<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
(Amendment No.1)
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of Earliest Event Reported): July 1, 1998
Bowne & Co., Inc.
(Exact name of registrant as specified in its charter)
Delaware 1-05842 13-2618477
(State or other jurisdiction (Commission (I.R.S. Employer
of incorporation) File Number) Identification No.)
345 Hudson Street, New York, NY 10014
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 924-5500
Not Applicable
Former name or former address, if changed since last report
<PAGE> 2
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS.
On July 1, 1998 Desi Acquisition, Inc. ("Acquiror"), a wholly owned
subsidiary of Bowne & Co., Inc. (the "Company"), acquired approximately
4,920,240 shares of Donnelley Enterprise Solutions Incorporated ("DESI"),
representing approximately 98.2% of DESI's outstanding shares of common stock,
for a cash price of $21.00 per share. The shares were purchased pursuant to a
tender offer to acquire all of the outstanding shares of DESI common stock
commenced on June 3, 1998.
On July 6, 1998, the Company completed the merger of Acquiror with DESI.
Upon consummation of the merger, DESI became a wholly-owned subsidiary of the
Company and the shareholders of DESI who did not tender their shares became
entitled to receive $21.00 per share. The total purchase price for DESI was
approximately $105 million for the shares of DESI Common Stock, plus certain
additional amounts paid for transaction expenses.
The funds used to consummate the acquisition came from existing cash and
borrowings of the Company under a revolving credit agreement, dated July 7, 1997
(the "Credit Agreement") with Fleet Bank, National Association, as
Administrative Agent and certain other lending institutions.
DESI is a single-source provider of integrated information management
solutions, primarily to professional service organizations, such as large law
firms, investment banks, and accounting firms.
On August 27, 1998, the Company and DESI completed the sale, for cash, of
the assets of the LANSystems division of DESI. LANSystems was acquired as part
of the Company's acquisition of DESI, and its disposition was contemplated as
part of the acquisition. The pro forma financial information included in item 7
of this report on Form 8-K/A gives effect to the closing of the sale of the
LANSystems assets, including the estimated effect of certain post-closing
adjustments to the initial purchase price.
1
<PAGE> 3
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
The following financial statements and pro forma financial information
omitted from Form 8-K for the event dated July 1, 1998, in reliance upon
instructions 7(a)(4) and 7(b)(2) of Form 8-K, are filed herewith.
Page No.
--------
(a) Financial Statements of the Business Acquired.
Financial Statements of Donnelley Enterprise Solutions
Incorporated
Independent Auditors' Report 3
Consolidated Balance Sheets as of December 31, 1997
and 1996 4
Consolidated Statements of Income for the Years ended
December 31, 1997, 1996 and 1995 5
Consolidated Statements of Shareholders' Equity for
the Years ended December 31, 1997, 1996 and 1995 6
Consolidated Statements of Cash Flows for the Years
ended December 31, 1997, 1996 and 1995 7
Notes to Consolidated Financial Statements 8-19
Condensed Consolidated Statement of Operations for the
six months ended June 30, 1998 (unaudited) 20
Condensed Consolidated Balance Sheet as of June 30, 1998
(unaudited) 21
Condensed Consolidated Statement of Cash Flows for
the six months ended June 30, 1998 (unaudited) 22
Notes to Condensed Consolidated Financial Statements
(unaudited) 23
(b) Pro Forma Financial Information.
Unaudited Pro Forma Condensed Consolidated Statements of
Income for the year ended December 31, 1997 and for
the six-month period ended June 30, 1998 25-26
Unaudited Pro Forma Condensed Consolidated Balance Sheets
as of June 30, 1998 27
Notes to Unaudited Pro Forma Condensed Consolidated
Financial Statements 28-29
(c) Exhibits (previously filed).
Exhibit 2.1 Agreement and Plan of Merger among Bowne &
Co., Inc., DESI Acquisition, Inc. and Donnelley
Enterprise Solutions Incorporated, dated as of May 27,
1998, incorporated herein by reference to Exhibit
11(c)(1) to Schedule 14D-1 of Bowne & Co., Inc.,
dated June 3, 1998.
