<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-21525
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-316071
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
161 NORTH CLARK STREET, SUITE 2400, CHICAGO, IL 60601
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (312) 419-7600
Indicate by check mark whether the registrant (1) has filed all reports
required 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 such filing
requirements for the past 90 days. YES [_] NO [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Common Stock, par value $0.01 per share: 5,005,000 shares outstanding as of
September 30, 1996.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income for the three and nine month periods
ended September 30, 1995 and 1996.................................... 1
Consolidated Balance Sheets as of December 31, 1995 and September 30,
1996................................................................. 2
Consolidated Statements of Cash Flows for the nine month period ended
September 30, 1995 and 1996.......................................... 3
Notes to Consolidated Financial Statements............................ 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................. 7
PART II--OTHER INFORMATION
Item 1. Legal Proceedings............................................... *
Item 2. Changes in Securities........................................... *
Item 3. Defaults Upon Senior Securities................................. *
Item 4. Submission of Matters to a Vote of Security Holders............. 10
Item 5. Other Information............................................... 10
Item 6. Exhibits and Reports on Form 8-K................................ 11
</TABLE>
Specifically, the words "intends," "expects," "plans," "anticipates,"
"estimates," and similar expressions are intended to identify forward looking
statements and statements included in this Report that are not historical
facts, including statements about the Company's beliefs and expectations about
continued market and industry growth and increased penetration rates are
forward looking statements.
- --------
*No response to this item is included herein for the reason that it is
inapplicable or the answer to such item is negative.
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS.
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------- ---------------
1995 1996 1995 1996
------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C>
Business services outsourcing revenues......... $11,740 $14,733 $32,850 $41,163
Information technology revenues................ 9,340 11,047 9,338 29,860
------- ------- ------- -------
Total Revenues............................... 21,080 25,780 42,188 71,023
Cost of revenues............................... 16,880 20,271 34,957 55,580
------- ------- ------- -------
Gross Profit................................. 4,200 5,509 7,231 15,443
Selling expenses............................... 2,136 2,224 3,385 6,856
General and administrative expenses............ 1,990 1,620 3,073 5,156
Amortization of goodwill....................... 148 229 148 535
Special charge (See Note 6).................... -- 300 -- 300
------- ------- ------- -------
Earnings (Loss) From Operations.............. (74) 1,136 625 2,596
Interest expense............................... 73 187 302 313
------- ------- ------- -------
Earnings (Loss) Before Income Taxes.......... (147) 949 323 2,283
Income taxes................................... 15 475 223 1,187
------- ------- ------- -------
Net Income (Loss)............................ $ (162) $ 474 $ 100 $ 1,096
======= ======= ======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
1
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
ASSETS 1995 1996
------ ------------ -------------
(UNAUDITED)
<S> <C> <C>
Current Assets:
Cash and equivalents.............................. $ 652 $ 551
Accounts receivable, less allowances for doubtful
accounts of $607 in 1995 and $424 in 1996........ 8,990 12,597
Unbilled receivables.............................. 1,473 6,525
Inventories....................................... 3,574 4,665
Prepaid expenses and other current assets......... 488 1,335
Income tax receivable............................. 1,188 1,228
Deferred income taxes............................. 1,222 1,066
------- -------
Total Current Assets............................ 17,587 27,967
Property and equipment, net, at cost................ 9,075 10,032
Deferred income taxes............................... 780 848
Goodwill, net....................................... 11,511 20,470
Other noncurrent assets............................. 59 61
------- -------
Total Assets.................................... $39,012 $59,378
======= =======
<CAPTION>
LIABILITIES AND SHAREHOLDER'S EQUITY
------------------------------------
<S> <C> <C>
Current Liabilities:
Capital lease obligations, current portion........ $ 1,347 $ 1,142
