R.R. Donnelley & Sons Company

and answer session by phone. To ask a question, you must be connected by phone as the webcast is a listen-only platform. If you wish to ask a question by phone, please press star 1 on your touchtone phone. Please note that this call is being recorded. I will now turn the call over to Johan Nystedt, RRD's Senior Vice President of Finance.

Thank you, Brandi, and thank you, everyone, for joining RRG's second quarter 2021 results conference call. Joining me on today's call are Dan Notz, RRG's president and chief executive officer, and Terry Peterson, our chief financial officer. At the conclusion of today's prepared remarks, Dan, Terry, and I will take questions. As a reminder, we have prepared supplemental slides for today's call, which can be found on the investor section of our website at rrd.com. As we review our results on today's call, I will be advancing the slides if you are connected by webcast. Alternatively, we will periodically reference page numbers on the supplemental slides for those participants who wish to follow along by advancing the slides themselves. The information reviewed during this call is addressed in more detail in our second quarter press release, a copy of which is posted on the investor section of our website at RID.com. This information was also furnished to the SEC in the Form 8-K we filed yesterday. In addition, we will also refer to forward-looking statements, including comments on our financial outlook and strategy all of which involve risk and uncertainties. Therefore, our actual results could differ materially from our current expectations. For a complete discussion of the factors that could cause our actual results to differ materially, please refer to the cautionary statement including in our earnings release and the risk factors included in our annual report on Form 10-K, our quarterly reports on Form 10-Q, and other filings with the SEC. Further, we will discuss non-GAAP financial information. We believe the presentation of non-GAAP results provides investors with useful supplementary information concerning the company's ongoing operations. These non-GAAP results are provided for informational purposes only. Any references to non-GAAP financial measures or reconsult to the comparable GAAP financial measures in the investor section of our website as part of our press release. I will now turn the call over to Dan.

