and other factors set forth in this Form 10-K and other company communications
generally. We do not undertake and specifically decline any obligation to
publicly release the results of any revisions to these forward-looking
statements that may be made to reflect any future events or circumstances
after the date of such statements or to reflect the occurrence of anticipated
or unanticipated events.
ITEM 2. PROPERTIES
Our corporate office is located in a leased office building in Chicago,
Illinois. In addition, we lease or own 51 U.S. facilities, including
manufacturing plants, which may have multiple facilities and warehouses. These
facilities encompass approximately 17.8 million square feet. We have nine
plants encompassing approximately 1.2 million square feet in South America,
Europe and Asia. Of the total manufacturing and warehouse facilities,
approximately 17.1 million square feet of space is owned, while the remaining
1.9 million square feet of space is leased. In addition, we have sales offices
across the United States, South America, Europe and Asia.
ITEM 3. LEGAL PROCEEDINGS
In November, 1996, a purported class action was brought against the company
in federal district court in Chicago, Illinois on behalf of current and former
African-American employees, alleging that the company racially discriminated
against them. The complaint seeks declaratory and injunctive relief, and asks
for actual, compensatory, consequential and punitive damages in an amount not
less than $500 million. Although the plaintiffs seek nationwide class
certification, most of the specific factual assertions of the complaint relate
to the closing of our Chicago catalog operations in 1993. Other general claims
relate to other company locations. In February, 1999, the magistrate judge
ruled that all claims relating to the Chicago catalog operations were
untimely. Plaintiffs have appealed this ruling. If the ruling of the
magistrate judge is upheld, the claims relating to other locations will still
be pending as is plaintiffs' motion for class certification.
In December, 1995, a class action was filed against the company in federal
district court in Chicago, Illinois alleging that older workers were
discriminated against in selection for termination upon closing of the Chicago
catalog operations. The suit also alleges that we violated the Employee
Retirement Income Security Act (ERISA) in determining benefits payable to
retiring or terminating employees. In August, 1997, the court certified
classes in each of the age discrimination and ERISA claims limited to former
employees of the Chicago operation.
In June, 1998, a purported class action was filed against the company in
federal district court in Chicago, Illinois on behalf of current and former
African-American employees, alleging that the company racially discriminated
against them. While making many of the same general discrimination claims
contained in the 1996 case, the plaintiffs in this case also claim retaliation
by the company for filing discrimination charges or otherwise complaining of
race discrimination. The complaint seeks the same relief and damages as sought
in the 1996 case.
The 1996 and 1995 cases relate primarily to the circumstances surrounding
the closing of the Chicago catalog operations. The company believes that it
acted properly in the closing of the operations. The company also believes
that it has a number of valid defenses to all of the claims made and it will
vigorously defend its actions. However, because the cases are in the
preliminary stages, management cannot make a meaningful estimate of any loss
that could result from an unfavorable outcome of any of the pending cases.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1998.
6
EXECUTIVE OFFICERS AND OTHER PRINCIPAL OFFICERS OF R. R. DONNELLEY & SONS
COMPANY
[Download Table]
Name, Age and Officer Business Experience During
Positions with the Company(1) Since Past Five Years(2)
----------------------------- ------- --------------------------
Haven E. Cockerham, 1998 Management responsibilities for
51, Senior Vice President, Compensation; Benefits; Employee
Human Resources Relations, Diversity and Corporate
Human Resources; Recruiting; and
Management and Organizational
Development. Prior experience as Vice
President, Human Resources, at
Detroit Edison Company, a provider of
electrical utilities, and as
President, Cockerham, McCain &
Associates, Inc., a provider of
management consulting services.
William L. Davis 1997 Management responsibilities as
55, Chairman of the Chairman of the Board and Chief
Board and Chief Executive Officer. Prior experience
Executive Officer(1) as Senior Executive Vice President at
Emerson Electric Company,
manufacturer of electrical,
electronic and related products.
James R. Donnelley 1983 Management responsibilities as Vice
63, Director, Vice Chairman of the Board and for
Chairman of the Board Corporate Communication, Community
Relations and Government Affairs.
Prior management responsibility for
Corporate Development.
Monica M. Fohrman 1988 Management responsibilities for Legal
49, Senior Vice President, Department and Secretary's Office.
General Counsel and Secretary(1)
Cheryl A. Francis 1995 Management responsibilities for
45, Executive Vice President Corporate Development, Investor
and Chief Financial Officer(1) Relations, Treasury, Financial
Reporting and Accounting, Real
Estate, Internal Audit and Taxes.
Prior management responsibilities for
Purchasing. Prior experience as
Treasurer at FMC Corporation, a
diversified manufacturer of chemicals
and machinery.
Gary L. Sutula, 1997 Management responsibilities for
54, Senior Vice President Technology Planning and Operations;
and Chief Information Officer Applications Solutions Delivery; and
the Year 2000 Program. Prior
experience as Senior Vice President
and Chief Information Officer at
Transamerica Financial Services, a
provider of international consumer
lending services.
Jonathan P. Ward 1985 Management responsibilities for
43, President and Merchandise Media, Magazine
Chief Operating Officer(1) Publishing Services,
Telecommunications, Financial
Services, Book Publishing Services,
Worldwide Procurement, Donnelley
Logistic Services and International
Operations. Prior sales and
manufacturing responsibility for
Merchandise Media and Financial
Services.
Michael W. Winkel 1999 Management responsibilities for
53, Executive Strategy Planning. Prior experience
Vice President, Strategy(1) as Corporate Vice President
responsible for corporate planning
and global operations at Monsanto
Company, a diversified manufacturer
of chemicals, pharmaceuticals and
agricultural products.
--------
(1) Executive officer of the Company.
(2) Each officer named has carried on his or her principal occupation and
employment in the company for more than five years with the exception of
Haven E. Cockerham, William L. Davis, Cheryl A. Francis, Gary L. Sutula,
and Michael W. Winkel as noted in the table above.
7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock is listed and traded on the New York Stock Exchange,
Chicago Stock Exchange and Pacific Exchange, Inc.
As of January 29, 1999, there were 9,695 stockholders of record. Information
about the quarterly prices of the common stock, as reported on the New York
Stock Exchange-Composite Transactions, and dividends paid during the two years
ended December 31, 1998, is contained in the chart below:
[Download Table]
Common Stock Prices
------------------------------------
Dividends
Paid 1998 1997
----------- ------------------- ----------------
1998 1997 High Low High Low
----- ----- --------- --------- -------- -------
First Quarter.................. $0.20 $0.19 $42 1/8 $35 1/8 $36 7/8 $29 5/8
Second Quarter................. 0.20 0.19 46 1/4 42 1/16 39 3/4 32 5/8
Third Quarter.................. 0.21 0.20 47 3/4 34 13/16 41 1/16 34 3/8
Fourth Quarter................. 0.21 0.20 44 11/16 34 37 5/8 32 5/8
Full Year...................... 0.82 0.78 47 3/4 34 41 1/16 29 5/8
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
(Not Covered by Auditors' Report)
(Thousands of dollars, except per-share data)
[Download Table]
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
Net sales............... $5,018,436 $4,892,944 $5,063,821 $5,080,775 $4,227,496
Net income (loss)*...... 294,580 130,631 (157,625) 298,793 268,603
Net income (loss) per
common share*.......... 2.08 0.89 (1.04) 1.92 1.73
Total assets............ 3,787,819 4,134,166 4,443,828 5,030,680 4,318,787
Non-current liabilities. 1,588,641 1,730,047 2,044,818 2,012,635 1,669,984
Cash dividends per
common share........... 0.82 0.78 0.74 0.68 0.60
--------
* Net income (loss) includes the following one-time items: 1998 gains on the
sale of the company's remaining interest in two former subsidiaries of $169
million ($101 million after-tax, or $0.71 per diluted share) and loss from
operations of businesses held for sale of $80 million (with no associated
tax benefit, or $0.56 per diluted share); 1997 restructuring and impairment
charges of $71 million ($42 million after-tax, or $0.29 per diluted share)
and loss from operations of businesses held for sale of $114 million ($76
million after-tax, or $0.51 per diluted share); 1996 restructuring and
impairment charges of $442 million ($374 million after taxes and minority
interest, or $2.45 per diluted share), gains on partial divestiture of
subsidiaries of $80 million ($48 million after-tax, or $0.31 per diluted
share) and loss from operations of businesses held for sale of $123 million
($86 million after-tax, or $0.56 per diluted share).
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Operating Results
One-Time Items--We refer to the following one-time items throughout
Management's Discussion and Analysis of Operations:
1998 reported net income included:
. a gain on the sale of our remaining interest in Metromail Corporation of
$146 million ($87 million after-tax),
. a gain on the sale of our remaining interest in Donnelley Enterprise
Solutions Incorporated (DESI) of $23 million ($14 million after-tax), and
8
. a loss from operations of businesses held for sale of $80 million (with
no associated tax benefit).
1997 reported net income included:
. a restructuring and impairment charge of $71 million ($42 million after-
tax), and
. a loss from operations of businesses held for sale of $114 million ($76
million after-tax).
1996 reported net income included:
. a gain on the initial public offering of Metromail of $44 million ($26
million after-tax),
. a gain on the initial public offering of DESI of $36 million ($22 million
after-tax),
. a restructuring and impairment charge of $442 million ($374 million after
taxes and minority interest benefit), and
. a loss from operations of businesses held for sale of $123 million ($86
million after-tax).
Highlights--Excluding one-time items, 1998 net income rose to $273 million,
or $1.93 per diluted share, from $249 million, or $1.69 per diluted share, a
year ago. The improved results primarily reflect the benefits of our
productivity initiatives. Including one-time items, in 1998 we earned $295
million in net income compared with $131 million in 1997.
Excluding one-time items, the $92 million earned in the fourth quarter of
1998 compares with $88 million in the same period of 1997. On a diluted per-
share basis, adjusted earnings were $0.67 in this fourth quarter compared with
$0.60 in the fourth quarter of 1997. Including one-time items, the $92 million
earned in the fourth quarter of 1998 compares with a net loss of $9 million in
the fourth quarter of 1997. In the fourth quarter of 1997 we recognized the
$71 million ($42 million after-tax) restructuring and impairment charge
referred to above and the loss from operations of businesses held for sale
that included a $100 million ($60 million after-tax) provision to adjust the
carrying values of CS&T and MMI.
Excluding one-time items, 1996 net income was $255 million, or $1.66 per
diluted share. Including one-time items, the net loss was $158 million.
Revenue
Net sales in 1998 were $5.0 billion, up 2.6% from 1997's net sales of $4.9
billion. Value-added revenue, or net sales less the cost of materials
(primarily paper and ink), was $3.1 billion, up 3.8% from 1997.
Volume in most of our markets was higher than a year ago. During most of
1998, we benefited from strong magazine advertising; high consumer confidence,
which created more demand for catalogs and retail inserts; and strong capital
markets. Also, a directory customer moved production from late 1997 into early
1998. These favorable factors were partially offset by lower book sales as the
industry continued to work through inventory management issues. Pricing
pressure continued in many of our markets, but to a lesser degree than in past
years as we continue to differentiate our services.
In addition to the growth in sales from a year ago, the composition of
revenue was also more favorable. Compared with last year, fewer pass-through
sales, or sales of materials and services purchased on our customers' behalf,
reduced revenue in 1998 but enhanced margins. Lower paper prices and reduced
paper sales to some customers, where our markup for buying the paper for the
customer did not cover our costs of financing and storage, resulted in lower
pass-through revenue. In addition, we encouraged some customers to buy
services directly from third parties rather than through us at a slight
markup. With these changes, both the sales and expense are no longer recorded
in our financial results. These factors primarily affected Merchandise Media.
While net sales were down in Merchandise Media compared with last year, value-
added revenue increased.
9
Net sales for 1996 were 3.5% higher than 1997 but included revenue from
Metromail and DESI ($206 million), which were consolidated at that time due to
our ownership interest, as well as our discontinued commercial printing
operations in the United Kingdom ($59 million). Despite 1997's sales being
lower than in 1996, value-added revenue was essentially equal to 1996 levels.
