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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(Mark
One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
COMMISSION FILE NO. 0-21525
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DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
----------------
DELAWARE 13-316071
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
161 NORTH CLARK STREET, SUITE 2400, CHICAGO, IL 60601
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
(312) 419-7600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
par value $.01 per share
----------------
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
such filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 16, 1998 was $25,918,750 based upon the closing price
on March 16, 1998.
The number of shares of the registrant's common stock outstanding as of
March 16, 1998 was 5,005,000.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy statement to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934 is incorporated into Part III hereof.
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PART I
ITEM 1. BUSINESS
GENERAL
Donnelley Enterprise Solutions Incorporated (the "Company" or "DESI") is a
single-source provider of integrated information management services to
professional service organizations, primarily large law firms, investment
banks and accounting firms. DESI offers its clients the opportunity to focus
on their core businesses by outsourcing a variety of functions, including
business services, integration services, and systems management. The Company
has experienced growth by expanding its service offerings, adding new clients,
increasing business with existing clients and capitalizing on the growing
trend toward outsourcing. In 1997, the Company's total revenues were $110.8
million, with business services outsourcing, integration services and systems
management outsourcing contributing $68.8 million, $35.1 million and $6.9
million, respectively.
BACKGROUND
R.R. Donnelley & Sons Company ("R.R. Donnelley") began offering reprographic
services in 1988 through a division known as Donnelley Business Services
("DBS") and expanded its service offerings to include networked and electronic
color printing, mailroom and facsimile services, word processing, desktop
publishing and imaging. In June 1995, DBS broadened its capabilities from
managing paper-based information to include the management of electronic
information through the acquisition of LANSystems, Inc. ("LANSystems") which
has provided integration services since 1983, including systems integration,
consulting, technical training and software development. As of January 1,
1996, R.R. Donnelley contributed the assets of DBS to LANSystems and changed
LANSystems' corporate name to Donnelley Enterprise Solutions Incorporated.
Beginning in February 1996, DESI began providing systems management
outsourcing services, which include system administration, desktop maintenance
and operation of the help-desk function. On November 5, 1996, DESI completed
an initial public offering of 2,860,000 shares of its common stock (the
"IPO"), resulting in the reduction of R.R. Donnelley's ownership in the
Company to approximately 42.8%.
SERVICES
Corporations are focusing their resources on their core businesses and
outsourcing their auxiliary support functions to third party specialists.
Additionally, the highly competitive labor market has increased outsourcing
demand for both technical and labor intensive processes. The Company
capitalizes on this opportunity by offering the following services:
Business Services Outsourcing
The Company's outsourcing portfolio encompasses a comprehensive array of
business services, including document services, desktop publishing and imaging
services.
Document Services. The Company provides reprographic, networked and
electronic color printing, mailroom and facsimile services through sites
located at the client's offices. Operations are up to 24-hours a day on
weekdays with scheduled weekend services. The reprographic operations
typically encompass black and white copying, color copying, networked printing
and binding services. The critical documents produced include legal briefs,
contracts, investment banking pitch books, presentations, tax filings and
litigation documents. The Company's average client site includes 15 document-
production employees, for whom a typical job may entail the reproduction of a
50 page document with five color inserts, spiral binding and turn-around time
of less than two hours. Monthly volumes per client site range from 50,000 to
10,000,000 pages. Reprographic services are billed monthly on a unit basis,
typically with monthly minimum volume requirements.
Mailroom services include sorting and delivery, overnight express and
messenger support. Facsimile services include both manual and electronic fax
transmission and receipt. Mail services are billed monthly to the client as a
fixed management fee plus overtime expenses. Facsimile services are billed to
the client as a fixed management fee plus overtime expenses or on a per unit
basis.
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Desktop Publishing. The Company provides on-site word processing,
proofreading, desktop publishing and graphics design services. Documents range
from high-volume text, complex numerical tables and regulatory-compliance
documents to client newsletters, presentations and marketing brochures.
Operations are typically multi-shift, employing between 10 and 20 operators
who produce client documentation within a turnaround period of less than 24
hours. Word processing services are priced on a per page, per hour or per
project basis with a minimum monthly management fee.
Imaging. The Company provides on-site imaging services and production
support such as scanning, document indexing, storage and retrieval. The
Company provides a complete turnkey service, including integration, database
development, project management and system administration. The Company's
services enable clients to process information more efficiently, store
documents electronically and retrieve information at the desktop or remotely.
A typical operation includes a cross-trained staff of five employees
performing each of the imaging tasks, which scan and index 50,000 pages per
month. Due to the project nature of this work, temporary employees are used to
staff peak volume periods. The Company supplies and networks multiple servers
located at the client's offices as well as at other offices, such as that of a
client's co-counsel. Imaging services are billed monthly on a per unit basis,
with monthly volume requirements.
Contracts and Pricing. Client engagements typically involve contracts
ranging from three to five years in duration, although the Company has entered
into a limited number of shorter-term contracts at the request of its clients.
The majority of DESI's contracts are cancelable only for cause, but the
Company generally is willing to renegotiate contracts that no longer meet the
needs of its clients. The Company believes that this policy is beneficial in
that it improves client relationships and promotes the efficient use of the
Company's resources. Substantially all of the Company's outsourcing contracts
are priced on a per unit basis for each service provided. Furthermore,
substantially all of the Company's current outsourcing contracts include a
minimum amount of services the client agrees to use, with the minimum
generally related to the historical volumes of the client. In the vast
majority of contracts the Company is able to increase or decrease the unit
pricing for each of the outsourcing services provided pursuant to a particular
contract on the anniversary date of such contract in order to reflect changes
in the actual costs of labor and supplies. The typical outsourcing contract
also provides that DESI will supply all of the equipment necessary for the
delivery of its services, the bulk of which the Company leases from third-
party vendors.
Integration Services
The Company's integration services include systems integration, software
development and technical training services.
Systems Integration. The Company provides network design, installation,
configuration and on-going maintenance for distributed computing environments.
The project range includes networks with 250 to 5,000 users, often in multiple
offices connected by a wide-area network. Projects vary in scope and duration.
Projects involving a single office typically are completed in three to six
months while large projects involving major infrastructure, operating system
upgrades and multiple applications in multiple locations, some of which may be
located outside of the United States, typically span 12 to 18 months. More
than half of integration services revenues come from engineering services
projects while the remaining revenues come from the resale of hardware or
software products. The Company also offers design and implementation of
electronic document management systems ("EDMS"). EDMS allows for fast and
efficient access to information held within a company's enterprise-wide
networks. The Company also enters into maintenance contracts on network
equipment and servers with a number of clients for which the Company has
completed a major systems integration project. Many of those clients have
elected coverage for 24 hours per day, seven days per week.
Software Development. The Company offers software development services that
include custom utilities, application and data integration and rapid
application development. Custom utilities developed in the C and C++
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programming languages are designed to take advantage of system-level features
and enhance program functionality. In the area of application and data
integration, the Company specializes in developing solutions for moving data
from different computing platforms as well as in and out of various
applications. The Company's software development team uses a variety of
programming languages, such as Microsoft Visual Basic and Borland's Delphi, to
facilitate rapid application development in client/server database
environments. In addition, Lotus Notes, Microsoft Exchange Server and Novell
lnc.'s GroupWise are used to create workflow and groupware solutions.
Technical Training. The Company offers technical training services that
include application training customized to the specific end user business
environment. The training services group provides project management,
documentation development and production and on-site training and support.
Contracts and Pricing. The Company's systems integration services are priced
on a fixed-fee basis or a time and materials basis. Cost-based pricing is used
for computer and network hardware. Contracts typically include a scope of work
and acceptance criteria for identifying project completion. Payment terms
include a downpayment, and invoices are submitted in accordance with the
achievement of negotiated milestones or dates during the projects. The
Company's maintenance contracts are priced on an annual basis with payments
usually made in advance.
Systems Management Outsourcing
The Company's information technology outsourcing services include systems
and network management, help desk and telecommunications.
Systems and Network Management. The Company typically provides on-site
technical staff to monitor and manage the client's local and wide area network
services including implementing network and systems management tools and
reporting on capacity, utilization and performance.
Help Desk. The Company provides on-site help desk services which typically
include 5-20 technical staff responding to as many as 3000 calls per month 7
days per week, 24 hours per day weekdays with scheduled weekend hours. The
Company supplies call tracking and reporting tools and utilizes a proprietary
Lotus Notes knowledge system nationally in all its operations. Information
regarding problem resolution is accumulated daily and then replicated system-
wide for use at all sites. Help desk professionals are certified on the
client's complete application suite.
Telecommunications. The Company offers on-site telecommunications support to
manage the voice and data networks at the client site. The service includes
moves, adds, and changes to the client voice network and vendor evaluation and
management.
Contracts and Pricing. Client engagements typically involve contracts
ranging from three to five years in duration. The majority of DESI's contracts
are cancelable only for cause, but the Company generally is willing to
renegotiate contracts that no longer meet the needs of its clients due to
changing client needs or service levels. The Company believes that this policy
is beneficial in that it improves client relationships and promotes the
efficient use of the Company's resources. Substantially all of the Company's
systems management outsourcing contracts are priced on a monthly management
fee basis for services provided. The management fees are priced based on
service levels, which are mutually agreed upon with the customer.
CLIENTS
The Company has been successful in establishing strong relationships with a
significant number of the leading firms in its target markets. In 1997, the
Company provided services to 37 of the 100 largest law firms as ranked by the
American Lawyer for 1996 and 8 of the 10 largest investment banks ranked by
dollar volume of public debt and equity issuances for 1997 as reported by
Securities Data Company. The Company is marketing desktop publishing and
electronic document management systems within the broader commercial market.
The Company believes that these markets, because they consist of sophisticated
professional service organizations for which document and computer processing
are critical, can benefit from the knowledge that the Company has
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accumulated in its current markets and will therefore provide an opportunity
to expand DESI's potential client base without compromising its ability to
maintain its high-quality standards and utilize its proven processes and
experience.
In 1997, approximately 10.2% of the Company's revenues came from business,
integration and systems management services provided to firms other than law
firms, investment banks and accounting firms. In 1996, approximately 23.1% of
the Company's revenues came from business, integration and systems management
services provided to firms other than law firms, investment banks and
accounting firms. The decrease in this percentage has occurred as a result of
the Company's focus on its target markets.
As of December 31, 1997, the Company provided business services outsourcing
under approximately 48 contracts, at over 54 client office locations, most of
which are located in New York, San Francisco, Chicago, Los Angeles,
Washington, D.C., Dallas and certain other major cities in the United States.
In 1997, the Company has expanded its business services offerings at an
investment banking client in Hong Kong and began a new investment banking
business services operation in Singapore. In 1997, the Company provided
integration services to nearly 200 clients. The Company has implemented
projects in offices located in many major European and Asian financial
centers. In 1997, the Company provided systems management outsourcing under
six contracts, at eleven client office locations, located in New York, San
Francisco, Chicago, Dallas, Washington, D.C. and Los Angeles.
SALES AND MARKETING
The Company markets its services primarily through 23 account executives and
sales managers who are responsible for existing clients as well as future
client development. In addition, DESI's senior management plays an active and
ongoing role in the sales process.
The Company targets high-level decision makers within a particular
professional service organization who share a commitment to the delivery of
quality service. The typical contract for business services outsourcing and
systems management outsourcing is signed between six and nine months after
discussions begin with a potential client. The sales cycle with regard to
integration services is typically between three and six months. The Company
believes that it is important to involve seasoned account executives, as well
as its executive officers, in the sales process.
The Company also employs a variety of business development and direct
marketing techniques in order to augment the work done by its own sales force,
increase industry awareness and generate interest in its services. Regular
direct mail initiatives and regular participation in industry trade shows and
conferences in its target markets have been effective historically. The
Company also co-sponsors executive business briefings and cooperative
marketing programs with vendor partners, such as Microsoft Corporation and PC
Docs Inc. Finally, several of the Company's senior executives serve as
industry spokespersons and frequently author articles on industry trends,
service issues and emerging technologies, as well as contributing to DESI's'
Research technical publication.
STRATEGY
DESI's principal growth strategy is to leverage its industry knowledge of
law and investment banking services and its service record in order to expand
into new services and markets. Key elements of the Company's strategy include
(i) increasing penetration in its target markets; (ii) leveraging its
outsourcing expertise to expand to new services such as desktop publishing and
systems management outsourcing; (iii) cross-selling its services to existing
clients; and (iv) attracting and retaining outstanding employees.
The Company believes its competitive strengths are as follows:
. Established Premier Client Base in Target Markets--DESI has well-
established relationships with a significant number of industry leaders
in its target markets. These relationships with high-quality professional
service organizations have been an important factor in enabling the
Company to add new clients.
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. Accumulated Knowledge and Expertise in Target Markets--DESI has
accumulated knowledge of the best practices to address the unique needs
of the professional service organizations in its target markets.
. Ability to Identify and Meet Client Demand for Expanded Services--DESI
has expanded to new services in response to client needs. Its in-depth
customer knowledge translates to business opportunity. Examples of
expanded services include desktop publishing, systems management
outsourcing, records management and technical training.
. Expansion into Markets Outside our Target Markets--DESI is expanding into
markets other than our target market in the services of desktop
publishing and in the integration of electronic document management
systems. The Company's desktop publishing operations have opportunities
in Fortune 1000 businesses that utilize desktop publishing services to
market their core business. The Company expects similar opportunities for
growth in the EDMS market, where the Company has significant depth and
experience in delivering electronic document management solutions to
clients.
. Proven Quality Driven Processes--DESI has developed proven, cost-
effective processes for the delivery of business services outsourcing and
information technology services, including a copyrighted production
management system which permits the Company to monitor the quality of
services provided by tracking use, service levels, turnaround and
efficiency. The Company utilizes a Lotus Notes based knowledge system,
which provides for accumulating information and leveraging the Company's
experience in problem resolution.
. Depth, Experience and Expertise of Service Delivery Personnel--The
Company has been successful in attracting and retaining talented,
motivated employees in critical positions which involve extensive client
interaction, including the client managers who oversee the performance of
the Company's business services and the technical staff providing help
desk and network support services.
COMPETITION
The Company believes that the primary competitive factors in the business
services outsourcing and information technology services markets include
reputation, a proven track record in industries served, an in-depth knowledge
of clients' businesses, strong technical expertise, project management
experience and an ability to streamline business processes. Although price is
a competitive factor within the Company's markets, it is not the principal
basis on which the Company competes because the Company's strategy is to be a
premier provider of business services outsourcing and information technology
services to firms in its target markets, which depend on high-quality, timely
work product and technical expertise.
The Company competes with the in-house capabilities of those firms in the
Company's target markets that perform their own business services, integration
and systems management functions of the types offered by the Company.
The Company's business services compete with numerous national and regional
companies. The Company's document services compete with several large national
companies, including Pitney Bowes Management Services and Xerox Business
Services, as well as several smaller regional companies, some of whom provide
only certain of such services or focus on a particular geographic region of
the United States. Competition in the Company's target markets for other
business services provided by the Company, such as word processing and desktop
publishing, is fragmented with few competitors. The competition in these areas
is limited to Tascor Incorporated. The competitors for the business service of
imaging include Quorum Corp., Aspen Systems Corp., Litigation Information
Technologies, Lason Inc. and Arthur Andersen LLP.
The market for the Company's integration services is subject to rapid change
and is highly competitive. Within this market, the Company competes with a
large number of participants, with no single organization having a dominant
market share of the Company's target markets. Competition for integration
services comes from a large number of market participants, including
management consulting firms, big six accounting firms, systems integrators,
facilities management companies and the professional service groups of large
computer manufacturers such as International Business Machines Corp. ("IBM")
and Hewlett Packard Co. Within the systems integration arena, the Company
competes primarily with national firms with legal-industry focus, including
Systems Research and Application Corp. and TechLaw Automation Partners.
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The Company's systems management outsourcing competes primarily in the legal
market. This market is relatively new and not competitive. The demand in this
market is growing as law firms are realizing the advantage to outsourcing
their systems management function.
Many participants in the business services outsourcing and integration
services markets have significantly greater financial, technical and marketing
resources; greater name recognition; and generate greater integration services
and outsourcing revenues than does DESI. The Company believes, however, that
its competitive strengths, including its reputation as a high-quality provider
of business services outsourcing, integration services and systems management
outsourcing and its knowledge and expertise in the markets that it serves,
have enabled it to be successful in persuading firms in its target markets to
use certain services offered by the Company to compete with its current
competitors.
HUMAN RESOURCES
The Company's business involves the delivery of professional services and is
labor intensive. The Company's performance depends, to a large extent, on the
continued service of its key technical personnel and client management
personnel and its ability to continue to attract, retain and motivate such
personnel. The Company provides its employees a motivational and interactive
work environment that features continuous and extensive professional
development opportunities and bonuses based on client satisfaction and company
performance, as well as a flat organizational structure that emphasizes
decision-making at the client manager level.
The Company has a comprehensive recruitment program in place to attract
highly qualified employees for business services outsourcing, integration
services and systems management outsourcing. To strengthen its expertise in
its target markets, the Company often recruits individuals with hands-on
experience and proven industry knowledge in the legal, investment banking and
accounting industries. The Company augments ongoing advertisements in national
newspapers and industry-trade publications with a company-wide employee
referral program and regular participation in job fairs and legal-specific
trade shows and conferences. The Company is a member of the On-line Career
Center and uses this vehicle to post jobs and receives resumes via the
Internet. The Company engages in selective recruiting at colleges with strong
engineering programs. In addition, the Company belongs to the Technical
Recruiter's Association in New York and employs the assistance of outside
recruitment firms on a limited basis.
The Company has a diversified training program that includes vendor-specific
certification, review of best practices and an extensive mentor program. In
1997, employees received 89 engineering certifications from computer and
hardware vendors including Microsoft Corporation, Novell Inc. and PC Docs Inc.
As part of the Company's rigorous in-house training, new employees participate
in a variety of courses such as Customized Workflow Training, Understanding a
Law Firm, Quality Assurance, Problem Resolution and Team Building. In
addition, employees attend mandatory human resources training seminars,
including seminars concerning diversity, sexual harassment and performance
leadership. In 1997, the Company started a training program for integration
services employees called Boot Camp. This training program is designed to give
every employee a comprehensive understanding of the integration services
project lifecycle, from sales through fulfillment, and the importance of their
role in it.
As of December 31, 1997, the Company had 1,192 employees, of which 1,147
were full-time employees. Approximately 852 persons were dedicated to
providing business services, including approximately 778 engaged in providing
on-site services to clients, of whom approximately 711 were hourly employees.
Approximately 215 persons were dedicated to providing integration services,
including approximately 155 technical employees. Approximately 95 persons were
dedicated to systems management outsourcing, including approximately 86
technical employees. Approximately 30 persons were dedicated to corporate
staff functions. None of the Company's personnel is covered by a collective
bargaining agreement. The Company believes that its relations with its
employees are good.
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ITEM 2. PROPERTIES
The principal executive offices of the Company are located in Chicago,
Illinois, where the Company leases a 20,000 square foot facility pursuant to a
lease expiring in May 2002. The Company provides its outsourcing services
primarily through locations at its clients' offices. Such locations are
generally provided by the client without a lease and at no cost to the
Company. The Company leases an 11,400 square foot facility in New York, New
York pursuant to a lease expiring in April 2002. The Company has 6 regional
sales offices, most of which are subject to short-term leases of not more than
three years. The Company believes that its existing facilities are adequate
for its current needs. The Company anticipates that additional space may be
required as business expands and believes that it will be able to obtain such
additional space as needed.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various claims and legal actions which arise in
the ordinary course of business. The Company believes such claims and legal
actions, individually and in the aggregate, will not have a material adverse
effect on the business or financial condition of the Company. A former client
filed suit against the Company in 1996 and the Company filed a counter claim
in 1997. The Company is of the opinion that the claim and related counterclaim
will not have a material impact on the results of operations of the Company in
the period in which resolved.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1997.
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
Information with respect to those individuals who currently serve as
executive officers of the Company is set forth below. Executive officers of
the Company are appointed annually by the Board of Directors and serve until
their successors have been duly elected and qualified.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- -------------------------------------------
<C> <C> <S>
Rhonda I. Kochlefl .... 39 Chairman, President and Chief Executive
Officer and Director
Thomas A. Munro ....... 36 Vice President, Chief Financial Officer and
Assistant Secretary
Nestor P. Holynskyj ... 35 Chief Technology Officer
Linda A. Finkel........ 38 President, Donnelley Business Services
Robert A. Lento........ 36 President, LANSystems
David J. Shea.......... 42 President, Systems Management Group
Kenneth M. Goldstein .. 51 Vice President, Human Resources
</TABLE>
Rhonda I. Kochlefl has been the Chairman, President and Chief Executive
Officer of the Company since February 1996. From January 1995 to February
1996, she was the President of DBS, and, from June 1995 to February 1996, she
was the Chairman of LANSystems. From 1992 to 1995, she was Vice President,
Division Director of DBS. From 1988 to 1991, she was General Manager for the
eastern region of DBS, for which she was responsible for all sales and
operations. Ms. Kochlefl has been a director of the Company since February
1996.
Thomas A. Munro has been Vice President, Chief Financial Officer since
January 1998 and Vice President, Corporate Controller and Assistant Secretary
since March 1997. From 1995 to February 1997, he served as Controller of DBS.
From 1993 to 1995, he was Financial and Operations Manager of DBS. He joined
R.R Donnelley in 1987 and held various financial positions with R.R.