Amounts due to LANSystems earnout participants.... -- 8,700
Dividend note and accrued interest................ -- 8,128
Advances due to R.R. Donnelley.................... 3,988 20,309
Accounts payable.................................. 6,321 6,097
Accrued salary and benefits....................... 3,046 2,935
Accrued other expenses............................ 1,652 1,153
Customer prepayments.............................. 3,538 542
Deferred revenues................................. 1,332 946
------- -------
Total Current Liabilities....................... 21,224 49,952
Capital lease obligations........................... 1,778 1,195
Other noncurrent liabilities........................ 253 --
Shareholder's Equity:
Common stock--$.01 par value, 15,000,000
authorized shares; 3,145,000 issued and
outstanding at December 31, 1995 and September
30, 1996......................................... 31 31
Preferred stock--$.01 par value, 1,000,000
authorized shares; none issued and outstanding... -- --
Additional paid-in capital........................ 15,726 7,726
Retained earnings................................. -- 474
------- -------
Total Shareholder's Equity...................... 15,757 8,231
------- -------
Total Liabilities and Shareholder's Equity...... $39,012 $59,378
======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
2
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1995 1996
-------- --------
<S> <C> <C>
Cash flows provided by (used in) operating activities:
Net income.......................................... $ 100 $ 1,096
Depreciation and amortization....................... 2,410 3,301
Amortization of goodwill............................ 148 535
Net changes in assets and liabilities............... (6,064) (15,020)
-------- --------
Net cash provided by (used in) operating
activities..................................... (3,406) (10,088)
-------- --------
Cash flows used in investing activities:
Capital expenditures................................ (2,953) (4,095)
Acquisition of LANSystems by related party.......... (16,633) --
-------- --------
LANSystems contingent payments...................... -- (9,494)
-------- --------
Net cash used in investing activities........... (19,586) (13,589)
-------- --------
Cash flows (used for) provided by financing
activities:
Advances for (to) related parties, net.............. 9,646 24,449
Repayments/dividend to related party................ (100) (8,622)
Contribution of LANSystems from related party....... 15,757 --
Due LANSystems earnout participants................. -- 8,700
Principal payments on capital leases................ (2,134) (951)
Principal payments on borrowings.................... -- --
-------- --------
Net cash (used for) provided by financing
activities..................................... 23,169 23,576
-------- --------
Net increase (decrease) in cash and equivalents..... 177 (101)
Cash and equivalents, at beginning of period.... -- 652
-------- --------
Cash and equivalents, at end of period.......... $ 177 $ 551
======== ========
The changes in assets and liabilities, net of balances
assumed through acquisitions, were as follows:
Decrease (increase) in assets:
Receivables, net.................................. $ (2,860) $ (8,659)
Inventories....................................... 69 (1,091)
Prepaid expenses and other........................ (23) (847)
Income tax receivable............................. (98) (40)
Deferred income taxes............................. (289) 88
Other noncurrent assets........................... 7 (2)
Increase (decrease) in liabilities:
Accounts payable.................................. (1,291) (224)
Accrued salary and benefits....................... 1,285 (111)
Accrued other expenses............................ 817 (499)
Customer prepayments.............................. (1,363) (2,996)
Deferred revenues................................. (2,565) (386)
Other noncurrent liabilities...................... 247 (253)
-------- --------
Net change in assets and liabilities................ $ (6,064) $(15,020)
======== ========
Interest............................................ 187 313
Income taxes........................................ $ 0 $ 246
======== ========
Supplemental non-cash investing and financing
activities:
Capital leases...................................... $ 541 $ 187
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND NATURE OF OPERATIONS
Donnelley Enterprise Solutions Incorporated (the "Company") is a single-
source provider of integrated information management services to professional
service organizations, primarily large law firms, investment banks and
accounting firms. The Company operates entirely within the information
management services segment. Within this segment, the Company offers two
general categories of services: business services outsourcing and information
technology services.
