DONNELLEY R R & SONS CO, 10-Q, 1999-08-13

DONNELLEY R R & SONS CO
10-Q, 1999-08-13
COMMERCIAL PRINTING

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 1999

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-4694

R. R. DONNELLEY & SONS COMPANY

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of

incorporation or organization)

36-1004130

(I.R.S. Employer

Identification No.)

77 West Wacker Drive,
Chicago, Illinois

(Address of principal executive offices)

60601

(Zip Code)

Registrant’s Telephone Number (312) 326-8000

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

Number of shares of common stock outstanding

as of July 31, 1999

127,671,691

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

Index		Page Number(s)
Condensed Consolidated Statements of Income (Unaudited) for the three and six months ended June 30, 1999 and 1998		3

Condensed Consolidated Balance Sheets (Unaudited) as of June 30, 1999 and December 31, 1998		4

Condensed Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 1999 and 1998		5

Notes to Condensed Consolidated Financial Statements (Unaudited)		6 - 9

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Comparison of Second Quarter and First Half 1999 to 1998		9 - 13

Changes in Financial Condition		14

Year 2000		14 - 15

Other Information		15 - 16

Item 3. Quantitative and Qualitative Disclosures about Market Risk		17

PART II
OTHER INFORMATION
Item 1. Legal Proceedings		18

Item 5. Other Information		18

Item 6. Exhibits and Reports on Form 8-K		18

R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(Thousands of dollars, except share data)

	Three Months Ended June 30				Six Months Ended June 30
	1999		1998		1999		1998
Net sales	$1,195,170		$1,155,964		$2,374,986		$2,329,561
Cost of sales	935,920		915,216		1,872,800		1,870,754

Gross profit	259,250		240,748		502,186		458,807
Selling and administrative expenses	156,346		143,429		307,707		273,649
Income (loss) from operations of businesses held for sale	(1,931	)	(80,067	)	(4,890	)	(80,067	)

Earnings from operations	100,973		17,252		189,589		105,091
Other income (expense):
Interest expense	(23,726	)	(19,689	)	(43,621	)	(39,636	)
Gain on sale of Metromail shares	—		145,656		—		145,656
Other income —net	8,098		1,764		10,889		1,881

Earnings before income taxes	85,345		144,983		156,857		212,992
Provision for income taxes	32,858		86,246		60,390		110,049

Net income	52,487		58,737		96,467		102,943


Net income per share of common stock:
Basic	$0.41		$0.42		$0.74		$0.72
Diluted	$0.40		$0.41		$0.73		$0.71

Cash dividends per basic share	$0.21		$ 0.20		$0.42		$0.40


Average basic shares outstanding	129,450,000		140,835,000		131,157,000		142,450,000
Average diluted shares outstanding	130,601,000		143,824,000		132,632,000		144,995,000

See accompanying Notes to Condensed Consolidated Financial Statements.

R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

June 30, 1999 and December 31, 1998

(Thousands of dollars, except share data)

	1999		1998
ASSETS
Cash and equivalents	$50,374		$66,226
Receivables, less allowance for doubtful accounts of $15,269 in 1999 and $14,279 in 1998	800,276		843,094
Inventories	194,299		182,931
Prepaid expenses	78,744		63,040

Total current assets	1,123,693		1,155,291

Property, plant and equipment, at cost	4,593,680		4,368,754
Accumulated depreciation	2,822,886		2,667,827

Net property, plant and equipment	1,770,794		1,700,927
Goodwill and other intangibles, net of accumulated amortization of $195,279 in 1999 and $183,589 in 1998	388,062		381,394
Other noncurrent assets	542,108		515,029
Net assets of businesses held for sale	40,582		45,476

Total assets	$3,865,239		$3,798,117


LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable	$284,475		$331,257
Accrued compensation	160,041		188,187
Short-term debt	60,000		60,000
Current and deferred income taxes	31,902		2,263
Other accrued liabilities	274,134		242,251

