Credit Opinion: R.R. Donnelley & Sons Company
Global Credit Research - 13 Aug 2013
Chicago, Illinois, United States

Ratings
Category Moody's Rating

Outlook Corporate Family Rating Sr Sec Bank Credit Facility Senior Unsecured Commercial Paper Speculative Grade Liquidity

Negative Ba2 Baa2/LGD1 Ba3/LGD4 NP SGL-2

Contacts
Analyst Phone

Bill Wolfe/Toronto Donald S. Carter, CFA/Toronto

416.214.3847 416.214.3851

Key Indicators
R.R. Donnelley & Sons Company 2010 2011 2012 LTM Q2-2013 $10,018.9 $10,611.0 $10,221.9 $10,278.5 4.0x 4.6x 4.4x 4.4x 5.7% 8.6% 7.9% 8.8% 3.1x 2.6x 2.6x 2.6x 4.2x 3.9x 3.6x 3.5x 15.0% 13.3% 14.2% 13.2%

Net Sales (in Millions) Debt / EBITDA FCF / Debt (EBITDA-Capex) / Interest (FFO+Interest) / Interest RCF / Debt All ratios reflect Moody's Standard Accounting Adjustments

Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide.

Opinion Rating Drivers
- Muted general economic conditions and continued over-capacity limit prospects for cash flow growth - The rating depends on ongoing de-levering

Corporate Profile
Headquartered in Chicago, Illinois, R.R. Donnelley & Sons Company (RR Donnelley) is North America's largest commercial printing company, with annual revenues of approximately $10.3 billion of which 74% comes from North American operations while 26% is international. RR Donnelley provides pre-media, printing, logistics and business process outsourcing products and services.

SUMMARY RATING RATIONALE
RR Donnelley is weakly positioned at the Ba2 level because of elevated leverage and very weak industry

fundamentals evidenced by stalled revenue growth. With organic revenue growth having stalled and given the implication that EBITDA will stagnate, management implemented more conservative Debt-to-EBITDA policies, and the rating assumes significant debt repayment as efforts to restore financial flexibility unfold. We expect management to apply virtually all of the company's nearly $300 million of annual free cash flow (Moody's estimated) towards debt reduction for the foreseeable future. The rating continues to benefit from the company's resilient cash flow profile. During the 2008/2009 recession, despite 2009 revenue being 15% less than in 2008 and despite a 34% EBITDA decline, the company remained cash flow positive in 2009.

DETAILED RATING CONSIDERATIONS
- MUTED GENERAL ECONOMIC CONDITIONS AND CONTINUED OVER-CAPACITY LIMIT PROSPECTS FOR CASH FLOW GROWTH Commercial printing is a very fragmented and competitive industry with chronic over-capacity that causes pricing and margin pressure. This pressure was significantly magnified in the 2008/2009 recession. Conditions rebounded in 2010, however, based on shipments of key paper grades used by commercial printing companies, we believe the 2010 gains were given back in 2011 and conditions have been relatively stagnant since then. We believe that capacity utilization, the value of industrial production, and consumption of paper grades consumed by commercial printing companies, three parameters we track to gauge industry conditions, remain at or below recessionary trough levels. We also see little potential for improvement as digital media continues to displace print. We estimate industry-wide capacity utilization at 60%-to-70%. Permanent improvement in the capacity utilization rate will be difficult to manage. We know from paper and forest products industry indicators that North American demand for coated and uncoated communications papers, key paper grades for commercial printing, is on a long term downwards trend of approximately 5% per year. Consequently, even with consolidation shuttering printing capacity, we anticipate fundamentals languishing and margins remaining in the same general range as recent observations. RR Donnelley continues to diversify its revenue base. However, the company is unable to diversify into businesses with growth prospects that exceed GDP, and we believe that diversification efforts involve taking share from competitors in adjacent industries. Consequently, while the effort is credit-positive, at best it is playing margin-maintaining defense but does not provide cash flow up-side. - THE RATING DEPENDS ON ONGOING DE-LEVERING The company's debt load and dividend pay-out were sized prior to recent industry contraction and ongoing margin compression that has reduced EBITDA. In its February 26, 2013 earnings release, RR Donnelley announced a more conservative, 2.25x-to-2.75x, target range for leverage of Debt-to-EBITDA (revised from 2.5x-to-3.0x). The target leverage range revision and stage-setting for de-levering are both credit-positive, however, pending Moody's adjusted Debt-to-EBITDA reaching 3.75x by 2015, RR Donnelley will be weakly positioned at the Ba2 rating level. We expect interest expense plus the dividend will consume an aggregate of more than 45% of EBITDA during 2013 and 2014. With capital expenditures consuming a further 28% of EBITDA and with cash taxes increasing and with mandated pension funding, conversion of EBITDA into (after-dividend) free cash flow is somewhat limited at approximately $300 million per year, a modest 6% of debt (in the above discussion, capital expenditures, EBITDA, interest expense and debt are inclusive of Moody's standard adjustments). The rating assumes significant debt repayment as efforts to restore financial flexibility unfold. We expect management to apply all of the company's nearly $300 million of Moody's-estimated after-dividend free cash flow towards debt reduction for the foreseeable future. Execution risks include unexpected operational set-backs or a change in management's commitment. The rating continues to benefit from the company's resilient cash flow profile. During the 2008/2009 recession, despite 2009 revenue being 15% less than in 2008 and despite a 34% EBITDA decline, the company remained cash flow positive in 2009. Together with good liquidity, this provides important downside protection. There is also the potential of dividend reduction augmenting debt reduction efforts. Despite a constant per share dividend over the past several years and share buy-backs that have reduced the share count, the proportion of cash from operations (before working capital changes) consumed by the dividend has increased from 16% in 2007 to an estimated 21% LTM. While the rating does not presume dividend reduction, nor does it presume asset sales which are also a possible source of supplementary cash flow, accelerated debt reduction would be credit-positive.