Thanks, Johan. Good morning, everyone. It's great to be with you, and thank you for joining our call today. On behalf of everyone at RRB, I hope that you and your families continue to stay healthy and safe. On today's call, I will recap our second quarter results and provide a number of examples that demonstrate how we are delivering value for our clients in winning new business in a recovering yet challenging business environment. Before turning the call over to Terry, I will also share a number of important awards that we've received recognizing our diversity, equity, and inclusion efforts. Building on our first quarter momentum, we delivered strong second quarter results through the ongoing execution of our strategic initiatives while protecting the health and safety of our colleagues around the globe. Highlighted by double-digit organic net sales growth, a significant increase in adjusted income from operations, expanded operating margins, and our lowest second quarter outstanding debt balance since the spin in 2016, I am very pleased with our performance in the quarter. I'd like to provide a little more color on our results. Net sales of $1.15 billion were up 11.4% organically versus the prior year, representing our fourth consecutive quarter of improved sales trends. Our favorable sales performance is a direct result of our ability to support our clients' strengthening demand across our portfolio as the majority of our product and service categories delivered year-over-year sales growth in the quarter. Our sales and service teams are working closely with our clients to effectively manage their increasing volumes while also remaining laser-focused on converting our opportunity pipeline into new wins. On a segment basis, business services delivered 11.6% organic growth driven by very strong performance in our commercial print, packaging, and labels offerings. Marketing Solutions also reported double-digit organic growth of 10.3%, despite the census not repeating, with higher digital print and direct marketing volumes driving the improvement. As expected, we are seeing client marketing activity increasing as the economy recovers, and we believe that trend will continue as the year progresses. I'm also pleased to report that RRD Marketing Solutions, which was established only four years ago, is now one of the 10 largest marketing service agencies in the U.S. and among the 20 largest in the world, according to the 77th Ad Age Agency Report. We reported $41 million in adjusted income from operations, a $20 million or 96% increase compared to the prior year, despite a number of sizable headwinds, including higher variable incentive compensation, primarily due to an increase in our stock price, unfavorable foreign exchange, and the census project not repeating. We also expanded our adjusted operating margin by 150 basis points versus the prior year as a result of our strong operational execution focus in our streamlined cost structure. Notably, both our adjusted income from operations and operating margin for the quarter exceeded our pre-pandemic 2019 second quarter earnings and margin. On the balance sheet, our total debt outstanding was down nearly $500 million from the same period a year ago, which represents our lowest second quarter level since the spin in 2016. Our favorable results for both the quarter and the first half of the year are directly attributable to the sustained focus and execution of our strategic priorities. We continue to execute at a high level, strengthening our core performance by aggressively driving our productivity initiatives, improving our operating leverage, and lowering our cost to serve. We are favorably shifting our business mix through sustained sales growth in our strategic product categories, and we continue to target our investments towards expanding our capabilities, building scale, and enhancing our operational agility. While we always have more work to do, we are confident in our strategy and the actions we are taking to position R&D for future success. We're emerging from the pandemic as a stronger R&D with enhanced ability to flex our capabilities across industries, including financial, healthcare, retail, and services, some of our strongest industry verticals. We have an extensive portfolio of products and services, and we've demonstrated that we can help clients efficiently connect with their customers in times of both contraction and in times of growth. I'd like to share a few examples that highlight how we are effectively leveraging our industry-leading capabilities to support our clients' communication needs. We secured a new agreement with Ellume, an Australian digital diagnostics company, who was recently awarded a $231.8 million contract by the United States government to accelerate production of its COVID-19 home test in the U.S. The company's test is the first over-the-counter self-test authorized by the Food and Drug Administration. This rapid antigen test sold without a prescription can be performed at home with the test results conveniently delivered to your personal smartphone in just 15 minutes. Ellume selected R&D to manage its entire U.S. supply chain because of our scope and expertise in rapidly scaling diagnostic test kits. The program takes advantage of the integration of our packaging and labels capabilities coupled with our supply chain solutions and commercial print offerings. We're excited to expand our relationship with Emerus, a leading synthetic biotechnology company that owns and operates a family of fast-growing, clean beauty brands created with sustainable and natural ingredients. Our idea has provided superior printing and packaging capabilities to Emerus since 2019, and we are proud to produce the retail carton packaging for the North American launch of their new color cosmetics brand. Amherst is committed to using sustainable packaging for its products, and R&D was able to offer a customized Amstock solution that meets these objectives made from 100% post-consumer waste. R&D designed and developed a variety of carton structures and printing shades of custom mixed soy-based inks which match the colors of the cosmetics. Through our breadth and scale, R&D has been able to provide the massive scope needed to fulfill Amherst's rapidly expanding growth needs. Last, we are working with Novocare, a global oncology company, on an integrated solution extending beyond printed marketing material. Novacure conducts patient satisfaction surveys in Europe and wanted to do the same in the United States. The company leveraged our capabilities in survey design, printed mail, response capture and reporting, as well as data insights to successfully produce and mail the survey. RD compiled the results, captured responses, and leveraged our data analytics team to provide actionable insights to Novacure. Building on our current capabilities, we are developing new offerings in support of our clients' evolving needs. For our retail clients, we are launching a comprehensive suite of in-store marketing support services to seamlessly manage the design, ideation, procurement, and installation of store signage and fixture solutions. In-store communications have become increasingly important to manage rapidly changing consumer expectations and buying behaviors. On-site marketing services is part of our industry-leading capabilities designed to help retailers, including restaurants, home improvement stores, grocery and convenience stores, reimagine their physical environments and drive their growth objectives. RV's global outsourcing creative team announced this quarter a PDF remediation solution that will help companies make their documents more accessible to people with sight, cognition, and other disorders that may impact readability of web content. The solution combines R&D's proprietary technology and human expertise to help organizations achieve digital inclusivity and regulatory compliance across a variety of communication channels. Before I turn the call over to Terry, I'd like to emphasize our commitment to fostering an environment where all employees belong, are valued, and have an equal opportunity to pursue their career aspirations and reach their full potential. Because of our efforts in this area, RRD was recently named to Forbes List of America's Best Employers for Diversity 2021, recognizing our ongoing dedication to diversity, equity, and inclusion. We also were recognized as one of the best places to work for those with disabilities by DisabilityIN, a nonprofit dedicated to business disability inclusion. We're honored to receive both of these acknowledgments and will continue our strong focus on enhancing and embracing a diverse, equitable, and inclusive culture at RD. With that, I will now turn it over to Terry to review our financials for the quarter, as well as our improved full-year guidance that reflects our solid first half operating performance, the resilience and scale of our portfolio, and the strength of our brand. Terry, over to you.