Total current liabilities	810,552		823,958

Long-term debt	1,292,003		998,978
Deferred income taxes	254,659		260,692
Other noncurrent liabilities	415,908		413,611
Shareholders ’ equity:
Common stock, at stated value ($1.25 par value)
Authorized shares: 500,000,000; Issued 140,889,050 in 1999 and 140,889,050 in 1998	308,462		308,462
Retained earnings	1,361,847		1,325,634
Cumulative translation adjustments	(63,184	)	(55,050	)
Unearned compensation	(4,712	)	(6,118	)
Reacquired common stock, at cost	(510,296	)	(272,050	)

Total shareholders’ equity	1,092,117		1,300,878

Total liabilities and shareholders’ equity	$3,865,239		$3,798,117

See accompanying Notes to Condensed Consolidated Financial Statements.

R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

For the Six Months Ended June 30

(Thousands of dollars)

	1999		1998
Cash flows provided by (used for) operating activities:
Net income	$96,467		$102,943
Loss from operations of businesses held for sale, net of tax	3,010		80,067
Gain on sale of Metromail, net of tax	—		(87,394	)
Depreciation	159,320		161,969
Amortization	22,538		22,855
(Gain) on sale of assets	(2,985	)	(8,587	)
Net change in operating working capital	(8,519	)	24,245
Net change in other assets and liabilities	27,297		77,079
Other	(17,349	)	(17,007	)

Net cash provided by operating activities	279,779		356,170

Cash flows provided by (used for) investing activities:
Capital expenditures	(133,173	)	(108,429	)
Other investments including acquisitions, net of cash acquired	(155,966	)	(22,234	)
Dispositions of assets	—		16,023
Disposition of Metromail, net of tax	—		238,438

Net cash provided by (used for) investing activities	(289,139	)	123,798

Cash flows provided by (used for) financing activities:
Net increase (decrease) in borrowings	291,097		(195,552	)
Issuances of common stock	14,274		53,539
Acquisition of common stock	(254,520	)	(294,085	)
Cash dividends on common stock	(55,340	)	(57,116	)

Net cash used for financing activities	(4,489	)	(493,214	)

Effect of exchange rate changes on cash and equivalents	(2,003	)	(825	)
Net increase in cash from businesses held for sale	—		28,098

Net change in cash and equivalents	(15,852	)	14,027
Cash and equivalents at beginning of period	66,226		47,814

Cash and equivalents at end of period	$50,374		$61,841

See accompanying Notes to Condensed Consolidated Financial Statements.

R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. The condensed consolidated financial statements included herein are unaudited (although the balance sheet at December 31, 1998 is condensed from the audited balance sheet at that date) and have been prepared by the company to conform with the requirements applicable to this quarterly report on Form 10-Q. Certain information and disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been omitted as permitted by such requirements. However, the company believes that the disclosures made are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes included in the company’s 1998 Annual Report on Form 10-K.

The condensed consolidated financial statements included herein reflect, in the opinion of the company, all adjustments (which include only normal, recurring adjustments) necessary to present fairly the financial information for such periods. Certain prior year amounts have been reclassified to maintain comparability with current year classifications.

NOTE 2. Components of the company’s inventories at June 30, 1999, and December 31, 1998, were as follows:

	(Thousands of Dollars)
	1999		1998
Raw materials and manufacturing supplies	$117,837		$121,490
Work in process	178,858		150,775
Finished goods	1,405		1,220
Progress billings	(52,864	)	(42,217	)
LIFO reserve	(50,937	)	(48,337	)

Total inventories	$194,299		$182,931


NOTE 3. The following provides supplemental cash flow information:
	(Thousands of Dollars)
	Six Months Ended June 30
	1999		1998
Interest paid	$37,101		$39,253
Income taxes paid	$22,016		$26,966

NOTE 4. 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. 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 August 10, 1999, the district court judge denied the company’s motion for partial summary judgment on the basis of timeliness. Discovery is underway.

R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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.

N OTE 5. The company has adopted the Statement of Financial Accounting Standards No. 130, Comprehensive Income. This statement is intended to report a measure of all changes in shareholders ’ equity that result from either recognized transactions or other economic events, excluding capital stock transactions, which impact shareholders’ equity. For the company, the only difference between net income and comprehensive income is the effect of the increase in unrealized foreign currency translation losses of $0.8 million and $8 million for the three and six months ended June 30, 1999 and $8 million and $13 million for the three and six months ended June 30, 1998. Total comprehensive income was $52 million and $88 million for the three and six months ended June 30, 1999 and $51 million and $90 million for the three and six months ended June 30, 1998.