Liquidity
With challenging fundamentals and a business whose activity levels are volatile, RR Donnelley needs to have solid liquidity arrangements. We assess the company's liquidity arrangements as being good (SGL-2). RR Donnelley has a well-spaced ladder of debt maturities and we expect the company to generate in excess of $300 million some 25% of EBITDA, after interest expense (30% of EBITDA), capital expenditures (28% of EBITDA), and dividends (16% of EBITDA). This source of liquidity would normally be augmented by cash on hand, but $248 million of the company's $354 million cash balance is held offshore and is subject to local country income or withholding taxes if repatriated, implying that the usable cash balance is much lower. RR Donnelley's main source of third party liquidity is a $1.15 billion revolving credit facility that matures in October 2017. The facility is sized at a reasonable 11% of annual sales. At June 30, 2013, the revolver was undrawn and the company had a cash balance of $354 million (although, as noted above, a significant portion was held off-shore and would result in significant taxes were it repatriated). Access to the credit facility is subject to two financial covenants, total debt to EBITDA and EBITDA to Interest Expense (as defined in the credit agreement). The applicable thresholds are 3.75x for the total debt to EBITDA test and 3.0x for the EBITDA to Interest Expense, and as of June 30, 2013, the applicable measures as 2.9x and 4.7x, respectively, indicating reasonable cushion. Covenant compliance is not expected to restrict access to the revolving credit facility over the next several quarters.

Structural Considerations
RR Donnelley is an operating company that also holds equity interests in various other operating companies. The company's non-debt liabilities reside both at RR Donnelley and a number of its subsidiaries, while all rated debts reside solely at RR Donnelley. The revolving credit facility benefits from secured up-stream guarantees from various operating subsidiaries. However, since the $1.15 billion revolving facility is small relative to the company's $3.4 billion pool of unsecured notes, and with advantageous access to realization proceeds and ample value coverage, its rating is three notches higher, Baa2, than the company's Ba2 CFR. Reciprocally, the relatively small size of the revolving credit facility leaves sufficient residual value covering the senior unsecured pool that its rating is only one notch below the CFR at Ba3.

Rating Outlook
Given the potential of a change in management's de-leveraging commitment as well as accelerating declines in the broadly-defined commercial printing industry, the outlook is negative.

What Could Change the Rating - Up
Presuming stronger industry fundamentals and solid liquidity, positive outlook or ratings actions could result from Moody's-adjusted free cash flow-to-Debt (FCF/TD) to increasing on a sustainable basis into the 10%-to- 15% range. At that level of FCF, Moody's-adjusted Debt-to-EBITDA would likely be in the 3.0x-to-3.5x range. Given adverse systemic influences, the negative ratings outlook, and with recent measures at a significant discount to the upgrade guidance measures (estimated 2012 FCF/TD is 5.9%; Debt-to-EBITDA is 4.4x), an upgrade over the next couple of years is unlikely.

What Could Change the Rating - Down
Interruption of delivering towards 3.75x Moody's-adjusted Debt-to-EBITDA by 2015 could result in a CFR downgrade, as would adverse liquidity developments, a downwards revision in existing financial guidance or a more than 2.5% decrease in annual organic revenue.

Rating Factors
R.R. Donnelley & Sons Company Global Publishing Industry [1][2] Factor 1: Scale and Diversity (25%) Current LTM 6/30/2013 Measure Score

[3]Moody's 12-18 month Forward
View* As of August 2013

a) Consolidated Revenue (USD

$10.3

A

$10.1 - $10.2

A

Billions) b) Market Position: Content and Services c) Business and Geographic Diversity
Factor 2: Operating Performance and Volatility (17.5%)

Ba Ba

Ba Ba

Ba Ba

a) Consolidated Revenue Growth vs. Nominal GDP b) Revenue Volatility
Factor 3: Financial Policy and Event (10%)

B Baa Ba 4.4x 8.8% 2.6x B B B Ba3 4.0x - 4.3x 5% - 6% 2x - 3x

Ba Baa Ba B B B Ba3 Ba2

a) Financial Policy and Event Risk
Factor 4: Financial Strength (47.5%)

a) Debt / EBITDA b) Free cash flow / Debt c) (EBITDA-CapEx) / Interest
Rating:

a) Weighted Average Factor Result b) Actual Rating Assigned

[1] All ratios are calculated using Moody's Standard Accounting Adjustments. [2] Based on financial data as of 6/30/2013(L); Source: Moody's Financial Metrics [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures

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