Thank you, Dan. Our second quarter was strong across the board despite a third consecutive quarter of significant foreign exchange headwinds and the lapping of the census project. Our sales came in near the top end of our earlier estimates, and we posted our first organic net sales growth since the pandemic began to impact our global operations late in the first quarter of 2020. Additionally, our second quarter represents the fourth consecutive quarter where we have reported improvements in our organic sales performance. In fact, the majority of our products and services categories reported growth in the quarter, including labels and packaging, where we also reported our fourth consecutive quarter of organic growth as demand for e-commerce-related products continues to be strong. Adjusted income from operations in the current quarter was very strong as it not only exceeded our previous expectation and prior year results, but it also exceeded pre-pandemic 2019 second quarter results despite lower sales. We are seeing a nice flow through on our recovering sales due to the continued focus on our cost structure, which is driving significantly improved operating margins. From a debt perspective, our debt level is up slightly from the beginning of the year as we begin to build working capital for the upcoming sales peak, which is consistent with most previous years. Versus June of 2020, our outstanding debt is down $494 million, and we are now sitting at the lowest amount of debt outstanding that we have ever reported for any second quarter since the 2016 spin. While demand for our products and services continues to strengthen, we, like most companies, are working hard to overcome significant challenges related to labor shortages, supply chain disruptions, inflationary increases, and shipping delays caused by container shortages in key ports, including China. We have mostly overcome these challenges in the second quarter, and we expect to continue doing so for the balance of the year as these challenges are not expected to subside in the foreseeable future. I'll talk more about our outlook later in my prepared remarks, but first, let me get started with a review of our second quarter performance. Turning to slide eight, net sales were up 13.5% in the second quarter, which included $21.7 million of a benefit due to foreign exchange. On an organic basis, we reported growth in net sales of 11.4%. We reported sales increases in most of our product categories due to increasing demand for our products and services, including demand from the continuing recovery from the COVID-19 pandemic. For the segments, business services reported another strong quarter with organic growth of 11.6%. All product categories except for statements delivered organic growth. Importantly, we again delivered organic growth in our strategic focus areas including packaging, labels, and supply chain management as we continue to win new business and grow sales with our existing clients. Also, the strong performance in our commercial print products includes increased demand from our clients who sell trading cards. Marketing Solutions reported organic growth of 10.3% as a result of increases in clients' marketing-related spend partially offset by last year's census project, which was completed in mid-2020. All product categories except for digital and creative solutions experienced organic growth. On slide nine, adjusted income from operations of $41 million was $20.1 million higher than the second quarter of 2020. In addition, the corresponding operating margin increased from 2.1% in 2020 to 3.6% this quarter, representing an increase of 150 basis points. Higher sales volume combined with targeted actions taken to reduce the company's cost structure benefited both our adjusted income from operations and operating margins and more than offset higher variable incentive compensation expense, largely driven by the increase in our stock price. Approximately $9 million in unfavorable foreign exchange, which is mostly associated with our operations in China, and last year's Census project. Adjusted SG&A expense of $143.6 million in the second quarter was up $9 million, or 6.7% from the prior year, reflecting an increase in sales commission expense on higher sales, as well as higher variable incentive compensation expense. As a percentage of sales, adjusted SG&A expense improved from 13.3% in 2020 to 12.5% this quarter, reflecting the company's ongoing efforts to lower our cost to serve. Adjusted earnings per share from continuing operations was $0.07 in the second quarter as compared to a loss per share of $0.10 reported in the prior year quarter. The increase was attributable to higher adjusted income from operations and lower adjusted interest expense partially offset by unfavorable income taxes. Our adjusted effective tax rate was 66.9% in the quarter versus 28.2% a year ago. Last year's tax rate reflects the benefits from the CARES Act, and the current period is negatively impacted by a foreign statutory tax rate increase. Our gap results for the quarter included pre-tax restructuring, impairment, and other charges of $9.7 million, which were $18.7 million lower than last year due to lower employee termination charges associated with the aggressive cost actions taken at the beginning of the pandemic to reduce our cost structure and one-time charges related to a consulting agreement. In addition, we incurred a $9.2 million charge related to terminating certain interest rate swap agreements associated with the portion of our term loans repaid in the quarter and a loss on debt extinguishment of $6.2 million, primarily associated with writing off unamortized debt issue costs. Turning now to the balance sheet and cash flow on slide 10. As of June 30th, 2021, we had total cash on hand of $237.2 million, a total debt outstanding