Expenses
Gross profit in 1998 grew by $108 million. This 11% increase over 1997 came
from our focus on productivity initiatives, as well as higher volume. Gross
profit as a percentage of sales improved to 21.1% in 1998 compared with 19.4%
in 1997. The gross profit ratio in 1996 was 19.2%.
Our cost of materials in both 1998 and 1997 was $1.9 billion compared with
$2.1 billion in 1996. The primary raw materials we use are paper and ink.
Because the price of paper can be volatile, in periods of rising prices the
company's revenues and costs for materials increase; in periods of falling
prices, revenues and material costs decline. The company purchases or
customers supply paper used in the printing process. Customer-supplied paper
is reflected in neither our revenues nor cost of materials. If we purchase
paper for the customer, we recover the cost as a pass-through cost, at a
margin that is lower than the margin we earn for printing and related
services.
In 1998, the price of paper for grades employed in our manufacturing process
declined approximately 6% from the prior year due to oversupply and price
competition. We reduced the amount of paper purchased on behalf of customers
in selected cases where the markup recovered on the paper did not cover our
associated costs. In 1997, the cost of paper ranged from 5% to 10% per short
ton higher than 1996 prices.
Our results also are affected by the price of scrap (by-product) paper,
which we sell. In 1997, the company began to record income from the sale of
by-products as a recovery of the cost of materials and reclassified prior-year
financial results to more accurately reflect the impact of by-products on
operations. In 1998, by-products recovery increased by less than $1 million.
In 1997, by-products recovery declined by $1 million from 1996.
Selling and administrative expense increased by 11% to $570 million in 1998
compared with the prior year. In addition to volume-related increases and
higher consolidated Stream International expenses, most of the increase was
related to information systems-related expenditures. (See "Year 2000"
discussion on page 15.) The ratio of selling and administrative expense to net
sales was 11.4% in 1998 compared with 10.4% in 1997 and 10.2% in 1996.
Operating earnings, excluding the loss from operations of businesses held
for sale and the $71 million ($42 million after-tax) restructuring and
impairment charge in 1997, increased by $49 million from a year ago to reach
$488 million in 1998. The 11% increase reflects the company's focus on
productivity in our core business. Operating margins, excluding the loss from
operations of businesses held for sale and the 1997 restructuring and
impairment charge, were 9.7% in 1998 compared with 9.0% in 1997 and 8.9% in
1996.
Non-Operating Items
Net interest expense for 1998 declined 14% to $78 million due to lower
average debt balances associated with improvements in balance sheet
management. In 1997, net interest expense declined 5% from the prior year to
$91 million, reflecting lower average interest rates and lower average debt
balances.
Other income for 1998 decreased by $16 million to $10 million. The decline
is due to non-recurring gains in 1997 on the sale of investments in our
venture-capital portfolio. Other income for 1997 was $9 million higher than in
1996 due to lower corporate-owned life insurance expense, partially offset by
lower gains on the sale of non-core investments.
10
Events Affecting Comparability
Restructuring/Impairment Charges Excluding Charges for Operations of
Businesses Held for Sale--In December 1997, the company announced a $71
million ($42 million after-tax) restructuring and impairment charge related to
the discontinuation of activities no longer aligned with our strategic focus,
including:
. the sale of our Coris content-management software operation,
. the shutdown of our Crawfordsville, Indiana, book fulfillment operations,
. the closing of a development office in Singapore, and
. the development of certain manufacturing information systems.
During 1996, the company recorded two restructuring charges--totaling $442
million ($374 million after taxes and minority interest benefit)--to
restructure various operations and write down certain impaired assets,
including equipment, intangibles and investments in non-core businesses.
Approximately $195 million of the charge related to restructuring and
realigning our gravure operations in North America, including the costs of
closing facilities in Casa Grande, Arizona, and Newton, North Carolina.
Approximately $122 million was related to other manufacturing restructuring,
including:
. discontinuing catalog and magazine printing in the United Kingdom,
leading to the consolidation of two facilities into a single directory
printing facility,
. discontinuing book prepress operations in Barbados, and
. consolidating a stand-alone book bindery in Scranton, Pennsylvania, into
an existing facility.
The remaining $125 million was for write-downs of equipment, intangibles and
investments in non-core businesses in accordance with Statement of Financial
Accounting Standards (SFAS) 121, Accounting for Impairment of Long-Lived
Assets.
Restructuring/Impairment Charges for Operations of Businesses Held for
Sale--In the second quarter of 1998, the company recorded an $80 million
impairment charge related to the write-down of goodwill on the books of CS&T.
We did not recognize a tax benefit from this charge because we were unable to
absorb the unrealized capital loss.
In the fourth quarter of 1997, we recognized a $100 million ($60 million
after-tax) provision to adjust the carrying costs of CS&T and MMI to their
estimated net realizable values. (See "Stream, CS&T and MMI" discussion on
page 5 for additional details.)
In 1996, we recognized two restructuring charges to reposition the worldwide
operations of CS&T and MMI that totaled $119 million ($61 million after taxes
and minority interest benefit). In March 1996, we recorded an $86 million
charge ($44 million after taxes and minority interest benefit), which included
provisions for the closing of a plant in Wetherby, England, and MMI's
Crawfordsville, Indiana, documentation printing and diskette replication
operations. In July 1996, we took an additional $33 million charge ($17
million after taxes and minority interest benefit) to further restructure
MMI's operations.
Divestitures--Metromail, which had been wholly owned by the company,
completed an initial public offering of its common stock in June 1996, which
reduced our interest in Metromail to approximately 38%. In March 1998,
Metromail entered into a merger agreement with The Great Universal Stores,
P.L.C. (GUS), and we committed to sell our remaining interest in Metromail to
GUS. In April 1998, we received approximately $297 million, or $238 million
after-tax, for our remaining interest in Metromail.
DESI, which had been wholly owned by the company, completed an initial
public offering of its common stock in November 1996, which reduced our
interest in DESI to approximately 43%. In May 1998, DESI entered into a merger
agreement with Bowne & Co., Inc. (Bowne), and we committed to sell our
remaining interest in DESI to Bowne. In July 1998, we received approximately
$45 million, or $36 million after-tax, for our remaining interest in DESI.
11
We used proceeds from the Metromail and DESI transactions to repurchase
shares. (See "Share Repurchase" discussion below.)
Corporate-Owned Life Insurance (COLI)--We have used COLI to fund employee
benefits for several years. In 1996, the United States Health Care Reform Act
eliminated the deduction for interest from loans borrowed against COLI
programs. 1998 was the final year of the phase-out period for deductions.
Without the COLI deduction, we anticipate a higher effective tax rate in 1999
and future years.
The Internal Revenue Service (IRS), in its routine audit of the company, has
disallowed the COLI interest deductions we claimed in our 1990 to 1992 tax
returns. The company has challenged this position in a formal protest filed
with the IRS Appeals division. We expect to resolve the issue eventually in a
manner that does not materially affect our financial position and results of
operations.
Share Repurchase--In 1998, we purchased 13.2 million shares of our stock for
approximately $544 million in open-market and privately negotiated
transactions. These repurchases were part of two share repurchase programs we
announced in 1998. In January 1998, the Board of Directors authorized the
repurchase of up to $500 million of company stock, and in September the board
authorized the repurchase of up to $300 million of additional company stock.
These programs were authorized to be completed by December 1999; the first was
completed in 1998. Both programs include shares purchased to issue under our
various stock option plans.
In 1997, we purchased approximately 2.3 million shares to issue under
various stock option plans. The number of diluted shares outstanding as of
December 31, 1997, was 147 million, while the full-year average number of
diluted shares outstanding was 148 million.
In 1996, we repurchased $250 million of common stock in addition to
purchasing approximately 2.3 million shares to issue under various stock
option plans. The number of diluted shares outstanding as of December 31,
1996, was 147 million, while the full-year average number of diluted shares
outstanding was 154 million.
Loss from Operations of Businesses Held for Sale--In 1998, the loss from
operations of businesses held for sale was $80 million (with no associated tax
benefit), or $0.56 per diluted share, which reflects the second-quarter
impairment charge recorded to write down CS&T's goodwill. In 1997, the after-
tax loss from operations of businesses held for sale was $76 million, or $0.51
per diluted share. This amount includes the $100 million ($60 million after-
tax) provision to adjust the carrying values of CS&T and MMI to their net
realizable values. In 1997, there were also $16 million in after-tax operating
losses from CS&T and MMI.
In 1996, the after-tax loss from operations of businesses held for sale was
$86 million, or $0.56 per diluted share. This amount includes the two
restructuring and impairment charges to reposition the worldwide operations of
CS&T and MMI that totaled $119 million ($61 million after taxes and minority
interest benefit). The 1996 loss also includes $25 million of after-tax
operating losses related to CS&T and MMI.
Cash Flow
Operating Activities--The company's main source of liquidity is cash from
operating activities. In 1998, cash provided from operating activities was
$733 million, down slightly from 1997's $742 million, which was principally
driven by the initial success of our program begun in 1997 to reduce working
capital.
The 1998 levels of working capital were lower than a year ago despite higher
sales. The cash conversion cycle (days sales outstanding plus days inventory
on hand minus days payables outstanding) continued to improve to 38 days from
43 days a year ago and 47 days in 1996. The ratio of working capital to sales
has also continued to improve to 6.3% in 1998 from 8.0% in 1997 and 10.3% in
1996.
12
Investing Activities--Our principal recurring investing activities are
capital expenditures to improve our productivity of operations and to expand
in specific markets. In 1998, capital expenditures totaled $225 million, a
$135 million decline from 1997. Spending levels in 1998 reflect our
disciplined investment process, which includes evaluating a broad range of
alternatives, and our focus on productivity, which tends to emphasize less
costly process-enhancement investments. In 1998, we also invested in some
systems-related and other improvements that were expensed rather than
capitalized. In 1999 and future years, we expect annual capital spending to
increase to between $300 million and $350 million, still well below levels of
recent years, reflecting the improved discipline and process supporting our
investment activities.
During 1998, we continued our initiative to sell operations and assets no
longer aligned with our strategic priorities. In 1998, we generated $301
million net of taxes from these activities, which included selling our
remaining interests in Metromail and DESI, in addition to $26 million
associated with the sale of other assets. In 1997, we generated $51 million
net of taxes from selling our interest in three European joint ventures and
disposing of interests from our venture-capital portfolio. In 1996, the
company generated, net of taxes, $277 million and $23 million from
transactions related to its partial disposition of its ownership in Metromail
and DESI, respectively, and an additional $32 million from other dispositions.
During 1998, we increased our investment in two of our international
operations. In July, we purchased additional outstanding shares of Editorial
Lord Cochrane S.A., the largest printer in Chile, to increase our ownership
position to 78% from 55%. In November, we purchased the interests of our
partner in our Poland operation, the Polish-American Printing Company, to take
100% ownership. Previously, we owned 51%. These actions give us the ability to
better control the future direction of these growing operations, which are
strategically important. Results historically have been consolidated for both
entities, as our ownership was higher than 50%.
We announced two small, strategic acquisitions in 1998. In October, we
purchased Ediciones Eclipse S.A. de C.V., a Mexico City-based printer of
retail inserts. This acquisition complements our existing capabilities in
nearby San Juan del Rio, Mexico, and makes us the largest commercial printer
in this emerging country. In December, we purchased GTE's St. Petersburg,
Florida, directory-printing plant. The agreement included a long-term contract
to print certain GTE directories. This acquisition brings us important
geographic and operating benefits by extending our core directory-printing
capabilities into the southeastern United States. This allows us to reposition
work within our U.S. operations and produce directories closer to final
distribution points, simplifying logistics and accelerating delivery for
directory publishers.
Financing Activities--Financing activities include net borrowings, dividend
payments and share repurchases. The company's net borrowings declined by $156
million in 1998, $226 million in 1997 and $160 million in 1996. The decline in
1998 was a result of strong working capital management, lower capital spending
and cash generated from the disposition of assets no longer aligned with the
company's strategic priorities, partially offset by share repurchase activity.