Exhibit 2.2 Credit Agreement, dated as of July 7, 1997, by and
among Bowne & Co., Inc. the subsidiary borrowers
party thereto, Fleet Bank, National Association, as
Administrative Agent, the Bank of Montreal, as
Documentation Agent and the lenders party thereto,
incorporated herein by reference to Exhibit 11(b)(1)
to Schedule 14D-1 of Bowne & Co., dated June 3, 1998.
2
<PAGE> 4
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
3
<PAGE> 5
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.
4
<PAGE> 6
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.
5
<PAGE> 7
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.
6
<PAGE> 8
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.
7
<PAGE> 9
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
8
<PAGE> 10
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
9
<PAGE> 11
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.
10
<PAGE> 12
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,
11
<PAGE> 13
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
12
<PAGE> 14
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.
13
<PAGE> 15
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
14
<PAGE> 16
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>
15
<PAGE> 17
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
16
<PAGE> 18
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.
17
<PAGE> 19
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>
18
<PAGE> 20
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.
17. SUBSEQUENT EVENTS-(UNAUDITED)
On July 6, 1998, the Company was acquired by and merged with a wholly-owned
subsidiary of Bowne & Co., Inc.
On August 27, 1998, Winstar Communications, Inc. purchased the assets of
LANSystems, a division of the Company.
19
<PAGE> 21
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1998
---------------
<S> <C>
Revenues....................................................... $62,041
Cost of revenues............................................... 45,712
-------
Gross profit................................................... 16,329
Selling, general and administrative expenses................... 23,123
Amortization of goodwill....................................... 540
Interest expense, net.......................................... 395
-------
Loss before income tax benefit................................. (7,729)
Income tax benefit............................................. (399)
-------
Net loss.................................................... $(7,330)
=======
</TABLE>
-------------------------------------------------------------------------
See accompanying notes to condensed consolidated financial statements.
20
<PAGE> 22
APPENDIX I
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30,
1998
--------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents .............................................. $ 1,860
Accounts receivable, less allowances for doubtful accounts of $3,717.... 22,134
Unbilled receivables ................................................... 8,165
Inventories ............................................................ 3,649
Prepaid expenses and other current assets .............................. 984
Income tax receivable .................................................. 2,082
Deferred income taxes .................................................. 2,107
-------
Total current assets ............................................... 40,981
Property and equipment, net .............................................. 15,865
Goodwill, net ............................................................ 18,618
Other noncurrent assets .................................................. 40
-------
Total assets ....................................................... $75,504
=======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit ......................................................... $10,000
Capital lease obligations, current portion ............................. 1,017
Notes payable .......................................................... 111
Accounts payable ....................................................... 7,421
Accrued expenses ....................................................... 13,337
Customer prepayments ................................................... 250
Deferred revenues ...................................................... 1,485
-------
Total current liabilities .......................................... 33,621
-------
Noncurrent liabilities:
Capital lease obligations .............................................. 1,695
Deferred income taxes .................................................. 1,404
Notes payable .......................................................... 19
-------
Total noncurrent liabilities ....................................... 3,118
-------
Shareholders' equity:
Common stock--$.01 par value, 15,000,000 authorized Shares;
5,012,307 issued and outstanding ..................................... 50
Preferred stock--$.01 par value, 1,000,000 authorized Shares;
none issued and outstanding .......................................... --
Additional paid-in capital ............................................. 49,322
Accumulated deficit .................................................... (10,607)
-------
Total shareholders' equity ......................................... 38,765
-------
Total liabilities and shareholders' equity ......................... $75,504
=======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
- -------------------------------------------------------------------------------
21
<PAGE> 23
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1998
---------
<S> <C>
Cash flows provided by (used in) operating activities:
Net loss ........................................................... $(7,330)
Depreciation and amortization ........................................ 2,672
Amortization of goodwill ............................................. 540
Gain on sale of equipment ............................................ (47)
Net changes in assets and liabilities ................................ 1,188
-------
Net cash used in operating activities ...................... (2,977)
-------
Cash flows provided by (used in) investing activities:
Capital expenditures ................................................. (1,826)
Net proceeds on sale of equipment .................................... 80
-------
Net cash used in investing activities ...................... (1,746)
-------
Cash flows provided by (used in) financing activities:
Advances, net ........................................................ (526)
Line of credit ....................................................... 4,400
Notes payable ........................................................ (55)
Proceeds from employee stock purchase plan ........................... 77
Principal payments on capital leases ................................. (544)
-------
Net cash provided by financing activities .................. 3,352
-------
Net decrease in cash and cash equivalents ................................. (1,371)
Cash and cash equivalents at beginning of period .......................... 3,231
-------
Cash and cash equivalents at end of period................................. $ 1,860
=======
</TABLE>
See accompanying notes to Condensed Consolidated financial statements.