NOTE 2. INITIAL PUBLIC OFFERING
On November 5, 1996, the Company completed an initial public offering of
2,860,000 shares of Common Stock (the "IPO" or "Offering"), 1,855,000 of which
were sold by the Company, and 1,005,000 of which were sold by R.R. Donnelley &
Sons Company ("R.R. Donnelley"). Prior to the IPO, the Company was a wholly-
owned subsidiary of R.R. Donnelley. Of the $42.5 million of net proceeds to the
Company from the IPO, (1) approximately $8.7 million was used in final payment
for certain contingent obligations arising from the acquisition of LAN Systems,
Inc. ("LANSystems"), (2) $20.3 million was used in repayment of advances owed
R.R. Donnelley, and (3) approximately $8.1 million was used in repayment of the
$8.0 million Dividend Note and accrued interest. The remaining $5.4 million
will be used for general corporate purposes.
As a result of the IPO, the number of shares of common stock outstanding
increased to 5,005,000 shares (including 5,000 of restricted shares granted to
a key executive) from the 3,145,000 shares outstanding prior to the IPO and
total equity increased to approximately $50.7 million.
NOTE 3. BASIS OF PRESENTATION AND CARVE-OUT
The financial statements included herein are unaudited and have been prepared
by the Company to conform with the requirements applicable to this Quarterly
Report on Form 10-Q. Accordingly, 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 financial statements should be
read in conjunction with, and have been prepared in conformity with the
accounting principles reflected in the financial statements and related notes
in the Company's Registration Statement on Form S-1 (No. 333-10127) that became
effective on October 30, 1996.
Consolidated Financial Statements and other financial data appearing in this
Form 10-Q reflect the results of operations, financial position and cash flows
of the Company on a carve-out basis and are derived from the historical
consolidated financial statements and financial data of the Company. The
consolidated financial statements have been adjusted to reflect certain
expenses and liabilities incurred by R.R. Donnelley on behalf of the Company.
The Company believes that the assumptions underlying all such adjustments are
reasonable; however, the consolidated financial statements do not necessarily
reflect the expenses and liabilities that would have been incurred by the
Company operating as a stand alone entity.
The Company has entered into certain agreements pursuant to which R.R.
Donnelley or its affiliates have agreed to perform certain legal, tax, data
processing, risk management, employee benefit, credit and collection, cash
management and banking and accounts payable services for the Company. The
Company will be charged fees and expenses for these services, but retains the
right to terminate certain services provided under the agreements upon 30 days
notice.
The consolidated financial statements for the three and nine months ended
September 30, 1995 reflect the results of operations of LANSystems commencing
on July 1, 1995.
4
<PAGE>
The interim financial statements herein reflect, in the opinion of the
Company, all normal and recurring adjustments necessary to present fairly the
financial information for the periods presented. Certain items have been
reclassified to conform with current period classifications. The 1996 interim
results are not necessarily indicative of the results which may be expected
for the remainder of the year.
NOTE 4. EARNINGS PER SHARE
The pro forma earnings per share calculation set forth below does not
reflect actual shares issued and outstanding at September 30, 1995 and 1996,
but assumes the 5,000,000 common shares outstanding upon the completion of the
Offering and the 5,000 restricted common shares issued to a key executive (See
Note 2) were outstanding at these dates.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- -------------------
1995 1996 1995 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net income (loss)................ $ (162) $ 474 $ 100 $ 1,096
========= ========= ========= =========
Earnings (loss) per share........ (0.03) 0.09 0.02 0.22
========= ========= ========= =========
Common shares outstanding........ 5,005,000 5,005,000 5,005,000 5,005,000
========= ========= ========= =========
</TABLE>
(Earnings (loss) per share based on 3,145,000 common shares, the number of
shares outstanding prior to the offering, was (0.05) and 0.15 for the quarters
ended September 30, 1995 and 1996, respectively, and 0.03 and 0.35 for the
nine months ended September 30, 1995 and 1996, respectively.)
NOTE 5. PRO FORMA BALANCE SHEET
The unaudited pro forma as adjusted balance sheet as of September 30, 1996
set forth below illustrates the completion of the Offering and the use of a
significant portion of the $42.5 million net proceeds received by the Company
therefrom in final payment of approximately $8.7 million for certain
contingent obligations arising from the acquisition of LANSystems, the
repayment of the $8.0 million Dividend Note and accrued interest thereon and
the repayment of the $20.3 million in advances owed to R.R. Donnelley at
September 30, 1996.