Commercial paper is our primary source of short-term financing. On December
31, 1998, we had $122 million outstanding in commercial paper borrowing. In
addition, at December 31, 1998, we had a $400 million unused revolving credit
facility with a number of banks. This facility provides support for issuing
commercial paper and other credit needs. Management believes the company's
cash flow and borrowing capability are sufficient to fund its operations.
Cash used to repurchase common stock, net of dispositions, was $457 million
in 1998 (see "Share Repurchase" discussion on page 12). In 1997, $36 million
of net cash was used to purchase common stock, primarily to cover options
granted to employees. In 1996, $274 million of net cash was used to repurchase
shares.
Dividends to shareholders totaled $115 million in 1998, $115 million in 1997
and $113 million in 1996.
13
Financial Condition--Our financial position remains strong as evidenced by
our year-end balance sheet. Our total assets were $3.8 billion, $346 million
lower than in 1997, due to the increased focus on managing capital. We have
reduced capital expenditures through disciplined investing while more
aggressively managing working capital and disposing of assets no longer
aligned with our strategic focus. 1998 average invested capital (total debt
and equity, less our investment in businesses held for sale, computed on a 12-
month average) was $2.5 billion, a $197 million decline from 1997. Increased
earnings, excluding one-time items, in conjunction with the decrease in
invested capital, have contributed to a 150 basis point improvement in return
on average invested capital to 12.9% in 1998.
At year-end 1998, the debt-to-capital ratio increased to 45%, from 43% in
1997. The company's year-end debt-to-total-market-value decreased to 19% from
22% a year ago. Over long periods of time, our goal for an optimal capital
structure is to manage this ratio within a range of 20% to 25%.
Other Information
Human Resources--As of December 31, 1998, approximately 31,000 full-time
employees worked for the company in our core printing operations. Stream
International employed another 5,300 people. In our core printing operations,
approximately 86% of our employees work in the United States, and
approximately 5% of those are covered by collective bargaining agreements. Of
the approximately 4,300 people working in our international operations, 27%
are covered by collective bargaining agreements.
While the number of U.S. employees decreased slightly from a year ago,
minority and female representation among professionals, officials and managers
increased by 26% and 18%, respectively. Minority representation is now 12%
among our U.S. professionals, officials and managers while female
representation is now 34%. Minorities represent 14% of our U.S. workforce and
females represent 33%.
Technology--We remain a technology leader, investing not only in print-
related technologies such as computer-to-plate, customer connectivity and
digital imaging capabilities, but also in Internet-based business models, such
as our SelectSource(R) and HouseNet(R) services. These businesses help our
customers effectively deliver their content on the Internet.
SelectSource and HouseNet address the online needs of catalogers and
publishers, respectively. SelectSource offers content conversion and site
development services for catalog and retail customers. HouseNet, an online
community of interest focused on home improvement topics, aggregates content
around the themes of home, garden, crafts and money management to offer a one-
stop information resource for consumers. HouseNet was recently named Yahoo's
number-one site for home improvement information for 1998.
Book Publishing Services also applies technology to create solutions that
enable our customers to manage and distribute content in multiple media
formats. In 1998, we signed a contract with a major customer to create a
global, digital archive, as well as a new custom publishing solution allowing
education customers to build books online. In addition, Book Publishing
Services is the leading supplier of conversion services to the emerging
electronic book marketplace.
In the production process for print, increased digitization allows us to
implement world-class manufacturing techniques. Digital workflows, coupled
with on-press instrumentation and advanced statistical process control
techniques, will allow us to more effectively manage both our manufacturing
assets and our raw material inputs. Additionally, new digital imaging
capabilities are allowing higher levels of customization, enabling highly
personalized printed products to be delivered to consumers.
We are focused on investing in technologies that help us deliver products,
services and solutions that are valued by our customers and thereby contribute
to our financial performance.
14
Year 2000
Process control and information systems are becoming increasingly important
to the effective management of the company. Increased spending on new systems
and updating of existing systems will be necessary. In the near term, we are
focusing these efforts on ensuring that processes and systems are Year 2000
compliant. In addition, the company is focused on an initiative to upgrade and
standardize the company's information technology infrastructure, which has the
incidental effect of addressing certain of the company's Year 2000 compliance
issues. We have deferred a number of other infrastructure and systems
initiatives that would support continuous productivity improvements and
enhanced service capabilities until after the company completes its Year 2000
efforts.
The Year 2000 compliance issue stems from the computer industry's practice
of conserving data storage by using two digits to represent a year. Systems
and hardware using this format may process data incorrectly or fail with the
use of dates in the next century. These types of failures can influence
applications that rely on dates to perform calculations (such as an accounts
receivable aging report), as well as facility systems (such as building
security and heating) and manufacturing equipment.
The company's efforts to address Year 2000 compliance issues in our core
business include:
. evaluating internal computing infrastructure, business applications and
shop-floor systems for Year 2000 compliance,
. replacing or renovating systems and applications as necessary to assure
such compliance, and
. testing the replaced or renovated systems and applications.
Our efforts in these respects are well under way, and we currently expect
that all phases of such efforts will be completed by mid-1999. In addition to
our internal remediation activities, we are continuing to evaluate compliance
by key suppliers, vendors and other external companies, including customers
whose systems interact with ours. We expect to substantially complete this
evaluation in early 1999. Separate Year 2000 compliance programs are in
progress at Stream International and CS&T.
Although the company expects internal systems to be Year 2000 compliant as
described above, we intend to prepare a contingency plan that will specify
what we plan to do if critical systems, processes, suppliers, vendors and
external companies encounter Year 2000 issues. We have launched a contingency
planning effort focused on these areas and the establishment of processes,
structures and procedures for coordinating our contingency response efforts.
Specific plans will be developed throughout the course of the year.
Company employees, assisted by the expertise of external consultants where
necessary, staff the Year 2000 compliance efforts. Actual spending on our Year
2000 initiative in 1998 was $45 million, which is reflected in administrative
expense. Management expects 1999 expenses to be similar. These estimated
expenses do not include costs being capitalized with respect to the company's
information and technology infrastructure upgrade and standardization
initiative or estimated costs associated with Year 2000 initiatives at Stream
International or CS&T.
Litigation
In 1996, a purported class action was brought against the company on behalf
of current and former African-American employees alleging that the company
racially discriminated against them. The complaint seeks declaratory and
injunctive relief, and asks for actual, compensatory, consequential and
punitive damages in an amount not less than $500 million. Although the
plaintiffs seek nationwide class certification, most of the specific factual
assertions of the complaint relate to the closing of our Chicago catalog
operations in 1993. Other general claims relate to other company locations. In
February, 1999, the magistrate judge ruled that all claims relating to the
Chicago catalog operations were untimely. Plaintiffs have appealed this
ruling. If the ruling of the magistrate judge is upheld, the claims relating
to other facilities will still be pending as is plaintiffs' motion for class
certification.
15
In 1995, a class action was filed against the company alleging that older
workers were discriminated against in selection for termination upon closing
of the Chicago catalog operations. The suit also alleges that we violated the
Employee Retirement Income Security Act (ERISA) in determining benefits
payable to retiring or terminating employees. In August, 1997, the court
certified classes in each of the age discrimination and ERISA claims limited
to former employees of the Chicago operation.
In 1998, a purported class action was filed against the company on behalf of
current and former African-American employees, alleging that the company
racially discriminated against them. While making many of the same general
discrimination claims contained in the 1996 case, the plaintiffs in this case
also claim retaliation by the company for the filing of discrimination charges
or otherwise complaining of race discrimination. The complaint seeks the same
relief and damages as sought in the 1996 case.
The 1996 and 1995 cases relate primarily to the circumstances surrounding
the closing of the Chicago catalog operations. The company believes that it
acted properly in the closing of the operations. The company also believes
that it has a number of valid defenses to all of the claims made and it will
vigorously defend its actions. However, because the cases are in the
preliminary stages, management cannot make a meaningful estimate of any loss
that could result from an unfavorable outcome of any of the pending cases.
Environmental Regulations
Our business is subject to various laws and regulations relating to employee
health and safety and to environmental protection. Our policy is to comply
with all laws and regulations that govern protection of the environment and
employee health and safety. Our overriding principles are to create
sustainable compliance and an injury-free workplace. We do not anticipate that
compliance will have a material adverse effect on our competitive or
consolidated financial positions.
Outlook
The commercial printing industry in the United States (our primary
geographic market) is highly competitive in most product categories and
geographic regions. Competition is largely based on price, quality and
servicing the special needs of customers. Industry analysts believe that there
is overcapacity in most commercial printing markets. Therefore, competition is
fierce.
We are a large user of paper, bought by us or supplied to us by our
customers. The cost and supply of certain paper grades used in the
manufacturing process will continue to affect our financial results. However,
management currently does not see any disruptive conditions affecting prices
and supply of paper in 1999.
Postal costs are a significant component of our customers' cost structure.
Changes in postal rates, which became effective in January 1999, are not
expected to negatively affect the company. In fact, postal rate increases
enhance the value of Donnelley Logistic Services to our customers, as we are
able to improve the cost and efficiency of mail processing and distribution.
This ability to deliver mail on a more precise schedule and at a lower cost
should enhance our position in the marketplace.
In addition to paper and postage costs, consumer confidence and economic
growth are key drivers of print demand. While current economic conditions
remain favorable, there is uncertainty around 1999's business environment. A
significant change in the economic outlook could affect demand for the
company's products, particularly in the financial printing market.
In the longer term, technological changes, including the electronic
distribution of information, present both risks and opportunities for the
company. We believe that with our competitive strengths, including our
comprehensive service offerings, technology leadership, depth of management
experience, customer relationships and economies of scale, we can develop the
most valuable solutions for our customers, which should result in growth in
shareholder value throughout the next year and into the new millennium.
16
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The company is exposed to market risk from changes in interest rates and
foreign exchange rates. However, the company generally maintains more than
half of its debt at fixed rates (approximately 70% at December 1998), and
therefore its exposure to short-term interest rate fluctuations is immaterial
to the consolidated financial statements of the company as a whole. The
company's exposure to adverse changes in foreign exchange rates also is
immaterial to the consolidated financial statements of the company as a whole,
and the company occasionally uses financial instruments to hedge exposures to
foreign exchange rate changes. The company does not use financial instruments
for trading purposes and is not a party to any leveraged derivatives. Further
disclosure relating to financial instruments is included in the Debt Financing
and Interest Expense note in the Notes to Consolidated Financial Statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial information required by Item 8 is contained in Item 14 of Part
IV and listed on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning the directors and officers of the company is
contained on pages 6 and 14-15 of the company's definitive Proxy Statement
dated February 18, 1999, and is incorporated herein by reference. See also the
list of the company's officers and related information under "Executive
Officers and Principal Officers of R.R. Donnelley & Sons Company" at the end
of Part I of this annual report.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation for the year ended December
31, 1998, and, with respect to certain of such information, prior years, is
contained on pages 21-24 and 28-30 of the company's definitive Proxy Statement
dated February 18, 1999, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning the beneficial ownership of the company's common
stock is contained on pages
18-20 of the company's definitive Proxy Statement dated February 18, 1999, and
is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
17
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. Financial Statements
The financial statements listed in the accompanying index (page F-1) to
the financial statements are filed as part of this annual report.
2. Financial Statement Schedule
The financial statement schedule listed in the accompanying index (page
F-1) to the financial statements is filed as part of this annual
report.
3. Exhibits
The exhibits listed on the accompanying index to exhibits (pages E-1
through E-2) are filed as part of this annual report.
(b)Reports on Form 8-K
No current Report on Form 8-K was filed during the quarter ended
December 31, 1998.
(c)Exhibits
The exhibits listed on the accompanying index (pages E-1 through E-2)
are filed as part of this annual report.
(d)Financial Statements omitted--
Certain schedules have been omitted because the required information is
included in the consolidated financial statements or notes thereto or
because they are not applicable or not required.
18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, on the 31st day
of March, 1999.
R. R. DONNELLEY & SONS COMPANY
/s/ Gregory A. Stoklosa
By __________________________________
Gregory A. Stoklosa,
Vice President and Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated, on the 31st day of March, 1999.