N OTE 6. The company operates in the commercial printing industry. Substantially all revenues result from the sale of printed products and services 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 because of 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 —refer to “Businesses Held for Sale” under Item 2 of this Form 10-Q 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” (page F-6 in the 1998 Annual Report on Form 10-K).

R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Industry Segment Information

In Thousands	Commercial Print	Businesses Held for Sale		Corporate		Other ⁽¹⁾		Adjustments ⁽²⁾		Consolidated Total
Second Quarter 1999
Sales	$1,141,359	$271,962		$ —		$53,811		$(271,962	)	$1,195,170
Earnings (loss) from operations	94,215	(1,931	)	7,126		1,563		—		100,973
Earnings (loss) before income taxes	101,703	(1,931	)	(15,881	)	1,454		—		85,345
Assets	3,098,679	289,214		637,824		88,154		(248,632	)	3,865,239


Second Quarter 1998
Sales	$1,102,233	$224,427		$—		$53,731		$(224,427	)	$1,155,964
Earnings (loss) from operations	91,797	(80,067	)	5,653		(131	)	—		17,252
Earnings (loss) before income taxes	97,520	(80,067	)	127,603		(73	)	—		144,983
Assets	2,991,284	325,605		616,128		93,017		(279,062	)	3,746,972


Six Months Ended June 30, 1999
Sales	$2,262,548	$471,085		$—		$112,438		$(471,085	)	$2,374,986
Earnings (loss) from operations	187,082	(4,890	)	3,922		3,475		—		189,589
Earnings (loss) before income taxes	194,557	(4,890	)	(35,826	)	3,016		—		156,857


Six Months Ended June 30, 1998
Sales	$2,219,676	$400,200		$—		$109,885		$(400,200	)	$2,329,561
Earnings (loss) from operations	176,424	(80,067	)	7,638		1,096		—		105,091
Earnings (loss) before income taxes	187,858	(80,067	)	104,152		1,049		—		212,992

(1)	Represents other operating segments of the company.

(2)	Refer to discussion of “Businesses Held for Sale,” under Item 2 of this Form 10-Q which describes the separate presentation of the net assets and results of operations of businesses held for sale.

N OTE 7. 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 or results of operations.

NOTE 8. In April 1999, the company acquired certain net assets of the Communicolor division of The Standard Register Company (Communicolor). Communicolor, with locations in Newark, Ohio and Eudora, Kansas, is a provider of personalization services and printer of innovative direct-mail campaigns. The acquisition was accounted for using the purchase method of accounting.

In April 1999, the company issued $200 million of 6 ⁵ / 8 % debentures due 2029. Proceeds received from the sale were used to reduce outstanding commercial paper borrowings incurred for working capital purposes and in connection with the financing of the company’s acquisitions of Communicolor and the financial printing unit of Cadmus Communications, with the remainder used for general corporate purposes.

NOTE 9. In March 1998, Metromail Corporation (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 37% interest in Metromail to GUS. In April 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.

NOTE 10. In the second quarter of 1998, the company recorded an $80 million impairment charge (with no associated tax benefit) related to the write-down of goodwill at Corporate Software & Technologies (CS&T). CS&T is reported as businesses held for sale in the accompanying financial statements—refer to “Businesses Held for Sale” under Item 2 of this Form 10-Q for additional information.

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Comparison of Second Quarter and First Six Months of 1999 to 1998

About the Company

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. At the end of June 1999, we had approximately 32,000 employees working in our core printing operations on four continents. We also had 53 manufacturing plants with a broad range of capabilities to serve our customers. 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:

Magazine Publishing Services, serving the consumer, trade and specialty magazine markets;

Merchandise Media, serving the consumer and business-to-business catalog, retail insert and direct mail markets;

Telecommunications, serving the global directory needs of telecommunications providers;

Book Publishing Services, serving the trade, children ’s, religious and educational book markets; and

Financial Services, 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 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 more of our end markets.