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF SEPTEMBER 30, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
OFFERING PRO FORMA AS
ASSETS ACTUAL PROCEEDS REPAYMENTS ADJUSTED
------ ------- -------- ---------- ------------
<S> <C> <C> <C> <C>
Current Assets:
Cash and equivalents................ $ 551 $42,461 $ (37,137) $ 5,875
Other current assets................ 27,416 -- -- 27,416
------- ------- --------- -------
Total Current Assets.............. 27,967 42,461 (37,137) 33,291
Other assets.......................... 31,350 -- -- 31,350
Other noncurrent assets............... 61 -- -- 61
------- ------- --------- -------
Total Assets...................... $59,378 $42,461 $ (37,137) $64,702
======= ======= ========= =======
<CAPTION>
LIABILITIES AND SHAREHOLDER'S EQUITY
- ------------------------------------
<S> <C> <C> <C> <C>
Current Liabilities:
Capital lease options, current
portion............................ $ 1,142 -- -- $ 1,142
Amounts due to LANSystems earnout
participants....................... 8,700 -- (8,700) --
Dividend note and interest.......... 8,128 -- (8,128) --
Advances due to R.R. Donnelley...... 20,309 -- (20,309) --
Other current liabilities........... 11,674 -- -- 11,674
------- ------- --------- -------
Total Current Liabilities......... 49,953 -- (37,137) 12,816
------- ------- --------- -------
Capital lease obligations. noncurrent
portion.............................. 1,195 -- -- 1,195
Total Shareholder's Equity............ 8,230 42,461 -- 50,691
------- ------- --------- -------
Total Liabilities and
Shareholder's Equity............. $59,378 $42,461 $ (37,137) $64,702
======= ======= ========= =======
</TABLE>
5
<PAGE>
NOTE 6. SPECIAL CHARGE
The Company recorded a charge of $300,000 in the third quarter of 1996 to
reflect the departure, effective October 4, 1996, of Thomas P. Bradbury who
served as President of the LANSystems division. Mr. Bradbury's departure,
which was on an amicable basis, has resulted in his responsibilities being
assumed by Mr. Steve Fredette, formerly the Regional Vice President and
General Manager of LANSystems Eastern Region, pending the hiring of his
replacement, which is expected to occur by the end of the year. The Company
and Mr. Bradbury have entered into a severance agreement pursuant to which the
Company agreed to continue paying Mr. Bradbury his salary through June 21,
1997, pay him a pro-rated bonus for 1996 and permit him to participate in the
Company's employee benefit plans through such date.
NOTE 7. CREDIT AGREEMENT
The Company entered into a $22.0 million credit agreement with Harris Trust
and Savings Bank on November 5, 1996. The credit agreement will be used in
conjunction with cash flows from operations to fund ongoing operations,
seasonal cash needs, and for continued growth and investment.
6
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL
The following is a discussion and analysis of the historical results of
operations and financial condition of the Company and factors affecting the
Company's financial resources. This discussion should be read in conjunction
with the unaudited financial statements, including the notes thereto, set
forth under "Financial Statements" and the Company's Registration Statement on
Form S-1 (No. 333-10127) that became effective on October 30, 1996.