Signature and Title Signature and Title
/s/ William L. Davis /s/ Thomas S. Johnson
------------------------------------- -------------------------------------
William L. Davis Thomas S. Johnson
Chairman of the Board and Director
Chief Executive Officer, Director
(Principal Executive Officer) /s/ George A. Lorch
-------------------------------------
/s/ Cheryl A. Francis George A. Lorch
------------------------------------- Director
Cheryl A. Francis
Executive Vice President and /s/ M. Bernard Puckett
Chief Financial Officer -------------------------------------
(Principal Financial Officer) M. Bernard Puckett
Director
/s/ Gregory A. Stoklosa
------------------------------------- /s/ Oliver R. Sockwell
Gregory A. Stoklosa -------------------------------------
Vice President and Controller Oliver R. Sockwell
(Principal Accounting Officer) Director
/s/ Joseph B. Anderson, Jr. /s/ Bide L. Thomas
------------------------------------- -------------------------------------
Joseph B. Anderson, Jr. Bide L. Thomas
Director Director
/s/ Martha Layne Collins /s/ Stephen M. Wolf
------------------------------------- -------------------------------------
Martha Layne Collins Stephen M. Wolf
Director Director
/s/ James R. Donnelley
-------------------------------------
James R. Donnelley
Director
/s/ Judith H. Hamilton
-------------------------------------
Judith H. Hamilton
Director
19
ITEM 14(a). INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
[Download Table]
Page(s)
-------
Consolidated Statements of Income for each of the three years ended
December 31, 1998..................................................... F-2
Consolidated Balance Sheets at December 31, 1998 and 1997.............. F-3
Consolidated Statements of Cash Flows for each of the three years ended
December 31, 1998..................................................... F-4
Consolidated Statements of Shareholders' Equity for each of the three
years ended December 31, 1998......................................... F-5
Notes to Consolidated Financial Statements............................. F-6
Report of Independent Public Accountants............................... F-21
Unaudited Interim Financial Information, Dividend Summary and Financial
Summary............................................................... F-22
Report of Independent Public Accountants on Financial Statement
Schedule.............................................................. F-23
Financial Statement Schedule
II--Valuation and Qualifying Accounts................................ F-24
F-1
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Thousands of Dollars, Except Per-Share Data
[Download Table]
Year Ended December 31
----------------------------------
1998 1997 1996
---------- ---------- ----------
Net sales.................................. $5,018,436 $4,892,944 $5,063,821
Cost of sales.............................. 3,960,239 3,942,339 4,092,895
---------- ---------- ----------
Gross profit............................... 1,058,197 950,605 970,926
Selling and administrative expenses........ 569,779 511,115 518,288
Restructuring and impairment charge........ -- 70,702 441,709
Loss from operations of businesses held for
sale...................................... 80,067 113,594 122,789
---------- ---------- ----------
Earnings from operations................... 408,351 255,194 (111,860)
Other income (expense):
Interest expense......................... (78,166) (90,765) (95,482)
Gain on sale of investments and stock
offerings of subsidiaries............... 168,903 -- 80,041
Other, net............................... 10,217 25,742 16,821
---------- ---------- ----------
Earnings (loss) before income taxes........ 509,305 190,171 (110,480)
Income taxes............................... 214,725 59,540 47,145
---------- ---------- ----------
Net Income (Loss)...................... $ 294,580 $ 130,631 $ (157,625)
========== ========== ==========
Net Income (Loss) per Share of Common Stock
Basic.................................... $ 2.11 $ 0.90 $ (1.04)
Diluted.................................. 2.08 0.89 (1.04)
See accompanying Notes to Consolidated Financial Statements.
F-2
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
Thousands of Dollars, Except Share Data
[Download Table]
December 31
----------------------
1998 1997
---------- ----------
Assets
Cash and equivalents................................. $ 66,226 $ 47,814
Receivables, less allowances for doubtful accounts of
$14,279 in 1998 and $16,259 in 1997................. 843,094 814,664
Inventories.......................................... 182,931 201,402
Prepaid expenses..................................... 52,742 82,691
---------- ----------
Total Current Assets............................... 1,144,993 1,146,571
========== ==========
Net property, plant and equipment, at cost, less
accumulated depreciation of $2,667,827 in 1998 and
$2,426,649 in 1997.................................. 1,700,927 1,788,116
Goodwill and other intangibles, net of accumulated
amortization of $183,589 in 1998 and $150,563 in
1997................................................ 381,394 396,604
Other non-current assets............................. 515,029 648,168
Net assets of businesses held for sale............... 45,476 154,707
---------- ----------
Total Assets....................................... $3,787,819 $4,134,166
========== ==========
Liabilities
Accounts payable..................................... $ 331,257 $ 291,666
Accrued compensation................................. 188,187 152,235
Short-term debt...................................... 60,000 45,000
Current and deferred income taxes.................... 76,605 58,888
Other accrued liabilities............................ 242,251 264,833
---------- ----------
Total Current Liabilities.......................... 898,300 812,622
========== ==========
Long-term debt....................................... 998,978 1,153,226
Deferred income taxes................................ 284,908 229,538
Other non-current liabilities........................ 304,755 347,283
---------- ----------
Total Non-current Liabilities...................... 1,588,641 1,730,047
========== ==========
Shareholders' Equity
Common stock at stated value ($1.25 par value)
Authorized shares: 490,000,000; Issued: 140,889,050
in 1998 and 150,889,050 in 1997..................... 308,462 320,962
Retained earnings.................................... 1,325,634 1,528,406
Cumulative translation adjustments................... (55,050) (45,782)
Unearned compensation................................ (6,118) (9,414)
Reacquired common stock, at cost..................... (272,050) (202,675)
---------- ----------
Total Shareholders' Equity......................... 1,300,878 1,591,497
---------- ----------
Total Liabilities and Shareholders' Equity......... $3,787,819 $4,134,166
========== ==========
See accompanying Notes to Consolidated Financial Statements.
F-3
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Thousands of Dollars
[Download Table]
Year Ended December 31
-------------------------------
1998 1997 1996
--------- --------- ---------
Cash flows provided by (used for) operating
activities:
Net income (loss)........................... $ 294,580 $ 130,631 $(157,625)
Loss from operations of businesses held for
sale, net of tax........................... 80,067 75,894 86,142
Gain on sale of investments and stock
offerings of subsidiaries, net of tax...... (101,342) -- (80,041)
Restructuring and impairment charges, net of
tax and minority interest.................. -- 42,421 374,449
Depreciation................................ 317,432 327,770 316,290
Amortization................................ 50,371 50,160 48,986
Gain on sale of assets...................... (13,446) (16,028) (17,758)
Net change in operating working capital..... 79,146 117,386 (20,355)
Net change in other assets and liabilities.. 40,657 20,023 30,735
Other....................................... (14,630) (6,019) (12,856)
--------- --------- ---------
Net Cash Provided by Operating Activities. 732,835 742,238 567,967
========= ========= =========
Cash flows provided by (used for) investing
activities:
Capital expenditures........................ (225,222) (360,195) (370,906)
Proceeds from collection of advances to
affiliates................................. -- -- 277,013
Proceeds from stock offering of subsidiary.. -- -- 23,492
Other investments including acquisitions,
net of cash acquired....................... (91,184) (47,526) (24,165)
Disposition of assets....................... 26,498 51,276 31,563
Disposition of investments, net of tax...... 274,079 -- --
--------- --------- ---------
Net Cash Used For Investing Activities.... (15,829) (356,445) (63,003)
========= ========= =========
Cash flows provided by (used for) financing
activities:
Net decrease in borrowings.................. (155,545) (225,967) (160,329)
Disposition of reacquired common stock...... 82,710 45,762 53,058
Acquisition of common stock................. (539,434) (82,041) (327,130)
Cash dividends paid......................... (114,898) (114,934) (112,645)
--------- --------- ---------
Net Cash Used for Financing Activities.... (727,167) (377,180) (547,046)
========= ========= =========
Effect of exchange rate changes on cash and
equivalents.................................. (592) (775) (395)
--------- --------- ---------
Net Increase in Cash from Businesses Held for
Sale......................................... 29,165 18,659 41,551
--------- --------- ---------
Net Increase (Decrease) in Cash and
Equivalents.................................. 18,412 26,497 (926)
--------- --------- ---------
Cash and Equivalents at Beginning of Year..... 47,814 21,317 22,243
--------- --------- ---------
Cash and Equivalents at End of Year........... $ 66,226 $ 47,814 $ 21,317
========= ========= =========
Changes in operating working capital, net of acquisitions and divestitures:
1998 1997 1996
--------- --------- ---------
Decrease (increase) in assets:
Receivables--net............................ $ (27,041) $ 103,077 $ 149,048
Inventories--net............................ 18,846 (3,496) 42,919
Prepaid expenses............................ 29,972 5,116 (78,086)
Increase (decrease) in liabilities:
Accounts payable............................ 37,352 6,249 (81,477)
Accrued compensation........................ 30,049 30,347 17,606
Other accrued liabilities................... (10,032) (23,907) (70,365)
--------- --------- ---------
Net Change in Operating Working Capital....... $ 79,146 $ 117,386 $ (20,355)
========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
F-4
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Thousands of Dollars, Except Share Data
[Enlarge/Download Table]
Reacquired Common Unearned
Common Stock Stock Compensation Other
--------------------- ---------------------- Restricted Retained Comprehensive
Shares Amount Shares Amount Stock Earnings Income Total
----------- -------- ----------- --------- ------------ ---------- ------------- ----------
Balance at December 31,
1995................... 158,608,800 $330,612 (4,656,261) $(142,243) $(9,297) $2,023,131 $(29,033) $2,173,170
Net loss................ (157,625) (157,625)
Translation adjustments. 2,453 2,453
----------
Comprehensive income.... (155,172)
Treasury stock
purchases.............. (2,333,691) (77,131) (77,131)
Cash dividends.......... (112,645) (112,645)
Common shares issued
under stock programs... 1,654,697 48,880 3,895 283 53,058
Common shares retired
under repurchase plan.. (7,719,750) (9,650) (240,349) (249,999)
----------- -------- ----------- --------- ------- ---------- -------- ----------
Balance at December 31,
1996................... 150,889,050 320,962 (5,335,255) (170,494) (5,402) 1,512,795 (26,580) 1,631,281
Net income.............. 130,631 130,631
Translation adjustments. (19,202) (19,202)
----------
Comprehensive income.... 111,429
Treasury stock
purchases.............. (2,293,757) (82,041) (82,041)
Cash dividends.......... (114,934) (114,934)
Common shares issued
under stock programs 1,857,792 49,860 (4,012) (86) 45,762
----------- -------- ----------- --------- ------- ---------- -------- ----------
Balance at December 31,
1997................... 150,889,050 320,962 (5,771,220) (202,675) (9,414) 1,528,406 (45,782) 1,591,497
Net income.............. 294,580 294,580
Translation adjustments. (9,268) (9,268)
----------
Comprehensive income.... 285,312
Treasury stock
purchases.............. (13,196,393) (543,743) (543,743)
Cash dividends.......... (114,898) (114,898)
Common shares issued
under stock programs 2,400,991 78,444 3,296 970 82,710
Common shares retired
under repurchase plan (10,000,000) (12,500) 10,000,000 395,924 (383,424) --
----------- -------- ----------- --------- ------- ---------- -------- ----------
Balance at December 31,
1998................... 140,889,050 $308,462 (6,566,622) $(272,050) $(6,118) $1,325,634 $(55,050) $1,300,878
=========== ======== =========== ========= ======= ========== ======== ==========
See accompanying Notes to Consolidated Financial Statements.
F-5
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summary of Significant Accounting Policies
Basis of Consolidation--The consolidated financial statements include the
accounts of the company and its majority-owned subsidiaries. Minority
interests in the income (loss) of consolidated subsidiaries ($4 million of
expense, $6 million of expense and $2 million of income in 1998, 1997 and
1996, respectively) are included in other expense on the Consolidated
Statements of Income. Intercompany items and transactions are eliminated in
consolidation. The company held investments in unconsolidated affiliates,
including the net assets of businesses held for sale, of $132 million and $430
million at December 31, 1998 and 1997, respectively.