of $1.54 billion, which was up $38.8 million versus the prior year end due to slightly higher net working capital as we begin to prepare for the upcoming holiday season. Availability on the credit facility was $462 million at the end of the quarter, and total available liquidity, including cash on hand, was $699.2 million. Our gross leverage ratio of 3.8 times at June 30th, 2021 improved from 4.7 times at June 30th, 2020, while the net leverage ratio of 3.3 times improved from 3.9 times a year ago. Cash used in operating activities during the six months ended June 30th, 2021 with $64.8 million compared to $44.2 million in the prior year period. The increase in cash used from operations during 2021 is primarily driven by $23.9 million of LSC bankruptcy-related payments, mostly associated with lump-sum settlements for employee retirement obligations, higher tax and incentive compensation payments, and a $9.2 million payment to terminate certain interest rate swap agreements. In addition, the prior year results included $16.4 million of positive operating cash flow from discontinued operations. These factors were partially offset by a lower restructuring and interest payments. Capital expenditures in the six months ended June 30, 2021, of $29.9 million, or $8.2 million lower compared to last year. Slide 11 summarizes several key actions we have taken to improve our balance sheet. Collectively, our efforts have yielded a reduction in total debt outstanding of nearly $850 million since 2016, while significantly improving both our gross and net leverage. In regards to the pending sale of our printing facility in Shenzhen, China, we continue to wait for the required government approval so we can complete this transaction. The buyer has recently notified us that the process of getting the regulatory approvals from the Chinese government is taking longer than originally expected and that they do not expect the transaction to close until sometime after 2022. Once the transaction does close, we expect to record a significant gain on the sale and repatriate the net proceeds to the U.S. To date, we have collected $123.3 million in deposits and and we are scheduled to collect an additional deposit of approximately $50 million later this year. Our contract with the buyer requires them to pay the final installment in 2022, even if the government's approval is delayed. If the buyer fails to comply with terms of the agreement or terminate for any reason, RRD is entitled to retain 30% of the purchase price in liquidated damages. Also, year to date, we have sold four properties which generated proceeds of approximately $5 million. Slide 12 shows the various maturities of our outstanding debt as of December 31st, 2020 and on June 30th. During the second quarter, we issued $450 million of new senior secured notes due in 2026 and used the proceeds to repay portions of our term loan and credit facility. In addition, we amended and extended our credit facility, which now matures in 2026. Completing these two transactions represents another significant step forward in our strategic initiative to improve our balance sheet flexibility. Our expectations for full year 2021 are reflected on slide 13. Although many uncertainties remain, including those related to the pace of recovery from the pandemic, supply chain disruptions, inflationary increases and shipping delays, the company is providing the following improved guidance for the year. Net sales for the year are now expected to be up 1% to 3%, taking into consideration reductions from the census project and one-time pandemic-related projects in the last half of 2020, offset by further economic recovery as the year progresses. The company has significantly increased its expectation for non-GAAP adjusted income from operations and now expects it to be roughly flat to the prior year after including the negative impact of foreign exchange. At current exchange rates, foreign exchange is now expected to be $28 million unfavorable for the year. This outlook also assumes the company continues to overcome the impact from future inflation, labor shortages, and supply chain disruptions while continuing to benefit from aggressive cost reduction actions. Previously, the company had expected its full-year non-GAAP-adjusted income from operations to be flat two up slightly versus the prior year, excluding the unpredictable impact from changes in foreign exchange. Appreciation expense is expected to be approximately $135 million for the year. Non-GAAP interest expense is expected to be approximately $120 million, excluding the second quarter GAAP-only charge of $9.2 million associated with terminating certain interest rate swap agreements in connection with the April 2021 term loan repayment. The approximately $15 million reduction is expected to include benefits from prior repurchases and repayment of higher interest rate debt along with lower average borrowings and a lower average interest rate in 2021 as compared to 2020. The full year non-GAAP effective tax rate is expected to be approximately 38%, which is higher than reported in 2020 as non-recurring benefits from the CARES Act were reflected in the prior year. Operating cash flow is expected to be slightly lower than the prior year, reflecting a reduction due to payments to settle LSC bankruptcy-related obligations and repayment of half of the employer portion of payroll taxes deferred in 2020. Capital expenditures are expected to be approximately $80 million. As part of our agreement to sell the printing facility in China, the company expects to collect one additional deposit of approximately $50 million later in 2021. The company also expects to continue generating proceeds from monetizing other assets, including proceeds from selling additional facilities. And now, operator, let's open up the line for questions.