Donnelley.
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Nestor P. Holynskyj has been Chief Technology Officer of the Company since
January 1998. He served as Vice President, Consulting Services Group of
LANSystems and Vice President/General Manager, Eastern region of LANSystems
from 1990 to 1998. From 1980 to 1990, he held two Vice President positions at
J.P. Morgan.
Linda A. Finkel has been President of the DBS division of DESI since
February 1996. From 1994 to 1996, she served as the Vice President/General
Manager for the central region of DBS. She joined R.R. Donnelley in 1982 and
held various positions with R.R. Donnelley, including that of information
services account executive.
David J. Shea has been the President of the Systems Management division of
DESI since February 1997. Prior to becoming the President, he served as the
Senior Vice President and General Manager of the Systems Management division
from July 1996 to February 1997. Mr. Shea was the Vice President and General
Manager of the eastern region of DBS and eastern region General Manager of DBS
from November 1993 to June 1996. From 1990 to 1993, he was Client Solutions
Executive and Consulting Practice Manager of Integrated Systems Solutions
Corporation, a systems outsourcing subsidiary of IBM.
Robert A. Lento has been the President of the LANSystems division since
January 1997. From January 1995 to 1997, he was the Senior Vice President of
Operations for Entex Information Services, Inc. ("Entex"), an integration
services firm. From 1992 to 1995, Mr. Lento was a Regional Director of Entex.
From 1990 to 1992, he was a General Manager of Entex. Prior to joining Entex,
Mr. Lento was the owner of Computer Professionals, Inc., which was acquired by
Entex in 1990.
Kenneth M. Goldstein has been Vice President, Human Resources since June of
1996. Prior to this position, from 1982 to 1996, he held various positions
with R.R. Donnelley, including Director of Human Resource Planning, Director
of Human Resources for the commercial print sector, Director of Organizational
Development, Manager of Supervisory and Management Development and Training
Administrator of R.R. Donnelley's Los Angeles manufacturing division. Mr.
Goldstein also taught for the Los Angeles Unified School District.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the Nasdaq National Market (NASDAQ
symbol: DEZI). The Company's Common Stock began trading on October 31, 1996 in
connection with the IPO. Prior to such time, R.R. Donnelley was the sole
stockholder of the Company.
As of March 16, 1998, there were 943 beneficial holders of the Company's
Common Stock.
The following table sets forth the high and low bid prices of the Company's
Common Stock as reported by the Nasdaq National Market for the period
beginning October 31, 1996 and ending December 31, 1997.
<TABLE>
<CAPTION>
FISCAL YEAR 1996 HIGH LOW
---------------- ------ ------
<S> <C> <C>
Fourth Quarter
(October 31 to December 31)................................ 26 1/4 19 1/4
<CAPTION>
FISCAL YEAR 1997
----------------
<S> <C> <C>
First Quarter
(January 1 to March 31) ................................... 25 9 1/8
Second Quarter
(April 1 to June 30)....................................... 11 3/8 9 1/2
Third Quarter
(July 1 to September 30) .................................. 14 1/8 8 1/8
Fourth Quarter
(October 1 to December 31) ................................ 10 7/8 7 3/8
</TABLE>
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The Company declared and paid a cash dividend of $622,000 as of June 30,
1996, and, in July 1996, declared a dividend of $8.0 million paid in the form
of the Dividend Note that was paid in full with proceeds from the IPO. The
Company currently intends to retain future earnings for use in its business
and, therefore, does not anticipate paying any cash dividends in the
foreseeable future. Payment of any cash dividends in the future will depend on
the Company's results of operations, financial condition, cash requirements
and other factors deemed relevant by the Board of Directors of the Company. In
addition, the Company's credit facility contains restrictions on the Company's
payment of cash dividends.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected historical consolidated financial
data of DESI. Income statement data for each of the three years in the period
ended December 31, 1997 and balance sheet data as of December 31, 1996 and
1997 have been derived from the audited consolidated financial statements of
DESI contained herein. Income statement data for the years ended December 31,
1993 and 1994 and balance sheet data as of December 31, 1994 and 1995 have
been derived from audited consolidated financial statements not contained in
this Form 10-K. Balance sheet data as of December 31, 1993 has been derived
from unaudited information of DESI. The unaudited financial data includes all
adjustments that the Company considers necessary for a fair presentation of
the consolidated financial position as of December 31, 1993. The information
set forth below should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations," and
Consolidated Financial Statements of DESI and notes thereto included elsewhere
in this Annual Report on Form 10-K.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1993 1994 1995(1) 1996(1) 1997(1)
------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT:
Revenues............................ $23,527 $34,745 $65,944 $96,464 $110,844
Cost of revenues.................... 18,800 27,800 52,858 75,537 88,545
------- ------- ------- ------- --------
Gross profit...................... 4,727 6,945 13,086 20,927 22,299
Selling expenses.................... 1,665 2,110 5,563 9,929 8,973
General and administrative
expenses........................... 1,333 1,540 5,908 7,812 16,381
Amortization of goodwill............ -- -- 295 804 1,072
Special charge...................... -- -- -- 300 --
------- ------- ------- ------- --------
Earnings (loss) from operations... 1,729 3,295 1,320 2,082 (4,127)
Interest expense, net............... 184 283 522 384 553
------- ------- ------- ------- --------
Earnings (loss) before income
taxes............................ 1,545 3,012 798 1,698 (4,680)
Income tax expense (benefit)........ 684 1,277 495 1,073 (1,400)
------- ------- ------- ------- --------
Net income (loss)................. $ 861 $ 1,735 $ 303 $ 625 $ (3,280)
======= ======= ======= ======= ========
Basic and diluted earnings (loss)
per share (2)...................... $ (.66)
========
Pro forma earnings per share
(3)(4)............................. $ .12
=======
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA (AT END OF
PERIOD):
Total assets........................ $ 6,826 $ 9,813 $39,696 $76,176 $77,073
Advances due to related party....... 2,181 191 4,672 6,455 510
Debt, including capital lease
obligations........................ 2,672 3,845 3,125 2,467 8,296
Total shareholders' equity (4)...... -- -- 15,757 49,452 46,016
</TABLE>
- --------
(1) Income statement data for the years ended December 31, 1995, 1996 and 1997
includes the results of operations of LANSystems, which the Company
acquired in June 1995, beginning July 1, 1995.
9
<PAGE>
(2) Basic and diluted earnings per share is based upon implementation of
Statement of Financial Accounting Standards No. 128, "Earnings per Share".
(3) Pro forma earnings per share is computed by dividing net income for the
year ended December 31, 1996 by the total shares outstanding subsequent to
the IPO of 5,005,000.
(4) No shareholders' equity is shown as of the periods ended December 31, 1993
through 1994 because the Company was operated as a division of R.R.
Donnelley during such periods.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Overview
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. DESI offers its clients the opportunity
to focus on their core businesses by outsourcing a variety of functions,
including business services outsourcing and systems management outsourcing.
Through the integration services group, the Company also offers integration
services to the professional services market. The Company has experienced
growth by expanding its service offerings, adding new clients, increasing
business with its existing clients, and capitalizing on the growing trend
toward outsourcing. In 1997, the Company's total revenues were $110.8 million,
with business services outsourcing, integration services and systems
management outsourcing contributing $68.8 million, $35.1 million and $6.9
million, respectively. In 1996, the Company's total revenues were $96.5
million, with business services outsourcing, integration services and systems
management outsourcing contributing $57.1 million, $38.4 million and $1.0
million, respectively.
DESI commenced its outsourcing operations in 1988 as a provider of
reprographic services and has expanded its service offerings to include
networked and electronic color printing, mailroom and facsimile services,
desktop publishing and imaging. In June 1995, the Company broadened its
capabilities from managing paper-based information to include the management
of electronic information through the acquisition of LANSystems, which has
provided integration services, including systems integration, software
development, consulting and technical training, since 1983. In February 1996,
the Company began providing systems management outsourcing services.
For the year ended December 31, 1995, revenues from the Company's top 20
clients accounted for 70.4% of revenues, with revenues from the top two
clients accounting for 8.9% and 7.3%, respectively. For the year ended
December 31, 1996, the Company's top 20 clients accounted for approximately
61.0% of the Company's revenues, with the top two clients accounting for
approximately 10.6% and 6.0% of such revenues, respectively. For the year
ended December 31, 1997, the Company's top 20 clients accounted for
approximately 69.4% of the Company's revenues, with the top two clients
accounting for approximately 12.6% and 7.0% of such revenues, respectively.
Eleven of the contracts with business outsourcing clients and one contract
with a systems management client expire prior to December 31, 1998. Although
most of the Company's business outsourcing and systems management outsourcing
contracts are cancelable only for cause, DESI is generally willing to
renegotiate contracts that no longer meet the needs of its clients.
The Company's revenues are derived primarily from (i) monthly fees under its
business services outsourcing contracts, (ii) fees relating to integration
projects, (iii) the resale of hardware or software products, (iv) monthly fees
under its system management outsourcing contracts, (v) monthly fees under
integration services maintenance contracts and (vi) technical training
projects. The Company typically enters into contracts with its business
services clients that have terms ranging from three to five years. These
contracts generally provide for monthly minimum payments based on the client's
historical volumes. Substantially all of the Company's business services
outsourcing contracts are priced on a per unit basis for each service provided
and allow for annual increases or decreases of the unit pricing for each of
the outsourcing services provided in order to reflect actual costs of
10
<PAGE>
equipment, labor and supplies. The Company typically enters into systems
management outsourcing contracts with terms that average three years. System
management contracts are priced on a monthly fixed fee basis, plus a fee for
overtime and additional services. Integration services contracts are priced on
a fixed-fee basis or a time-and-materials basis. Contracts for integration
projects typically include scope of work and acceptance criteria for
identifying project completion. The Company typically seeks to obtain an
increase in its fees if a client makes any significant change to the original
scope of a project. Payment terms for these contracts include a down payment,
and invoices are submitted in accordance with the achievement of negotiated
milestones or dates during the projects.
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 presence in the legal and investment banking markets with five
new clients in 1997 and six client service expansions to new locations,
partially offset by the loss of four clients. The company's systems management
group increased its client base in the legal and investment banking markets by
adding six new clients in 1997. Integration services revenue included several
large scale implementations of Windows NT in both the legal and investment
banking markets. The Company expects to continue to capitalize on the
marketplaces' migration from Netware to Windows 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
desktop publishing service, systems management outsourcing and integration
service related revenues which typically generate a higher margin. The
revenues associated with the resale of hardware or software products,
generally associated with a typical integration project, were 41.7% of total
integration services revenues for 1997, as compared to 48.6% in 1996. The
Company provides products to its clients only as an accommodation and
generally as required for particular projects. The Company's maintenance
contracts are priced on an annual basis with payments made generally in
advance.
DESI's cost of revenues associated with business services outsourcing are
comprised of wages, supplies, equipment and start-up costs; its cost of
revenues associated with systems management revenues are comprised of wages,
start-up costs and depreciation on fixed assets; and its cost of revenues
associated with its integration services are comprised of computer equipment
and software and labor costs. The Company's margins on resold products within
integration services are lower than those for business service outsourcing and
systems management outsourcing. Integration services margins tend to fluctuate
more than business services outsourcing margins and systems management
outsourcing margins.
DESI's selling expenses are comprised of sales and support salaries,
commissions and travel and entertainment. Selling expenses as a percentage of
revenues for integration services are significantly higher than for business
outsourcing services due to the long-term annuity nature of DESI's business
outsourcing contracts.
DESI's research and development activities, the costs of which are included
in general and administrative expenses, consist of software and hardware
product evaluation, trial integration of purchased hardware and software, user
productivity benchmarking and the development of custom integration software.
The Company's results of operations are sensitive to the state of the U.S.
professional service economy, particularly as it affects the Company's target
markets. The volume of services provided by the Company generally are lower in
periods in which activities of the Company's clients are reduced by economic
or other factors. The resulting decline in the Company's revenues from a
particular client affects the Company's net income because a large percentage
of the Company's costs are fixed. In addition, clients have imposed pricing
pressures on the Company during periods in which their activities are reduced
because of their own reduced levels of profitability, thereby adversely
affecting the Company's gross margins and results of operations. Again, these
pricing pressures have been offset by a growth in revenues and the Company's
ability to attract new clients who desire to reduce their expenses by
outsourcing certain services to the Company.
11
<PAGE>
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.
Prior to the IPO, the Company was a wholly-owned subsidiary of R.R. Donnelley.
Of the $41.7 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 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 $4.6 million was 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 million.
Relationship with R.R. Donnelley
Prior to the Offering, DESI operated as a separate business within R.R.
Donnelley. It had relied on R.R. Donnelley for its financing needs and for a
number of support services, including legal, tax, insurance, benefits
administration, data processing and payroll. As of December 31, 1997, the
Company had advances payable to R.R. Donnelley totaling approximately
$510,000, which is disputed. As of December 31, 1996, the Company had advances
payable to R.R. Donnelley totaling approximately $6.5 million, which includes
both the fees related to the Transition Services Agreement and Benefit
Administration Services Agreement, as well as amounts funded by R.R. Donnelley
on behalf of the Company as specified in the Transition Services Agreement.
See Note 4 of Notes to the Consolidated Financial Statements of DESI.
The 1995 consolidated financial statements reflect the results of
operations, financial position and cash flows of the Company on a carve-out
basis; that is, the financial statements have been adjusted to reflect certain
expenses and liabilities incurred by R.R. Donnelley on behalf of the Company.
The 1996 consolidated financial statements through the closing of the IPO are
also on a carve-out basis. The Company believes that the assumptions
underlying all such adjustments are reasonable; however, such consolidated
financial statements do not necessarily reflect the results of operations,
financial position and cash flows of the Company had the Company operated as a
separate entity during the periods presented. Income taxes reflected in such
consolidated financial statements through the closing of the IPO were
determined as if the Company had filed a separate return.
The Company entered into certain agreements (the Transition Services
Agreement and the Benefit Administration Services Agreement) pursuant to which
R.R. Donnelley or its affiliates had 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 was charged fees and expenses for these services and retained the
right to terminate services provided under the agreements upon 30 days notice.
The Benefit Administration Services Agreement was terminated as of December
31, 1996. The Transition Services Agreement was terminated throughout 1997
with the last service terminated as of November 30, 1997. Fees related to the
Transition Services Agreement in 1997 were $219,000 while fees related to the
Transition Services Agreement and Benefit Administration Services Agreement in
1996 were $66,000 and $544,000, respectively.
Acquisition of LANSystems
LANSystems was acquired on June 21, 1995 for cash of approximately $16.6
million and certain contingent payment obligations. The acquisition was
accounted for as a purchase, with the excess of the purchase price over the
fair market value of net assets acquired being allocated to goodwill in the
amount of approximately $11.8 million. The goodwill is being amortized over
its estimated useful life of 20 years. LANSystems was acquired by R.R.
Donnelley and, as such, the Company was not required to provide cash for the
acquisition. The earnout
12
<PAGE>
provisions resulted in contingent payments of $9.5 million to former
LANSystems shareholders and management participants. Payments made to the
recipients of the contingent payments have been treated as additional purchase
price for LANSystems, resulting in an increase in goodwill of approximately
$9.5 million, which is being amortized over the remaining useful life
(approximately 19 years).
The consolidated financial statements for the year ended December 31, 1995
reflect the results of operations of LANSystems commencing on July 1, 1995.
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's consolidated
statements of income as a percentage of revenues for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1995(1) 1996 1997
------- ----- -----
<S> <C> <C> <C>
Business services outsourcing revenues................. 69.3% 59.1% 62.1%
Integration services revenues.......................... 30.7 39.9 31.7
Systems management outsourcing revenues................ -- 1.0 6.2
----- ----- -----
Total revenues....................................... 100.0 100.0 100.0
Business services outsourcing cost of revenues......... 84.0 82.0 78.9
Integration services cost of revenues.................. 71.4 73.6 83.3
Systems management outsourcing cost of revenues........ -- 49.8 72.8
----- ----- -----
Total cost of revenues............................... 80.2 78.3 79.9
Business services outsourcing gross profit............. 16.0 18.0 21.1
Integration services gross profit...................... 28.6 26.4 16.8
Systems management outsourcing gross profit............ -- 50.2 27.2
----- ----- -----
Total gross profit................................... 19.9 21.7 20.1
Selling expenses....................................... 8.4 10.3 8.1
General and administrative expenses.................... 9.0 8.1 14.8
Amortization of goodwill............................... .5 0.8 1.0
Special charge......................................... -- 0.3 --
----- ----- -----
Earnings (loss) from operations...................... 2.0 2.2 (3.8)
Interest expense, net.................................. 0.8 0.4 0.5
----- ----- -----
Earnings (loss) before income taxes.................. 1.2 1.8 (4.3)
Income tax expense (benefit)........................... 0.7 1.1 (1.3)
----- ----- -----
Net income (loss).................................... 0.5% 0.6% (3.0)%
===== ===== =====
</TABLE>
- --------
(1) The results of operations of LANSystems are included in DESI's
consolidated statements of income since July 1, 1995.
Year ended December 31, 1997 compared to year ended December 31, 1996
Revenues for the year ended December 31, 1997 totaled $110.8 million, a
14.8% increase over 1996 revenues of $96.5 million. This $14.3 million
increase was comprised of a $11.8 million, or 20.7%, increase in business
services outsourcing revenues, a $3.3 million decrease attributable to
integration services and a $5.9 million increase attributable to systems
management outsourcing. Business services outsourcing growth was due to a $9.0
million increase in revenues from new clients and a $2.8 million increase in
revenues from existing clients. The integration services revenue decrease of
$3.3 million was primarily due to a $3.3 million change in estimate resulting
from the reduction in scope on certain integration projects, operating
performance issues and an increase in the estimated hours required to complete
certain other projects. Revenues from integration services were comprised of
$14.6 million from the resale of hardware and software products and $20.5
million from services. Systems management outsourcing growth of $5.9 million
was due to five new outsourcing contracts.
13
<PAGE>
Cost of revenues of $88.5 million increased as a percentage of revenues to
79.9% from 78.3% in 1996 because of a decrease in the integration services
margins, offset by an increase in the business services outsourcing margins.
Business services outsourcing margins increased as a result of increased
revenues in higher margin services, a decrease in start-up costs and higher
productivity at client sites. Integration services margins decreased primarily
as a result of a $2.3 million change in estimate resulting from the reduction
in scope on certain integration projects, operating performance issues and an
increase in the estimated hours required to complete certain other projects.
Selling expenses decreased $1.0 million, or 10%, from 1996, and as a
percentage of revenues, decreased to 8.1% in 1997 from 10.3% in 1996. Selling
expenses as a percentage of revenues decreased primarily due to turnover of
integration services sales staff and delays in hiring new staff.
General and administrative expenses increased $8.6 million, or 110%, from
1996, and as a percentage of revenues, increased to 14.8% in 1997 from 8.1% in
1996. General and administrative expenses as a percentage of revenues
increased primarily due to an increase in the allowance for doubtful accounts
of $3.6 million recorded in the third quarter of 1997, the start up of systems
management outsourcing services, additional expenses necessary to operate as a
public company and the increased investment in administrative systems. These
investments, which are substantially complete, include a new financial system
and a common technology platform.
Amortization of goodwill was $1.1 million, compared to $0.8 million in 1996.
The increase was due to a full year of amortization in 1997, as goodwill
increased during the third quarter of 1996 due to earnout payments related to
the LANSystems acquisition.
A special charge of $300,000 was recorded in 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.
Interest expense increased to $0.6 million from $0.4 million in 1996
primarily due to interest expense related to borrowings on the line of credit.
In 1997, the Company's effective income tax rate was a benefit of 29.9%,
primarily due to a taxable loss in 1997. The Company's effective income tax
rate was 63.2% in 1996. The 1996 effective rate exceeded the U.S. federal
statutory rate due to the effect of nondeductible goodwill and state taxes.
Net income decreased $3.9 million to a net loss of $3.3 million in 1997 as a
result of the foregoing factors.
Year ended December 31, 1996 compared to year ended December 31, 1995
Revenues for the year ended December 31, 1996 totaled $96.5 million, a 46.3%
increase over 1995 revenues of $65.9 million. This $30.5 million increase was
comprised of a $11.4 million, or 24.9%, increase in business services
outsourcing revenues and a $19.1 million increase attributable to integration
services. Business services outsourcing growth was due to a $3.7 million
increase in revenues from new clients and a $7.5 million increase in revenues
from existing clients. Integration services growth resulted from the inclusion
of LANSystems for all of 1996. Revenues from integration services were
comprised of $19.1 million from the resale of hardware and software products
and $20.3 million from services.
Cost of revenues of $75.5 million decreased as a percentage of revenues to
78.3% from 80.2% in 1995 because of an increase in the business services
outsourcing margins, offset by a decrease in the integration services margin.
Business services outsourcing margins increased as a result of increased
revenues in higher margin services, a decrease in start-up costs, higher
productivity at client sites and a reduction in equipment expense due to
vendor renegotiations. Integration services margins decreased as a result of a
less than expected LANSystems revenue growth, increased subcontracted labor
and lower productivity from new hires.
14
<PAGE>
Selling expenses increased $4.4 million, or 78.5%, from 1995, and as a
percentage of revenues, increased to 10.3% in 1996 from 8.4% in 1995. Selling
expenses as a percentage of revenues increased primarily due to the LANSystems
acquisition being included for a full year ($3.3 million) and the start up of
systems management outsourcing services.
