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-- U.S.-based commercial printing company R.R. Donnelley reported third quarter results that were weaker than expected, with revenues down 6.5% and EBITDA flat. -- We are affirming our 'BB' rating on the company. -- We are revising our outlook to negative from stable. We are concerned that the rate of revenue decline could accelerate, with repercussions for discretionary cash flow, especially given our weak economic forecasts for 2013. Nov 6 - Standard & Poor's Ratings Services today affirmed its 'BB' corporate credit rating, as well as its other ratings, on Chicago-based R.R. Donnelley & Sons Co. (RRD). At the same time, we revised the rating outlook to negative from stable. The company reported weaker-than-expected results for the third quarter (ended Sept 30, 2012), with revenues declining 6.5% in part because of steep declines for commercial printing and variable printing services, which are economically sensitive. We see the risk that revenues declines, which had been generally in the low single digits, could accelerate, especially given the weak economic forecasts for 2013, with the result that leverage will not decline to the upper-3x area (currently 4.3x as of Sept 30, 2012), which is our target for the current 'BB' rating. Our ratings on RRD are predicated on the company's positive cash flow generation (despite revenue declines), and the assumption that leverage will decline to the high 3x area by the end of 2013, provided that economic and pricing pressures do not worsen. We regard the company's financial risk profile as "significant" (based on our criteria). Our "fair" business risk profile reflects RRD's market position and efficiencies associated with its critical mass. The company faces secular declines in several of its products and pricing pressure because of industry overcapacity. We believe that these trends could cause RRD's organic revenue to decline over the near and intermediate term. The printing industry has steadily lost ground to electronic distribution of content and online advertising. As a result, it has been afflicted by overcapacity, chronic pricing pressure, and the need to continuously take out costs. RRD is the largest participant in the industry, with broad-based services that address a variety of end markets. RRD's size confers important efficiencies, the capacity to provide one-stop service to clients, the ability to invest in leading technology, and the ability to cope with pricing pressure more successfully than many of its competitors. Nevertheless, several of its important end markets, notably the magazine, retail inserts, directory, and book businesses, are subject to long-term adverse fundamentals as well as general economic cyclicality. In the third quarter, its commercial printing business and variable printing businesses, which are economically sensitive, experienced significant declines. Industry volume shrinkage is likely to continue to necessitate capacity downsizing and restructuring charges. Our base-case scenario incorporates our expectation that revenue could decline at a low-single-digit percent rate for 2012 and 2013. We believe EBITDA will decline at a mid-single-digit percent rate in 2012 and could decline at a more accelerated rate in 2013 because the company's ability to cut costs in line with revenue decline is limited as a result of its high fixed costs. This would cause EBITDA margin to decline to under 11%. We expect free cash flow of about $450 million in 2012 and 2013 (even though 2013 will benefit from a lower pension contribution). In the third quarter, revenue declined 6.5% (5.2% on an organic basis). EBITDA, which we calculate including restructuring charges, was flat, partially because these charges were lower. The EBITDA margin widened to 11.3% in the 12 months ended Sept. 30, 2012, from 10.6% in the same period last year. RRD's leverage (adjusted primarily for pension and lease obligations and including restructuring charges) was 4.3x for the 12 months ended Sept. 30, 2012. Leverage was above the adjusted debt-to-EBITDA range of between 3x and 4x that we associate with a "significant" financial risk profile. Management reiterated in its Nov. 1 earnings call that it intends to maintain a leverage target of 2.5x to 3.0x, according to its calculations, which excludes restructuring charges and pension and lease adjustments. This corresponds to a 3.6x to 4.1x leverage figure based on our methodologies. The company also stated that it intends to pay down debt this year and next year. We expect leverage will be in the low-4x area at the end of 2012 and could decline to the upper-3x area in 2013, assuming the company pays back some debt with free cash flow. Further weakening of the economy, coupled with additional restructuring charges by the company, could cause us to revise our leverage assumptions. The company converted about 20% of EBITDA to discretionary cash flow at Sept. 30, 2012. We expect the company to convert roughly 30% of EBITDA to discretionary cash flow this year. RRD has "adequate" liquidity, in our view, to cover its needs over the next 12 months, even with moderate unforeseen EBITDA declines. Our assessment of RRD's liquidity profile incorporates the following expectations and assumptions: -- We expect sources to cover uses by more than 1.2x for the upcoming 12 months. -- We believe sources minus uses would remain positive if EBITDA were to drop by 15%. -- Compliance with maintenance covenants would survive a 15% decline in EBITDA. -- We believe the company could absorb high-impact, low-probability impacts without refinancing. We expect RRD to generate positive discretionary cash flow of roughly $450 million for the full year after annual capital expenditures of roughly $200 million to $225 million, and dividend payments of roughly $190 million. We expect the company to generate about $300 million in discretionary cash flow in 2013, benefiting from recent pension legislation that relaxes a pension's sponsor's cash funding requirements, but offset by our expectation of lower EBITDA. RRD does not have any significant near-term maturities. The company had $767 million of availability under its new (Oct. 15) $1.15 billion revolving credit facility ($344 million drawn). Covenants include a 3.75x total leverage ratio and a 3.0x interest coverage covenant. In addition, the company had $393 million of cash on its balance sheet as of Sept. 30, 2012. For the latest recovery analysis, see Standard & Poor's recovery report on Donnelley, to be published on RatingsDirect as soon as possible following the release of this report. The negative rating outlook reflects our concern that revenue declines could accelerate from the historical 2.0%-2.5% rate, resulting in leverage remaining above 4x (the high end of our threshold for the current rating). We could lower the rating if we conclude that secular risks facing the company have increased and could cause organic revenue to decline at a brisker pace or that leverage will be chronically above 4x with little prospect for improvement. This could occur if revenue were to decline at a mid-single-digit percent rate and if the company's EBITDA margin were to decline. We could revise the outlook to stable if we become convinced that leverage will decline to below 4x on a sustainable basis. This could be achieved through the company using its free cash flow to repay debt as we do not anticipate a resumption of organic revenue and EBITDA growth in the next few years. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 Ratings List Rating Affirmed; Outlook Revised To From R.R. Donnelley & Sons Co. Corporate credit rating BB/Negative/-- BB/Stable/-- Ratings Affirmed R.R. Donnelley & Sons Co. Senior secured BBB- Recovery rating 1 Senior unsecured BB Recovery rating 4 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. 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