22
<PAGE> 24
DONNELLEY ENTERPRISE SOLUTIONS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 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
LANSystems, Inc. ("LANSystems") in a business combination accounted for as a
purchase. 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 (the "Company" or "DESI").
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.
The Company is a single-source provider of integrated information
management services primarily to professional service providers, such as
large law firms, investment banking firms and accounting firms. The Company
operates within the information management services business. The Company's
offerings include document services, such as reprographic, networked and color
printing, mailroom and facsimile services, desktop publishing, and imaging. The
Company's systems management services include help desk, network management and
systems administration.
On July 1, 1998 Desi Acquisition Inc. ("Acquiror"), a wholly owned
subsidiary of Bowne & Co., Inc. ("Bowne"), acquired approximately 4,920,240
shares of DESI. The shares were purchased pursuant to a tender offer to
acquire all of the outstanding shares of DESI common stock.
On July 6, 1998, Bowne completed the merger of Acquiror with DESI.
Upon consummation of the merger, DESI became a wholly-owned subsidiary of
Bowne. The total purchase price for DESI was approximately $105 million, plus
certain additional amounts paid for transaction expenses.
On August 27, 1998, Winstar Communications, Inc. purchased the assets of
LANSystems.
NOTE 2. BASIS OF PRESENTATION
The financial statements included herein are unaudited and have been
prepared by the Company to conform with the requirements applicable to Form
8K/A. Accordingly, certain information and disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been omitted as permitted by such requirements. These
financial statements should be read in conjunction with the Company's Annual
Report on Form 10-K for the year ended December 31, 1997, incorporated herein
by reference.
The interim financial statements herein reflect, in the opinion of the
Company, all normal and recurring adjustments necessary to present fairly the
financial information for the period presented. These statements include
certain expenses relating to the sale of the Company including approximately $7
million of compensation expense resulting from the settlement of stock options
and other related expenses by DESI pursuant to the acquisition. The 1998
interim results are not necessarily indicative of the results that may be
expected for the remainder of the year.
23
<PAGE> 25
Appendix II
Unaudited Pro Forma Condensed Consolidated Financial Information
The following Unaudited Pro Forma Condensed Consolidated Statements of
Income assume that the acquisition of Donnelley Enterprise Solutions,
Incorporated ("DESI") had occurred on January 1, 1997, combining the
consolidated results of Bowne and Co., Inc. and subsidiaries ("Bowne") and DESI
for the year ended December 31, 1997 and six months ended June 30, 1998. The
Unaudited Pro Forma Condensed Consolidated Balance Sheet as of June 30, 1998
reflects the acquisition as if it had occurred on June 30, 1998. The pro forma
information is derived from the historical financial statements of Bowne and
DESI, after giving effect to the acquisition using the purchase method of
accounting and assumptions and adjustments considered appropriate by Bowne,
certain of which are described in the accompanying Notes to Unaudited Pro Forma
Condensed Consolidated Financial Statements. The allocation of purchase price
to the assets acquired and liabilities assumed has been made using estimated
fair values that include values based on independent appraisals and management
estimates. These estimates may be subject to adjustment to reflect actual
amounts, primarily in the case of accrued liabilities. Any subsequent
adjustments are expected to occur by the Company's 1998 year-end and are not
expected to be material. On August 27, 1998, Bowne and DESI completed the sale
of the assets of LANSystems, a separate operating division of DESI. The pro
forma financial information gives effect to the closing of the sale of
LANSystems, including the effect of certain post-closing adjustments, to the
initial purchase price of DESI. The pro forma information is provided for
illustrative purposes only and is not necessarily indicative of the results of
operations or financial condition that actually would have been obtained if the
acquisition had occurred on the dates indicated or of the operating results
that may be obtained in the future.