General and administrative expenses increased $1.9 million, or 32.2%, from
1995 and as a percentage of revenues, decreased to 8.1% in 1996 from 9.0% in
1995. General and administrative expense increased primarily due to the
inclusion of LANSystems for the full year ($1.0 million), the closing of the
LANSystems' San Diego office ($0.3 million) and an investment in personnel to
support revenue growth.
Amortization of goodwill was $0.8 million, compared to $0.3 million in 1995.
The increase was due to the inclusion of the LANSystems acquisition for the
entire 1996 year.
A special charge of $300,000 was recorded in 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.
Interest expense, which primarily related to capital leases and the $8.0
million dividend note to R. R. Donnelley, was offset by interest income earned
on the proceeds from the Offering and decreased by $0.1 million.
The Company's effective income tax rate increased to 63.2% in 1996 from
62.0% in 1995. The effective tax rate exceeds the U.S. federal statutory rate
due to the effect of nondeductible goodwill amortization and state taxes.
Net income increased $0.3 million, or 106.3%, to $0.6 million in 1996 as a
result of the foregoing factors.
LIQUIDITY AND CAPITAL RESOURCES
Prior to the completion of the IPO, the Company 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. During the years ended December 31, 1995 and
1996, the Company factored $44.8 million and $45.1 million of receivables,
respectively. Factored receivables that remain uncollected were $14.6 million,
$3.5 million, and $.6 million at December 31, 1995, 1996 and 1997,
respectively, and are excluded from DESI's consolidated balance sheets. The
arrangement pursuant to which the Company sold such receivables to a
subsidiary of R.R. Donnelley was terminated on December 16, 1996.
On October 30, 1996, the Company entered into a credit agreement with Harris
Trust and Savings Bank (the "Bank") (the "Credit Agreement") under which it is
entitled to borrow up to $22.0 million on a revolving credit basis. Borrowings
under the Credit Agreement mature in November 1999, and 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, up to 125 basis
points per annum. In addition, the Company pays a commitment fee of 20 to 30
basis points per annum, depending on its fixed charge coverage ratio, on the
unused portion of the credit facility. The credit facility contains customary
financial and other covenants, including requirements to maintain a minimum
consolidated net worth, a minimum fixed charge coverage ratio and a maximum
leverage ratio, and restrictions on liens, investments, dividends,
indebtedness, acquisitions and transactions with affiliates. The Company has
historically not paid interest with respect to the advances it received from
R.R. Donnelley. The Company paid $658,000 in interest expense in 1997, of
which $334,000 is interest expense related to borrowings on the credit
facility, $314,000 relates to interest expense on capital leases and $10,000
relates to interest expense on notes payable. At December 31, 1997, the
Company was in compliance with all debt covenants and there were $5.6 million
in borrowings outstanding under the Credit Agreement.
15
<PAGE>
The Company had net cash provided by operations of $3.0 million for the year
ended December 31, 1997, as compared to net cash used by operations of $8.4
million in 1996. This increase of $11.4 million was primarily due to improved
collection and more timely invoicing of integration services clients in 1997
compared to 1996. Capital expenditures were $7.5 million in 1997, $7.3 million
in 1996 and $4.1 million in 1995. Capital expenditures have increased in 1996
and 1997 over 1995 due to the implementation of a common technology platform
and financial system. The Company expects to spend $3.9 million in 1998 on
capital projects mainly for new client start-ups. Net cash used for financing
activities was $1.6 million in 1997. Of the $1.6 million usage, $5.9 million
was used to pay advances due to a related party and $1.3 million was used for
payments on capital leases. This usage was partially funded by $5.6 million
provided by the Company's Credit Agreement.
For the year ended December 31, 1997, operating cash flow (net income plus
depreciation and amortization) was $3.1 million, down from $5.9 million in the
prior year. This decrease occurred primarily due to the changes in estimate
adjustments recorded in the third quarter of 1997. The Company believes cash
flows from operations and the credit facility will be sufficient to fund,
during the term of the credit facility, its ongoing operations and continued
growth and investment, including acquisitions.
CAUTIONARY STATEMENTS REGARDING FUTURE-LOOKING STATEMENTS
This Annual Report on Form 10-K is among certain communications by the
Company that contain forward-looking statements, including statements
regarding the Company's financial position, results of operations and market
position. These forward-looking statements are based on the Company's
estimates, assumptions, projections and current expectations. The Company
hereby notes several important factors that could cause the Company's actual
results and other matters to differ materially from the results, projections
and expectations expressed in the forward-looking statements.
Dependence on Key Clients. The loss of any one of the Company's major
clients could have a material adverse effect on the Company's business,
operating results or financial condition, in part because recommendations from
satisfied clients are critical to the Company's success in attracting new
clients.
Dependence on Ability to Manage Growth. The Company's future performance and
profitability will depend, in large part, on its ability to manage its growth,
particularly with respect to its decentralized workforce, which will require
DESI to continue to improve its operational, financial and other internal
systems and the training, motivation and management of its employees.
Sensitivity to Fluctuations in Professional Service Economy. The Company's
business and results of operations are sensitive to the state of the U.S.
professional service economy, particularly as it affects the Company's target
markets. The volume of services provided by the Company generally are lower in
periods in which activities of the Company's clients are reduced by economic
or other factors.
Risks Associated with Performance of Integration Projects. Most of DESI's
engagements to provide integration services involve projects that are critical
to the operations of its clients' businesses and that provide benefits that
may be difficult to quantify. The Company's failure or inability to meet a
client's expectations in the performance of a particular project by the
Company or due to a software or hardware defect could result in the incurrence
by the Company of a financial loss and could damage the Company's reputation
and adversely affect its ability to attract new business. The Company's
integration projects are priced on a fixed-fee basis or a time and materials
basis and contain scope of work and acceptance criteria for identifying
project completion.
Focus on Limited Target Markets. The Company focuses the marketing of its
services primarily on large law firms, investment banks and accounting firms,
and, therefore, the number of potential clients within the Company's target
markets is limited. Within these markets the Company faces several barriers to
its ability to increase revenues. Because of the limited number of
organizations in the Company's target markets, the need to overcome these
barriers with respect to any one potential client is greater than it would be
if the Company's target markets were larger.
16
<PAGE>
Ability to Grow through Introduction of New Services. The Company's business
strategies include growth through the introduction of new services, including
systems management outsourcing, that expand on the Company's expertise in
business services outsourcing and integration services. There can be no
assurance that DESI will be able to market successfully or operate profitably
any new services, or that the failure to perform such new services
satisfactorily would not adversely affect the Company's reputation as a
premier provider of information management services.
Dependence on Ability to Anticipate Technological Advances. The success of
DESI's integration services will depend, to a large extent, on its ability to
anticipate and develop solutions that keep pace with changes in information
processing technology, evolving industry standards and changing client
preferences. In addition, there can be no assurance that products or
technologies developed by third parties will not render the integration
services of the Company noncompetitive or obsolete.
Year 2000 Compliance. The Company is evaluating the impact, if any, of the
Year 2000 compliance issue. The Company has taken steps to correct any
potential problems that may occur. However, the Company could be impacted by
external companies and systems that interact with those of the Company.
Risks Associated with Integration of LANSystems and Growth through Future
Acquisitions. The Company's business strategies include growth through
acquisitions of businesses that meet client and market demands for an expanded
geographic presence, new services or enhanced skills. The Company's experience
of acquiring and integrating businesses is limited to its acquisition of
LANSystems in June 1995. The integration of LANSystems into the Company's
operations is not complete and there can be no assurance that the integration
of LANSystems' business will be completed successfully or that DESI's
management will be successful in managing the combined operations. There can
be no assurance that the Company will be successful in identifying potential
acquisitions or that, if identified, the acquisitions will be consummated on
acceptable terms or that any acquired assets or business will be integrated
successfully into the Company's operations.
Variability of Quarterly Results. The Company's quarterly operating results
will continue to be subject to variation, depending upon factors such as the
mix of business among the Company's services; the cost of materials, labor and
technology, particularly in connection with the delivery of business services;
the costs associated with initiating new outsourcing contracts or opening new
offices; the economic condition of the Company's target markets; and the costs
of acquiring and integrating new businesses.
Need to Attract and Retain Key Personnel in Highly Competitive Marketplace.
The Company's performance depends, to a large extent, on the continued service
of its key technical employees and client managers and its ability to continue
to attract, retain and motivate such personnel. The inability to attract,
retain and motivate such personnel could have a material adverse effect upon
the Company's business, operating results or financial condition.
Dependence on Senior Management. The Company's success depends, in part, on
its ability to retain its key executive officers and the effective performance
of such executive officers. The loss of one or more of the Company's key
executive officers could have a material adverse effect on the Company and its
prospects.
Lack of Operating History as a Stand-Alone Entity. Prior to the IPO, the
Company operated as a separate business within R.R. Donnelley. In addition,
prior to the Offering, the Company did not have its own stand-alone capital
structure, including levels of indebtedness typically associated with a stand-
alone entity in the Company's industry, and, therefore, did not manage its own
working capital borrowings. Although the Company has established new policies
and procedures applicable to the operation of a public company, there can be
no assurance that the Company will be able to manage successfully the
additional obligations of being a public company.
Financial Statement Presentation. Certain of the Company's consolidated
financial statements and other financial data appearing in this Annual Report
on Form 10-K reflect the results of operations, financial position and cash
flows of the Company on a carve-out basis and are derived from the historical
financial statements and
17
<PAGE>
financial data of the Company. The 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.
Principal Stockholder; Potential Conflicts of Interest; Possible Future
Sales of Common Stock by R.R. Donnelley. R.R. Donnelley holds 42.8% of the
outstanding Common of the Company. Consequently, R.R. Donnelley is able to
significantly influence such actions as the election of directors of the
Company, the approval of matters submitted for stockholder approval or
preventing a potential takeover (even if advantageous to the other
stockholders). Currently, two of the five members of the Board of Directors of
the Company are officers of R.R. Donnelley. Any officer of R.R. Donnelley who
serves as a director of the Company may have conflicts of interest in
addressing business opportunities and strategies with respect to which the
Company's and R.R. Donnelley's interests differ. Except with respect to
agreements and transactions between the Company and R.R. Donnelley, the
Company and R.R. Donnelley have not adopted any formal procedures designed to
assure that conflicts of interest will not occur or to resolve any such
conflicts that do occur.
Subject to certain restrictions, R.R. Donnelley may sell any and all of the
shares of Common Stock currently owned by it. No prediction can be made as to
the effect, if any, that future sales of Common Stock, or the availability of
Common Stock for future sale, will have on the market price of the Common
Stock prevailing from time to time.
Reference is also made to the Company's Registration Statement (No. 333-
10127) under "Risk Factors" for a more detailed discussion of the foregoing
and other factors that may affect the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Part IV, Item 14(a) of this Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information required by Item 10 of this Annual Report on Form 10-K
regarding directors is incorporated by reference to the section entitled
"Election of Directors" in the Company's Proxy Statement for its 1998 Annual
Meeting of Stockholders. The information required by Item 10 of this Annual
Report on Form 10-K regarding officers is included at the end of Part I of
this Annual Report on Form 10-K. Other information required by Item 10 of this
Annual Report on Form 10-K regarding both directors and officers is
incorporated by reference to the section entitled "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's Proxy Statement for its 1998
Annual Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of this Annual Report on Form 10-K is
incorporated by reference to the section entitled "Compensation and Other
Information Concerning Directors and Executive Officers" in the Company's
Proxy Statement for its 1998 Annual Meeting of Stockholders.
18
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required for by Item 12 of this Annual Report on Form 10-K
is incorporated by reference to the section entitled "Ownership of Capital
Stock" in the Company's Proxy Statement for its 1998 Annual Meeting of
Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required for by Item 13 of this Annual Report on Form 10-K
is incorporated by reference to the section entitled "Certain Transactions" in
the Company's Proxy Statement for its 1998 Annual Meeting of Stockholders.
19
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
See "Financial Statements" set forth below.
2. Financial Statement Schedules:
The following financial statement schedule is included as part of this
Annual Report on Form 10-K immediately following the signature page:
Schedule II--Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore
have been omitted.
3. 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)
10.4 Employment Agreement between Rhonda I. Kochlefl and the
Company.(1)(3)
10.7 Employment Agreement between Linda A. Finkel and the Com-
pany.(2)(3)
10.8 Severance Agreement between Thomas P. Bradbury and the
Company.(1)(3)
10.9 1996 Broad-Based Employee Stock Plan.(1)(3)
10.10 Agreement of Merger among R.R. Donnelley & Sons Company,
Donnelley DBS, Inc. and LAN Systems, Inc.(1)
10.11 Form of Credit Agreement among the Company, as Borrower,
and the Banks named therein.(1)
10.12 1997 Non-Employee Director Stock Plan.(2)(3)
10.13 Amended and Restated 1996 Stock Incentive Plan.(2)(3)
10.14 1997 Employee Stock Purchase Plan.(2)(3)
10.15 Employment Agreement between Robert A. Lento and the Com-
pany.(3)
10.16 Employment Agreement between David J. Shea and the Compa-
ny.(3)
23.1 Consent of Arthur Andersen LLP.
24.1 Powers of Attorney of Thomas A. Munro, Leo S. Spiegel,
Gregory A. Stoklosa, Charles F. Moran and W. Ed Tyler.
27.1 Financial Data Schedule.
99.1 Transition Services Agreement between the Company and R.R.
Donnelley.(1)
99.2 Benefit Administration Services Agreement between the Com-
pany and R.R. Donnelley.(1)
99.3 Tax Allocation and Indemnification Agreement between the
Company and R.R. Donnelley.(1)
</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) Incorporated herein by reference to the Company's Registration Statement
on Form 10-K for the year ended December 31, 1996, filed on March 28,
1997.
(3) Indicates a management contract or compensatory plan or agreement.
(b) Reports on Form 8-K
The following reports on Form 8-K were filed by the Company during the
fourth quarter of the year ended December 31, 1997:
October 31, 1997--Item 5, Other Events-- third quarter loss.
(c) Exhibits
See Item 14(a)3 above.
20
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants................................ F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997............ F-3
Consolidated Income Statements for the Years Ended December 31, 1995,
1996, and 1997......................................................... F-4
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 1995, 1996, and 1997................................ F-5
Consolidated Statements of Cash Flows for the Years Ended December 31,
1995, 1996, and 1997................................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of
Donnelley Enterprise Solutions Incorporated:
We have audited the accompanying consolidated balance sheets of DONNELLEY
ENTERPRISE SOLUTIONS INCORPORATED (a Delaware corporation) AND SUBSIDIARIES as
of December 31, 1997 and 1996, and the related consolidated statements of
income, changes in shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Donnelley
Enterprise Solutions Incorporated and Subsidiaries as of December 31, 1997 and
1996, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
Arthur Andersen LLP
Chicago, Illinois,
February 3, 1998
F-2
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
ASSETS 1996 1997
------ ------- -------
<S> <C> <C>
Current Assets:
Cash and equivalents........................................ $ 8,910 $ 3,231
Accounts receivable, less allowances for doubtful accounts
of $460 in 1996 and $3,944 in 1997......................... 21,228 22,611
Unbilled receivables........................................ 4,847 5,874
Inventories................................................. 4,144 3,550
Prepaid expenses and other current assets................... 1,728 1,499
Income tax receivable....................................... 1,533 2,418
Deferred income taxes....................................... 867 2,689
------- -------
Total current assets...................................... 43,257 41,872
Property and equipment, net................................... 12,646 15,999
Goodwill, net................................................. 20,213 19,158
Other noncurrent assets....................................... 60 44
------- -------
Total assets.............................................. $76,176 $77,073
======= =======
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
Current liabilities:
Line of credit.............................................. $ -- $ 5,600
Capital lease obligations, current portion.................. 1,162 959
Notes payable............................................... -- 111
Advances due to related party............................... 6,455 510
Accounts payable............................................ 7,633 8,585
Accrued salary and benefits................................. 2,280 3,340
Accrued other expenses...................................... 2,010 1,632
Customer prepayments........................................ 4,434 5,577
Deferred revenues........................................... 1,134 2,572
------- -------
Total current liabilities................................. 25,108 28,886
------- -------
Noncurrent Liabilities:
Capital lease obligations................................... 1,305 1,552
Deferred income taxes....................................... 311 545
Notes payable............................................... -- 74
------- -------
Total noncurrent liabilities.............................. 1,616 2,171
------- -------
Shareholders' equity:
Common stock--$.01 par value, 15,000,000 authorized Shares;
5,005,000 issued and outstanding at December 31, 1996 and
1997....................................................... 50 50
Preferred stock--$.01 par value, 1,000,000 authorized
Shares; none issued and outstanding........................ -- --
Additional paid-in capital.................................. 49,399 49,245
Cumulative translation adjustment........................... -- (2)
Retained earnings........................................... 3 (3,277)
------- -------
Total shareholders' equity................................ 49,452 46,016
------- -------
Total liabilities and shareholders' equity................ $76,176 $77,073
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONSOLIDATED INCOME STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1995 1996 1997
------- ------- --------
<S> <C> <C> <C>
Business services outsourcing revenues............... $45,684 $57,048 $ 68,848
Integration services revenues........................ 20,260 38,450 35,145
Systems management outsourcing revenues.............. -- 966 6,851
------- ------- --------
Total revenues................................... 65,944 96,464 110,844
------- ------- --------
Business services outsourcing cost of revenues....... 38,387 46,756 54,301
Integration services cost of revenues................ 14,471 28,300 29,258
Systems management outsourcing cost of revenues...... -- 481 4,986
------- ------- --------
Total cost of revenues........................... 52,858 75,537 88,545
------- ------- --------
Business services outsourcing gross profit........... 7,297 10,292 14,547
Integration services gross profit.................... 5,789 10,150 5,887
Systems management outsourcing gross profit.......... -- 485 1,865
------- ------- --------
Total gross profit............................... 13,086 20,927 22,299
------- ------- --------
Selling expenses..................................... 5,563 9,929 8,973
General and administrative expenses.................. 5,908 7,812 16,381
Amortization of goodwill............................. 295 804 1,072
Special charge....................................... -- 300 --
------- ------- --------
Earnings (loss) from operations.................. 1,320 2,082 (4,127)
Interest expense, net................................ 522 384 553
------- ------- --------
Earnings (loss) before income taxes.............. 798 1,698 (4,680)
Income tax expense (benefit)......................... 495 1,073 (1,400)
------- ------- --------
Net income (loss)................................ $ 303 $ 625 $ (3,280)
------- ------- --------
Basic and diluted earnings (loss) per share........ $ (.66)
========
Basic and diluted common shares outstanding........ 5,005
========
Pro forma earnings per share....................... $ .12
=======
Pro forma common shares outstanding................ 5,005
=======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL CUMULATIVE TOTAL
COMMON PAID-IN TRANSLATION RETAINED SHAREHOLDERS'
STOCK CAPITAL ADJUSTMENT EARNINGS EQUITY
------ ---------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1994 .................... $-- $ -- $-- $ -- $ --
Net income ............. -- -- -- 303 303
Contribution of
LANSystems from
related party ......... 31 15,726 -- -- 15,757
Repayments to related
party ................. -- -- -- (303) (303)
---- ------- ---- ------- -------
Balance at December 31,
1995 .................... 31 15,726 -- -- 15,757
Net income ............. -- -- -- 625 625
Initial public offering
proceeds,
net of expenses ....... 19 41,673 -- -- 41,692
Dividend to related
party ................. (8,000) -- (622) (8,622)
---- ------- ---- ------- -------
Balance at December 31,
1996 .................... 50 49,399 -- 3 49,452
Net loss ............... -- -- -- (3,280) (3,280)
Initial public offering
expenses .............. -- (154) -- -- (154)
Cumulative translation
adjustment ............ -- -- (2) -- (2)
---- ------- ---- ------- -------
Balance at December 31,
1997 .................... $ 50 $49,245 $ (2) $(3,277) $46,016
---- ------- ---- ------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1995 1996 1997
-------- -------- -------
<S> <C> <C> <C>
Cash flows provided by (used in) operating
activities:
Net income..................................... $ 303 $ 625 $(3,280)
Depreciation and amortization.................. 3,446 4,492 5,314
Amortization of goodwill....................... 295 804 1,072
Gain on sale of equipment...................... -- -- (227)
Net changes in assets and liabilities.......... (109) (14,289) 154
-------- -------- -------
Net cash provided by (used in) operating
activities................................ 3,935 (8,368) 3,033
-------- -------- -------
Cash flows provided by (used in) investing
activities:
Capital expenditures........................... (4,084) (7,347) (7,548)
Net proceeds on sale of equipment.............. -- -- 414
Acquisition of LANSystems by related party..... (16,633) -- --
LANSystems contingent payments................. -- (9,506) --
-------- -------- -------
Net cash used in investing activities...... (20,717) (16,853) (7,134)
-------- -------- -------
Cash flows provided by (used for) financing
activities:
Advances from (to) related parties, net........ 4,481 1,783 (5,945)
Line of credit................................. -- -- 5,600
Notes payable.................................. -- -- 185
Repayments/dividend to related party........... (303) (8,622) --
Contribution of LANSystems from related party.. 15,757 -- --
Net proceeds from the initial public offering.. -- 41,692 (154)
Principal payments on capital leases........... (1,301) (1,374) (1,262)
Principal payments on borrowings............... (1,200) -- --
Other.......................................... -- -- (2)
-------- -------- -------
Net cash provided by (used for) financing
activities................................ 17,434 33,479 (1,578)
-------- -------- -------
Net increase (decrease) in cash and equivalents.. $ 652 $ 8,258 $(5,679)
Cash and equivalents, at beginning of period..... -- 652 8,910
-------- -------- -------
Cash and equivalents, at end of period........... $ 652 $ 8,910 $ 3,231
======== ======== =======
The changes in assets and liabilities, net of
balances assumed through acquisitions, were as
follows:
Decrease (increase) in assets--
Receivables, net............................. $ (1,667) $(14,928) $(2,410)
Inventories.................................. 543 (570) 594
Prepaid expenses and other................... (24) (1,240) 229
Income tax receivable........................ (196) (345) (885)
Deferred income taxes........................ (496) 1,135 (1,822)
Other noncurrent assets...................... (3) (1) (1)
Increase (decrease) in liabilities--
Accounts payable............................. 671 1,312 952
Accrued salary and benefits.................. 1,081 (766) 1,060
Accrued other expenses....................... 1,214 358 (378)
Customer prepayments......................... 444 896 1,143
Deferred revenues............................ (1,917) (198) 1,438
Deferred income taxes........................ -- 311 234
Other noncurrent liabilities................. 241 (253) --
-------- -------- -------
Net change in assets and liabilities....... $ (109) $(14,289) $ 154
======== ======== =======
Cash paid during the period for:
Interest....................................... $ 522 $ 427 $ 658
Income taxes................................... 86 -- 1,337
======== ======== =======
Supplemental non-cash investing and financing
activities:
Capital leases................................. $ 581 $ 716 $ 1,306
======== ======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF OPERATIONS:
Donnelley Business Services ("DBS") was an unincorporated business unit of
R.R. Donnelley & Sons Company ("R.R. Donnelley") from its organization in 1988
through December 31, 1995. On June 21, 1995, R.R. Donnelley acquired LAN
Systems, Inc. ("LANSystems") in a business combination accounted for as a
purchase (see Note 14 for further discussion). Following the acquisition,
LANSystems was a wholly owned subsidiary of R.R. Donnelley and was operated
together with DBS. Effective January 1, 1996, R.R. Donnelley contributed the
assets and liabilities of DBS to LANSystems and LANSystems changed its name to
Donnelley Enterprise Solutions Incorporated ("DESI"). The 1995 consolidated
financial statements have been restated to reflect the consolidation of
entities under common control by R.R. Donnelley since the date of acquisition
of LANSystems. LANSystems is included in the results of operations in the
accompanying financial statements since July 1, 1995. DESI and its wholly
owned subsidiaries are collectively referred to herein as the "Company."