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's unaudited
consolidated statements of income as a percentage of revenues for the periods
indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ------------------
1995 1996 1995 1996
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Revenues
Business services
outsourcing................ 55.7% 57.1% 77.9% 58.0%
Information technology...... 44.3 42.9 22.1 42.0
--------- --------- -------- --------
Total revenues............ 100.0 100.0 100.0 100.0
Cost of revenues.............. 80.1 78.6 82.9 78.3
--------- --------- -------- --------
Gross profit.............. 19.9 21.4 17.1 21.7
Selling expenses.............. 10.1 8.6 8.0 9.7
General and administrative
expenses..................... 9.4 6.3 7.3 7.3
Amortization of goodwill...... 0.7 0.9 0.4 0.8
Special Charge................ -- 1.2 -- 0.4
--------- --------- -------- --------
Earnings from operations.. (0.3) 4.4 1.5 3.7
Interest expense.............. 0.3 0.7 0.7 0.4
--------- --------- -------- --------
Earnings before income
taxes.................... .00 3.7 0.8 3.2
Income taxes.................. 0.1 1.8 0.5 1.7
--------- --------- -------- --------
Net Income................ (.1)% 1.8% 0.2% 1.5%
========= ========= ======== ========
</TABLE>
- --------
Note: the results of operations of LANSystems are included in the Company's
consolidated statements of income since July 1, 1995.
Revenues
The Company's revenues for the three and nine months ended September 30,
1996 increased 22.3% and 68.4%, respectively, as compared to the corresponding
periods in 1995. The $28.8 million increase in revenues for the nine months
ended September 30, 1996 was comprised of an $8.3 million, or 25.3%, increase
in business services outsourcing revenues and a $20.5 million increase in
information technology services revenues, reflecting the June 1995 acquisition
of LANSystems.
Increased penetration in the Company's target markets is a key element in
its growth strategy. The Company's business services outsourcing group
increased its client base in the investment and commercial banking markets
with four new clients during the nine months ended September 30, 1996. Three
client service expansions combined with increased volumes in 1996 accounted
for a $6.2 million increase in revenue during the first nine months within the
business services outsourcing group. Cross-selling within the Company's
existing client base resulted in two new systems management outsourcing
contracts subsequent to the close of the third
7
<PAGE>
quarter. Information technology services revenue grew 18.3% to $11.1 million
for the three months ended September 30, 1996 compared to the comparable period
(the growth rate for all of 1995 compared to 1994 was 10.7%), due in part to
several large scale implementations of NT in both the legal and investment
banking markets. The Company expects to continue to capitalize on the
marketplaces' migration from Netware to NT.
The strategy to focus on higher margin technology related services continues
to drive a change in the Company's product mix, resulting in an increase in
information technology service related revenues which generate a higher margin.
Information technology services revenues for the three months ended September
30, 1996 were comprised of $5.6 million, or 50.4%, of hardware and software
product resales and $5.5 million, or 49.6%, of service related revenue,
compared with $5.2 million, or 56%, of hardware and software product resales
and $4.1 million, or 44.0%, of service related revenue for the three months
ended September 30, 1995.
Cost of Revenues; Selling and General and Administrative Expenses
During the three months ended September 30, 1996 and 1995, the Company's cost
of revenues as a percentage of revenues were 78.6% and 80.1%, respectively, and
during the nine months ended September 30, 1996 and 1995 were 78.3% and 82.9%,
respectively. The Company has managed to improve its cost of revenues as a
percentage of revenues by economies of scale and revenue growth.
Selling expenses as a percentage of revenues decreased for the three months
ended September 30, 1996 as compared to the corresponding period in 1995 to
8.6% from 10.1%, but increased for the nine months ended September 30, 1996 as
compared to 1995 to 9.7% from 8.0%. The decrease in selling expenses for the
three months ended September 30, 1996 as compared to 1995 is attributable to
increased cross-selling to existing clients. The increase in selling expenses
as a percentage of revenues for the nine months ended September 30, 1996 as
compared to 1995 was primarily due to the inclusion of LANSystems for the full
period, as selling expenses for information technology services are higher than
for business outsourcing services due to the long term nature of business
outsourcing services' contracts. Additionally, the Company recorded higher
selling expenses as a result of the start up of systems management outsourcing
services and an overall investment in sales personnel to support future revenue
growth.
The increase in general and administrative expenses to $5.2 million from $3.1
million for the nine months ended September 30, 1996 compared to 1995 was
primarily due to the inclusion of LANSystems for the full period of 1996. The
decrease in general and administrative expenses for the three months ended
September 30, 1996 compared to 1995 was due to reduced accounts receivable
write offs.