The Unaudited Pro Forma Condensed Consolidated Financial Information should
be read in conjunction with the historical financial statements, and the related
notes thereto, of Bowne and DESI. The historical financial statements of DESI
as of December 31, 1997 and 1996 and for each of the years in the three year
period ending December 31, 1997 and the related notes thereto, and the
historical financial statements of DESI as of and for the six month period
ended June 30, 1998 and the related notes thereto are included herein. The
historical financial statements of Bowne and the related notes thereto as of
and for the year ended December 31, 1997 and as of and for the six-month period
ended June 30, 1998 and the related notes thereto, have been previously filed
with the Securities and Exchange Commission.
24
<PAGE> 26
BOWNE & CO., INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
(000's OMITTED EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL
---------------------------------------- PRO FORMA PRO FORMA
BOWNE DESI(1) COMBINED ADJUSTMENTS CONSOLIDATED
-------- -------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Net Sales................................ $716,647 $110,844 $827,491 $(35,145)(16) $792,346
Expenses:
Cost of sales.......................... 392,120 83,995 476,115 (28,782)(16) 447,333
Selling and administrative............. 203,362 24,590 227,952 (11,690)(16) 216,262
Depreciation and amortization.......... 29,669 6,386 36,055 2,560 (12)(16) 38,615
Interest............................... 1,621 557 2,178 3,399 (13) 5,577
Purchased in-process research and
development and other charges........ 6,991 -- 6,991 -- 6,991
-------- -------- -------- -------- --------
633,763 115,528 749,291 (34,513) 714,778
-------- -------- -------- -------- --------
Operating income (loss).................. 82,884 (4,684) 78,200 (632) 77,568
Gain on sale of subsidiary............... 35,273 -- 35,273 -- 35,273
Other income............................. 2,456 4 2,460 (986)(14)(16) 1,474
-------- -------- -------- -------- --------
Income (loss) before income taxes........ 120,613 (4,680) 115,933 (1,618) 114,315
Income taxes (benefit)................... 51,070 (1,400) 49,670 (30)(15) 49,640
-------- -------- -------- -------- --------
NET INCOME (LOSS)........................ $ 69,543 $ (3,280) $ 66,263 $ (1,588) $ 64,675
======== ======== ======== ======== ========
Net income per Common Share (17):
Basic ................................. $1.92 $1.79
Diluted ............................... $1.87 $1.74
Shares used in computing net income
per Share (17):
Basic ................................. 36,210 36,210
Diluted ............................... 37,178 37,178
See accompanying notes to unaudited pro forma condensed consolidated financial statements.
</TABLE>
25
<PAGE> 27
BOWNE & CO., INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Six Months Ended June 30, 1998
(000's omitted, except per share data)
<TABLE>
<CAPTION>
Pro forma Pro forma
Bowne DESI(1) Combined Adjustments Consolidated
-------- -------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Net sales .......................... $413,613 $62,041 $475,654 $(15,947)(16) $459,707
Expenses:
Cost of sales .................... 216,773 45,712 262,485 (12,239)(16) 250,246
Selling and administrative ....... 128,965 20,451 149,416 (5,095)(16) 144,321
Depreciation and amortization .... 16,726 3,212 19,938 1,159 (12)(16) 21,097
Interest ......................... 980 442 1,422 1,699 (13) 3,121
Purchased in-process research and
development and other charges .. 1,200 -- 1,200 -- 1,200
-------- ------- -------- -------- --------
364,644 69,817 434,461 (14,476) 419,985
-------- ------- -------- -------- --------
Operating income (loss)............. 48,969 (7,776) 41,193 (1,471) 39,722
Other income (expense) ............. (141) 47 (94) (492)(14)(16) (586)
-------- ------- -------- -------- --------
Income (loss) before income
taxes (benefit) ................... 48,828 (7,729) 41,099 (1,963) 39,136
Income taxes (benefit) ............. 20,423 (399) 20,024 (490)(15) 19,534
-------- ------- -------- -------- --------
Net income (loss)................... $ 28,405 $(7,330) $ 21,075 $ (1,473) $ 19,602
======== ======= ======== ======== ========
Net income per Common Share (17):
Basic ............................ $.77 $.53
Diluted .......................... $.75 $.52
Shares used in computing net income
per share (17):
Basic ............................ 36,676 36,676
Diluted .......................... 37,964 37,964
See accompanying notes to unaudited pro forma condensed consolidated financial statements.