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.
Of the $41.7 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 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 $4.6 million was used for general corporate purposes.
The Company is a single-source provider of integrated information management
services to professional service providers, primarily large law firms,
investment banking firms and accounting firms. The Company operates entirely
within the information management services segment. Within this segment, the
Company offers three general categories of services: business services
outsourcing, integration services and systems management outsourcing. The
Company's business services outsourcing offerings include document services,
such as reprographic, networked and color printing, mailroom and facsimile
services; word processing and desktop publishing; and imaging. The Company's
integration services ("LANSystems") include systems integration, consulting,
software development and technical training. The Company's systems management
outsourcing offerings include on-site management and administration of servers
and desktops, including the operation of client help desk functions.
2. SIGNIFICANT ACCOUNTING POLICIES:
Basis of Consolidation
The consolidated financial statements include all accounts of the Company.
All material intercompany balances and transactions are eliminated in
consolidation.
Revenue Recognition and Deferred Revenues
Business Services Outsourcing--The Company recognizes revenues related to
its business services outsourcing upon rendering of service. All outsourcing
contracts are billed on a monthly basis. At December 31, 1996 and 1997,
unbilled revenues amounted to $71,000 and $42,000, respectively.
Integration Services--For material integration projects with a duration of
three months or longer that require installation, system design and
integration, the Company recognizes revenue under the percentage-of-completion
method, using labor efforts incurred to date in relation to estimated total
labor costs of the contracts to measure stage of completion. The cumulative
effects of revisions of estimated total labor costs and revenues are recorded
F-7
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
in the period in which the facts requiring the revision become known. When a
loss is anticipated on a contract, the full amount thereof is provided
currently. Claims, including change orders, are reflected at estimated
recoverable amounts. At December 31, 1996 and 1997, estimated revenue in
excess of billings on contracts amounted to $4,776,000 and $5,841,000,
respectively.
For all other integration projects, the Company recognizes revenue upon
substantial completion of the project.
Amounts billed for systems maintenance contracts are recorded as deferred
revenue and recognized in revenue over the term of the contract on a straight-
line basis.
Systems Management Outsourcing--The Company recognizes revenues related to
its systems management outsourcing upon rendering of service. All outsourcing
contracts are billed on a monthly basis.
Cash Equivalents
The company considers all highly liquid instruments with a maturity of three
months or less when purchased to be cash equivalents for purposes of
classification in the consolidated balance sheets and consolidated statements
of cash flows. Cash equivalents are stated at cost, which approximates market
value.
Inventories
Inventories consist of materials and supplies and are carried at the lower
of weighted average cost or market.
Property and Equipment--Capitalization and Depreciation
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method based on useful lives of 2 to 7 years. Maintenance
and repair costs are charged to expense as incurred. When properties are
retired or disposed, the costs and related depreciation reserves are
eliminated and the resulting profit or loss is recognized in income.
Leasehold improvements are amortized over the life of the related lease.
Leased capitalized assets are depreciated over the life of the related lease
or the normal useful life of the asset, whichever is shorter.
Goodwill--Capitalization and Amortization
Goodwill consists of the excess of purchase price over the fair market value
of net assets acquired as a result of the acquisition of LANSystems on June
21, 1995. The goodwill is amortized over its estimated useful life of 20
years. Accumulated amortization at December 31, 1996 and 1997, was $1,099,000
and $2,171,000, respectively.
Impairment of Long-Lived Assets
The Company adopted Statement of Financial Accounting Standards No. 121
("FAS 121")--"Accounting for the Impairment of Long-Lived Assets" effective
January 1, 1995. In accordance with the requirements of FAS 121, the Company
periodically assesses whether events or circumstances have occurred that may
indicate the carrying value of its long-lived assets may not be recoverable.
When such events or circumstances indicate the carrying value of an asset may
be impaired, the Company uses an estimate based on the future undiscounted
cash flows to be derived from the asset over the remaining useful life of the
asset to assess whether or not the asset is recoverable. If the future
undiscounted cash flows to be derived over the life of the asset do not exceed
F-8
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the asset's net book value, the Company recognizes an impairment loss for the
amount by which the net book value of the asset exceeds its estimated fair
market value. The Company has not recognized any material impairment losses
for the years ended December 31, 1995, 1996 and 1997.
Research and Development
Research and development expenditures are charged to earnings as incurred
and amounted to $1,274,000, $1,206,000, and $1,942,000 for the years ended
December 31, 1995, 1996, and 1997, respectively. These costs are reflected in
the Company's consolidated statements of income as general and administrative
expenses.
Reclassifications
Certain prior year amounts have been reclassified to conform to fiscal year
1997 presentation. These changes had no impact on previously reported results
of operations or shareholders' equity.
Income Taxes
For the year ended December 31, 1995, and for the period beginning January
1, 1996 and ending November 4, 1996, the Company is included in the
consolidated federal income tax return of R.R. Donnelley. The Company filed a
short period return for the period beginning November 5, 1996 and ending
December 31, 1996 on a stand alone basis. The consolidated tax provision for
the years ended December 31, 1995 and 1996 is presented as if the Company
filed a separate tax return for the full years. Deferred taxes are provided
when tax laws and financial accounting standards differ with respect to the
amount of income calculated in a given year and the bases of assets and
liabilities, in accordance with Statement of Financial Accounting Standards
No. 109--"Accounting for Income Taxes." Income taxes through the completion of
the IPO were paid by R.R. Donnelley on behalf of the Company.
Fair Value of Financial Instruments
In accordance with the reporting requirements of Statement of Financial
Accounting Standard No. 107, "Disclosures about Fair Value of Financial
Instruments," the Company calculates the fair value of its financial
instruments and includes this additional information in the notes to the
consolidated financial statements when the fair value is different than the
carrying value of those financial instruments. When the fair value reasonably
approximates the carrying value, no additional disclosure is made.
Reporting Comprehensive Income
In June 1997 Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("FAS 130"), was issued, effective for fiscal years
beginning after December 15, 1997, which requires a different format for
presentation of information already included in the Company's financial
statements. The Company believes the impact of FAS 130 will not have a
material effect on the Company's financial statements.
Disclosures about Segments of an Enterprise and Related Information
In June 1997 Statement of Financial Accounting Standards No. 131,
"Disclosure about Segments of an Enterprise and Related Information" ("FAS
131"), was issued, effective for fiscal years beginning after December 15,
1997, which requires that public business enterprises report certain
information about operating segments and certain information about their
products and services, the geographic areas in which they operate and their
major customers. FAS 131 does not affect accounting principles and,
accordingly, will not require any change to reported financial position,
results of operations or cash flows. The Company is currently evaluating the
impact of FAS 131 on its segment reporting.
F-9
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Foreign Currency Translation Adjustment
The balance sheet accounts of the Company's foreign subsidiary and division
have been translated at the exchange rate in effect at the end of the year.
Income and expense accounts have been translated at the weighted average rates
in effect during the year.
Use of Estimates and Assumptions
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Significant estimates inherent in the
preparation of the accompanying consolidated financial statements include
management's estimate related to, among other things, allowances for doubtful
accounts, future cash flows associated with long-lived assets, valuation
allowances for deferred tax assets and contract revenues and expenses related
to integration services projects recognized using the percentage of completion
method. Actual results could differ from those estimates.
3. SIGNIFICANT CLIENTS:
A majority of the Company's revenues are attributable to clients operating
in the professional services industry. For the year ended December 31, 1995,
no clients accounted for greater than 10% of the Company's revenues. For the
years ended December 31, 1996 and 1997, one client accounted for approximately
11% and 13% of the Company's revenues, respectively.
4. TRANSACTIONS WITH R. R. DONNELLEY & SONS COMPANY:
Substantially all transactions with R.R. Donnelley & Sons Company were
terminated in 1996, with the exception of certain services provided under the
Transition Services Agreement, which were terminated in 1997, commissions paid
to R.R. Donnelley salesmen and integration services sales made to
R.R. Donnelley. Related-party transactions with R.R. Donnelley not disclosed
elsewhere in the financial statements are as follows:
Accounts Receivable Sold Without Recourse
The Company sold certain accounts receivable, without recourse, to R.R.
Donnelley Receivables, Inc. ("DRI"), a wholly owned subsidiary of R.R.
Donnelley. The amount of the receivables sold was directly offset against the
advances due to related party. The Company was not charged for any factoring
costs related to these receivables and, therefore, the financial statements do
not include any charge for factoring costs. During the year ended December 31,
1996 the Company factored $45.1 million of receivables to DRI. Factored
receivables that remain uncollected by DRI were $3.5 million and $565,000 at
December 31, 1996 and 1997, and are excluded from the accompanying
consolidated balance sheets.
As of December 16, 1996 the Company terminated the factoring agreement and
no longer factors any of its receivables.
Employee Benefit Programs
The Company's employees participated in various employee benefit programs
that were sponsored by R.R. Donnelley, including those employees acquired in
connection with the acquisition of LANSystems who began participating in all
such programs other than the defined benefit pension plan as of January 1,
1996 and,
F-10
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
with respect to the defined benefit pension plan, as of June 21, 1995. The
employee benefit programs sponsored by R.R. Donnelley included medical, dental
and life insurance, workers' compensation and a defined benefit pension plan.
The Company reimbursed R.R. Donnelley for its proportionate cost of these
programs based on historical experience and relative headcount. The Company
recorded expense related to the reimbursement of these costs of approximately
$1.9 million and $2.4 million in the years ended December 31, 1995 and 1996,
respectively. The costs were charged to cost of revenues, selling expense and
general and administrative expense based on the number of employees in each of
these categories. The Company believes its allocation of the proportionate
cost is reasonable. R.R. Donnelley is liable for all payments under these
programs and, thus, no liability for these benefits has been reflected on the
accompanying consolidated balance sheet.
The weighted average discount rate used in determining the actuarial present
value of the benefit obligation for the defined benefit pension plan was 7.25%
and 7.5% for the years ended December 31, 1995 and 1996, respectively. The
rate of increase in future compensation levels assumed was 4% for 1995 and
1996. The expected long-term rate of return on plan assets was 9.5% for both
years.
On May 1, 1996, the Company terminated its participation in the R.R.
Donnelley defined benefit pension plan. R.R. Donnelley has retained all assets
and liabilities related to the plan. All other benefit programs offered by
R.R. Donnelley were terminated on December 31, 1996.
Corporate Services
Prior to the completion of the IPO, R.R. Donnelley provided certain support
services to the Company including legal, tax, benefits administration, data
processing, internal audit and payroll services. These charges were allocated
by R.R. Donnelley to the Company based on various formulas which reasonably
approximate the actual costs incurred. The corporate assessments recorded by
the Company for these allocations in the accompanying consolidated income
statements were approximately $650,000 and $863,000 for the years ended
December 31, 1995, and 1996, respectively. The amounts allocated by R.R.
Donnelley are not necessarily indicative of the actual costs which may have
been incurred had the Company operated as an entity unaffiliated with R.R.
Donnelley. However, the Company believes that the allocation is reasonable and
in accordance with the Securities and Exchange Commission's Staff Accounting
Bulletin No. 55.
Sales Through R.R. Donnelley
The Company sold services to clients who are also clients of R.R. Donnelley.
For some of these sales, an R.R. Donnelley salesman would assist the Company
in making the initial client contact and executing the transaction. To
compensate for these services, the Company paid a commission fee to the
respective R.R. Donnelley salesman. Management believes these commission fees
approximated the actual costs which may have been incurred had the Company
operated as an entity unaffiliated with R.R. Donnelley. Total commissions
expense related to these sales approximated $65,000, $43,000 and $82,000 for
the years ended December 31, 1995, 1996 and 1997, respectively. The sales to
which these commissions relate approximated, $6,027,000, $3,936,000 and
$10,556,000, respectively. The Company sold integration services and products
to R.R. Donnelley. These sales approximated $955,000, $2,038,000 and $411,000
for the period July 1, 1995 through December 31, 1995 and the years ended
December 31, 1996 and 1997, respectively. The receivables from R.R. Donnelley
related to these sales are reflected in accounts receivable or in the advances
due to related party discussed below.
Impact of Operating as a Stand-Alone Entity
For the year ended December 31, 1995 and for the period beginning January 1,
1996 through November 4, 1996, the accompanying financial statements reflect
the Company's costs of doing business, including expenses
F-11
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
incurred by R.R. Donnelley on the Company's behalf in accordance with
Securities and Exchange Commission Staff Accounting Bulletin No. 55. However,
the Company estimates it would have incurred increased expenses as a stand-
alone company, as well as other incremental public company expenses.
Advances Due to Related Party
Prior to the IPO, advances due to related party represent advances from R.R.
Donnelley to fund operating and investing activities, net of cash advanced to
R.R. Donnelley from operating cash flows generated by the Company. Advances
owed to R.R. Donnelley are non-interest bearing. The advances outstanding upon
the completion of the IPO were paid in full at November 4, 1996 with proceeds
from the offering.
Advances due to related party as of December 31, 1996 relate to services
provided to the Company by R.R. Donnelley under the Transition Services
Agreement and the Benefit Administration Agreement. Under these agreements,
R.R. Donnelley or its affiliates 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. Of the
approximately $6.5 million due to R.R. Donnelley as of December 31, 1996,
approximately $66,000 and $544,000 relate to fees under the Transition
Services Agreement and Benefit Administration Agreement, respectively. The
remaining balance reflects cash fundings made on behalf of the Company by R.R.
Donnelley under the Transition Services Agreement. The $510,000 due to R.R.
Donnelley as of December 31, 1997 is disputed.
The Benefit Administration Agreement terminated on December 31, 1996. The
Transition Services Agreement was terminated at the Company's request on
November 30, 1997.
5. PRO FORMA AND BASIC AND DILUTED EARNINGS PER SHARE
The pro forma earnings per share calculation set forth below does not
reflect the actual weighted average shares outstanding during the years ended
December 31, 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 were outstanding for these years.
<TABLE>
<CAPTION>
1995 1996
--------- ---------
<S> <C> <C>
Net income........................................... $ 303,000 $ 625,000
Pro forma earnings per share......................... $ 0.06 $ 0.12
Pro forma common shares outstanding.................. 5,005,000 5,005,000
</TABLE>
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128"),
which became effective in the fourth quarter of 1997. FAS 128 replaces the
presentation of earnings per share reflected on the income statement with a
dual presentation of basic earnings per share and diluted earnings per share.
Basic earnings per share excludes dilution and is computed by dividing net
income by the weighted average numbers of common shares outstanding during the
period. Diluted earnings per share reflects the potential dilution that could
occur if stock options and other commitments to issue common stock were
exercised resulting in the issuance of common stock that then shared in the
earnings of the Company. Basic and diluted earnings per share for the year
ended 1997 were the same. The effect of outstanding stock options was not
included in the computation of diluted earnings per share because to do so
would have been antidilutive. These options could potentially dilute earnings
per share in the future.
F-12
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
--------- ---------
<S> <C> <C>
Machinery and equipment............................. $ 18,211 $ 21,817
Capital leases...................................... 7,089 8,239
Leasehold improvements.............................. 541 867
--------- ---------
Total property and equipment.................... 25,841 30,923
Accumulated depreciation and amortization........... (13,195) (14,924)
--------- ---------
Net property and equipment...................... $ 12,646 $ 15,999
========= =========
</TABLE>
Depreciation and amortization expense of property and equipment included in
the accompanying consolidated income statements was $3,446,000, $4,492,000,
and $5,314,000 for the years ended December 31, 1995, 1996 and 1997,
respectively.
7. LEASE OBLIGATIONS:
The Company leases office space and various office equipment. These leases
are mainly accounted for as operating leases. Rental costs under operating
lease agreements including variable charges approximated $6,065,000,
$8,157,000 and $8,370,000 for the years ended December 31, 1995, 1996 and
1997, respectively.
The Company leases a significant amount of equipment used at its business
services outsourcing sites. Some leases are accounted for as capital leases.
The gross amounts of property and equipment representing capital leases in the
accompanying consolidated balance sheets at December 31, 1996 and 1997 were
approximately $7,089,000 and $8,239,000, respectively. Similar amounts for
accumulated amortization were $4,818,000 and $5,888,000, respectively.
Amortization of capital lease assets is included in depreciation and
amortization expense of property and equipment.
Minimum future lease obligations at December 31, 1997, are as follows (in
thousands):
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
--------- -------
<S> <C> <C>
Period ending December 31--
1998................................................. $2,762 $1,288
1999................................................. 2,358 981
2000................................................. 1,714 605
2001................................................. 1,055 211
2002 and thereafter.................................. 828 118
------ ------
Total minimum payments............................. $8,717 $3,203
======
Less: Amount representing interest..................... (692)
------
Present value of minimum lease payments................ $2,511
======
</TABLE>
8. SPECIAL CHARGE:
The Company recorded a charge of $300,000 in the year ended December 31,
1996 to reflect the departure, effective October 4, 1996, of Thomas P.
Bradbury who served as President of the LANSystems division. The Company and
Mr. Bradbury entered into a severance agreement pursuant to which the Company
agreed to
F-13
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
9. CREDIT AGREEMENT:
The Company entered into a $22.0 million credit agreement with Harris Trust
and Savings Bank on October 30, 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. Amounts
available under the facility will not exceed a percentage of the Company's
billed and unbilled accounts receivable, and borrowings will mature in
November 1999 and bear interest (i) at the prime rate announced by the bank
acting as agent under the facility or (ii) at the applicable LIBOR rate plus,
depending on the Company's fixed charge coverage ratio, up to 125 basis points
per annum. In addition, the Company will pay a commitment fee of 20 to 30
basis points per annum, depending on its fixed charge coverage ratio, on the
unused portion of the credit agreement. The commitment fees for the years
ended December 31, 1996 and 1997 were $7,700 and $33,400, respectively. $5.6
million in borrowings at a weighted average rate of 6.94% were outstanding at
December 31, 1997.
The facility contains customary financial and other covenants, including
requirements to (i) maintain a minimum consolidated net worth of not less than
80% of consolidated net worth on November 6, 1996 plus 50% of consolidated
positive net income for each fiscal quarter; (ii) a minimum fixed charge
coverage ratio specified quarterly; and (iii) a funded debt to cash flow ratio
of not more than 2.5 to 1, and restrictions on liens, investments, dividends,
indebtedness, acquisitions and transactions with affiliates. The Company was
in compliance with all debt covenants as of December 31, 1997. The facility
may be extended an additional year upon receipt of notice by the
Administrative Agent before the second, third and fourth anniversary dates of
the Agreement and terminates in full on November 5, 1999.
10. COMMITMENTS AND CONTINGENCIES:
The Company is 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 position of the Company. A former client
filed suit against the Company in 1996 and the Company filed a counter claim
in 1997. The Company is of the opinion that the claim and the related
counterclaim will not have a material impact on the results of operations of
the Company in the period in which resolved.