Sales results by business unit for the second quarter and first six months of 1999 and 1998 are presented below:

Net Sales by Business Unit

Second Quarter Ended June 30, (Thousands of Dollars)	1999	% of Total	1998	% of Total
Magazine Publishing Services	$270,850	23%	$272,836	24%
Merchandise Media	268,421	22%	275,301	24%
Telecommunications	192,909	16%	175,519	15%
Book Publishing Services	177,307	15%	176,718	15%
Financial Services	173,479	15%	147,109	13%
Other	112,204	9%	108,481	9%

	$1,195,170	100%	$1,155,964	100%

Six Months Ended June 30, (Thousands of Dollars)	1999	% of Sales	1998	% of Sales
Magazine Publishing Services	$552,274	23%	$564,514	24%
Merchandise Media	541,033	23%	560,178	24%
Telecommunications	400,497	17%	365,532	16%
Book Publishing Services	347,327	15%	346,797	15%
Financial Services	304,733	13%	272,397	12%
Other	229,122	9%	220,143	9%

	$2,374,986	100%	$2,329,561	100%

Consolidated Results of Operations

Net income for the second quarter of 1999 was $52 million, or $0.40 per diluted share, compared to net income of $59 million, or $0.41 per diluted share for the prior year quarter. Second quarter 1999 included an after-tax loss from businesses held for sale of $1.2 million ($0.01 per diluted share). Second quarter 1998 included an $87 million after-tax gain on the sale of Metromail ($0.61 per diluted share), and an $80 million after-tax loss from businesses held for sale ($0.56 per diluted share). Excluding the effects of these one-time items, net income for the second quarter of 1999 was $54 million, or $0.41 per diluted share, compared to net income of $51 million, or $0.36 per diluted share a year ago. The effective tax rate for the second quarter of 1999 was 38.5%, lower than the comparable quarter a year ago of 59%. In 1998, we did not record a tax benefit in the second quarter on the $80 million impairment charge due to the uncertainty with respect to our ability to realize the tax loss in the future, which increased our overall effective rate for the quarter and year-to-date.

Net income for the first half of 1999 was $96 million, or $0.73 per diluted share, compared to net income of $103 million, or $0.71 per diluted share for the prior year period. First half 1999 included an after-tax loss from businesses held for sale of $3 million ($0.02 per diluted share). First half 1998 included an $87 million after-tax gain on the sale of Metromail ($0.60 per diluted share) and an $80 million after-tax loss from businesses held for sale ($0.55 per diluted share). Excluding the effects of these one-time items, net income for the first half of 1999 was $99 million, or $0.75 per diluted share, compared to net income of $96 million, or $0.66 per diluted share a year ago. Excluding the impact of the 1998 Metromail gain and the impairment charge noted above, the overall effective tax rate increased in 1999 to 38.5% from 35% in 1998 due to the phase-out of deductions for the company’s corporate-owned life insurance programs (COLI). Diluted earnings per share for 1999 also reflect the effect of the company’s share repurchase program.

Consolidated Net Sales

Net sales for the second quarter of 1999, including materials such as paper and ink, increased $39 million, or 3% from a year ago, despite lower paper prices and fewer pass-through materials sales. Paper prices across our Magazine Publishing Services and Merchandise Media markets have declined approximately 10%–15% from the previous year. In several of our markets, but primarily Magazine Publishing and Merchandise Media, the proportion of customer-supplied paper has increased in 1999 resulting in fewer pass-through materials sales. Second quarter 1999 sales net of materials increased $49 million, or 7% from a year ago, which reflected our emphasis on higher value-added products and services. The acquisitions of Cadmus Financial and Communicolor contributed $25 million in net sales for the second quarter of 1999.