Nature of Operations--The company provides a wide variety of print and
print-related services and products for specific customers, primarily under
contract. Some contracts provide for progress payments from customers as
certain phases of the work are completed; however, revenue is not recognized
until the earnings process has been completed in accordance with the terms of
the contracts. Some customers furnish paper for their work, while in other
cases the company purchases the paper and resells it to the customer.
Cash and Equivalents--The company considers all highly liquid debt
instruments purchased with original maturities of three months or less to be
cash equivalents.
Inventories--Inventories include material, labor and factory overhead and
are stated at the lower of cost or market. The cost of approximately 78% and
80% of the inventories at December 31, 1998 and 1997, respectively, has been
determined using the Last-In, First-Out (LIFO) method. This method reflects
the effect of inventory replacement costs in earnings; accordingly, charges to
cost of sales reflect recent costs of material, labor and factory overhead.
The remaining inventories are valued using the First-In, First-Out (FIFO) or
specific identification methods.
Capitalization, Depreciation and Amortization--Property, plant and equipment
are stated at cost. Depreciation is computed principally on the straight-line
method based on useful lives of 15 to 33 years for buildings and 3 to 15 years
for machinery and equipment. Maintenance and repair costs are charged to
expense as incurred. Major overhauls are capitalized as reductions to
accumulated depreciation. When properties are retired or disposed, the costs
and accumulated depreciation are eliminated and the resulting profit or loss
is recognized in income. Goodwill ($174 million and $156 million, net of
accumulated amortization, at December 31, 1998 and 1997, respectively) is
amortized over periods ranging from 10 to 40 years. Other intangibles
represent primarily the cost of acquiring print contracts and volume
guarantees and are amortized over the periods in which benefits will be
realized.
Use of Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Comprehensive Income--In 1998, the company adopted SFAS 130, Reporting
Comprehensive Income. This statement establishes rules for the reporting of
comprehensive income and its components. Comprehensive income consists of net
income and foreign currency translation adjustments and is presented in the
Consolidated Statements of Shareholders' Equity. The adoption of SFAS 130 had
no impact on total shareholders' equity.
Reclassifications--Certain prior year amounts have been reclassified to
conform to the 1998 presentation.
F-6
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Businesses Held for Sale
During 1996, Stream International Holdings, Inc. (SIH), an 80%-owned equity
investment of the company, reorganized into three independent businesses:
Stream International, which provides outsource technical support services;
Corporate Software & Technology (CS&T), a software distribution company; and
Modus Media International (MMI), a global manufacturing and fulfillment
business. CS&T and MMI comprised substantially all of the company's investment
and net income in SIH.
On December 15, 1997, SIH's businesses became separate companies and the
company's ownership interest in SIH was restructured. The company converted
its equity and debt positions in Stream International into 87% of the common
stock of that business. Additionally, the company converted its equity and
debt positions in CS&T into 86% of the common stock of CS&T and sold its
equity and debt positions in MMI for non-voting preferred stock of MMI. The
disposition of the company's interest in CS&T will be effected through the
sale of the business, which is planned to occur during 1999.
In connection with the planned disposition of CS&T and the restructuring of
the company's interest in MMI, the company has reported its interests in CS&T
and MMI as businesses held for sale. During December 1998, the net assets and
results of operations of businesses held for sale were reclassified from
discontinued operations because the planned sale of CS&T did not occur in
1998, as originally intended. The net assets of CS&T were included in net
assets of businesses held for sale, as of December 31, 1998 and 1997. The non-
voting preferred stock in MMI was included in other non-current assets as of
December 31, 1998 and 1997.
During 1998, the company recorded an $80 million (with no associated tax
benefit) impairment charge related to the write-down of goodwill on the books
of CS&T. Additionally, the company recorded a fourth-quarter 1997 impairment
charge of $100 million ($60 million after-tax) to adjust the carrying costs of
CS&T and MMI to their estimated net realizable values.
As part of the restructuring program announced in the first half of 1996,
the company recorded restructuring and impairment charges of $119 million ($61
million after-tax) for businesses held for sale. The charges primarily related
to the repositioning of MMI and CS&T's worldwide operations and the
restructuring of their software manufacturing, printing, kitting and
fulfillment operations.
Summary financial information of businesses held for sale has been disclosed
within the "Industry Segment Information" footnote (see F-18).
Divestitures
On June 19, 1996, Metromail Corporation (the company's previously wholly
owned subsidiary, which is a leading provider of market-oriented consumer
information and reference services) completed an initial public offering of
13.8 million shares of its common stock at $20.50 per share. As a result of
the offering, the company's interest in Metromail was reduced to approximately
38% (37% as of December 31, 1997). Approximately $250 million of the proceeds
from the completed offering were used by Metromail to retire certain
indebtedness owed to the company. The company in turn used the payment from
Metromail to pay down debt and for general corporate purposes. The transaction
resulted in a pre-tax gain for the company of $44 million and a tax provision
of $18 million. As a result of this transaction, the company changed its
method of accounting for Metromail from consolidation to the equity method,
effective July 1, 1996. Under the equity method, the company recognizes in
income its proportionate share of the net income of Metromail. Metromail's
1996 net sales and operating earnings were $126 million and $13 million,
respectively, through the date of the initial public offering.
F-7
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In March 1998, Metromail entered into a merger agreement with The Great
Universal Stores, P.L.C. (GUS), pursuant to which GUS initiated a tender offer
for the outstanding shares of Metromail. In conjunction with the merger, the
company committed to sell its remaining interest in Metromail to GUS. On April
13, 1998, the company received $297 million, or approximately $238 million
after-tax, for its remaining interest in Metromail. The company recognized a
pre-tax gain of $146 million ($87 million after-tax) from this transaction.
On November 4, 1996, Donnelley Enterprise Solutions Incorporated (DESI),
formerly a wholly owned subsidiary of the company and a single-source provider
of integrated information-management services to professional service
organizations, completed an initial public offering of 2.9 million shares of
its common stock at $25.00 per share, of which 1.0 million were offered by the
company. As a result of the offering, the company's interest in DESI was
reduced to approximately 43%. The company received approximately $52 million
from the net proceeds of the shares sold and from repayment of amounts owed by
DESI, which was used for general corporate purposes. The transaction resulted
in a pre-tax gain of $36 million, or $22 million after taxes. As a result of
this transaction, the company changed its method of accounting for DESI from
consolidation to the equity method, effective November 1, 1996.
In May 1998, DESI entered into a merger agreement with Bowne & Co., Inc.
(Bowne), pursuant to which Bowne initiated a tender offer to acquire all
outstanding shares of DESI. In conjunction with the merger, the company
committed to sell its remaining interest in DESI to Bowne. On July 7, 1998,
the company received $45 million, or approximately $36 million after-tax, for
its remaining interest in DESI. The company recognized a pre-tax gain of $23
million ($14 million after-tax) from this transaction.
Acquisitions
During 1998, the company increased its investment in subsidiaries located in
South America and Poland, in addition to acquiring other smaller, print-
related businesses. The aggregate cost of these investments was $86 million in
cash, of which $69 million was paid in 1998 and $17 million will be paid in
1999. All of these acquisitions have been accounted for as purchases.
Restructuring and Impairment Charges
In the first half of 1996, the company provided for the restructuring and
realignment of its gravure printing operations in North America, the
repositioning of other businesses, the write-down of certain equipment and the
impairment of intangible assets and investments in non-core businesses. These
actions resulted in pre-tax charges of $442 million ($374 million after taxes
and minority interest benefit). Approximately $195 million of the charges were
related to its gravure platform realignment and approximately $122 million
were related to other manufacturing restructuring. The charges also included
$125 million in write-downs of equipment, intangibles and investments in non-
core businesses.
In December 1997, the company provided for the impairment of assets and
restructuring costs related primarily to the elimination of activities that no
longer support the company's strategic focus. These included the impaired
development costs of certain manufacturing systems, the sale of Coris, the
company's content-management software subsidiary, and the shutdown of book
fulfillment operations in Crawfordsville, Indiana.
Impairment losses related to the 1996 and 1997 charges totaled $385 million
pre-tax and were calculated based on the excess of the carrying amount of
assets over the assets' fair values. The fair value of an asset is generally
determined as the discounted estimate of future cash flows generated by the
asset.
As of December 31, 1998, the company's restructuring programs are
substantially complete.
F-8
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Inventories
The components of the company's inventories were as follows:
[Download Table]
December 31
------------------
1998 1997
-------- --------
In thousands
Raw materials and manufacturing supplies.................... $121,490 $123,280
Work in process............................................. 150,775 153,142
Finished goods.............................................. 1,220 1,047
Progress billings........................................... (42,217) (31,715)
LIFO reserve................................................ (48,337) (44,352)
-------- --------
Total................................................... $182,931 $201,402
======== ========
The company's cost of sales was increased by LIFO provisions of $4.5 million
in 1998 and $0.6 million in 1997, and decreased by $7.5 million in 1996. The
company uses the external-index method of valuing LIFO inventories.
Property, Plant and Equipment
The following table summarizes the components of property, plant and
equipment (at cost):
[Download Table]
December 31
---------------------
1998 1997
---------- ----------
In thousands
Land...................................................... $ 32,336 $ 33,755
Buildings................................................. 617,029 634,114
Machinery and equipment................................... 3,719,389 3,546,896
---------- ----------
Total................................................. $4,368,754 $4,214,765
========== ==========
Commitments and Contingencies
As of December 31, 1998, authorized expenditures on incomplete projects for
the purchase of property, plant and equipment totaled $233 million. Of this
total, $93 million has been contractually committed. The company has a variety
of commitments with suppliers for the purchase of paper, ink and other
materials for delivery in future years at prevailing market prices.
The company has operating lease commitments totaling $322 million extending
through various periods to 2009. The lease commitments total $54 million for
1999, range from $34 million to $47 million in each of the years 2000-2003 and
total $108 million for years 2004 and thereafter.
The company also has future annual commitments totaling $32 million to
invest in various affordable housing limited partnerships that provide
cumulative annual tax benefits and credits in amounts greater than the
investments.
The company is not exposed to significant accounts receivable credit risk,
due to its customer diversity with respect to industry classification,
distribution channels and geographic locations.
On November 25, 1996, a purported class action was brought against the
company in federal district court in Chicago, Illinois, on behalf of all
current and former African-American employees, alleging that the company
racially discriminated against them in violation of the Civil Rights Act of
1871, as amended, and the U.S.
F-9
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Constitution (Jones, et al. v. R.R. Donnelley & Sons Co.). The complaint seeks
declaratory and injunctive relief, and asks for actual, compensatory,
consequential and punitive damages in an amount not less than $500 million.
Although plaintiffs seek nationwide class certification, most of the specific
factual assertions of the complaint relate to the closing by the company of
its Chicago catalog operations in 1993. Other general claims relate to other
company locations. On February 11, 1999, the magistrate judge ruled that all
claims relating to the Chicago catalog operations were untimely. Plaintiffs
have appealed this ruling. If the ruling of the magistrate judge is upheld,
the claims relating to other locations will still be pending as is plaintiffs'
motion for class certification.
On December 18, 1995, a class action was filed against the company in
federal district court in Chicago alleging that older workers were
discriminated against in selection for termination upon the closing of the
Chicago catalog operations (Gerlib, et al. v. R.R. Donnelley & Sons Co.). The
suit also alleges that the company violated the Employee Retirement Income
Security Act (ERISA) in determining benefits payable to retiring or terminated
employees. On August 14, 1997, the court certified classes in both the age
discrimination and ERISA claims limited to former employees of the Chicago
catalog operations.
On June 30, 1998, a purported class action was filed against the company in
federal district court in Chicago on behalf of current and former African-
American employees, alleging that the company racially discriminated against
them in violation of Title VII of the Civil Rights Act of 1964 (Adams, et al.
v. R.R. Donnelley & Sons Co.). While making many of the same general
discrimination claims contained in the Jones complaint, the Adams plaintiffs
are also claiming retaliation by the company for the filing of discrimination
charges or otherwise complaining of race discrimination. The complaint seeks
the same relief and damages as sought in the Jones case.