11. INCOME TAXES:
The components of the provision for income taxes are as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
----------------------
1995 1996 1997
----- ------ -------
<S> <C> <C> <C>
Federal--
Current......................................... $ 884 $ (306) $ 178
Deferred........................................ (478) 963 (1,266)
State--
Current......................................... 107 (67) 10
Deferred........................................ (18) 483 (322)
----- ------ -------
Total provision............................... $ 495 $1,073 $(1,400)
===== ====== =======
</TABLE>
F-14
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A reconciliation of the effective tax rate from the statutory U.S. federal
income tax rate of 34% is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------------
1995 1996 1997
---- ---- -----
<S> <C> <C> <C>
Federal rate.......................................... 34.0% 34.0% (34.0)%
State taxes........................................... 11.2 11.4 (7.3)
Goodwill amortization................................. 11.3 13.8 6.5
Meals and entertainment............................... 5.4 4.1 1.7
Other................................................. 0.1 (0.1) 3.2
---- ---- -----
Effective tax rate.................................. 62.0% 63.2% (29.9)%
==== ==== =====
</TABLE>
The following summarizes the estimated tax effect of significant cumulative
temporary differences that are included in the net deferred income tax asset,
which is classified between current and long-term in the accompanying
consolidated balance sheets (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1996 1997
----- ------
<S> <C> <C>
Vacation liability......................................... $ 162 $ 231
Payroll and related liabilities............................ 136 --
Allowance for doubtful accounts............................ 140 1,680
Inventory.................................................. 328 457
Revenue recognition........................................ (42) (256)
Miscellaneous, other....................................... 143 210
Net operating loss carryforwards........................... -- 367
----- ------
Total net current deferred tax asset................... 867 2,689
----- ------
Accumulated depreciation................................... 593 391
LANSystems contingent payments............................. (926) (947)
Miscellaneous, other....................................... 22 11
----- ------
Total net noncurrent deferred tax liability............ (311) (545)
----- ------
Total.................................................. $ 556 $2,144
===== ======
</TABLE>
The Company has not provided a valuation allowance for deferred tax assets
because, although realization is not assured, the Company believes it is more
likely than not that such tax assets will be recognized through reversals of
taxable timing differences and taxable income in future periods. The current
net operating loss carryforwards expire between the years ended December 31,
2000 and 2010.
12. EMPLOYEE BENEFIT PLANS
Effective January 1, 1997, the Company offered employees a 401(k) savings
plan with the Company matching a portion of the amounts contributed by
employees. An employee is eligible to receive the employer match after being
employed by the Company for one year, if that employee was not hired by
January 1, 1997. The Company matches 50% of the first 5% of the employee's
contribution. Vesting on the employer match occurs over five years. For the
year ended December 31, 1997, the Company contributed $441,000 to the 401(k)
savings plan.
The Company instituted a stock purchase plan in 1997 that begins effective
January 1, 1998. Under the plan, the Company allows employees with at least
one year of service with the Company to participate. Each employee
F-15
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
may invest up to 10% of their base compensation at a discount of 15% off the
fair market value of the stock price on the last day of the offering periods,
which are January 1, April 1, July 1 and October 1. The Company has not
incurred any expense related to the plan in 1997 as it is not effective until
January 1, 1998.
13. STOCK-BASED COMPENSATION PLANS
The Company has three stock option plans, the 1996 Stock Incentive Plan
("Incentive Plan"), the 1996 Broad-Based Employee Stock Plan ("Broad-Based
Plan") and the 1997 Non-Employee Director Plan, as well as the 1997 Employee
Stock Purchase Plan. See Note 12. The Company accounts for these plans under
APB Opinion No. 25, under which no compensation cost has been recognized.
Had compensation cost for these plans been determined consistent with FASB
Statement No. 123, the Company's net income and earnings per share would have
been reduced to the following pro forma amounts:
<TABLE>
<CAPTION>
1996 1997
-------- -----------
<S> <C> <C>
Net Income (Loss):
As Reported....................................... $625,000 $(3,280,000)
Pro Forma......................................... 538,000 (4,099,000)
Basic and diluted EPS:
As Reported....................................... $ 0.12 $ (0.66)
Pro Forma......................................... 0.11 (0.82)
</TABLE>
The Company may grant options for up to 400,000 shares of Common Stock under
both the Incentive Plan and the Broad-Based Plan. Under both Plans, the option
price equals the stock's market price on date of grant. These options vest
over periods of two to four years and expire after ten years. Upon completion
of the IPO, a total of 313,950 options were awarded under these plans to
employees of the Company at an exercise price of $25.00 per share.
Additionally, 5,000 shares of restricted Common Stock were granted to a key
executive upon completion of the IPO. No other options were outstanding at
December 31, 1996. For the year ended December 31, 1997, a total of 332,375
options were outstanding. A summary of the status of the Company's stock
option plans at December 31, 1996 and 1997 is presented below:
<TABLE>
<CAPTION>
1996 1997
----------------- -----------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
------- -------- ------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning of year.... -- $ -- 300,625 $25.00
Granted............................. 313,950 25.00 107,750 12.55
Exercised........................... 0 -- 0 --
Forfeited........................... (13,325) 25.00 (76,000) 23.54
Expired............................. 0 -- 0 --
------- ------ ------- ------
Outstanding at end of year.......... 300,625 $25.00 332,375 $21.30
======= ====== ======= ======
Exercisable at end of year.......... 0 $ -- 62,045 $25.00
======= ====== ======= ======
Weighted average fair value of
options............................ $15.46 $ 8.13
====== ======
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model. The assumptions used to estimate the
fair value of these grants in 1996 and 1997 were, respectively: risk-free
interest rate of 6.2% and 6.4%, an expected dividend yield of 0% and 0%, an
expected volatility of 53.0% and 78.4% and a grant life of seven years and
five years, respectively.
F-16
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
14. ACQUISITION OF LANSYSTEMS:
As discussed in Note 1, LANSystems was acquired on June 21, 1995 for cash of
approximately $16.6 million and certain contingent payment obligations
("earnout"). The acquisition was accounted for as a purchase, with the excess
of the purchase price over the fair market value of net assets acquired being
allocated to goodwill in the amount of approximately $11.8 million. The
goodwill is being amortized over its estimated useful life of 20 years.
The earnout provisions provided for contingent payments of up to $12.9
million payable to former LANSystems shareholders and management participants
based on the achievement of specified financial targets for the years ended
December 31, 1995 through 1998. In the year ended December 31, 1996, the
earnout was renegotiated and a final payment was made. In this regard, $9.5
million was recorded as additional goodwill related to the earnout.
The following unaudited pro forma income statement was prepared to
illustrate the estimated effects of the acquisition as if it had occurred on
January 1, 1995. The pro forma adjustments are based on the available
information and upon certain assumptions the Company believes are reasonable.
The pro forma income statement does not purport to represent what the
Company's income statements would actually have been if such transaction in
fact had occurred on January 1, 1995, or to project the Company's income
statements for any future period. The information below reflects an adjustment
for the amortization of goodwill based on the new cost basis of the Company,
as well as an adjustment to the income tax provision to reflect the tax effect
of the aforementioned adjustment.
<TABLE>
<CAPTION>
1995
--------------
(IN THOUSANDS)
<S> <C>
Revenues................................................... $79,545
Cost of revenues .......................................... 64,336
-------
Gross profit........................................... 15,209
Selling expenses........................................... 7,918
General and administrative expenses........................ 7,096
Amortization of goodwill................................... 1,065
-------
Earnings (loss) from operations........................ (870)
Interest expense, net...................................... 543
-------
Earnings (loss) before income taxes.................... (1,413)
Income taxes............................................... (63)
-------
Net income (loss)...................................... $(1,350)
=======
</TABLE>
15. QUARTERLY DATA (UNAUDITED):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH FULL
FOR THE FISCAL YEARS ENDED QUARTER QUARTER QUARTER QUARTER YEAR
-------------------------- ------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
December 31, 1996
Revenues ......................... $20,451 $24,792 $25,780 $25,441 $ 96,464
Gross profit ..................... 4,371 5,562 5,509 4,668 20,110
Net income (loss) ................ (69) 691 474 (471) 625
Pro forma earnings (loss) per
share ........................... $ (0.01) $ 0.13 $ 0.09 $ (0.09) $ 0.12
======= ======= ======= ======= ========
December 31, 1997
Revenues ......................... $27,038 $28,727 $25,509 $29,570 $110,844
Gross profit ..................... 5,901 7,064 3,590 5,744 22,299
Net income (loss) ................ 236 578 (4,222) 128 (3,280)
Basic and diluted earnings (loss)
per share........................ $ .05 $ 0.12 $ (0.84) $ .03 $ (0.66)
======= ======= ======= ======= ========
</TABLE>
F-17
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The pro forma earnings per share calculation does not reflect the actual
weighted average shares outstanding during the year ended December 31, 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 were
outstanding for this year.
16. CHANGES IN ESTIMATE:
In the third quarter of 1997, the Company recorded two adjustments resulting
from changes in estimate. One adjustment affected revenue and gross profit by
$3.3 million and $2.3 million, respectively, for a change in estimate in
integration and consulting services at LANSystems resulting from the
reductions in scope on certain integration projects, operating performance
issues and an increase in the estimated number of hours required to complete
certain other projects. The second adjustment resulted primarily from a change
in estimate in the allowance for doubtful accounts in the amount of $3.6
million, which was primarily due to the increased age of the receivables at
LANSystems which lessens the likelihood of collection.
F-18
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THE REGISTRANT
HAS DULY CAUSED THIS ANNUAL REPORT ON FORM 10-K TO BE SIGNED ON ITS BEHALF BY
THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN CHICAGO, ILLINOIS ON MARCH 26,
1998.
Donnelley Enterprise Solutions
Incorporated
/s/ Rhonda I. Kochlefl
By___________________________________
Name: Rhonda I. Kochlefl
Title: Chairman, President and
Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS ANNUAL
REPORT ON FORM 10-K HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES
AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Rhonda I. Kochlefl Chairman, President and March 26, 1998
____________________________________ Chief Executive Officer and
Rhonda I. Kochlefl Director (principal
executive officer)
* Senior Vice President and March 26, 1998
____________________________________ Chief Financial Officer
Thomas A Munro (principal financial and
accounting officer)
* Director March 26, 1998
____________________________________
Leo S. Spiegel
* Director March 26, 1998
____________________________________
Gregory A. Stolkosa
* Director March 26, 1998
____________________________________
Charles F. Moran
* Director March 26, 1998
____________________________________
</TABLE> W. Ed tyler
/s/ Rhonda I. Kochlefl
*By: __________________________
Rhonda I. Kochlefl
Attorney-in-Fact
F-19
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
We have audited in accordance with generally accepted auditing standards,
the consolidated financial statements of Donnelley Enterprise Solutions
Incorporated included in this Form 10-K and have issued our report thereon
dated February 3, 1998. Our audits were made for the purpose of forming an
opinion on the basic financial statements taken as a whole. The schedule
listed on page S-2 is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures
applied in the audits of the basic financial statements and in our opinion,
fairly states in all material respects the financial data required to be set
forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 3, 1998
S-1
<PAGE>
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DEDUCTIONS
ADDITIONS WRITE-OFFS
BALANCE ----------------------- OF TRADE
AT THE CHARGES TO RECEIVABLES, BALANCE
ALLOWANCES FOR DOUBTFUL BEGINNING CHARGES TO OTHER NET OF AT END
ACCOUNTS OF PERIOD EXPENSES(1) ACCOUNTS(2) RECOVERIES OF PERIOD
- ----------------------- --------- ----------- ----------- ------------ ---------
<S> <C> <C> <C> <C> <C>
For the Year Ended
December 31, 1995...... -- $ 413 $217 $ (23) $ 607
For the Year Ended
December 31, 1996...... $607 $ 248 -- $(395) $ 460
For the Year Ended
December 31, 1997...... $460 $3,700 -- $(216) $3,944
</TABLE>
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(1) These amounts represent provisions for doubtful accounts that are included
in both sales and general and administrative expenses.
(2) These amounts represent additions to the reserve resulting from the
purchase of LAN Systems, Inc. by R. R. Donnelley & Sons Company in 1995.
S-2
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIAL
EXHIBIT PAGE
NUMBER DOCUMENT DESCRIPTION NUMBER
------- -------------------------------------------------------- ----------
<C> <S> <C>
First Amended and Restated Certificate of Incorporation
3.1 of the Company.(1)
3.2 By-laws of the Company.(1)
Employment Agreement between Rhonda I. Kochlefl and the
10.4 Company.(1)(3)
Employment Agreement between Linda A. Finkel and the
10.7 Company.(2)(3)
Severance Agreement between Thomas P. Bradbury and the
10.8 Company.(1)(3)
10.9 1996 Broad-Based Employee Stock Plan.(1)(3)
10.10 Agreement of Merger among R.R. Donnelley & Sons Company,
Donnelley DBS, Inc. and LAN Systems, Inc.(1)
10.11 Form of Credit Agreement among the Company, as Borrower,
and the Banks named therein.(1)
10.12 1997 Non-Employee Director Stock Plan.(2)(3)
10.13 Amended and Restated 1996 Stock Incentive Plan.(2)(3)
10.14 1997 Employee Stock Purchase Plan.(2)(3)
Employment Agreement between Robert A. Lento and the
10.15 Company.(3)
Employment Agreement between David J. Shea and the
10.16 Company.(3)
23.1 Consent of Arthur Andersen LLP.
24.1 Powers of Attorney of Thomas A. Munro, Leo S. Spiegel,
Gregory A. Stoklosa,
Charles F. Moran and W. Ed Tyler.
27.1 Financial Data Schedule.
Transition Services Agreement between the Company and
99.1 R.R. Donnelley.(1)
Benefit Administration Services Agreement between the
99.2 Company and R.R. Donnelley.(1)
99.3 Tax Allocation and Indemnification Agreement between the
Company and
R.R. Donnelley.(1)
</TABLE>
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(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) Incorporated herein by reference to the Company's Registration Statement
on Form 10-K for the year ended December 31, 1996, filed on March 28,
1997.
(3) Indicates a management contract or compensatory plan or agreement.
<PAGE>
EXHIBIT 10.15
EMPLOYMENT AGREEMENT
This Employment Agreement is made as of January 9, 1997 by and among
Donnelley Enterprise Solutions Incorporated, a Delaware corporation (the
"Company"), and Robert A. Lento (the "Executive").
WHEREAS, the Company desires to employ the Executive as its President,
LANSystems division, and the Executive desires to accept such employment,
for the term and upon the conditions set forth in this Agreement.
Agreement
Now, therefore, the parties hereto hereby agree as follows:
1. Employment. Subject to the terms and conditions set forth in this
Agreement, the Company offers and the Executive hereby accepts employment,
effective as of January 13, 1997.
2. Term. Subject to earlier termination as hereafter provided, the
Executive shall be employed hereunder for an original term commencing on the
Effective Date and ending at 5:00 p.m., Chicago time, on the fourth anniversary
of the Effective Date, or such later date to which the parties may agree. The
term of this Agreement is hereafter referred to as "the term of this Agreement"
or "the term hereof".
3. Capacity and Performance.
3.1. Offices. During the term hereof and for the compensation
described in Section 4 below, the Executive shall serve as the Division
President, LANSystems division. The Executive shall be subject to the
direction of the Chairman, President and Chief Executive Officer of the
Company (or any one of them to whom the Executive then reports, hereinafter
referred to as the "Reporting Executive"), and shall have such other
powers, duties and responsibilities consistent with the Executive's
position as President, LANSystems division, as may from time to time be
prescribed by the Reporting Executive. In addition, for so long as the
Executive is employed by the Company and, unless otherwise determined by
the Reporting Executive, without further compensation, the Executive shall
serve as a director of one or more of the Company's subsidiaries if so
elected or appointed from time to time.
<PAGE>
3.2. Performance. During the term hereof, the Executive shall be
employed by the Company and shall perform and discharge (faithfully,
diligently and to the best of the Executive's ability) such duties and
responsibilities on behalf of the Company and its subsidiaries as may be
designated from time to time by the Reporting Executive. During the term
hereof, the Executive shall devote the Executive's full business time and
attention to the advancement of the business and interests of the Company
and its subsidiaries and to the discharge of the Executive's duties and
responsibilities hereunder. Nothing contained herein shall be construed to
prohibit or restrict the Executive from (a) serving in various capacities
in community, civic, religious or charitable organizations, (b) serving as
a member of the boards of non-affiliated entities provided such entities do
not compete with the Company and such service does not create a conflict of
interest as determined by the Board, or (c) attending to personal business
and investment matters. It is expressly agreed that any such service or
activity permitted by the previous sentence shall not unreasonably
interfere with the performance of the Executive's duties and, if so, the
Executive, after consultation with the Board, will comply with the
reasonable requests to cease or limit the service or activity.
4. Compensation and Benefits. As compensation for all services performed
by the Executive under this Agreement and performance of the Executive's duties
and of the obligations to the Company and its subsidiaries, pursuant to this
Agreement or otherwise and subject to Section 5 hereof:
4.1. Base Salary. During the term hereof, the Company shall pay the
Executive a base salary at the rate of $210,000 per year, payable in
accordance with the payroll practices of the Company for its executives but
no less than monthly and subject to increase at any time or from time to
time by the Reporting Executive in his or her sole discretion. Such base
salary, as from time to time increased, is hereafter referred to as the
"Base Salary". The Base Salary payable to the Executive in 1997 shall be
prorated for the period from the Effective Date through December 31, 1997
and for any subsequent period of service less than one full year.
4.2. Bonus Compensation. During the term hereof, the Company from
time to time shall pay the Executive an annual bonus (the "Bonus"). The
Bonus in respect of 1997 (the "1997 Bonus") will be calculated as follows:
The Company will calculate the dollar amount of the 1997 LANSystems Bonus
pursuant to Section 4.2.1. below and the dollar amount of the 1997 DESI
Bonus pursuant to Section 4.2.2. below, adjust such amounts in accordance
with Section 4.2.3, and pay to the Executive the sum of such
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<PAGE>
amounts:
4.2.1. (a) If the Targeted Operating Income (as defined below)
for the LANSystems Division for calendar year 1997 (the "1997
LANSystems TOI"), is less than (TBD) (the "Minimum LANSystems
Target"), the 1997 LANSystems Bonus shall equal zero;
(b) If the 1997 LANSystems TOI is equal to or greater than the
Minimum LANSystems Target but less than (TBD) (the "Base LANSystems
Target"), the 1997 LANSystems Bonus shall equal the number obtained by
multiplying 30% of the Executive's 1997 Salary by a fraction (which
shall not be greater than one), the numerator of which is the
difference between the 1997 LANSystems TOI and the Minimum LANSystems
Target and the denominator of which is the amount determined by
subtracting the Minimum LANSystems Target from the Base LANSystems
Target;
(c) If the 1997 LANSystems TOI is equal to or greater than the
Base LANSystems Target but less than (TBD) (the "Maximum LANSystems
Target"), the 1997 LANSystems Bonus shall equal the sum of the number
obtained by multiplying 60% of the Executive's 1997 Salary by a
fraction (which shall not be greater than one), the numerator of which
is the difference between the 1997 LANSystems TOI and the Base
LANSystems Target and the denominator of which is the amount
determined by subtracting the Base LANSystems Target from the Maximum
LANSystems Target; or
(d) If the 1997 LANSystems TOI is equal to or greater than the
Maximum LANSystems Target, the 1997 LANSystems Bonus shall equal 60%
of the Executive's 1997 Salary.
4.2.2. (a) If the Adjusted Operating Income (as defined below)
for DESI taken as a whole for calendar year 1997 (the "1997 DESI
AOI"), is less than (TBD) (the "Minimum DESI Target"), the 1997 DESI
Bonus shall equal zero;
(b) If the 1997 DESI TOI is equal to or greater than the Minimum
DESI Target but less than (TBD) (the "Base DESI Target"), the 1997
DESI Bonus shall equal the sum of the number obtained by multiplying
10% of the Executive's 1997 Salary by a fraction (which shall not be
greater than one), the numerator of which is the difference between
the 1997 DESI AOI and the Minimum DESI Target and the denominator of
which
-3-
<PAGE>
is the amount determined by subtracting the Minimum DESI Target from
the Base DESI Target;
(c) If the 1997 DESI TOI is equal to or greater than the Base
DESI Target but less than (TBD) (the "Maximum DESI Target"), the 1997
DESI Bonus shall equal the sum of the number obtained by multiplying
20% of the Executive's 1997 Salary by a fraction (which shall not be
greater than one), the numerator of which is the difference between
the 1997 DESI TOI and the Base DESI Target and the denominator of
which is the amount determined by subtracting the Base DESI Target
from the Maximum DESI Target; or
(d) If the 1997 DESI TOI is equal to or greater than the Maximum
DESI Target, the 1997 DESI Bonus shall equal 20% of the Executive's
1997 Salary.
4.2.3. Any compensation paid to the Executive as Bonus shall be
in addition to the Base Salary. The 1997 Bonus payable to the
Executive shall be pro-rated for any period of service less than a
full year by multiplying (x) the amount of the Bonus calculated for
such year by (y) a fraction, the numerator of which is the number of
days from and including January 1 of such year through and including
the effective date of the Executive's termination of employment and
the denominator of which is 365. All bonus and benefit plans are
subject to annual review and change by the Board relative to key
strategic objectives for the year.