Second quarter 1999 net sales for the combined commercial print market of Magazine Publishing Services and Merchandise Media decreased 2% from a year ago, primarily as a result of lower paper prices and more customer-supplied paper, partially offset by higher volumes. Merchandise Media net sales for the second quarter included $18 million from the Communicolor acquisition in April 1999. Book Publishing Services net sales were essentially flat for the second quarter, due to more customer-supplied paper and the shutdown of a fulfillment and distribution center that offset base volume increases. Net sales for Telecommunications increased 10% for the second quarter, driven primarily by both higher directory and non-directory volumes and timing shifts from the fourth quarter of 1998. Net sales for Financial Services increased 18% for the second quarter, related primarily to market share gains in the capital markets and higher mutual fund business activity levels.

First half 1999 net sales, including materials such as paper and ink, increased $45 million, or 2% from a year ago, despite lower paper prices and fewer pass-through materials sales. For the first half of 1999, paper prices were down 10% –15% from a year ago across the Magazine Publishing Services and Merchandise Media markets. Sales net of materials increased 6% for the first half of 1999, reflecting our emphasis on higher value-added products and services. The acquisitions of Cadmus Financial and Communicolor contributed $29 million in net sales for the first half of 1999.

First half 1999 net sales for the combined Magazine Publishing Services and Merchandise Media markets decreased 3% from a year ago, which reflected lower paper prices and a shift to more customer-supplied paper, partially offset by higher volumes. Net sales for Telecommunications increased 10% for the first half primarily due to higher volume and the timing shifts from 1998 noted above. Book Publishing Services net sales were flat for the first half of 1999, as strong one-color volumes were offset by lower fulfillment and distribution revenues. First half 1999 net sales for Financial Services increased 12%, related primarily to volume increases, driven by our strong performance in the capital markets and higher mutual fund business activity levels.

Consolidated Expenses

Gross profit for the second quarter of 1999 increased by 8% to $259 million compared to $241 million for the same period last year. Second quarter gross profit as a percentage of sales increased to 21.7% from 20.8% a year ago. Gross profit for the first half of 1999 increased by 9% to $502 million compared to $459 million for the same period last year. First half gross profit as a percentage of sales increased to 21.1% from 19.7% a year ago. The increase in gross margin for both the second quarter and first half of 1999 reflects primarily the results of our continued productivity initiatives. As of June 30, 1999, we have implemented specific targeted productivity improvement plans at 20 of our manufacturing facilities. The initiatives are targeted towards making our operations more productive by analyzing all aspects of the production process.

Selling and administrative expenses for the second quarter of 1999 increased 9% to $156 million, or 13.1% of sales compared to 12.4% for the prior year. Of the 9% increase, 3% was a result of the impact of the Communicolor and Cadmus acquisitions, and the remainder was due primarily to investments in building capabilities in areas such as procurement, paper services and marketing.

Selling and administrative expenses for the first half of 1999 increased by 12% to $308 million, or 13.0% of sales compared to 11.7% last year. Of the 12% increase, 3% was due to an increase in Year 2000 and Information Technology spending over the prior year, 2% was a result of the Communicolor and Cadmus acquisitions, and the remainder was due to higher volumes as well as upgrading our capabilities as noted above.

Summary of Expense Trends

Second Quarter Ended June 30,	1999	1998	% Increase (Decrease)
(Thousands of Dollars)	1999	1998	% Increase (Decrease)
Cost of materials	$ 417,049	$ 426,944	(2.32%	)
Cost of manufacturing	428,575	395,719	8.30%
Depreciation	79,992	80,743	(0.93%	)
Amortization	10,304	11,810	(12.75%	)
Selling and administrative	156,346	143,429	9.01%
Net interest expense	23,726	19,689	20.50%


Six Months Ended June 30,	1999	1998	% Increase (Decrease)
(Thousands of Dollars)	1999	1998	% Increase (Decrease)
Cost of materials	$ 846,063	$ 882,085	(4.08%	)
Cost of manufacturing	844,879	803,845	5.10%
Depreciation	159,320	161,969	(1.64%	)
Amortization	22,538	22,855	(1.39%	)
Selling and administrative	307,707	273,649	12.45%
Net interest expense	43,621	39,636	10.05%

Nonoperating Items

Interest expense increased $4 million for both the quarter and the first six months of 1999 due to higher average debt levels related to recent acquisitions and the completion of the share repurchase program.