</TABLE>
26
<PAGE> 28
Bowne & CO., INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 1998
(000'S OMITTED EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
HISTORICAL
------------------------------- PRO FORMA PRO FORMA
BOWNE DESI(1) COMBINED ADJUSTMENTS CONSOLIDATED
----- ---- -------- ----------- ------------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 37,235 $ 1,860 $ 39,095 $(30,000)(2) $ 9,095
Marketable securities.................................... 6,090 -- 6,090 -- 6,090
Trade accounts receivable, net........................... 216,506 30,299 246,805 (14,032)(7)(11) 232,773
Inventories.............................................. 57,194 3,649 60,843 (3,093)(11) 57,750
Prepaid expenses and other current assets................ 15,468 5,173 20,641 (299)(11) 20,342
-------- ------- -------- -------- --------
Total current assets................................... 332,493 40,981 373,474 (47,424) 326,050
Property, plant and equipment, net......................... 145,157 15,865 161,022 (2,765)(5)(11) 158,257
Goodwill, net.............................................. 85,782 18,618 104,400 59,858 (8) 164,258
Other assets............................................... 23,530 40 23,570 14,909 (6)(8)(11) 38,479
-------- ------- -------- -------- --------
Totals............................................... $586,962 $75,504 $662,466 $ 24,578 $687,044
======== ======= ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current portion of long-term debt...... $ 6,992 $11,128 $ 18,120 $ -- $ 18,120
Accounts payable......................................... 36,380 7,421 43,801 (1,554)(11) 42,247
Accrued liabilities...................................... 94,242 15,072 109,314 10,800 (7)(11) 120,114
-------- ------- -------- -------- --------
Total current liabilities.............................. 137,614 33,621 171,235 9,246 180,481
Long-term debt--net of current portion..................... 41,594 1,714 43,308 56,642 (3)(4) 99,950
Deferred employee compensation and benefits and other
liabilities.............................................. 22,427 -- 22,427 -- 22,427
Deferred income taxes...................................... -- 1,404 1,404 5,655 (8) 7,059
-------- ------- -------- -------- --------
Total liabilities...................................... 201,635 36,739 238,374 71,543 309,917
-------- ------- -------- -------- --------
Stockholders' equity:
Preferred stock, par value $.01, none issued
Common stock, par value $.01, issued 19,767,680 shares
in 1998 and 19,605,555 shares in 1997.................. 198 50 248 (50)(9) 198
Additional paid-in capital............................... 39,107 49,322 88,429 (49,322)(9) 39,107
Retained earnings (deficit).............................. 364,515 (10,607) 353,908 2,407 (9)(10) 356,315
Treasury stock, at cost, 1,361,084 shares in 1998 and
1,366,793 shares in 1997............................... (16,514) -- (16,514) -- (16,514)
Other, net............................................... (1,979) -- (1,979) -- (1,979)
-------- ------- -------- -------- --------
Total stockholders' equity............................. 385,327 38,765 424,092 (46,965) 377,127
-------- ------- -------- -------- --------
Totals............................................... $586,962 75,504 $662,466 $ 24,578 $687,044
======== ======= ======== ======== ========
See accompanying notes to unaudited pro forma condensed consolidated financial statements.
</TABLE>
27
<PAGE> 29
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(000's OMITTED)
(1) Represents the historical financial information of DESI. The historical
financial information was derived from the audited financial statements of
DESI for the year ended December 31, 1997 and from the unaudited financial
statements as of and for the six months ended June 30, 1998.