Both the Jones and Gerlib cases relate primarily to the circumstances
surrounding the closing of the Chicago catalog operations. The company
believes that it acted properly in the closing of the operations. Further,
with regard to all three cases, the company believes it has a number of valid
defenses to all of the claims made and will vigorously defend its actions.
However, management is unable to make a meaningful estimate of any loss that
could result from an unfavorable outcome of any of the pending cases.
In addition, the company is a party to certain litigation arising in the
ordinary course of business which, in the opinion of management, will not have
a material adverse effect on the operations or financial condition of the
company.
Retirement Plans
The company's restated Retirement Benefit Plan (the Plan) is a non-
contributory defined benefit plan. Substantially all U.S. employees age 21 or
older are covered by the Plan. Normal retirement age is 65, but reduced early
retirement benefits are paid to fully vested participants at or after age 55.
As required, the company uses the projected unit credit actuarial cost method
to determine pension cost for financial reporting purposes. In conjunction
with this method, the company amortizes deferred gains and losses (using the
corridor method) and prior service costs over the average remaining service
life of its active employee population. In addition, a transition credit (the
excess of Plan assets plus balance sheet accruals over the projected
obligation as of January 1, 1987) is amortized over 19 years. For tax and
funding purposes, the entry age normal actuarial cost method is used. Plan
assets include primarily government and corporate debt securities, marketable
equity securities, commingled funds and group annuity contracts purchased from
a life insurance company. In the event of Plan termination, the Plan provides
that no funds can revert to the company and any excess assets over Plan
liabilities must be used to fund retirement benefits.
F-10
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In addition to pension benefits, the company provides certain healthcare and
life insurance benefits for retired employees. Substantially all of the
company's regular full-time U.S. employees become eligible for these benefits
upon reaching age 55 while working for the company and having 10 years of
continuous service at retirement. The company funds a portion of the
liabilities associated with these plans through a tax-exempt trust. The assets
of the trust are invested primarily in life insurance covering some of the
company's employees.
The following represents the obligations and plan assets at fair value for
the company's pension and postretirement plans at December 31:
[Download Table]
Postretirement
Pension Benefits Benefits
-------------------- ------------------
1998 1997 1998 1997
---------- -------- -------- --------
In Thousands
Benefit obligation at end of prior
year.................................. $ 950,223 $838,005 $233,437 $220,970
Service cost........................... 38,030 31,886 9,508 8,585
Interest cost.......................... 65,317 61,337 15,626 16,010
Plan participants' contributions....... -- -- 1,848 1,618
Amendments............................. 9,651 (1,640) -- --
Actuarial loss/(gain).................. 33,794 70,610 (1,894) 3,616
Acquisitions/plan
initiations/curtailments.............. 3,008 -- 244 380
Expected benefits paid................. (50,794) (49,975) (18,115) (17,742)
---------- -------- -------- --------
Benefit obligation at end of year.. $1,049,229 $950,223 $240,654 $233,437
========== ======== ======== ========
[Download Table]
Postretirement
Pension Benefits Benefits
---------------------- -----------------
1998 1997 1998 1997
---------- ---------- -------- --------
In Thousands
Fair value of plan assets at end of
prior year.......................... $1,421,849 $1,238,315 $262,813 $219,719
Actual return on plan assets......... 100,024 233,509 54,773 43,094
Acquisition.......................... 4,099 -- -- --
Employer contribution................ -- -- -- --
Plan participants' contributions..... -- -- -- --
Expected benefits paid............... (50,794) (49,975) -- --
---------- ---------- -------- --------
Fair value of plan assets at end
of year......................... $1,475,178 $1,421,849 $317,586 $262,813
========== ========== ======== ========
The following represents the funded status of these plans at December 31:
[Download Table]
Postretirement
Pension Benefits Benefits
-------------------- ------------------
1998 1997 1998 1997
--------- --------- -------- --------
In Thousands
Funded status........................ $ 425,949 $ 471,626 $ 76,933 $ 29,376
Unrecognized transition obligation... (68,948) (78,798) -- --
Unrecognized net actuarial
(gain)/loss......................... (143,023) (192,562) (77,739) (43,638)
Unrecognized prior service cost...... 29,219 22,908 (18,215) (24,950)
--------- --------- -------- --------
Prepaid (accrued) benefit cost... $ 243,197 $ 223,174 $(19,021) $(39,212)
========= ========= ======== ========
The weighted average assumptions used in the actuarial computations that
derived the above amounts were as follows:
[Download Table]
Pension Postretirement
Benefits Benefits
---------------- ----------------
1998 1997 1996 1998 1997 1996
---- ---- ---- ---- ---- ----
Discount rate............................... 6.75% 7.00% 7.50% 6.75% 7.00% 7.50%
Expected return on plan assets.............. 9.50 9.50 9.50 9.00 9.00 9.00
Average rate of compensation increase....... 4.00 4.00 4.00 4.00 4.00 4.00
F-11
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the measurement purposes of other retirement benefits, a 7.6% annual
rate of increase in the per-capita cost of covered healthcare benefits was
assumed for 1999. The rate was assumed to decrease gradually to 5.0% for 2008
and remain at that level thereafter.
The components of the net periodic benefit cost and total income and expense
were as follows:
[Enlarge/Download Table]
Pension Benefits Postretirement Benefits
------------------------------ ----------------------------
1998 1997 1996 1998 1997 1996
--------- --------- -------- -------- -------- --------
In thousands
Service cost............ $ 38,030 $ 31,886 $ 32,619 $ 9,508 $ 8,584 $ 8,626
Interest cost........... 65,317 61,337 58,121 15,626 16,010 14,712
Expected return on plan
assets................. (115,769) (104,516) (96,497) (20,671) (18,304) (16,509)
Amortization of
transition obligation.. (9,850) (9,850) (9,850) -- -- --
Amortization of prior
service cost........... 2,249 1,803 1,804 (6,345) (6,463) (6,754)
--------- --------- -------- -------- -------- --------
Net periodic benefit
cost............... (20,023) (19,340) (13,803) (1,882) (173) 75
Curtailment (gain)/loss. -- (1,400) (1,426) 244 -- (4,166)
--------- --------- -------- -------- -------- --------
Total
(income)/expense... $ (20,023) $ (20,740) $(15,229) $ (1,638) $ (173) $ (4,091)
========= ========= ======== ======== ======== ========
Assumed healthcare cost trend rates have a significant effect on the amounts
reported for postretirement benefits. A 1-percentage-point change in assumed
healthcare cost trend rates would have the following effects for the year
ended December 31, 1998:
[Download Table]
1% Increase 1% Decrease
----------- -----------
In Thousands
Effect on total of service and interest cost
components..................................... $ 526 $ (514)
Effect on postretirement benefit obligation..... 7,460 (7,236)
Income Taxes
Cash payments for income taxes were $152 million, $60 million and $76
million in 1998, 1997 and 1996, respectively. The components of income tax
expense for the years ending December 31, 1998, 1997 and 1996, were as
follows:
[Download Table]
1998 1997 1996
-------- -------- --------
In Thousands
Federal
Current.......................................... $139,180 $ 68,909 $ 84,340
Deferred......................................... 35,222 (17,675) (38,720)
State.............................................. 40,323 8,306 1,525
-------- -------- --------
Total.......................................... $214,725 $ 59,540 $ 47,145
======== ======== ========
F-12
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The significant deferred tax assets and liabilities were as follows:
[Download Table]
December 31
-----------------
1998 1997
-------- --------
In Thousands
Deferred tax liabilities:
Accelerated depreciation................................... $170,343 $160,779
Investments................................................ 67,122 61,303
Pensions................................................... 83,521 84,710
Other...................................................... 60,183 42,290
-------- --------
Total deferred tax liabilities........................... 381,169 349,082
-------- --------
Deferred tax assets:
Postretirement benefits.................................... 15,685 15,685
Accrued liabilities........................................ 64,726 78,832
Investments................................................ 73,301 49,036
Other...................................................... 29,689 49,679
-------- --------
Total deferred tax assets................................ 183,401 193,232
-------- --------
Valuation allowance.......................................... 44,949 15,980
-------- --------
Net deferred tax liabilities................................. $242,717 $171,830
======== ========
The company has used corporate-owned life insurance (COLI) to fund employee
benefits for several years. In 1996, the United States Health Care Reform Act
was passed, eliminating the deduction for interest from loans borrowed against
COLI programs. 1998 was the final year of the phase-out period for deductions.
Without the COLI deduction, the company anticipates a higher effective tax
rate in 1999 and future years.
The Internal Revenue Service (IRS), in its routine audit of the company, has
disallowed the $34 million of tax benefit that resulted from the COLI interest
deductions claimed by the company in its 1990 to 1992 tax returns. The company
has challenged this position in a formal protest filed with the IRS Appeals
division. The company expects to resolve the issue eventually in a manner that
does not materially impact its financial position and results of operations.
The following table outlines the reconciliation of differences between the
U.S. statutory tax rates and the rates used by the company in determining net
income:
[Download Table]
1998 1997 1996
---- ----- -----
Federal statutory rate.................................... 35.0% 35.0% (35.0)%
Restructuring and impairment charges...................... -- -- 78.9
Foreign tax rates......................................... -- (2.6) (3.0)
State and local income taxes, net of U.S. federal income
tax benefit.............................................. 5.1 2.8 12.8
Goodwill amortization..................................... 0.3 0.3 5.6
Benefits resulting from corporate-owned life insurance
programs................................................. (1.5) (7.0) (7.5)
Affordable housing investment credits..................... (3.9) (10.4) (17.6)
Change in valuation allowance............................. 5.3 6.6 11.0
Other..................................................... 1.9 6.6 (2.5)
---- ----- -----
Total................................................. 42.2% 31.3% 42.7%
==== ===== =====
F-13
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Debt Financing and Interest Expense
The company's debt consisted of the following:
[Download Table]
December 31
---------------------
1998 1997
---------- ----------
In Thousands
Commercial paper......................................... $ 121,500 $ 258,020
Medium-term notes due 1999-2005 at a weighted average
interest rate of 6.93%.................................. 370,000 409,000
9.125% debentures due December 1, 2000................... 199,862 199,790
8.875% debentures due April 15, 2021..................... 80,807 149,692
8.82% debentures due April 15, 2031...................... 68,898 --
7.0% notes due January 1, 2003........................... 109,843 109,804
Other.................................................... 108,068 71,920
---------- ----------
Total................................................ $1,058,978 $1,198,226
========== ==========
Based upon the interest rates currently available to the company for
borrowings with similar terms and maturities, the fair value of the company's
debt exceeds its book value at December 31, 1998, by approximately $87
million. The company's notes and debentures are not actively traded and
contain no call provisions.
At December 31, 1998, the company had available credit facilities of $400
million with a group of domestic and foreign banks, of which $200 million
expires December 10, 1999. The remaining $200 million expires December 10,
2003. The credit arrangements provide support for the issuance of commercial
paper and other credit needs. As of December 31, 1998, there has been no
borrowing under these credit facilities. The company pays an annual commitment
fee on the total unused credit facilities of 0.06% for the 364-day facility
and 0.08% for the 5-year facility.
At December 31, 1998, the company had $283 million of commercial paper and
short-term debt outstanding, of which $223 million is classified as long-term
since the company has the ability and intent to maintain such debt on a long-
term basis. The weighted average interest rate on all commercial paper debt
outstanding during 1998 was 5.44% (4.92% at December 31, 1998). Annual
maturities of long-term debt (excluding commercial paper and short-term debt)
are as follows: 2000--$248 million, 2001--$9 million, 2002--$72 million,
2003--$128 million and thereafter $319 million.
The following table summarizes interest expense included in the Consolidated
Statements of Income:
[Download Table]
1998 1997 1996
------- -------- --------
In Thousands
Interest incurred................................. $83,162 $100,724 $107,198
Amount capitalized as property, plant and
equipment........................................ (4,996) (9,959) (11,716)
------- -------- --------
Total......................................... $78,166 $ 90,765 $ 95,482
======= ======== ========
Interest paid, net of capitalized interest, was $79 million, $90 million and
$93 million in 1998, 1997 and 1996, respectively.
F-14
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Earnings per Share
In accordance with SFAS 128, Earnings per Share, the company has computed
basic and diluted earnings per share (EPS) using the treasury stock method.