Amortization of Goodwill
During the three and nine months ended September 30, 1996, amortization of
goodwill increased 54.7% to $229,000 and 261.5% to $535,000, respectively,
compared to the corresponding periods in 1995. This increase is due to the
inclusion of LANSystems for the full period and $8.7 million of additional
goodwill recorded in the quarter for certain contingent obligations arising
from the acquisition.
Special Charge
The Company recorded a special charge of $300,000 in the third quarter of
1996 to reflect the severance agreement related to the departure, effective
October 4, 1996, of Thomas P. Bradbury who served as President of the
LANSystems division. Mr. Bradbury's replacement is expected to be hired by the
end of the year.
Interest Expense
Interest expense increased 156.2% to $187,000 for the three months ended
September 30, 1996 compared to the prior year as the result of the additional
$128,000 of interest expense associated with the $8.0 million dividend note
payable to R.R. Donnelley. This note was paid in full upon the completion of
the Offering (see Note 2). For the nine months ended September 30, 1996,
interest expense increased only 3.6% compared to the
8
<PAGE>
prior period due to the lower average outstanding levels of capital lease
obligations in 1996, offset by the interest related to the Dividend Note.
Income Tax Rate
The Company's effective tax rate decreased to 52.0% for the nine months
ended September 30, 1996 from 69.0% for the nine months ended September 30,
1995. The decrease in the effective tax rate is due in part to the increase in
pretax income which was offset in part by the effect of non-deductible
goodwill.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations, capital expenditures and acquisitions
through cash flows from operations, amounts advanced interest-free from R.R.
Donnelley, and the sale of its business services outsourcing accounts
receivable to a subsidiary of R.R. Donnelley. These receivables were sold
without recourse and the Company was not charged any factoring cost and are
not included on the Company's consolidated balance sheets. The arrangements
under which these services were provided by R.R. Donnelley terminated upon
completion of the IPO.
On November 5, 1996, the Company entered into a credit agreement with Harris
Trust and Savings Bank (the "Bank") (the "Credit Agreement") under which it
will be entitled to borrow up to $22.0 million on a revolving credit basis.
Borrowings under the Credit Agreement will mature in three years and will bear
interest (i) at the prime rate announced by the Bank or (ii) at the applicable
LIBOR rate plus, depending on the Company's fixed charge coverage ratio, 75 to
125 basis points per annum (presently at 75 basis points). At November 19,
1996, there were no borrowings outstanding under the Credit Agreement.
For the first nine months of 1996, operating cash flow (net income plus
depreciation and amortization of $3.8 million) was $10.1 million up from $3.4
million the prior year period. The Company believes cash flows from operations
and the credit agreement described above will be sufficient to fund its
ongoing operations, continued growth and investment, including acquisitions,
on a long-term basis.
Capital expenditures for the nine months ended September 30, 1996 totaled
$4.1 million, an increase of $1.1 million over the first nine months of 1995.
Capital expenditures for the full year are expected to be approximately $5.5
million.
9
<PAGE>
PART II--OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Prior to the IPO, the Company had been a wholly-owned subsidiary of R.R.
Donnelley. During the third quarter of 1996 the sole stockholder of the
Company, by written consent dated August 5, 1996, approved an amendment to the
Certificate of Incorporation of the Company and by written consent dated
September 23, 1996, the sole stockholder approved the First Amended and
Restated Certificate of Incorporation of the Company and designated three
classes of directors, Class I, consisting of Daniel I. Malina, Class II,
consisting of Leo S. Spiegel, and Class III, consisting of Rhonda I. Kochlefl
and W. Ed Tyler.