4.3. Stock Options. The Company has established the 1997 Stock
Incentive Plan (the "Plan") for management/employees of the Company
pursuant to which options may be granted for common stock of the Company
("Common Stock"). As soon as practical after the Effective Date, the
Company shall grant to the Executive, pursuant to the Plan, options to
purchase a total of 25,000 shares of Common Stock at an exercise price
equal to the fair market value of the common stock on the date of grant
(the "Options"). Subject to the termination of employment provisions
contained in the agreement evidencing the Options, the Options will become
exercisable in four cumulative annual installments on the one year (25%),
two year (25%), three year (25%) and four year (25%) anniversaries of the
Effective Date, subject to acceleration of vesting in accordance with the
terms of the agreement evidencing the Options.
4.4. Vacations. During the term hereof, the Executive shall be
entitled to four (4)
-4-
<PAGE>
weeks of vacation per annual vacation period of the Company, such vacation
to be taken at such times and intervals as shall be determined by the
Executive in the Executive's reasonable discretion. The Executive may not
accumulate or carry over from one calendar year to another any unused,
accrued vacation time, unless the Reporting Executive determines that
business demands require deferral and carry over of vacation from any year
into up to the first six (6) months of the succeeding year. The Executive
shall not be entitled to compensation for vacation time not taken, except
that upon termination of employment, the Executive shall be paid for all
vacation time accrued but not taken.
4.5. Other Benefits. During the term hereof and subject to any
contribution therefor generally required of executives of the Company, the
Executive shall be entitled to participate in all employee benefit plans
and other programs (including, but not limited to, any medical, dental,
retirement, disability, life insurance, sick leave and other benefits) from
time to time adopted by the Board and in effect for executives of the
Company generally, except to the extent such plans are in a category of
benefit otherwise already provided to the Executive. Such participation
shall be subject to (i) the terms of the applicable plan documents, (ii)
generally applicable Company policies and (iii) the discretion of the Board
or any administrative or other committee provided for in or contemplated by
such plan. The Company may alter, modify, add to or delete its employee
benefit plans at any time as the Board, in its sole judgment, determines to
be appropriate.
4.6. Business Expenses. The Company shall pay or reimburse the
Executive for all reasonable business expenses incurred or paid by the
Executive in the performance of the Executive's duties and responsibilities
hereunder, subject to (i) any expense policy of the Company set by the
Board from time to time, and (ii) such reasonable substantiation and
documentation requirements as may be specified by the Board from time to
time.
4.7. Severance. In the event the Executive's employment with the
Company is (i) terminated by the Company other than for Cause in accordance
with Section 5.4 or (ii) terminated by the Executive in accordance with
Section 5.5, the Executive will be entitled to receive twenty-four (24)
monthly payments equal to the Executive's then applicable Base Salary
calculated on a monthly basis at the time of such termination (i.e., 1/12th
of the Base Salary), paid on the last day of a calendar month.
5. Termination of Employment and Severance Benefits. Notwithstanding the
provisions of Section 2 hereof, the Executive's employment hereunder shall
terminate prior to the expiration of the term of this Agreement under the
following circumstances:
-5-
<PAGE>
5.1. Retirement or Death. In the event of the Executive's retirement
or death during the term hereof, the Executive's employment hereunder shall
immediately and automatically terminate. In the event of the Executive's
retirement after the age of sixty-five, age fifty-five with the prior
consent of the Board or death during the term hereof, the Company shall pay
to the Executive (or in the case of death, the Executive's designated
beneficiary or, if no beneficiary has been designated by the Executive, to
the Executive's estate) (i) Base Salary earned but unpaid through and
including the date of such retirement or death, (ii) any amount payable
pursuant to Section 4.6, (iii) any unpaid portion of any Bonus for any
fiscal year preceding the year in which such retirement or death occurs
that was earned but had not previously been paid and (iv) at the times the
Company pays its executives bonuses in accordance with its general payroll
policies, any Bonus which would have been paid had such retirement or death
not occurred during the fiscal year of such retirement or death (pro-rated
based on a formula, the numerator of which shall be the number of days
during the fiscal year of such retirement or death in which the Executive
was employed by the Company and the denominator of which shall be 365 or
366, as the case may be).
5.2. Disability.
5.2.1. The Company may terminate the Executive's employment
hereunder, upon written notice to the Executive, in the event that the
Executive becomes disabled during the Executive's employment hereunder
through any illness, injury, accident or condition of either a
physical or psychological nature and, as a result, is unable to
perform substantially all of the Executive's duties and
responsibilities hereunder for an aggregate of one hundred eighty
(180) days during any period of three hundred and sixty-five (365)
consecutive calendar days.
5.2.2. The Board may designate another employee to act
temporarily in the Executive's place during any period of the
Executive's disability. Notwithstanding any such designation, the
Executive shall continue to receive the Base Salary in accordance with
Section 4.1 and to receive benefits in accordance with Section 4.5, to
the extent permitted by the then current terms of the applicable
benefit plans, until the Executive becomes eligible for disability
income benefits under any disability income plan maintained by the
Company or until the termination of the Executive's employment,
whichever shall first occur. Upon becoming so eligible, or upon such
termination, whichever shall first occur, the Company shall pay to the
Executive (i) Base Salary earned but unpaid through and including the
date of such eligibility or termination, (ii) any amount payable
-6-
<PAGE>
pursuant to Section 4.6, (iii) any unpaid portion of any Bonus for any
fiscal year preceding the year in which such eligibility or
termination occurs that was earned but had not previously been paid
and (iv) at the times the Company pays its executives bonuses in
accordance with its general payroll policies, any Bonus which would
have been paid had disability not occurred during the fiscal year in
which such eligibility or termination occurs (pro-rated based on a
formula, the numerator of which shall be, as applicable, (i) the
number of days from and including January 1 of the fiscal year in
which such eligibility occurs to but excluding the date of such
eligibility or (ii) the number of days on which the Executive was
employed by the Company during the fiscal year in which such
termination occurs and the denominator of which shall be 365 or 366,
as the case may be).
5.2.3. Except as provided in Section 5.2.2, while receiving
disability income payments under any disability income plan maintained
by the Company, the Executive shall not be entitled to receive any
Base Salary under Section 4.1 or Bonus payments under Section 4.2 but
shall continue to participate in the Company's benefit plans in
accordance with Section 4.5 and the terms of such plans, until the
termination of the Executive's employment. During the twelve (12)
month period from and including the date of termination, the Company
shall pay for the cost of the Executive's participation in the
Company's group medical and dental plans, provided that the Executive
is entitled to continue such participation under applicable law and
the terms of such plan.
5.2.4. If any question shall arise as to whether during any
period the Executive is disabled through any illness, injury, accident
or condition of either a physical or psychological nature so as to be
unable to perform substantially all of the Executive's duties and
responsibilities hereunder, the Executive may, and at the request of
the Company shall, submit to a medical examination by a physician
either (i) mutually selected by the Company and the Executive or the
Executive's duly appointed guardian or (ii) failing mutual agreement,
a physician selected by each of a physician selected by the Company
and a physician selected by the Executive, to determine whether the
Executive is so disabled and such determination shall for the purposes
of this Agreement be conclusive of the issue. If such question shall
arise and the Executive shall fail to submit to such medical
examination, the Board's determination of the issue shall be binding
on the Executive.
5.3. By the Company for Cause. The Company may terminate the
Executive's
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<PAGE>
employment hereunder for Cause as provided in Section 11.2. If the
Executive's employment hereunder is terminated for Cause, the Company shall
have no further obligation or liability to the Executive relating to the
Executive's employment hereunder, or the termination thereof, except that
the Company shall pay to the Executive (i) Base Salary earned but unpaid
through and including the date of termination, (ii) any amount payable
pursuant to Section 4.6, and (iii) any other amounts accrued by the
Executive but unpaid through and including the date of termination (it
being understood that a Bonus does not accrue until December 31 of the year
on which such Bonus is based).
5.4. By the Company other than for Cause. The Company may terminate
the Executive's employment hereunder other than for Cause at any time after
the Effective Date upon two weeks prior written notice to the Executive. In
the event of such termination, then the Company shall pay the Executive (i)
Base Salary earned but unpaid through and including the date of
termination, (ii) any amount payable pursuant to Section 4.6, (iii) the
amounts specified in Section 4.7, (iv) any unpaid portion of any Bonus for
any fiscal year preceding the year in which such termination occurs that
was earned but had not previously been paid, (v) at the times the Company
pays its executives bonuses in accordance with its general payroll
policies, any Bonus which would have been paid had termination not occurred
during the fiscal year in which such termination occurs (pro-rated based on
a formula, the numerator of which shall be the number of days during the
fiscal year in which such termination occurs the Executive was employed by
the Company and the denominator of which shall be 365 or 366, as the case
may be), and (vi) any other amounts accrued by the Executive but unpaid
through and including the date of termination. In addition, 100% of the
number of shares of Common Stock subject to each option, including the
Options, held by the Executive on the date of such termination and which
are then unexercisable shall become exercisable as of the date of such
termination, and such Options may be exercised for a period up to ninety
(90) days following termination of the Executive's employment.
5.5. By the Executive upon Breach or for Good Reason. The Executive
may terminate the Executive's employment hereunder (i) in the event that
the Company fails to perform, in any material respect, its obligations
under this Agreement, after written notice to the Company setting forth in
reasonable detail the nature of such breach if such breach remains uncured
for a period of 30 days following such written notice to the Company
provided that said notice shall not be required in the event of repeated,
intentional or willful failure to perform by the Company, (ii) there is a
material diminution in the responsibilities, duties and powers of the
Executive, or (iii) the Executive's offices are moved from their present
location to a location outside of the New York metropolitan area. In the
event of termination in accordance with this Section 5.5, then the Company
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<PAGE>
shall pay to the Executive (i) Base Salary earned but unpaid through and
including the date of termination, (ii) any amount payable pursuant to
Section 4.6, (iii) the amounts specified in Section 4.7, (iv) any unpaid
portion of any Bonus for any fiscal year preceding the year in which such
termination occurs that was earned but had not previously been paid, (v) at
the times the Company pays its executives bonuses in accordance with its
general payroll policies, any Bonus which would have been paid had
termination not occurred during the fiscal year in which such termination
occurs (pro-rated based on a formula, the numerator of which shall be the
number of days during the fiscal year in which such termination occurs the
Executive was employed by the Company and the denominator of which shall be
365 or 366, as the case may be), and (vi) any other amounts accrued by the
Executive but unpaid through and including the date of termination. In
addition, 100% of the number of shares of Common Stock subject to each
option, including the Options, held by the Executive on the date of such
termination and which are then unexercisable shall become exercisable as of
the date of such termination, and such Options may be exercised for a
period up to ninety (90) days following termination of the Executive's
employment.
5.6. By the Executive Other than upon Breach or for Good Reason. The
Executive may terminate the Executive's employment hereunder at any time
upon ninety (90) days' written notice to the Company. In the event of
termination of the Executive pursuant to this Section 5.6, the Board may
elect to waive the period of notice, or any portion thereof, and, whether
or not the Board so elects, the Company shall pay to the Executive (i) Base
Salary for the full notice period, (ii) any amount payable pursuant to
Section 4.6, (iii) at the times the Company pays its executives bonuses in
accordance with its general payroll policies, any Bonus which would have
been paid had termination not occurred during the fiscal year in which such
termination occurs (pro-rated as set forth in Section 5.5 above), and (iv)
any other amounts accrued by the Executive but unpaid through and including
the date of termination.
5.7. Post-Agreement Employment. In the event the Executive remains
in the employ of the Company or any of its Affiliates following termination
of this Agreement, by the expiration of the term hereof or otherwise, then
such employment shall be at will, unless otherwise agreed in writing.
6. Effect of Termination. The provisions of this Section 6 shall apply in
the event of termination due to the expiration of the term of this Agreement,
pursuant to Section 5 or otherwise.
6.1. Receipt of Certain Benefits. It is the mutual intention of the
Company and
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<PAGE>
the Executive that the Executive receive the full benefit of the
compensation and benefits provided to the Executive during the term hereof
which compensation and benefits may be payable over periods beyond the
particular year of employment. The Executive shall not be obligated to seek
other employment by way of mitigation of the amounts due to the Executive
nor shall the Executive's earnings after termination reduce the Company's
obligations hereunder. Nothing in this Section 6.1 is intended or shall be
construed to affect the rights and obligations of the Company and its
Affiliates, on the one hand, and the Executive, on the other, with respect
to any loans, stock pledge arrangements, option plans or other agreements
to the extent said rights or obligations survive termination of employment
under the provisions of the documents relating thereto.
6.2. Termination of Health and Welfare Benefits. Except for medical
and dental insurance coverage continued pursuant to Sections 5.2 hereof and
any right of continuation of health coverage to the extent provided by
Sections 601 through 608 of ERISA, health and welfare benefits shall
terminate pursuant to the terms of the applicable benefit plans based on
the date of termination of the Executive's employment without regard to any
continuation of Base Salary or other payments to the Executive following
such date of termination pursuant to Section 5.
6.3. Survival of Certain Provisions. Provisions of this Agreement
shall survive any termination if so provided herein or if necessary or
desirable fully to accomplish the purposes of such provision, including,
without limitation, the obligations of the Executive under Sections 7 and 8
hereof. The obligation of the Company to make payments to or on behalf of
the Executive under Sections 4.7, 5.4 or 5.5 hereof is expressly
conditioned upon the Executive's continued full performance of obligations
under Sections 7 and 8 hereof. The Executive recognizes that, except as
expressly provided in Section 4.7, 5.4 or 5.5, no compensation is earned
after termination of employment.
7. Confidential Information; Intellectual Property.
7.1. Confidentiality. The Executive acknowledges that the Company and
its Affiliates continually develop Confidential Information, that the
Executive may develop Confidential Information for the Company or its
Affiliates and that the Executive may learn of Confidential Information
during the course of employment. The Executive will comply with the
policies and procedures of the Company for protecting Confidential
Information and shall never disclose to any Person (except as required by
applicable law or for the proper performance of the Executive's duties and
responsibilities to the Company and its Affiliates), or use for the
Executive's own benefit or gain or otherwise use in a manner adverse to the
interests of the Company and its Affiliates, any
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<PAGE>
Confidential Information obtained by the Executive incident to the
Executive's employment or other association with the Company or any of its
Affiliates. The Executive understands that this restriction shall continue
to apply after the Executive's employment terminates, regardless of the
reason for such termination. Notwithstanding the foregoing, the Executive's
covenant not to disclose Confidential Information does not apply to
information which (i) becomes generally available to the public or
otherwise becomes known through sources other than the Executive, (ii) is
subsequently disclosed to the Executive by a source other than the Company
who was under no duty of confidence or (iii) is required to be disclosed by
the Executive through discovery in litigation or by order of a court or
otherwise as required by law.
7.2. Return of Documents. All documents, records, tapes and other
media of every kind and description relating to the business, present or
otherwise, of the Company or its Affiliates and any copies, in whole or in
part, thereof (the "Documents"), whether or not prepared by the Executive,
shall be the sole and exclusive property of the Company and its Affiliates,
provided, however, that Executive shall in all cases be entitled to retain
copies of documents relating to the Executive's employment rights,
compensation, benefits or other obligations of the Company to the Executive
and the Executive to the Company. The Executive shall safeguard all
Documents and shall surrender to the Company at the time the Executive's
employment terminates, or at such earlier time or times as the Board or its
designee may specify, all Documents then in the Executive's possession or
control.
7.3. Assignment of Rights to Intellectual Property. The Executive
shall promptly and fully disclose all Intellectual Property to the Company.
The Executive hereby assigns and agrees to assign to the Company (or as
otherwise directed by the Company) the Executive's full right, title and
interest in and to all Intellectual Property. The Executive agrees to
execute any and all applications for domestic and foreign patents,
copyrights or other proprietary rights and to do such other acts (including
without limitation the execution and delivery of instruments of further
assurance or confirmation) requested by the Company to assign the
Intellectual Property to the Company and to permit the Company to enforce
any patents, copyrights or other proprietary rights to the Intellectual
Property. The Executive will not charge the Company for time spent in
complying with these obligations. All copyrightable works that the
Executive creates shall be considered "work made for hire".
8. Agreement not to Compete with the Business. The Executive agrees that
during the term of the Executive's employment hereunder and for a period of two
(2) years following the date of termination thereof (the "Non-Competition
Period"), the Executive will not, directly or
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indirectly (a) own, manage, operate, control or participate in any manner in the
ownership, management, operation or control of, or be connected as an officer,
employee, partner, director, principal, consultant, agent or otherwise with, or
have any financial interest in, or aid or assist anyone else in the conduct of,
any business, venture or activity which competes with the business of the
Company, or any group, division or subsidiary of the Company, as described in
the Company's Registration Statement on Form S-1 relating to the Company's
initial public offering of Common Stock or, beginning with the Company's Annual
Report on Form 10-K for the year ending December 31, 1996, the Company's most
recent Annual Report on Form 10-K filed with the Securities and Exchange
Commission prior to the date (the "Date of Termination") the Executive's
employment under this Agreement is terminated (hereinafter, "Competitive
Business") in the United States or any other geographic area where such
Competitive Business is being conducted at the Date of Termination or (b)
recruit or otherwise seek to induce any employees of the Company or any of its
subsidiaries to terminate their employment or violate any agreement with or duty
to the Company or any of its subsidiaries. It is understood and agreed that, for
the purposes of the foregoing provisions of this Section 8, (i) no business,
venture or activity shall be deemed to be a Competitive Business unless not less
than five percent of the Company's consolidated gross sales or operating income
is derived from, or not less than five percent of the Company's consolidated
assets are devoted to, such business, venture or activity; and (ii) no business,
venture or activity conducted by any entity by which the Executive is employed
or in which the Executive is interested or with which the Executive is connected
or associated shall be deemed to be a Competitive Business unless it is one from
which five percent or more of such entity's consolidated gross sales or
operating income is derived, or to which five percent or more of such entity's
consolidated assets are devoted; provided, however, that if the actual gross
sales or operating income or assets of such entity derived from or devoted to
such business, venture or activity is equal to or in excess of 10% of the most
nearly comparable figure for the Company, such business, venture or activity of
such entity shall be deemed to be a Competitive Business. Further, ownership of
not more than five percent of the voting stock of any publicly held corporation
shall not, of itself, constitute a violation of this Section 8.
9. Enforcement of Covenants. The Executive acknowledges that the
Executive has carefully read and considered all the terms and conditions of this
Agreement, including without limitation the restraints imposed upon the
Executive pursuant to Sections 7 and 8 hereof. The Executive agrees that said
restraints are necessary for the reasonable and proper protection of the Company
and its Affiliates and that the restraints are reasonable as to the definition
of Competitive Business and length of time. The Executive further acknowledges
that, were the Executive to breach any of the covenants or agreements contained
in Sections 7 or 8 hereof, the damage to the Company could be irreparable. The
Executive therefore agrees that the Company, in addition to any other remedies
available to it, shall be entitled to preliminary and permanent injunctive
relief against any breach or threatened breach by the Executive of any of said
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covenants or agreements. The parties further agree that in the event that any
provision of Section 7 or 8 hereof shall be determined by any Court of competent
jurisdiction to be unenforceable by reason of its being extended over too great
a time, too large a geographic area or too great a range of activities, such
provision shall be deemed to be modified to permit its enforcement to the
maximum extent permitted by law.
10. Conflicting Agreements. The Executive hereby represents and warrants
that the execution of this Agreement and the performance of the Executive's
obligations hereunder will not breach or be in conflict with any other agreement
to which or by which the Executive is a party or is bound and that the Executive
is not now subject to any covenants against competition or similar covenants
that would affect the performance of the Executive's obligations hereunder. The
Executive will not disclose to or use on behalf of the Company or any of its
Affiliates any proprietary information of a third party without such party's
consent.
11. Definitions. Terms defined elsewhere in this Agreement are used
herein as so defined. In addition, the following terms shall have the following
meanings:
11.1. Affiliates. "Affiliates" means all persons and entities
directly or indirectly controlling, controlled by or under common control
with the Company.
11.2. Cause. The following events or conditions shall constitute
"Cause" for termination: (i) the willful refusal of the Executive to
substantially perform the Executive's duties to the Company (other than any
refusal resulting from the Executive's incapacity due to physical or mental
illness), including the Executive's obligations under this Agreement or
(ii) a willful and material breach by the Executive of Section 7.1, 7.3 or
8 or (iii) a conviction for fraud, embezzlement or other act of dishonesty
by the Executive that causes material injury to the Company or any of its
Affiliates or (iv) conviction of, or plea of nolo contendere to, any felony
involving dishonesty or moral turpitude; or (v) the Executive's engaging in
activities (A) which constitute a violation of any policy, rule or
regulation adopted by the Company, including policies related to conflicts
of interest, insider trading, reimbursement of business expenses and the
like, or (B) which result in a material injury to the business, financial
condition, results of operations or prospects of the Company or its
Affiliates, as determined by the Board or a committee thereof.
For purposes of this Section 11.2, no act or failure to act on the
Executive's part shall be deemed "willful" unless done, or omitted to be
done, by the Executive not in good faith and without reasonable belief that
the actions or omissions were in the best interest of the Company.
Notwithstanding and with respect to clause (i) only in the
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immediately preceding paragraph, the Executive shall not be deemed
terminated for Cause unless and until there shall have been delivered to
the Executive a copy of a resolution duly adopted by the affirmative vote
of not less than 75% of the entire membership of the Board (excluding the
Executive if the Executive is a member of the Board) at a meeting of the
Board called and held for such purpose (after reasonable notice to the
Executive and an opportunity for the Executive, together with the
Executive's counsel, to be heard before the Board and after the Executive
has been provided with a period of not less than 30 days within which to
correct the situation) finding that in the opinion of the Board the
Executive engaged in the conduct set forth in such clause (i) and
specifying the particulars in reasonable detail.