Thank you. We will now begin the question and answer session. If you have a question, please press star, then the number 1 on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star, then 1 on your touchtone phone. Your first question comes from the line of Charles Schroeser with CJS Securities.

Hi, good morning.

Good morning, Charlie. Hi, Charlie.

Hey, very impressive growth in the quarter. I wanted to kind of take a few minutes if we could, Dan, maybe to just delve a little bit deeper by product line. That's the drivers there, obviously. Commercial print was a pretty big outlier in growth. And you mentioned trading cards as being part of that. But maybe let's dive in a little bit deeper here to try and figure out what was more kind of catch-up business, you know, kind of one-time versus, you know, potentially more sustainable growth.

Yeah, Charlie, I'll go touch on a number of the different product categories that we mentioned that really contributed to our growth in the quarter. And if I start within business services, commercial print being at the top of that list, I think it's important to note that trading cards clearly had an impact on that. But it's also important to note within that business, it's really a combination of different types of products that we are producing as part of that commercial print platform. So there are... There are brochures and such that are a little bit more of the marketing variety. There are informational-type documents in terms of instructions for use, et cetera. There are health care documents that run through that platform, and the trading card piece that runs through that platform. So a lot of different products within that. But I'd say generally, Charlie, I would attribute it more to a – strengthening of broad client demand as opposed to specific or unique one-time events outside of the strengthening of trading cards and the peaks and valleys we see within that. But I'd describe that more as a general recovery of small to midsize and large client volumes flowing through commercial print. Within packaging and labels, Terry touched on it, but continued strength through e-commerce channels is making a, you know, continue to drive volumes on that front, particularly from a label standpoint and from a packaging, you know, new wins that we've had there and strengthening overall demand on that front from clients as the economy recovers is a core element of that as well. And supporting that from a supply chain services perspective also within business services. If I shift to marketing solutions and I focus on, you know, really the digital print and the direct marketing side, I would say the same thing, that the digital print has a variety of different products that run through it, and DM, pretty much straightforward there, another type of product that's running through that. But the general message I would give everyone there is that's a recovering product client demand environment as opposed to being driven by one-off type activities that occurred in the second quarter.

Excellent. Thank you very much. Sorry for you. If you could spend a couple minutes maybe just to talk about the guidance and expand a little bit more as to what we should see in the current Q3 quarter and how we should think about the assumptions there.