ITEM 5. OTHER INFORMATION
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. Certain statements in this filing and elsewhere (such as in other filings
by the Company with the Securities and Exchange Commission, press releases,
presentations by the Company or its management and oral statements) may
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 which may
cause the actual results, performance or achievements of the Company to be
materially different from future results, performance or achievements expressed
or implied by such forward looking statements. Such factors are discussed in
the Company's Registration Statement (No. 333-10127) under "Risk Factors," and
include, among other things, the dependence of the Company on key clients; the
Company's ability to manage growth; the sensitivity of the Company's business
and results of operations to fluctuations in the U.S. professional service
economy; risks associated with performance of information technology projects
that are critical to the operations of the Company's clients; the Company's
focus on a limited number of target markets and, therefore, a limited number of
potential clients; the ability of the Company to grow through the introduction
of new services, including systems management outsourcing; the Company's
ability to anticipate technological advances; the risks associated with the
integration of LAN Systems, Inc. and the Company's strategy of growth through
acquisitions; the variability of the Company's quarterly operating results; the
Company's ability to attract and retain key personnel in a highly competitive
marketplace; and market and general economic factors. Specifically, the words
"intends," "expects," "plans," "anticipates," "estimates," and similar
expressions are intended to identify forward looking statements included in
this Report that are not historical facts, including statements about the
Company's beliefs and expectations about continued market and industry growth
and increased penetration rates are forward looking statements.
10
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
<TABLE>
<C> <S> <C>
3.1 First Amended and Restated Certificate of Incorporation of
the Company. (1)
3.2 By-laws of the Company. (1)
10.1 Transition Services Agreement between the Company and R.R.
Donnelley. (1)
10.2 Benefit Administration Services Agreement between the Com-
pany and R.R. Donnelley. (1)
10.3 Tax Allocation and Indemnification Agreement between the
Company and R.R. Donnelley. (1)
10.4 Employment Agreement between Rhonda I. Kochlefl and the
Company. (1)(2)
10.5 Employment Agreement between Leo S. Spiegel and the Compa-
ny. (1)(2)
10.6 Severance Agreement between Thomas P. Bradbury and the
Company. (1)(2)
10.7 1996 Stock Incentive Plan. (1)(2)
10.8 1996 Broad-Based Employee Stock Plan. (1)(2)
10.9 Agreement of Merger among R.R. Donnelley & Sons Company,
Donnelley DBS, Inc. and LAN Systems, Inc. (1)
10.10 Form of Credit Agreement among the Company, as Borrower,
and the Banks named therein. (1)
27.1 Financial Data Schedule.
</TABLE>
- --------
(1) Incorporated herein by reference to the Company's Registration Statement on
Form S-1 (No. 333-10127), declared effective on October 30, 1996.
(2) Indicates a management contract or compensatory plan or agreement.
(b) No Current Report on Form 8-K was filed by the Company during the third
quarter of 1996.
11
<PAGE>
SIGNATURE
PURSUANT TO THE REQUIREMENT OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
Donnelley Enterprise Solutions
Incorporated
/s/ Luke F. Botica
By: _________________________________
Luke F. Botica Senior Vice
President and Chief Financial
Officer
Date: November 20, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996
<PERIOD-START> JUL-01-1996 JAN-01-1996
<PERIOD-END> SEP-30-1996 SEP-30-1996
<CASH> 0 551
<SECURITIES> 0 0
<RECEIVABLES> 0 19,546
<ALLOWANCES> 0 (424)
<INVENTORY> 0 4,665
<CURRENT-ASSETS> 0 27,967
<PP&E> 0 13,333
<DEPRECIATION> 0 3,301
<TOTAL-ASSETS> 0 59,378
<CURRENT-LIABILITIES> 0 49,952
<BONDS> 0 0
<COMMON> 0 31
0 0
0 0
<OTHER-SE> 0 8,200
<TOTAL-LIABILITY-AND-EQUITY> 0 59,378
<SALES> 0 0
<TOTAL-REVENUES> 25,780 71,023
<CGS> 0 0
<TOTAL-COSTS> 20,271 55,580
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 187 313
<INCOME-PRETAX> 949 2,283
<INCOME-TAX> 475 1,187
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 474 1,096
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0 0
</TABLE>