11.3. Confidential Information. "Confidential Information" means any
and all information of the Company and its Affiliates that is not generally
known by others with whom they compete or do business, or with whom they
plan to compete or do business and any and all information the disclosure
of which would otherwise be adverse to the interests of the Company or any
of its Affiliates. Confidential Information includes without limitation
such information relating to (i) the services or products sold or offered
by the Company or any of its Affiliates, (ii) the costs, sources of supply,
financial performance and strategic plans of the Company and its
Affiliates, (iii) the identity and special needs of the customers of the
Company and its Affiliates and (iv) the people and organizations with whom
the Company and its Affiliates have business relationships and those
relationships. Confidential Information also includes comparable
information that the Company or any of its Affiliates have received
belonging to others or which was received by the Company or any of its
Affiliates with any understanding that it would not be disclosed.
11.4. ERISA. "ERISA" means the federal Employee Retirement Income
Security Act of 1974 or any successor statute, and the rules and
regulations thereunder, and in the case of any referenced section thereof
any successor section thereto, collectively and as from time to time
amended and in effect.
11.5. Intellectual Property. "Intellectual Property" means
inventions, discoveries, developments, methods, processes, compositions,
works, concepts and ideas (whether or not patentable or copyrightable or
constituting trade secrets) conceived, made, created, developed or reduced
to practice by the Executive (whether alone or with others, whether or not
during normal business hours or on or off Company premises) during the
Executive's employment that relate to either the business of the Company or
any of its Affiliates or any prospective activity of the Company or any of
its Affiliates.
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11.6. Person. "Person" means an individual, a corporation, an
association, a partnership, a limited liability company, an estate, a trust
and any other entity or organization.
12. Withholding. All payments made by the Company under this Agreement
shall be reduced by any tax or other amounts required to be withheld by the
Company under applicable law.
13. Miscellaneous.
13.1. Assignment. Neither the Company nor the Executive may make any
assignment of this Agreement or any interest herein (provided, however,
that nothing contained herein shall be construed to place any limitation or
restriction on the transfer of the Common Stock in addition to any
restrictions set forth in any agreement applicable to such shares) without
the prior written consent of the other. This Agreement shall inure to the
benefit of and be binding upon the Company and the Executive, and their
respective successors, executors, administrators, heirs and permitted
assigns.
13.2. Severability. If any portion or provision of this Agreement
shall to any extent be declared illegal or unenforceable by a court of
competent jurisdiction, then the application of such provision in such
circumstances shall be deemed modified to permit its enforcement to the
maximum extent permitted by law, and both the application of such portion
or provision in circumstances other than those as to which it is so
declared illegal or unenforceable and the remainder of this Agreement shall
not be affected thereby, and each portion and provision of this Agreement
shall be valid and enforceable to the fullest extent permitted by law.
13.3. Waiver; Amendment. No waiver of any provision hereof shall be
effective unless made in writing and signed by the waiving party. The
failure of either party to require the performance of any term or
obligation of this Agreement, or the waiver by either party of any breach
of this Agreement, shall not prevent any subsequent enforcement of such
term or obligation or be deemed a waiver of any subsequent breach. This
Agreement may be amended or modified only by a written instrument signed by
the Executive and the Company.
13.4. Notices. Any and all notices, requests, demands and other
communications provided for by this Agreement shall be in writing and shall
be effective when delivered in
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person or two business days after being deposited in the United States
mail, postage prepaid, registered or certified, and addressed (a) in the
case of the Executive, to Robert A. Lento, LANSystems, 300 Park Avenue
South, New York, New York 10010 or, (b) in the case of the Company, at its
principal place of business and to the attention of the Chief Executive
Officer; or to such other address as either party may specify by notice to
the other.
13.5. Entire Agreement. This Agreement constitutes the entire
agreement between the parties with respect to the terms and conditions of
the Executive's employment and, except as otherwise provided herein,
supersedes all prior communications, agreements and understandings, written
or oral, with the Company with respect to the terms and conditions of the
Executive's employment, including the Original Agreement.
13.6. Headings. The headings and captions in this Agreement are for
convenience only and in no way define or describe the scope or content of
any provision of this Agreement.
13.7. Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be an original and all of which together
shall constitute one and the same instrument.
13.8. Governing Law. This Agreement shall be governed by and
construed in accordance with the domestic substantive laws of the State of
Illinois without giving effect to any choice or conflict of laws provision
or rule that would cause the application of the domestic substantive laws
of any other jurisdiction.
13.9. Legal Fees. In any action brought by the Executive to enforce
the Executive's rights hereunder, DESI shall reimburse, indemnify and hold
harmless the Executive from her fees and reasonable expenses of counsel;
provided, however, that such indemnification shall not extend to any action
brought by the Executive in bad faith or without a reasonable likelihood of
success under the terms of this Agreement.
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IN WITNESS WHEREOF, this Agreement has been executed by the Company, by its
duly authorized representative, and by the Executive, as of the date first above
written.
THE COMPANY: DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
By /s/ Rhonda I. Kochlefl
-------------------------------------------
Rhonda I. Kochlefl
Chairman, President & CEO
THE EXECUTIVE: /s/ Robert A. Lento
----------------------------------------------
Robert A.Lento
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EXHIBIT 10.16
EMPLOYMENT AGREEMENT
This Employment Agreement is made as of March 1, 1997 by and among
Donnelley Enterprise Solutions Incorporated, a Delaware corporation (the
"Company"), and David Shea (the "Executive").
WHEREAS, the Company desires to employ the Executive as its President,
Systems Management Group division ("SMG"), and the Executive desires to
accept such employment, for the term and upon the conditions set forth in
this Agreement.
Agreement
---------
Now, therefore, the parties hereto hereby agree as follows:
1. Employment. Subject to the terms and conditions set forth in this
Agreement, the Company offers and the Executive hereby accepts employment,
effective as of March 1, 1997.
2. Term. Subject to earlier termination as hereafter provided, the
Executive shall be employed hereunder for an original term commencing on the
Effective Date and ending at 5:00 p.m., Chicago time, on the fourth anniversary
of the Effective Date, or such later date to which the parties may agree. The
term of this Agreement is hereafter referred to as "the term of this Agreement"
or "the term hereof".
3. Capacity and Performance.
------------------------
3.1. Offices. During the term hereof and for the compensation
described in Section 4 below, the Executive shall serve as the Division
President, SMG division. The Executive shall be subject to the direction
of the Chairman, President and Chief Executive Officer of the Company (or
any one of them to whom the Executive then reports, hereinafter referred to
as the "Reporting Executive"), and shall have such other powers, duties and
responsibilities consistent with the Executive's position as President, SMG
division, as may from time to time be prescribed by the Reporting
Executive. In addition, for so long as the Executive is employed by the
Company and, unless otherwise determined by the Reporting Executive,
without further compensation, the Executive shall serve as a director of
one or more of the Company's subsidiaries if so elected or appointed from
time to time.
<PAGE>
3.2. Performance. During the term hereof, the Executive shall be
employed by the Company and shall perform and discharge (faithfully,
diligently and to the best of the Executive's ability) such duties and
responsibilities on behalf of the Company and its subsidiaries as may be
designated from time to time by the Reporting Executive. During the term
hereof, the Executive shall devote the Executive's full business time and
attention to the advancement of the business and interests of the Company
and its subsidiaries and to the discharge of the Executive's duties and
responsibilities hereunder. Nothing contained herein shall be construed to
prohibit or restrict the Executive from (a) serving in various capacities
in community, civic, religious or charitable organizations, (b) serving as
a member of the boards of non-affiliated entities provided such entities do
not compete with the Company and such service does not create a conflict of
interest as determined by the Board, or (c) attending to personal business
and investment matters. It is expressly agreed that any such service or
activity permitted by the previous sentence shall not unreasonably
interfere with the performance of the Executive's duties and, if so, the
Executive, after consultation with the Board, will comply with the
reasonable requests to cease or limit the service or activity.
4. Compensation and Benefits. As compensation for all services performed
by the Executive under this Agreement and performance of the Executive's duties
and of the obligations to the Company and its subsidiaries, pursuant to this
Agreement or otherwise and subject to Section 5 hereof:
4.1. Base Salary. During the term hereof, the Company shall pay the
Executive a base salary at the rate of $175,000 per year, payable in
accordance with the payroll practices of the Company for its executives but
no less than monthly and subject to increase at any time or from time to
time by the Reporting Executive in his or her sole discretion. Such base
salary, as from time to time increased, is hereafter referred to as the
"Base Salary". The Base Salary payable to the Executive in 1997 shall be
prorated for the period from the Effective Date through December 31, 1997
and for any subsequent period of service less than one full year.
4.2. Bonus Compensation. During the term hereof, the Company from
time to time shall pay the Executive an annual bonus (the "Bonus"). The
Bonus in respect of 1997 (the "1997 Bonus") will be calculated as follows:
The Company will calculate the dollar amount of the 1997 SMG Bonus pursuant
to Section 4.2.1. below and the dollar amount of the 1997 DESI Bonus
pursuant to Section 4.2.2. below, adjust such amounts in accordance with
Section 4.2.3, and pay to the Executive the sum of such amounts:
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4.2.1. (a) If the Targeted Operating Income (as defined below)
for the SMG Division for calendar year 1997 (the "1997 SMG TOI"), is
less than 70% x Base SMG Target (the "Minimum SMG Target"), the 1997
SMG Bonus shall equal zero;
(b) If the 1997 SMG TOI is equal to or greater than the Minimum
SMG Target but less than (TBD) (the "Base SMG Target"), the 1997 SMG
Bonus shall equal the number obtained by multiplying 30% of the
Executive's 1997 Salary by a fraction (which shall not be greater than
one), the numerator of which is the difference between the 1997 SMG
TOI and the Minimum SMG Target and the denominator of which is the
amount determined by subtracting the Minimum SMG Target from the Base
SMG Target;
(c) If the 1997 SMG TOI is equal to or greater than the Base SMG
Target but less than 150% x SMG Target (the "Maximum SMG Target"), the
1997 SMG Bonus shall equal the sum of the number obtained by
multiplying 60% of the Executive's 1997 Salary by a fraction (which
shall not be greater than one), the numerator of which is the
difference between the 1997 SMG TOI and the Base SMG Target and the
denominator of which is the amount determined by subtracting the Base
SMG Target from the Maximum SMG Target; or
(d) If the 1997 SMG TOI is equal to or greater than the Maximum
SMG Target, the 1997 SMG Bonus shall equal 60% of the Executive's 1997
Salary.
4.2.2. (a) If the Adjusted Operating Income (as defined below)
for DESI taken as a whole for calendar year 1997 (the "1997 DESI
AOI"), is less than 70% x Base DESI Target (the "Minimum DESI
Target"), the 1997 DESI Bonus shall equal zero;
(b) If the 1997 DESI TOI is equal to or greater than the Minimum
DESI Target but less than (TBD) (the "Base DESI Target"), the 1997
DESI Bonus shall equal the sum of the number obtained by multiplying
10% of the Executive's 1997 Salary by a fraction (which shall not be
greater than one), the numerator of which is the difference between
the 1997 DESI AOI and the Minimum DESI Target and the denominator of
which is the amount determined by subtracting the Minimum DESI Target
from the Base DESI Target;
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(c) If the 1997 DESI TOI is equal to or greater than the Base
DESI Target but less than 150% x Base DESI Target (the "Maximum DESI
Target"), the 1997 DESI Bonus shall equal the sum of the number
obtained by multiplying 20% of the Executive's 1997 Salary by a
fraction (which shall not be greater than one), the numerator of which
is the difference between the 1997 DESI TOI and the Base DESI Target
and the denominator of which is the amount determined by subtracting
the Base DESI Target from the Maximum DESI Target; or
(d) If the 1997 DESI TOI is equal to or greater than the Maximum
DESI Target, the 1997 DESI Bonus shall equal 20% of the Executive's
1997 Salary.
4.2.3. Any compensation paid to the Executive as Bonus shall be
in addition to the Base Salary. The 1997 Bonus payable to the
Executive shall be pro-rated for any period of service less than a
full year by multiplying (x) the amount of the Bonus calculated for
such year by (y) a fraction, the numerator of which is the number of
days from and including January 1 of such year through and including
the effective date of the Executive's termination of employment and
the denominator of which is 365. All bonus and benefit plans are
subject to annual review and change by the Board relative to key
strategic objectives for the year.
4.3. Vacations. During the term hereof, the Executive shall be
entitled to four (4) weeks of vacation per annual vacation period of the
Company, such vacation to be taken at such times and intervals as shall be
determined by the Executive in the Executive's reasonable discretion. The
Executive may not accumulate or carry over from one calendar year to
another any unused, accrued vacation time, unless the Reporting Executive
determines that business demands require deferral and carry over of
vacation from any year into up to the first six (6) months of the
succeeding year. The Executive shall not be entitled to compensation for
vacation time not taken, except that upon termination of employment, the
Executive shall be paid for all vacation time accrued but not taken.
4.4. Other Benefits. During the term hereof and subject to any
contribution therefor generally required of executives of the Company, the
Executive shall be entitled to participate in all employee benefit plans
and other programs (including, but not limited to, any medical, dental,
retirement, disability, life insurance, sick leave and other benefits) from
time to time adopted by the Board and in effect for executives of the
Company
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generally, except to the extent such plans are in a category of benefit
otherwise already provided to the Executive. Such participation shall be
subject to (i) the terms of the applicable plan documents, (ii) generally
applicable Company policies and (iii) the discretion of the Board or any
administrative or other committee provided for in or contemplated by such
plan. The Company may alter, modify, add to or delete its employee benefit
plans at any time as the Board, in its sole judgment, determines to be
appropriate.
4.5. Business Expenses. The Company shall pay or reimburse the
Executive for all reasonable business expenses incurred or paid by the
Executive in the performance of the Executive's duties and responsibilities
hereunder, subject to (i) any expense policy of the Company set by the
Board from time to time, and (ii) such reasonable substantiation and
documentation requirements as may be specified by the Board from time to
time.
4.6. Severance. In the event the Executive's employment with the
Company is (i) terminated by the Company other than for Cause in accordance
with Section 5.4 or (ii) terminated by the Executive in accordance with
Section 5.5, the Executive will be entitled to receive twenty-four (24)
monthly payments equal to the Executive's then applicable Base Salary
calculated on a monthly basis at the time of such termination (i.e., 1/12th
of the Base Salary), paid on the last day of a calendar month.
5. Termination of Employment and Severance Benefits. Notwithstanding the
provisions of Section 2 hereof, the Executive's employment hereunder shall
terminate prior to the expiration of the term of this Agreement under the
following circumstances:
5.1. Retirement or Death. In the event of the Executive's retirement
or death during the term hereof, the Executive's employment hereunder shall
immediately and automatically terminate. In the event of the Executive's
retirement after the age of sixty-five, age fifty-five with the prior
consent of the Board or death during the term hereof, the Company shall pay
to the Executive (or in the case of death, the Executive's designated
beneficiary or, if no beneficiary has been designated by the Executive, to
the Executive's estate) (i) Base Salary earned but unpaid through and
including the date of such retirement or death, (ii) any amount payable
pursuant to Section 4.6, (iii) any unpaid portion of any Bonus for any
fiscal year preceding the year in which such retirement or death occurs
that was earned but had not previously been paid and (iv) at the times the
Company pays its executives bonuses in accordance with its general payroll
policies, any Bonus which would have been paid had such retirement or death
not occurred during the fiscal year of such retirement or death (pro-rated
based on a formula, the numerator of which shall be the number of days
during the fiscal year of such retirement or death in
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which the Executive was employed by the Company and the denominator of
which shall be 365 or 366, as the case may be).
5.2. Disability.
----------
5.2.1. The Company may terminate the Executive's employment
hereunder, upon written notice to the Executive, in the event that the
Executive becomes disabled during the Executive's employment hereunder
through any illness, injury, accident or condition of either a
physical or psychological nature and, as a result, is unable to
perform substantially all of the Executive's duties and
responsibilities hereunder for an aggregate of one hundred eighty
(180) days during any period of three hundred and sixty-five (365)
consecutive calendar days.
5.2.2. The Board may designate another employee to act
temporarily in the Executive's place during any period of the
Executive's disability. Notwithstanding any such designation, the
Executive shall continue to receive the Base Salary in accordance with
Section 4.1 and to receive benefits in accordance with Section 4.5, to
the extent permitted by the then current terms of the applicable
benefit plans, until the Executive becomes eligible for disability
income benefits under any disability income plan maintained by the
Company or until the termination of the Executive's employment,
whichever shall first occur. Upon becoming so eligible, or upon such
termination, whichever shall first occur, the Company shall pay to the
Executive (i) Base Salary earned but unpaid through and including the
date of such eligibility or termination, (ii) any amount payable
pursuant to Section 4.6, (iii) any unpaid portion of any Bonus for any
fiscal year preceding the year in which such eligibility or
termination occurs that was earned but had not previously been paid
and (iv) at the times the Company pays its executives bonuses in
accordance with its general payroll policies, any Bonus which would
have been paid had disability not occurred during the fiscal year in
which such eligibility or termination occurs (pro-rated based on a
formula, the numerator of which shall be, as applicable, (i) the
number of days from and including January 1 of the fiscal year in
which such eligibility occurs to but excluding the date of such
eligibility or (ii) the number of days on which the Executive was
employed by the Company during the fiscal year in which such
termination occurs and the denominator of which shall be 365 or 366,
as the case may be).
5.2.3.Except as provided in Section 5.2.2, while receiving
disability
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income payments under any disability income plan maintained by the
Company, the Executive shall not be entitled to receive any Base
Salary under Section 4.1 or Bonus payments under Section 4.2 but shall
continue to participate in the Company's benefit plans in accordance
with Section 4.5 and the terms of such plans, until the termination of
the Executive's employment. During the twelve (12) month period from
and including the date of termination, the Company shall pay for the
cost of the Executive's participation in the Company's group medical
and dental plans, provided that the Executive is entitled to continue
such participation under applicable law and the terms of such plan.
5.2.4. If any question shall arise as to whether during any
period the Executive is disabled through any illness, injury, accident
or condition of either a physical or psychological nature so as to be
unable to perform substantially all of the Executive's duties and
responsibilities hereunder, the Executive may, and at the request of
the Company shall, submit to a medical examination by a physician
either (i) mutually selected by the Company and the Executive or the
Executive's duly appointed guardian or (ii) failing mutual agreement,
a physician selected by each of a physician selected by the Company
and a physician selected by the Executive, to determine whether the
Executive is so disabled and such determination shall for the purposes
of this Agreement be conclusive of the issue. If such question shall
arise and the Executive shall fail to submit to such medical
examination, the Board's determination of the issue shall be binding
on the Executive.
5.3. By the Company for Cause. The Company may terminate the
Executive's employment hereunder for Cause as provided in Section 11.2. If
the Executive's employment hereunder is terminated for Cause, the Company
shall have no further obligation or liability to the Executive relating to
the Executive's employment hereunder, or the termination thereof, except
that the Company shall pay to the Executive (i) Base Salary earned but
unpaid through and including the date of termination, (ii) any amount
payable pursuant to Section 4.6, and (iii) any other amounts accrued by the
Executive but unpaid through and including the date of termination (it
being understood that a Bonus does not accrue until December 31 of the year
on which such Bonus is based).
5.4. By the Company other than for Cause. The Company may terminate
the Executive's employment hereunder other than for Cause at any time after
the Effective Date upon two weeks prior written notice to the Executive.
In the event of such termination, then the Company shall pay the Executive
(i) Base Salary earned but unpaid through and including the date of
termination, (ii) any amount payable pursuant to
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Section 4.6, (iii) the amounts specified in Section 4.7, (iv) any unpaid
portion of any Bonus for any fiscal year preceding the year in which such
termination occurs that was earned but had not previously been paid, (v) at
the times the Company pays its executives bonuses in accordance with its
general payroll policies, any Bonus which would have been paid had
termination not occurred during the fiscal year in which such termination
occurs (pro-rated based on a formula, the numerator of which shall be the
number of days during the fiscal year in which such termination occurs the
Executive was employed by the Company and the denominator of which shall be
365 or 366, as the case may be), and (vi) any other amounts accrued by the
Executive but unpaid through and including the date of termination. In
addition, 100% of the number of shares of Common Stock subject to each
option, including the Options, held by the Executive on the date of such
termination and which are then unexercisable shall become exercisable as of
the date of such termination, and such Options may be exercised for a
period up to ninety (90) days following termination of the Executive's
employment.
5.5. By the Executive upon Breach or for Good Reason. The Executive
may terminate the Executive's employment hereunder (i) in the event that
the Company fails to perform, in any material respect, its obligations
under this Agreement, after written notice to the Company setting forth in
reasonable detail the nature of such breach if such breach remains uncured
for a period of 30 days following such written notice to the Company
provided that said notice shall not be required in the event of repeated,
intentional or willful failure to perform by the Company, (ii) there is a
material diminution in the responsibilities, duties and powers of the
Executive, or (iii) the Executive's offices are moved from their present
location to a location outside of the New York metropolitan area. In the
event of termination in accordance with this Section 5.5, then the Company
shall pay to the Executive (i) Base Salary earned but unpaid through and
including the date of termination, (ii) any amount payable pursuant to
Section 4.6, (iii) the amounts specified in Section 4.7, (iv) any unpaid
portion of any Bonus for any fiscal year preceding the year in which such
termination occurs that was earned but had not previously been paid, (v) at
the times the Company pays its executives bonuses in accordance with its
general payroll policies, any Bonus which would have been paid had
termination not occurred during the fiscal year in which such termination
occurs (pro-rated based on a formula, the numerator of which shall be the
number of days during the fiscal year in which such termination occurs the
Executive was employed by the Company and the denominator of which shall be
365 or 366, as the case may be), and (vi) any other amounts accrued by the
Executive but unpaid through and including the date of termination. In
addition, 100% of the number of shares of Common Stock subject to each
option, including the Options, held by the Executive on the date of such
termination and which are then unexercisable shall become exercisable as of
the date of such termination,
-8-
<PAGE>
and such Options may be exercised for a period up to ninety (90) days
following termination of the Executive's employment.