Yeah, I think, you know, if you start with the revenue, you know, as Dan mentioned, the second quarter really didn't have any kind of outliers by way of, you know, large kind of one-time projects. We always have smaller one-time projects kind of throughout, but there was, you know, now that the census is done, you know, there was really no outliers in that second quarter. Now, as we look ahead to the third and fourth quarter, we continue to see, you know, a strong demand coming through. The third and fourth quarter of last year, the comps do have a bit of a challenge in there in that we did have some one-time large pandemic-related projects that came through. At this point, we are not forecasting anything. Those came up very quickly last year, and honestly, we never forecast them in any of our guidance that we were issuing at the time. given how fast they came up. But that holds true right now. We do see a bit of a lapping challenge with those. Those were in third quarter and even a little bit more in fourth quarter. So those at this point will create some lapping challenges for us. But setting that aside, kind of the core demand for the products is good. We had a good recovering third and fourth quarter last year even without those projects. So we see ourselves continuing to build upon that as we go into the last half. The FX, I mentioned that at the current rates we're expecting a $28 million impact for the full year. We've booked $20 million of that already between Q1 and Q2, and the last eight would mostly hit right now in third quarter because it was fourth quarter of last year that the rates started to go against us. So we're lapping an easier quarter from that perspective. So that last $8 million, again, assuming the rates don't change here at all, we would expect that to really manifest itself in our third quarter earnings forecast. We'll continue to focus on the cost structure. That will continue to have benefits and hopefully offset some of these challenges for us. Stock price is another item right now that's providing and creating some volatility for us. We have a number of our – are awards that are subject to variable accounting, which means that we have to adjust them to whatever the current stock price is at every given quarter. So when the stock price goes up, we take adjustments to record more expense. And when the stock price goes down, it goes the other way. So that's been very volatile for us in first and second quarter. And it's hard to say and hard to predict what that will do for the last half. But that is certainly a challenge for us. Again, we We work to manage and control that as much as possible through, you know, identifying cost-out actions that can help offset potential negative impact there. And we'll continue to focus on trying to get ahead of it through other means like that. So, again, those are some of the kind of big things to think about as you look to the last half of the year.

Great. Thank you. And just lastly, just on the LSC obligations there, maybe touch a little bit more as to What steps are being taken to try and analyze that and put that behind you?

Yeah, so the payments mostly were to settle – we had favorable settlement opportunities with a couple of the MET plans, the multi-employer pension plans that we inherited through the LLC bankruptcy. So we did settle those with favorable discounts on those obligations on two of the three. So we have one – One plan still out there that's roughly, I think, about $13 million still on the balance sheet for our portion of that obligation. At the current time, we are not actively engaged with that plan to settle that. So my current expectation is that we would just... fund that on a recurring basis over the next 12 or 13 years. Again, the payment there, annual payments are very small. But again, unless we had a significant opportunity to settle that at a very, very favorable discount, we do not plan to further negotiate and further settle on that. So So with that said, you know, most of the big payments that we see in 2021 here related to the LLC bankruptcy, most of those are behind us. It's possible we could have a few small lease charges that we would have to fund for the balance of the year. But the big settlements, you know, the $24 million that we paid now, that for the most part is behind us, and we wouldn't expect anything like that to repeat in the last half of the 2021 year here.

Great, thanks. And just lastly for me, for Dan, just, you know, any commentary on the – I saw your response to the Chatham letter. Just, you know, any further commentary that you can provide us there?

Yeah, I wouldn't say we have any additional commentary there, Charlie, beyond what we have already released.

Great. Thank you very much.

Okay. Thanks, Charlie.

And as a reminder, if you would like to ask a question, please press star then the number one on your telephone keypad. Again, that is star then the number one. And there are no further questions at this time. I would now like to turn the call back over to Dan Knotts.

Great. Thanks, Brandi. A summary of our key takeaways can be found on slide 15 of our presentation. In closing, I'd like to express my sincere appreciation and gratitude to all of our employees around the world. The leadership, cooperation, and teamwork we are seeing at all levels of R&D is truly remarkable. I'm confident that the hard work we're doing today is building even stronger RRD for the future. Thank you for everything you are doing. We certainly appreciate you. Johan, back to you.

Thanks, Dan. As a reminder, information to access a webcast replay of RRD's second quarter 2021 results call can be found on the investor section of our website at rrd.com. Thank you for joining us. And that concludes the RRG second quarter 2021 earnings call.