Other income, net, in the second quarter of 1999 of $8 million was $6 million higher than a year ago due to lower COLI expense ($2 million), additional foreign exchange gains ($2 million), and other smaller miscellaneous items. For the first half of 1999, in addition to the items noted above, we had a $3 million gain on the sale of real estate.

In April 1998, we sold our remaining interest in Metromail to The Great Universal Stores, P.L.C. (GUS). We received $297 million in cash proceeds, or approximately $238 million after-tax, and recognized a pre-tax gain of $146 million ($87 million after-tax) on this transaction.

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.

On December 15, 1997, SIH’s businesses became separate companies and our ownership interest in SIH was restructured. We converted our equity and debt positions in Stream International into 87% of the common stock of that business and converted our equity and debt positions in CS&T into 86% of the common stock of CS&T. Additionally, we sold our equity and debt positions in MMI for non-voting preferred stock of MMI. The disposition of our interest in CS&T will be effected through the sale of the business, which is now planned to occur during 1999. In connection with the planned disposition of CS&T, we have reported our interest in CS& T as businesses held for sale.

At the time our ownership interests were restructured in December 1997, we had prepared a formal plan of disposition to sell the entire CS&T business as a going concern, which we had expected to execute within twelve months. By the second quarter of 1998, intensified competition had negatively impacted both current operating results and our valuation of CS&T. Accordingly, in the second quarter of 1998, we recorded an $80 million impairment charge (with no associated tax benefit) related to the writedown of goodwill at CS&T. As of 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. We have continued to actively pursue the sale of our interest in CS&T during 1999. The net assets of CS&T are included in net assets of businesses held for sale as of June 30, 1999 and December 31, 1998. Our investment in the non-voting preferred stock of MMI at both June 30, 1999 and December 31, 1998 is included in other non-current assets.

In the second quarter of 1999, we recorded a $2 million ($1.2 million after-tax) loss from operations of businesses held for sale, and for the first half of 1999 we recorded a $5 million ($3.0 million after-tax) loss from operations of businesses held for sale.

Summary financial information of businesses held for sale has been disclosed within the “Industry Segment Information ” (Note 6 of the Notes to Condensed Consolidated Financial Statements included in Part I of this Form 10-Q).

Changes in Financial Condition

Liquidity and Capital Resources

Net cash provided by operating activities in the first half of 1999 totaled $280 million, down $76 million from a year ago. The net change in other assets and liabilities of $50 million between these same periods related primarily to the timing of income tax payments due on the second quarter 1998 gain on the sale of Metromail. Accrued income taxes of $59 million at June 30, 1998 represented additional cash provided by operations for the first half of 1998. Operating working capital increased $33 million for the first half of 1999 compared to a year ago, driven primarily by higher accounts receivable balances and higher accrued compensation payments. Capital expenditures for the first six months of 1999 totaled $133 million versus the $108 million spent in the first half of 1998. Spending was directed principally to projects that further enhance productivity and to upgrade our systems infrastructure and capabilities companywide. Full-year capital spending is expected to exceed $300 million in 1999 in support of selected growth opportunities, including the opening of a new telephone directory plant in Brazil and expanding our Poland operations. Management believes that the company’s cash flow and borrowing capacity are sufficient to fund current operations and growth.

Our 1999 acquisition activity through June 30 includes the net assets of the financial printing unit of Cadmus Communication in March 1999, the net assets of the Communicolor division of The Standard Register Company in April 1999, the net assets of the Brazilian book printer Hamburg Gráfica Editora in May 1999, and the buyout of our partner’s 50% interest in the Argentinian printer Atlántida Cochrane in June 1999.

In April 1999, we issued $200 million of debentures primarily for financing of acquisitions and the completion of our share repurchase programs. At June 30, 1999, we had an unused revolving credit facility of $400 million with a number of banks. This credit facility provides support for the issuance of commercial paper and other credit needs.

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 continues to be necessary. We have most recently been 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 substantially complete. All but 11 low priority business applications have been renovated, tested and redeployed, and the remaining applications will be redeployed by October, 1999. Solutions have been deployed to address 95% of the 2,000 non-compliant shop-floor systems in use throughout the U.S. and other locations. The balance of the systems are scheduled to be addressed by October, 1999. Our infrastructure compliance work, including replacement of non-compliant equipment, is nearly complete, as is testing for all significant desktop applications in use throughout the company.