5.6. By the Executive Other than upon Breach or for Good Reason. The
Executive may terminate the Executive's employment hereunder at any time
upon ninety (90) days' written notice to the Company. In the event of
termination of the Executive pursuant to this Section 5.6, the Board may
elect to waive the period of notice, or any portion thereof, and, whether
or not the Board so elects, the Company shall pay to the Executive (i) Base
Salary for the full notice period, (ii) any amount payable pursuant to
Section 4.6, (iii) at the times the Company pays its executives bonuses in
accordance with its general payroll policies, any Bonus which would have
been paid had termination not occurred during the fiscal year in which such
termination occurs (pro-rated as set forth in Section 5.5 above), and (iv)
any other amounts accrued by the Executive but unpaid through and including
the date of termination.
5.7. Post-Agreement Employment. In the event the Executive remains
in the employ of the Company or any of its Affiliates following termination
of this Agreement, by the expiration of the term hereof or otherwise, then
such employment shall be at will, unless otherwise agreed in writing.
6. Effect of Termination. The provisions of this Section 6 shall
apply in the event of termination due to the expiration of the term of this
Agreement, pursuant to Section 5 or otherwise.
6.1. Receipt of Certain Benefits. It is the mutual intention of the
Company and the Executive that the Executive receive the full benefit of
the compensation and benefits provided to the Executive during the term
hereof which compensation and benefits may be payable over periods beyond
the particular year of employment. The Executive shall not be obligated to
seek other employment by way of mitigation of the amounts due to the
Executive nor shall the Executive's earnings after termination reduce the
Company's obligations hereunder. Nothing in this Section 6.1 is intended
or shall be construed to affect the rights and obligations of the Company
and its Affiliates, on the one hand, and the Executive, on the other, with
respect to any loans, stock pledge arrangements, option plans or other
agreements to the extent said rights or obligations survive termination of
employment under the provisions of the documents relating thereto.
6.2. Termination of Health and Welfare Benefits. Except for medical
and dental insurance coverage continued pursuant to Sections 5.2 hereof and
any right of continuation of health coverage to the extent provided by
Sections 601 through 608 of
-9-
<PAGE>
ERISA, health and welfare benefits shall terminate pursuant to the terms of
the applicable benefit plans based on the date of termination of the
Executive's employment without regard to any continuation of Base Salary or
other payments to the Executive following such date of termination pursuant
to Section 5.
6.3. Survival of Certain Provisions. Provisions of this Agreement
shall survive any termination if so provided herein or if necessary or
desirable fully to accomplish the purposes of such provision, including,
without limitation, the obligations of the Executive under Sections 7 and 8
hereof. The obligation of the Company to make payments to or on behalf of
the Executive under Sections 4.7, 5.4 or 5.5 hereof is expressly
conditioned upon the Executive's continued full performance of obligations
under Sections 7 and 8 hereof. The Executive recognizes that, except as
expressly provided in Section 4.7, 5.4 or 5.5, no compensation is earned
after termination of employment.
7. Confidential Information; Intellectual Property.
-----------------------------------------------
7.1. Confidentiality. The Executive acknowledges that the Company
and its Affiliates continually develop Confidential Information, that the
Executive may develop Confidential Information for the Company or its
Affiliates and that the Executive may learn of Confidential Information
during the course of employment. The Executive will comply with the
policies and procedures of the Company for protecting Confidential
Information and shall never disclose to any Person (except as required by
applicable law or for the proper performance of the Executive's duties and
responsibilities to the Company and its Affiliates), or use for the
Executive's own benefit or gain or otherwise use in a manner adverse to the
interests of the Company and its Affiliates, any Confidential Information
obtained by the Executive incident to the Executive's employment or other
association with the Company or any of its Affiliates. The Executive
understands that this restriction shall continue to apply after the
Executive's employment terminates, regardless of the reason for such
termination. Notwithstanding the foregoing, the Executive's covenant not
to disclose Confidential Information does not apply to information which
(i) becomes generally available to the public or otherwise becomes known
through sources other than the Executive, (ii) is subsequently disclosed to
the Executive by a source other than the Company who was under no duty of
confidence or (iii) is required to be disclosed by the Executive through
discovery in litigation or by order of a court or otherwise as required by
law.
7.2. Return of Documents. All documents, records, tapes and other
media of every kind and description relating to the business, present or
otherwise, of the Company or its Affiliates and any copies, in whole or in
part, thereof (the "Documents"), whether or
-10-
<PAGE>
not prepared by the Executive, shall be the sole and exclusive property of
the Company and its Affiliates, provided, however, that Executive shall in
all cases be entitled to retain copies of documents relating to the
Executive's employment rights, compensation, benefits or other obligations
of the Company to the Executive and the Executive to the Company. The
Executive shall safeguard all Documents and shall surrender to the Company
at the time the Executive's employment terminates, or at such earlier time
or times as the Board or its designee may specify, all Documents then in
the Executive's possession or control.
7.3. Assignment of Rights to Intellectual Property. The Executive
shall promptly and fully disclose all Intellectual Property to the Company.
The Executive hereby assigns and agrees to assign to the Company (or as
otherwise directed by the Company) the Executive's full right, title and
interest in and to all Intellectual Property. The Executive agrees to
execute any and all applications for domestic and foreign patents,
copyrights or other proprietary rights and to do such other acts (including
without limitation the execution and delivery of instruments of further
assurance or confirmation) requested by the Company to assign the
Intellectual Property to the Company and to permit the Company to enforce
any patents, copyrights or other proprietary rights to the Intellectual
Property. The Executive will not charge the Company for time spent in
complying with these obligations. All copyrightable works that the
Executive creates shall be considered "work made for hire".
8. Agreement not to Compete with the Business. The Executive agrees that
during the term of the Executive's employment hereunder and for a period of two
(2) years following the date of termination thereof (the "Non-Competition
Period"), the Executive will not, directly or indirectly (a) own, manage,
operate, control or participate in any manner in the ownership, management,
operation or control of, or be connected as an officer, employee, partner,
director, principal, consultant, agent or otherwise with, or have any financial
interest in, or aid or assist anyone else in the conduct of, any business,
venture or activity which competes with the business of the Company, or any
group, division or subsidiary of the Company, as described in the Company's
Registration Statement on Form S-1 relating to the Company's initial public
offering of Common Stock or, beginning with the Company's Annual Report on Form
10-K for the year ending December 31, 1996, the Company's most recent Annual
Report on Form 10-K filed with the Securities and Exchange Commission prior to
the date (the "Date of Termination") the Executive's employment under this
Agreement is terminated (hereinafter, "Competitive Business") in the United
States or any other geographic area where such Competitive Business is being
conducted at the Date of Termination or (b) recruit or otherwise seek to induce
any employees of the Company or any of its subsidiaries to terminate their
employment or violate any agreement with or duty to the Company or any of its
subsidiaries. It is understood and
-11-
<PAGE>
agreed that, for the purposes of the foregoing provisions of this Section 8, (i)
no business, venture or activity shall be deemed to be a Competitive Business
unless not less than five percent of the Company's consolidated gross sales or
operating income is derived from, or not less than five percent of the Company's
consolidated assets are devoted to, such business, venture or activity; and (ii)
no business, venture or activity conducted by any entity by which the Executive
is employed or in which the Executive is interested or with which the Executive
is connected or associated shall be deemed to be a Competitive Business unless
it is one from which five percent or more of such entity's consolidated gross
sales or operating income is derived, or to which five percent or more of such
entity's consolidated assets are devoted; provided, however, that if the actual
gross sales or operating income or assets of such entity derived from or devoted
to such business, venture or activity is equal to or in excess of 10% of the
most nearly comparable figure for the Company, such business, venture or
activity of such entity shall be deemed to be a Competitive Business. Further,
ownership of not more than five percent of the voting stock of any publicly held
corporation shall not, of itself, constitute a violation of this Section 8.
9. Enforcement of Covenants. The Executive acknowledges that the
Executive has carefully read and considered all the terms and conditions of this
Agreement, including without limitation the restraints imposed upon the
Executive pursuant to Sections 7 and 8 hereof. The Executive agrees that said
restraints are necessary for the reasonable and proper protection of the Company
and its Affiliates and that the restraints are reasonable as to the definition
of Competitive Business and length of time. The Executive further acknowledges
that, were the Executive to breach any of the covenants or agreements contained
in Sections 7 or 8 hereof, the damage to the Company could be irreparable. The
Executive therefore agrees that the Company, in addition to any other remedies
available to it, shall be entitled to preliminary and permanent injunctive
relief against any breach or threatened breach by the Executive of any of said
covenants or agreements. The parties further agree that in the event that any
provision of Section 7 or 8 hereof shall be determined by any Court of competent
jurisdiction to be unenforceable by reason of its being extended over too great
a time, too large a geographic area or too great a range of activities, such
provision shall be deemed to be modified to permit its enforcement to the
maximum extent permitted by law.
10. Conflicting Agreements. The Executive hereby represents and warrants
that the execution of this Agreement and the performance of the Executive's
obligations hereunder will not breach or be in conflict with any other agreement
to which or by which the Executive is a party or is bound and that the Executive
is not now subject to any covenants against competition or similar covenants
that would affect the performance of the Executive's obligations hereunder. The
Executive will not disclose to or use on behalf of the Company or any of its
Affiliates any proprietary information of a third party without such party's
consent.
-12-
<PAGE>
11. Definitions. Terms defined elsewhere in this Agreement are used
herein as so defined. In addition, the following terms shall have the following
meanings:
11.1. Affiliates. "Affiliates" means all persons and entities
directly or indirectly controlling, controlled by or under common control
with the Company.
11.2. Cause. The following events or conditions shall constitute
"Cause" for termination: (i) the willful refusal of the Executive to
substantially perform the Executive's duties to the Company (other than any
refusal resulting from the Executive's incapacity due to physical or mental
illness), including the Executive's obligations under this Agreement or
(ii) a willful and material breach by the Executive of Section 7.1, 7.3 or
8 or (iii) a conviction for fraud, embezzlement or other act of dishonesty
by the Executive that causes material injury to the Company or any of its
Affiliates or (iv) conviction of, or plea of nolo contendere to, any felony
involving dishonesty or moral turpitude; or (v) the Executive's engaging in
activities (A) which constitute a violation of any policy, rule or
regulation adopted by the Company, including policies related to conflicts
of interest, insider trading, reimbursement of business expenses and the
like, or (B) which result in a material injury to the business, financial
condition, results of operations or prospects of the Company or its
Affiliates, as determined by the Board or a committee thereof.
For purposes of this Section 11.2, no act or failure to act on the
Executive's part shall be deemed "willful" unless done, or omitted to be
done, by the Executive not in good faith and without reasonable belief that
the actions or omissions were in the best interest of the Company.
Notwithstanding and with respect to clause (i) only in the immediately
preceding paragraph, the Executive shall not be deemed terminated for Cause
unless and until there shall have been delivered to the Executive a copy of
a resolution duly adopted by the affirmative vote of not less than 75% of
the entire membership of the Board (excluding the Executive if the
Executive is a member of the Board) at a meeting of the Board called and
held for such purpose (after reasonable notice to the Executive and an
opportunity for the Executive, together with the Executive's counsel, to be
heard before the Board and after the Executive has been provided with a
period of not less than 30 days within which to correct the situation)
finding that in the opinion of the Board the Executive engaged in the
conduct set forth in such clause (i) and specifying the particulars in
reasonable detail.
11.3. Confidential Information. "Confidential Information" means any
and all information of the Company and its Affiliates that is not generally
known by others with
-13-
<PAGE>
whom they compete or do business, or with whom they plan to compete or do
business and any and all information the disclosure of which would
otherwise be adverse to the interests of the Company or any of its
Affiliates. Confidential Information includes without limitation such
information relating to (i) the services or products sold or offered by the
Company or any of its Affiliates, (ii) the costs, sources of supply,
financial performance and strategic plans of the Company and its
Affiliates, (iii) the identity and special needs of the customers of the
Company and its Affiliates and (iv) the people and organizations with whom
the Company and its Affiliates have business relationships and those
relationships. Confidential Information also includes comparable
information that the Company or any of its Affiliates have received
belonging to others or which was received by the Company or any of its
Affiliates with any understanding that it would not be disclosed.
11.4. ERISA. "ERISA" means the federal Employee Retirement Income
Security Act of 1974 or any successor statute, and the rules and
regulations thereunder, and in the case of any referenced section thereof
any successor section thereto, collectively and as from time to time
amended and in effect.
11.5. Intellectual Property. "Intellectual Property" means
inventions, discoveries, developments, methods, processes, compositions,
works, concepts and ideas (whether or not patentable or copyrightable or
constituting trade secrets) conceived, made, created, developed or reduced
to practice by the Executive (whether alone or with others, whether or not
during normal business hours or on or off Company premises) during the
Executive's employment that relate to either the business of the Company or
any of its Affiliates or any prospective activity of the Company or any of
its Affiliates.
11.6. Person. "Person" means an individual, a corporation, an
association, a partnership, a limited liability company, an estate, a trust
and any other entity or organization.
12. Withholding. All payments made by the Company under this Agreement
shall be reduced by any tax or other amounts required to be withheld by the
Company under applicable law.
13. Miscellaneous.
-------------
13.1. Assignment. Neither the Company nor the Executive may make any
assignment of this Agreement or any interest herein (provided, however,
that nothing
-14-
<PAGE>
contained herein shall be construed to place any limitation or restriction
on the transfer of the Common Stock in addition to any restrictions set
forth in any agreement applicable to such shares) without the prior written
consent of the other. This Agreement shall inure to the benefit of and be
binding upon the Company and the Executive, and their respective
successors, executors, administrators, heirs and permitted assigns.
13.2. Severability. If any portion or provision of this Agreement
shall to any extent be declared illegal or unenforceable by a court of
competent jurisdiction, then the application of such provision in such
circumstances shall be deemed modified to permit its enforcement to the
maximum extent permitted by law, and both the application of such portion
or provision in circumstances other than those as to which it is so
declared illegal or unenforceable and the remainder of this Agreement shall
not be affected thereby, and each portion and provision of this Agreement
shall be valid and enforceable to the fullest extent permitted by law.
13.3. Waiver; Amendment. No waiver of any provision hereof shall be
effective unless made in writing and signed by the waiving party. The
failure of either party to require the performance of any term or
obligation of this Agreement, or the waiver by either party of any breach
of this Agreement, shall not prevent any subsequent enforcement of such
term or obligation or be deemed a waiver of any subsequent breach. This
Agreement may be amended or modified only by a written instrument signed by
the Executive and the Company.
13.4. Notices. Any and all notices, requests, demands and other
communications provided for by this Agreement shall be in writing and shall
be effective when delivered in person or two business days after being
deposited in the United States mail, postage prepaid, registered or
certified, and addressed (a) in the case of the Executive, to David Shea,
23 Broad Street, Weston, CT, 06883 or, (b) in the case of the Company, at
its principal place of business and to the attention of the Chief Executive
Officer; or to such other address as either party may specify by notice to
the other.
13.5. Entire Agreement. This Agreement constitutes the entire
agreement between the parties with respect to the terms and conditions of
the Executive's employment and, except as otherwise provided herein,
supersedes all prior communications, agreements and understandings, written
or oral, with the Company with respect to the terms and conditions of the
Executive's employment, including the Original Agreement.
13.6. Headings. The headings and captions in this Agreement are for
-15-
<PAGE>
convenience only and in no way define or describe the scope or content of
any provision of this Agreement.
13.7. Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be an original and all of which together
shall constitute one and the same instrument.
13.8. Governing Law. This Agreement shall be governed by and
construed in accordance with the domestic substantive laws of the State of
Illinois without giving effect to any choice or conflict of laws provision
or rule that would cause the application of the domestic substantive laws
of any other jurisdiction.
13.9. Legal Fees. In any action brought by the Executive to enforce
the Executive's rights hereunder, DESI shall reimburse, indemnify and hold
harmless the Executive from her fees and reasonable expenses of counsel;
provided, however, that such indemnification shall not extend to any action
brought by the Executive in bad faith or without a reasonable likelihood of
success under the terms of this Agreement.
-16-
<PAGE>
IN WITNESS WHEREOF, this Agreement has been executed by the Company, by its
duly authorized representative, and by the Executive, as of the date first above
written.
THE COMPANY: DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
/s/ Rhonda I. Kochlefl
By________________________________
Rhonda I. Kochlefl
Chairman, President & CEO
THE EXECUTIVE: /s/ David Shea
_______________________________
David Shea
-17-
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our reports included in this Form 10-K, into Donnelley Enterprise Solutions
Incorporated's previously filed registration statement on Form S-8 (Registration
Nos. 333-15549, 333-33335, 333-33337, 333-33339).
Chicago, Illinois
March 26, 1998
-1-
<PAGE>
EXHIBIT 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints Rhonda I. Kochlefl his true
and lawful attorney-in-fact, with full power and authority, for the purpose of
executing, in the name and on behalf of the undersigned as a director and/or
officer of Donnelley Enterprise Solutions Incorporated, a Delaware corporation
(the "Company"), and Annual Report on Form 10-K for the year ended December 31,
1997, and any and all amendments to such Annual Report, and to each thereof is
so executed, for filing with the Securities and Exchange Commission. The
undersigned hereby grants unto such attorney-in-fact full power of substitution
and revocation in the premises and hereby ratifies and confirms all that such
attorney-in-fact may do or cause to be done by virtue of these presents.
Dated: March 26, 1998
/s/ Charles F. Moran
--------------------------
Name: Charles F. Moran
Director
<PAGE>
EXHIBIT 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints Rhonda I. Kochlefl his true
and lawful attorney-in-fact, with full power and authority, for the purpose of
executing, in the name and on behalf of the undersigned as a director and/or
officer of Donnelley Enterprise Solutions Incorporated, a Delaware corporation
(the "Company"), and Annual Report on Form 10-K for the year ended December 31,
1997, and any and all amendments to such Annual Report, and to each thereof is
so executed, for filing with the Securities and Exchange Commission. The
undersigned hereby grants unto such attorney-in-fact full power of substitution
and revocation in the premises and hereby ratifies and confirms all that such
attorney-in-fact may do or cause to be done by virtue of these presents.
Dated: March 26, 1998
/s/ Thomas A. Munro
-------------------------
Name: Thomas A. Munro
Chief Financial Officer
<PAGE>
EXHIBIT 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints Rhonda I. Kochlefl his true
and lawful attorney-in-fact, with full power and authority, for the purpose of
executing, in the name and on behalf of the undersigned as a director and/or
officer of Donnelley Enterprise Solutions Incorporated, a Delaware corporation
(the "Company"), and Annual Report on Form 10-K for the year ended December 31,
1997, and any and all amendments to such Annual Report, and to each thereof is
so executed, for filing with the Securities and Exchange Commission. The
undersigned hereby grants unto such attorney-in-fact full power of substitution
and revocation in the premises and hereby ratifies and confirms all that such
attorney-in-fact may do or cause to be done by virtue of these presents.
Dated: March 26, 1998
/s/ Leo S. Spiegel
------------------------
Name: Leo S. Spiegel
Director
<PAGE>
EXHIBIT 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints Rhonda I. Kochlefl his true
and lawful attorney-in-fact, with full power and authority, for the purpose of
executing, in the name and on behalf of the undersigned as a director and/or
officer of Donnelley Enterprise Solutions Incorporated, a Delaware corporation
(the "Company"), and Annual Report on Form 10-K for the year ended December 31,
1997, and any and all amendments to such Annual Report, and to each thereof is
so executed, for filing with the Securities and Exchange Commission. The
undersigned hereby grants unto such attorney-in-fact full power of substitution
and revocation in the premises and hereby ratifies and confirms all that such
attorney-in-fact may do or cause to be done by virtue of these presents.
Dated: March 26, 1998
/s/ Gregory A. Stoklosa
-----------------------------
Name: Gregory A. Stoklosa
Director
<PAGE>
EXHIBIT 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints Rhonda I. Kochlefl his true
and lawful attorney-in-fact, with full power and authority, for the purpose of
executing, in the name and on behalf of the undersigned as a director and/or
officer of Donnelley Enterprise Solutions Incorporated, a Delaware corporation
(the "Company"), and Annual Report on Form 10-K for the year ended December 31,
1997, and any and all amendments to such Annual Report, and to each thereof is
so executed, for filing with the Securities and Exchange Commission. The
undersigned hereby grants unto such attorney-in-fact full power of substitution
and revocation in the premises and hereby ratifies and confirms all that such
attorney-in-fact may do or cause to be done by virtue of these presents.
Dated: March 26, 1998
/s/ W. Ed Tyler
---------------------
Name: W. Ed Tyler
Director
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