[Download Table]
1998 1997 1996
-------- -------- ---------
In Thousands, Except Per-
Share Data
Average shares outstanding........................ 139,624 145,929 151,830
Effect of dilutive securities--options............ 2,241 1,579 1,811
-------- -------- ---------
Average shares outstanding, adjusted for dilutive
effects.......................................... 141,865 147,508 153,641
======== ======== =========
Net income (loss)................................. $294,580 $130,631 $(157,625)
Basic EPS....................................... $ 2.11 $ 0.90 $ (1.04)
Diluted EPS..................................... 2.08 0.89 (1.04)
======== ======== =========
Stock and Incentive Programs for Employees
Restricted Stock Awards--At December 31, 1998 and 1997, respectively, the
company had outstanding 400,000 and 542,000 restricted shares of its common
stock granted to certain officers. These shares are registered in the names of
the recipients, but are subject to conditions of forfeiture and restrictions
on sale or transfer for one to seven years from the grant date. Dividends on
the restricted shares are paid currently to the recipients and, accordingly,
the restricted shares are treated as outstanding shares. The expense of the
grant is recognized evenly over the vesting period.
The value of the restricted stock awards was $18 million and $20 million
based on the closing price of the company's stock at each year-end ($43.81 and
$37.25 at December 31, 1998 and 1997, respectively). During 1998, a total of
33,000 shares of restricted stock were issued with a grant date fair value of
$2 million. Charges to expense for this stock plan were $4 million, $5 million
and $2 million in 1998, 1997 and 1996, respectively.
Stock Purchase Plan--The company has a stock purchase plan for selected
managers and key staff employees. Under the plan, the company is required to
contribute an amount equal to 70% of participants' contributions, of which 50%
is applied to the purchase of stock and 20% is paid in cash. Amounts charged
to expense for this plan were $9 million in 1998. In 1996 and 1997, the
company failed to meet performance targets required under the plan, and no
expenses were incurred.
Incentive Compensation Plans--In 1998, the company implemented a new
management incentive plan designed to provide incentive compensation to
executive officers that is closely tied to the creation of value for company
shareholders. Awards under the new plan are largely based on the achievement
of Economic Value Added (EVA) improvement targets, along with earnings per
share objectives and other individual and strategic targets. The new plan
combines aspects of both an annual and long-term plan by adding a "banking"
feature, in which a portion of the amount earned in the year is paid out to
participants and a portion is deferred for payout in subsequent years. The
company has accrued for both the portion currently payable and the deferred
component. Prior to 1998, the company had both an annual incentive plan and a
long-term incentive plan for its executive officers. The company's incentive
compensation plans for other officers, managers and supervisors are primarily
based on annual improvements in EVA.
Stock Options--The company has incentive stock option plans for its
employees. Under these plans, the options vest from three to nine and one-half
years after date of grant and may be exercised, once vested, up to 10 years
from the date of grant. Under authorized Stock Incentive Plans, a maximum of
5.4 million shares were
F-15
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
available for future grants of stock options and restricted stock awards as of
December 31, 1998. The company accounts for employee stock options under
Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to
Employees, under which no compensation cost has been recognized. Had
compensation cost been determined consistent with SFAS 123, Accounting for
Stock-Based Compensation, the company's net income and respective earnings per
share would have been reduced to the following pro forma amounts:
[Download Table]
1998 1997 1996
-------- -------- ---------
In Thousands, Except Per-
Share Data
Net income
As reported..................................... $294,580 $130,631 $(157,625)
Pro forma....................................... 278,924 115,437 (171,333)
Basic earnings per share:
As reported..................................... $ 2.11 $ 0.90 $ (1.04)
Pro forma....................................... 2.00 0.79 (1.13)
Diluted earnings per share:
As reported..................................... $ 2.08 $ 0.89 $ (1.04)
Pro forma....................................... 1.97 0.78 (1.13)
The fair value of each option granted during the year is estimated on the
date of grant using the Black Scholes option-pricing model with the following
range of assumptions:
[Download Table]
1998 1997 1996
-------- -------- --------
Dividend yield.................................... 1.98% 2.24% 2.16%
Expected volatility............................... 26.51% 25.10% 22.92%
Risk-free interest rate........................... 5.28% 6.32% 6.39%
Expected life..................................... 10 Years 10 Years 10 Years
A summary of the status of the company's option activity is presented below:
[Enlarge/Download Table]
1998 1997 1996
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Shares Exercise Shares Exercise Shares Exercise
(thousands) Price (thousands) Price (thousands) Price
----------- -------- ----------- -------- ----------- --------
Options outstanding at
beginning of year...... 13,958 $33.04 14,916 $31.68 14,246 $30.98
Options granted......... 1,627 41.81 1,485 40.28 3,320 34.09
Options exercised....... (2,387) 29.77 (1,535) 25.25 (1,245) 21.41
Options forfeited....... (800) 33.47 (908) 35.60 (1,405) 39.39
------ ------ ------ ------ ------ ------
Options outstanding at
end of year............ 12,398 $34.80 13,958 $33.05 14,916 $31.68
====== ====== ====== ====== ====== ======
Options exercisable at
end of year............ 7,344 $31.93 6,397 $28.57 6,618 $27.18
====== ====== ====== ====== ====== ======
Weighted average fair
value of options
granted with:
Exercise price equal
to stock price on
grant date........... $15.01 $11.20 $11.64
Exercise price
exceeding stock price
on grant date........ N/A $ 8.10 $ 7.74
F-16
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following summarizes information about stock options outstanding at
December 31, 1998:
[Download Table]
Options Outstanding Options Exercisable
-------------------------------- --------------------
Average Weighted Weighted
Remaining Average Average
Shares Contractual Exercise Shares Exercise
(thousands) Life Price (thousands) Price
----------- ----------- -------- ----------- --------
$17.72-$38.06............. 9,284 6.00 Years $31.24 6,524 $30.29
$38.07-$76.96............. 3,114 8.40 Years $45.40 820 $44.93
------ ---------- ------ ----- ------
$17.72-$76.96............. 12,398 6.61 Years $34.80 7,344 $31.93
====== ========== ====== ===== ======
Other Information--Under the stock programs, authorized unissued shares or
treasury shares may be used. The company intends to reacquire shares of its
common stock to meet the stock requirements of these programs in the future.
Preferred Stock
The company has 2 million shares of $1.00 par value preferred stock
authorized for issuance. The Board of Directors may divide the preferred stock
into one or more series and fix the redemption, dividend, voting, conversion,
sinking fund, liquidation and other rights. The company has no present plans
to issue any preferred stock. One million of the shares are reserved for
issuance under the "Shareholder Rights Plan" discussed below.
Shareholder Rights Plan
The company maintains a Shareholder Rights Plan (the Plan) designed to deter
coercive or unfair takeover tactics, to prevent a person or group from gaining
control of the company without offering fair value to all shareholders and to
deter other abusive takeover tactics that are not in the best interest of
shareholders.
Under the terms of the Plan, each share of common stock is accompanied by
one right; each right entitles the shareholder to purchase from the company
one one-thousandth of a newly issued share of Series A Junior Preferred Stock
at an exercise price of $140.
The rights become exercisable 10 days after a public announcement that an
acquiring person (as defined in the Plan) has acquired 15% or more of the
outstanding common stock of the company (the Stock Acquisition Date), 10
business days after the commencement of a tender offer that would result in a
person owning 15% or more of such shares or 10 business days after an adverse
person (as defined in the Plan) has acquired 10% or more of such shares and
such ownership interest is likely to have a material adverse impact on the
company. The company can redeem the rights for $0.01 per right at any time
until 10 days following the Stock Acquisition Date (under certain
circumstances, the 10-day period can be shortened or lengthened by the
company). The rights will expire on August 8, 2006, unless redeemed earlier by
the company.
If, subsequent to the rights becoming exercisable, the company is acquired
in a merger or other business combination at any time when there is a 15% or
more holder, the rights will then entitle a holder (other than a 15% or more
shareholder or an adverse person) to buy shares of the acquiring company with
a market value equal to twice the exercise price of each right. Alternatively,
if a 15% holder acquires the company by means of a merger in which the company
and its stock survives, if any person acquires 15% or more of the company's
common stock or if an adverse person acquires 10% or more of the company's
common stock and such ownership is likely to have a material adverse impact on
the company, each right not owned by a 15% or more shareholder or an adverse
person would become exercisable for common stock of the company (or, in
certain circumstances, other consideration) having a market value equal to
twice the exercise price of the right.
F-17
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Industry Segment Information
The company operates exclusively in the commercial printing industry.
Substantially all revenues result from the sale of printed products to
customers in the following markets: Book Publishing Services, Financial
Services, Magazine Publishing Services, Merchandise Media and
Telecommunications. The company's management has aggregated its commercial
print businesses as one reportable segment due to strong similarities in the
economic characteristics, nature of products and services, production
processes, class of customer and distribution methods used. The company's
investment in businesses held for sale has been disclosed as a separate
reportable segment, as the revenues generated from these businesses are
unrelated to the commercial printing industry. (See the "Businesses Held for
Sale" footnote (F-7) for additional information.)
The company has disclosed earnings (loss) from operations as the primary
measure of segment earnings (loss). This is the measure of profitability used
by the company's chief operating decision-maker that is most consistent with
the presentation of profitability reported within the consolidated financial
statements. The accounting policies of the business segments reported are the
same as those described in the "Summary of Significant Accounting Policies"
(F-6).
F-18
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
[Enlarge/Download Table]
Commercial Businesses Consolidated
Print Held for Sale(3) Corporate(1) Other(2) Combined Adjustments(3) Total
---------- ---------------- ------------ -------- ---------- -------------- ------------
In Thousands
1998
Sales................... $4,804,824 $ 881,473 $ -- $213,612 $5,899,909 $ (881,473) $5,018,436
Restructuring and
impairment charges..... -- 80,067 -- -- 80,067 (80,067) --
Earnings (loss) from
operations............. 497,337 (80,067) (7,246) (1,673) 408,351 -- 408,351
Earnings (loss) before
income taxes........... 519,070 (80,067) 71,663 (1,361) 509,305 -- 509,305
Assets.................. 3,152,190 294,782 499,067 91,086 4,037,125 (249,306) 3,787,819
Depreciation and
amortization........... 351,061 10,745 -- 16,742 378,548 (10,745) 367,803
Capital expenditures.... 198,822 5,664 9,700 16,700 230,886 (5,664) 225,222
1997
Sales................... $4,706,098 $1,547,765 $ -- $186,846 $6,440,709 $(1,547,765) $4,892,944
Restructuring and
impairment charges..... 70,702 100,000 -- -- 170,702 (100,000) 70,702
Earnings (loss) from
operations............. 332,602 (113,594) 28,850 7,336 255,194 -- 255,194
Earnings (loss) before
income taxes........... 343,210 (113,594) (45,741) 6,296 190,171 -- 190,171
Assets.................. 3,502,461 348,252 389,849 87,149 4,327,711 (193,545) 4,134,166
Depreciation and
amortization........... 363,537 40,344 -- 14,393 418,274 (40,344) 377,930
Capital expenditures.... 319,249 43,597 21,500 19,446 403,792 (43,597) 360,195
1996
Sales................... $4,908,323 $1,526,369 $ -- $155,498 $6,590,190 $(1,526,369) $5,063,821
Restructuring and
impairment charges..... 435,209 118,924 -- 6,500 560,633 (118,924) 441,709
(Loss) earnings from
operations............. (4,665) (122,789) 23,015 (7,421) (111,860) -- (111,860)
Earnings (loss) before
income taxes........... 11,339 (122,789) 7,326 (6,356) (110,480) -- (110,480)
Assets.................. 3,496,768 690,864 483,940 76,987 4,748,559 (304,731) 4,443,828
Depreciation and
amortization........... 352,652 44,033 -- 12,624 409,309 (44,033) 365,276
Capital expenditures.... 348,792 35,258 2,100 20,014 406,164 (35,258) 370,906
--------
(1) Corporate earnings primarily consist of the following unallocated items:
net earnings of benefit plans (excluding service cost) of $74 million, $71
million and $61 million in 1998, 1997 and 1996, respectively, which were
offset by general corporate, management and information technology costs.