In addition to our internal remediation activities, we have completed an evaluation of readiness by our key suppliers and vendors, including those serving our wholly-owned foreign operations. Of 875 suppliers and vendors evaluated through personal interviews and site visits, less than 3% have been designated by us as deficient in their efforts. Action plans are being executed to address each of these deficient situations and at this time none is judged to be a significant risk to the continuity of operations. Nonetheless, we will be conducting follow-up assessments of these and other critical suppliers and vendors throughout the remainder of the year. 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 have implemented a process for development of contingency plans that specify what we plan to do if critical systems, processes, suppliers, vendors and external companies encounter Year 2000 issues. The contingency planning effort focuses on those areas where our testing or evaluation does not demonstrate Year 2000 readiness, or where the criticality of the business process would make contingency planning prudent. While the specifics of each location’s plan will vary, the general approach includes ensuring that key personnel, both local and at the Year 2000 program office, are on-site at the cut-over; backing up critical systems immediately prior to year-end; and identifying alternate methods of doing business with suppliers and customers if needed.

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 between $45 and $48 million of which $31 million was incurred in the first half of the year. 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.

Our failure to be Year 2000 compliant, or the failure of our key suppliers, vendors or customers to achieve compliance in a timely manner, could have a material adverse effect on the company. Despite our efforts, a short-term disruption in some of our operations could occur which our contingency planning attempts to, but may not fully, address. In particular, the company’s ability to operate in foreign markets could be materially affected by a failure of the local infrastructure.

Other Information

Share repurchase—In early July, 1999 we completed the $300 million stock repurchase program announced in September 1998. Under that authorization, we repurchased a total of 8.2 million shares at an average price of $36.71. Since July 1996, we have repurchased approximately 27.9 million shares, or about 18 percent of our outstanding shares, at a total cost of approximately $1 billion. Our debt-to-market-capitalization ratio at June 30, 1999 was approximately 25 percent, which management believes is appropriate.

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® and HouseNet® 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 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. Our digital archiving and customer publishing solution allows 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, 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.

Litigation—See Note 4 of the Notes to Condensed Consolidated Financial Statements included in Part I of this Form 10-Q.

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. 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, primarily at the revenue line. 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 DLS 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 enhances 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 the future 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 sustained growth in shareholder value.

Item 3

Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk from changes in interest rates and foreign exchange rates. However, we generally maintain more than half of our debt at fixed rates (approximately 67% at June 30, 1999), and therefore our exposure to short-term interest rate fluctuations is immaterial to the consolidated financial statements as a whole. Our exposure to adverse changes in foreign exchange rates also is immaterial to our consolidated financial statements as a whole, and we occasionally use financial instruments to hedge exposures to foreign exchange rate changes. We do not use financial instruments for trading purposes and are 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 included in our 1998 Annual Report on Form 10-K.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

On each of November 25, 1996, and June 30, 1998, purported class actions were brought against the company alleging racial discrimination and seeking actual, compensatory, consequential and punitive damages in an amount not less than $500 million. On December 18, 1995, a class action was brought against the company alleging age discrimination in connection with the 1993 closing of the company’s Chicago catalog operations, and violation of the Employee Retirement Income Security Act. These actions are described in Part I of this quarterly report on Form 10-Q.

Item 5. Other Information

Certain statements in this filing, including the discussions of management expectations for future periods and Year 2000 compliance, constitute “forward-looking statements ” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from the future results expressed or implied by those statements. Refer to Part I, Item 1 of the company’s 1998 Annual Report on Form 10-K for a description of such factors.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits

12		Computation of Earnings to Fixed Charges
27		Financial Data Schedule

(b) No current report on Form 8-K was filed during the second quarter of 1999.

SIGNATURE

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

R.R. D ONNELLEY & SONS COMPANY

/ S / GREGORY A. STOKLOSA

Corporate Controller

(Authorized Officer and

Chief Accounting Officer)

August 13, 1999

Date