(2) Represents cash purchase price of $105,258 consisting of the utilization
of $30,000 of cash and $75,258 of additional borrowings.
(3) Reflects borrowings with respect to the acquisition of DESI in the amount
of $75,258.
(4) Reflects net proceeds of $18,616 from the sale of LANSystems division used
to reduce long-term debt.
(5) Represents an adjustment of $1,114 to reflect DESI property, plant, and
equipment at its estimated fair market value.
(6) Assumed income tax effects resulting from acquisition of DESI.
(7) Represents costs directly associated with the acquisition of DESI.
(8) Eliminates existing DESI goodwill of $18,618 and records goodwill, other
intangible assets, and a deferred tax liability of $78,476, $14,500, and
$5,655, respectively, arising from the acquisition of DESI.
(9) Eliminates the historical equity accounts of DESI.
(10) Represents an $8,200 write off of purchased in process research and
development costs arising from the acquisition of DESI.
(11) Reflects an adjustment to eliminate the assets and liabilities of
LANSystems division of DESI sold to Winstar Communications, Inc. as
follows:
<TABLE>
<CAPTION>
<S> <C>
Trade accounts receivable ................... $13,494
Inventories ................................. 3,093
Prepaid expenses ............................ 299
Property, plant and equipment ............... 1,651
Other assets ................................ 31
Accounts payable ............................ (1,554)
Accrued liabilities ......................... (1,345)
</TABLE>
28
<PAGE> 30
(12) Reflects an adjustment of $4,291 and $2,145 for the year ended December
31, 1997 and for the six-month period ended June 30, 1998, respectively,
which represents the amortization of the intangible assets acquired in
connection with the acquisition of DESI.
(13) Reflects an adjustment of $3,399 and $1,699 for the year ended December
31, 1997 and for the six-month period ended June 30, 1998, respectively,
which represents additional interest expense in connection with $75,258
from the borrowings of the Company under a revolving credit agreement
partially offset by the repayment of approximately $18,616 from proceeds
received from the sale of LANSystems.
(14) Reflects an adjustment of $982 and $491 for the year ended December 31,
1997 and for the six-month period ended June 30, 1998, respectively, to
interest income as a result of the $30,000 cash payment in connection with
the acquisition of DESI.
(15) Reflects an adjustment of $30 and $490 for the year ended December 31,
1997 and for the six-month period ended June 30, 1998, respectively, for
the income tax benefit from the pro forma adjustments.
(16) Reflects an adjustment to eliminate the operating results of LANSystems
for the year ended December 31, 1997 and for the six-month period ended
June 30, 1998 as follows:
<TABLE>
<CAPTION>
Year ended Six-month
December 31, period ended
1997 June 30, 1998
------------ -------------
<S> <C> <C>
Net sales .................................. $35,145 $15,947
Expenses:
Cost of sales ............................ 28,782 12,239
Selling and administrative ............... 11,690 5,095
Depreciation and amortization ............ 1,731 986
------- -------
42,203 18,320
Operating loss ............................. (7,058) (2,373)
Other income ............................... 4 1
------- -------
Loss before income taxes ................... (7,054) (2,372)
Income taxes ............................... (3,218) (1,337)
------- -------
NET LOSS ................................... $(3,836) $(1,035)
======= =======
</TABLE>
(17) Reflects two-for-one stock split effective August 14, 1998.
29
<PAGE> 31
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
-----------------------------------------
As independent public accountants, we hereby consent to the inclusion in this
Form 8-K/A of our report dated February 3, 1998 on Donnelley Enterprise
Solutions Incorporated's financial statements for the year ended
December 31, 1997. It should be noted that we have not audited any financial
statements of the company subsequent to December 31, 1997 or performed any
audit procedures subsequent to the date of our report.
Arthur Andersen LLP
Chicago Illinois,
September 14, 1998
<PAGE> 32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BOWNE & CO, INC.
By: /s/ Denise K. Fletcher
---------------------------------
Name: Denise K. Fletcher
Title: Senior Vice President and
Chief Financial Officer
Dated: September 14, 1998