In addition to earnings from operations, corporate earnings before income
taxes include: 1998 interest expense of $83 million and gains on the sale
of the company's remaining interest in two former subsidiaries of $169
million; 1997 interest expense of $101 million and gains on the sale of
assets of $16 million; and 1996 interest expense of $107 million, gains on
the sale of assets of $18 million and gains on the partial divestitures of
subsidiaries of $80 million.
Corporate assets primarily consist of the following unallocated items at
December 31: 1998 benefit plan assets of $285 million and investments in
affordable housing of $120 million; 1997 benefit plan assets of $289
million and investments in affordable housing of $102 million; 1996 benefit
plan assets of $298 million and investments in affordable housing of $81
million.
(2) Represents other operating segments of the company.
(3) Refer to "Businesses Held for Sale" footnote (F-7), which describes the
separate presentation of the net assets and the results of operations of
businesses held for sale.
F-19
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Geographic Area Information
[Download Table]
Domestic International Combined(1)
---------- ------------- -----------
In Thousands
1998
Sales...................................... $5,118,959 $ 780,950 $5,899,909
Long-lived assets(2)....................... 2,250,739 364,962 2,615,701
1997
Sales...................................... 5,407,617 1,033,092 6,440,709
Long-lived assets(2)....................... 2,584,285 354,583 2,938,868
1996
Sales...................................... 5,582,266 1,007,924 6,590,190
Long-lived assets(2)....................... 2,618,086 480,246 3,098,332
--------
(1) Includes net sales and long-lived assets of the company and businesses held
for sale. Refer to "Businesses Held for Sale" footnote (F-7), which
describes the separate presentation of the net assets and the results of
operations of businesses held for sale.
(2) Includes net property, plant and equipment, goodwill and other intangibles,
and other non-current assets.
F-20
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
We have audited the accompanying consolidated balance sheets of R.R.
Donnelley & Sons Company (a Delaware corporation) and Subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of R.R. Donnelley & Sons
Company and Subsidiaries as of December 31, 1998 and 1997, and the results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
Chicago, Illinois
January 28, 1999
(except with respect to the matter discussed in paragraph 5 in the commitments
and contingencies footnote, as to which the date is February 11, 1999)
F-21
UNAUDITED INTERIM FINANCIAL INFORMATION, DIVIDEND
SUMMARY AND FINANCIAL SUMMARY
In Thousands, Except Per-Share Data
[Enlarge/Download Table]
Year Ended December 31
------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Full Year
---------- ---------- ---------- ---------- ----------
1998
Net sales............... $1,173,598 $1,155,963 $1,274,479 $1,414,396 $5,018,436
Gross profit............ 218,059 240,748 294,020 305,370 1,058,197
Net income.............. 44,206 58,737 99,244 92,393 294,580
Net income per diluted
share.................. 0.30 0.41 0.71 0.67 2.08
Stock market high....... 42 1/8 46 1/4 47 3/4 44 11/16 47 3/4
Stock market low........ 35 1/8 42 1/16 34 13/16 34 34
Stock market closing
price.................. 41 1/16 45 3/4 35 3/16 43 13/16 43 13/16
1997
Net sales............... $1,111,438 $1,146,521 $1,221,743 $1,413,242 $4,892,944
Gross profit............ 193,103 208,837 260,529 288,136 950,605
Net income (loss)....... 29,341 37,676 72,157 (8,543) 130,631
Net income (loss) per
diluted share.......... 0.20 0.25 0.49 (0.06) 0.89
Stock market high....... 36 7/8 39 3/4 41 1/16 37 5/8 41 1/16
Stock market low........ 29 5/8 32 5/8 34 3/8 32 5/8 29 5/8
Stock market closing
price.................. 34 7/8 36 5/8 35 7/16 37 1/4 37 1/4
Stock prices reflect New York Stock Exchange composite quotes.
Dividend Summary
[Download Table]
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
Quarterly rate per common share*............ $0.205 $0.195 $0.185 $0.170 $0.150
Yearly rate per common share................ 0.82 0.78 0.74 0.68 0.60
--------
* Averages (1998--$0.20 first two quarters and $0.21 last two quarters;
1997--$0.19 first two quarters and $0.20 last two quarters; 1996--$0.18
first two quarters and $0.19 last two quarters; 1995--$0.16 first two
quarters and $0.18 last two quarters; 1994--$0.14 first two quarters and
$0.16 last two quarters).
Financial Summary
[Download Table]
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
In Thousands, Except Per-Share Data
Net sales............... $5,018,436 $4,892,944 $5,063,821 $5,080,775 $4,227,496
Net income (loss)**..... 294,580 130,631 (157,625) 298,793 268,603
Net income (loss) per
common share**......... 2.08 0.89 (1.04) 1.92 1.73
Total assets............ 3,787,819 4,134,166 4,443,828 5,030,680 4,318,787
Non-current liabilities. 1,588,641 1,730,047 2,044,818 2,012,635 1,669,984
--------
** Net income (loss) includes the following one-time items: 1998 gains on the
sale of the company's remaining interest in two former subsidiaries of $169
million ($101 million after-tax, or $0.71 per diluted share) and loss from
operations of businesses held for sale of $80 million (with no associated
tax benefit, or $0.56 per diluted share); 1997 restructuring and impairment
charges of $71 million ($42 million after-tax, or $0.29 per diluted share)
and loss from operations of businesses held for sale of $114 million ($76
million after-tax, or $0.51 per diluted share); 1996 restructuring and
impairment charges of $442 million ($374 million after taxes and minority
interest, or $2.45 per diluted share), gains on partial divestiture of
subsidiaries of $80 million ($48 million after-tax, or $0.31 per diluted
share) and loss from operations of businesses held for sale of $123 million
($86 million after-tax, or $0.56 per diluted share).
F-22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Shareholders of
R.R. Donnelley & Sons Company:
We have audited, in accordance with generally accepted auditing standards,
the financial statements included in the Company's Annual Report to
Shareholders included in this Form 10-K, and have issued our report thereon
dated January 28, 1999. Our audit was made for the purpose of forming an
opinion on those statements taken as a whole. The schedule listed in the index
to the financial statements and financial statement schedules is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part
of the basic financial statements. This schedule has been subjected to the
auditing procedures applied in the audit of the basic financial statements
and, in our opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
Arthur Andersen LLP
Chicago, Illinois
January 28, 1999
F-23
SCHEDULE II
Valuation and Qualifying Accounts
Transactions affecting the allowances for doubtful accounts during the years
ended December 31, 1998, 1997 and 1996 were as follows:
[Download Table]
1998 1997 1996
-------- ------- -------
Thousands of dollars
Allowance for trade receivable losses:
Balance, beginning of year.................. $ 16,259 $14,205 $18,059
Balance, companies (sold) acquired during
year....................................... -- -- (4,834)
Provisions charged to income................ 12,551 10,676 9,877
-------- ------- -------
28,810 24,881 23,102
Uncollectible accounts written off, net of
recoveries................................. (14,531) (8,622) (8,897)
-------- ------- -------
Balance, end of year........................ $ 14,279 $16,259 $14,205
======== ======= =======
F-24
INDEX TO EXHIBITS*
Description Exhibit No.
------- --------
Agreement between R. R. Donnelley & Sons Company and Bain Cap- 2
ital, Inc.(1).................................................
Restated Certificate of Incorporation(2)....................... 3(i)
By-Laws........................................................ 3(ii)(a)
Amendment to By-Laws adopted January 28, 1999 ................. 3(ii)(b)
Form of Rights Agreement, dated as of April 25, 1996 between
R. R. Donnelley & Sons Company and First Chicago Trust Com-
pany of New York(3)...........................................
4(a)
Instruments Defining the Rights of Security Holders(4)......... 4(b)
Indenture dated as of November 1, 1990 between the Company and
Citibank, N.A. as Trustee(5)..................................
4(c)
Five-Year Credit Agreement dated December 11, 1998 among R. R.
Donnelley & Sons Company, the Banks named therein and The
First National Bank of Chicago, as Administrative Agent.......
4(d)
364-Day Credit Agreement dated December 11, 1998 among R. R.
Donnelley & Sons Company, the Banks named therein and The
First National Bank of Chicago, as Administrative Agent.......
4(e)
Retirement Policy for Directors, as amended(6)**............... 10(a)
Directors' Deferred Compensation Agreement, as amended(6)**.... 10(b)
Donnelley Shares Stock Option Plan, as amended(7).............. 10(c)
1993 Stock Ownership Plan for Non-Employee Directors, as 10(d)
amended(8)**...................................................
Senior Management Annual Incentive Plan, as amended(6)**....... 10(e)
Form of Severance Agreement for Senior Officers, as amend- 10(f)
ed(9)**.......................................................
1993 Stock Purchase Plan for Selected Managers and Key Staff
Employees, as amended(8)**....................................
10(g)
1986 Stock Incentive Plan, as amended(8)**..................... 10(h)
1991 Stock Incentive Plan, as amended(8)**..................... 10(i)
1995 Stock Incentive Plan, as amended(6)**..................... 10(j)
Forms of option agreement with certain executive officers and
directors, as amended(10)**...................................
10(k)
Form of option agreement with non-employee directors, as 10(l)
amended(6)**..................................................
Unfunded Supplemental Benefit Plan(5)**........................ 10(m)
Amendment to Unfunded Supplemental Benefit Plan adopted on 10(n)
April 25, 1991(11)**..........................................
Employment Agreement between R. R. Donnelley & Sons Company
and William L. Davis(12)**....................................
10(o)
Premium-Priced Option Agreement between R. R. Donnelley & Sons
Company and William L. Davis(12)**............................
10(p)
Employment Agreement between R. R. Donnelley & Sons Company
and Cheryl A. Francis(7)**....................................
10(q)
Agreement between R. R. Donnelley & Sons Company and W. Ed Ty- 10(r)
ler(1)**......................................................
Computation of Ratio of Earnings to Fixed Charges.............. 12
Subsidiaries of R. R. Donnelley & Sons Company................. 21
Consent of Independent Public Accountants dated March 31, 23
1999..........................................................
Financial Data Schedule........................................ 27
E-1
--------
*Filed with the Securities and Exchange Commission. Each such exhibit
may be obtained by a shareholder of the Company upon payment of $5.00
per exhibit.
**Management contract or compensatory plan or arrangement.
(1) Filed as Exhibit to Annual Report on Form 10-K for the year ended
December 31, 1997, filed on March 4, 1998, and incorporated by
reference.
(2) Filed as Exhibit to Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1996, filed on May 3, 1996, and incorporated
herein by reference.
(3) Filed as Exhibit to Form 8-A filed on June 5, 1996, and
incorporated herein by reference.
(4) Instruments, other than that described in 4(c) and 4(d), defining
the rights of holders of long-term debt not registered under the
Securities Exchange Act of 1934 of the registrant and of all
subsidiaries for which consolidated or unconsolidated financial
statements are required to be filed are being omitted pursuant to
paragraph (4)(iii)(A) of Item 601 of Regulation S-K. Registrant agrees
to furnish a copy of any such instrument to the Commission upon
request.
(5) Filed as Exhibit with Form SE filed on March 26, 1992, and
incorporated herein by reference.
(6) Filed as Exhibit to Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 1998, filed on November 12, 1998, and
incorporated herein by reference.
(7) Filed as Exhibit to Annual Report on Form 10-K for the year ended
December 31, 1996, filed on March 10, 1997, and incorporated herein by
reference.
(8) Filed as Exhibit to Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 1996, filed on November 1, 1996, and
incorporated herein by reference.
(9) Filed as Exhibit to Annual Report on Form 10-K for the year ended
December 31, 1993, filed on March 28, 1994.
(10) Filed as Exhibit to Form S-3 filed on January 15, 1998, and
incorporated herein by reference.
(11) Filed as Exhibit with Form SE filed on May 9, 1991 and
incorporated herein by reference.
(12) Filed as Exhibit to Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1997, filed on May 7, 1997, and
incorporated herein by reference.
E-2
Dates Referenced Herein and Documents Incorporated by Reference
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