-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B4t/8pl0nz9YgudE0HkbubRgp7i4y26DPPUfj6+qJbEyoWEtX9RALMp/fIpwXC88 toQwmTAH6FmISSbcK52Uiw== 0000950131-98-001500.txt : 19980306 0000950131-98-001500.hdr.sgml : 19980306 ACCESSION NUMBER: 0000950131-98-001500 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980304 SROS: CSX SROS: NYSE SROS: PCX FILER: COMPANY DATA: COMPANY CONFORMED NAME: DONNELLEY R R & SONS CO CENTRAL INDEX KEY: 0000029669 STANDARD INDUSTRIAL CLASSIFICATION: COMMERCIAL PRINTING [2750] IRS NUMBER: 361004130 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-04694 FILM NUMBER: 98557662 BUSINESS ADDRESS: STREET 1: 77 W WACKER DR CITY: CHICAGO STATE: IL ZIP: 60601 BUSINESS PHONE: 3123268000 MAIL ADDRESS: STREET 1: 77 W WACKER DRIVE CITY: CHICAGO STATE: IL ZIP: 60601 10-K405 1 FORM 10-K - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-K [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 NUMBER 1-4694 R. R. DONNELLEY & SONS COMPANY (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 36-1004130 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 77 WEST WACKER DRIVE, CHICAGO, ILLINOIS 60601 (ADDRESS OF PRINCIPAL EXECUTIVE (ZIP CODE) OFFICES) REGISTRANT'S TELEPHONE NUMBER--(312) 326-8000 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED - ----------------------------- --------------------------------------------- COMMON (PAR VALUE $1.25) NEW YORK, CHICAGO AND PACIFIC STOCK EXCHANGES PREFERRED STOCK PURCHASE RIGHTS NEW YORK, CHICAGO AND PACIFIC STOCK EXCHANGES 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 THE 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 STATE- MENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. [X] AS OF JANUARY 30, 1998, 144,870,461 SHARES OF COMMON STOCK WERE OUTSTANDING, AND THE AGGREGATE MARKET VALUE OF THE SHARES OF COMMON STOCK (BASED ON THE CLOSING PRICE OF THESE SHARES ON THE NEW YORK STOCK EXCHANGE--COMPOSITE TRANS- ACTIONS ON JANUARY 30, 1998) HELD BY NONAFFILIATES WAS $5,102,941,328. DOCUMENTS INCORPORATED BY REFERENCE PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT DATED FEBRUARY 18, 1998 ARE INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-K. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- TABLE OF CONTENTS
FORM 10-K ITEM NO. NAME OF ITEM PAGE --------- ------------ ---- Part I Item 1. Business................................................. 3 Item 2. Properties............................................... 5 Item 3. Legal Proceedings........................................ 5 Item 4. Submission of Matters to a Vote of Security Holders...... 6 Executive Officers of R. R. Donnelley & Sons Company..... 6 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..................................... 7 Item 6. Selected Financial Data.................................. 7 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 8 Item 7A. Quantative and Qualitative Disclosures about Market Risk. 8 Item 8. Financial Statements and Supplementary Data.............. 15 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..................... 15 Part III Item 10. Directors and Executive Officers of the Registrant....... 15 Item 11. Executive Compensation................................... 15 Item 12. Security Ownership of Certain Beneficial Owners and Management.............................................. 15 Item 13. Certain Relationships and Related Transactions........... 15 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................................ 16 Signatures............................................... 17 Index to Financial Statements and Financial Statement Item 14(a). Schedules............................................... F-1 Index to Exhibits........................................ E-1
2 PART I ITEM 1. BUSINESS R.R. Donnelley & Sons Company operates in a single industry segment as the largest commercial printer in North America. The company is a leading provider of printing and related services to the merchandising, magazine, book, directory and financial markets. The company applies its superior skills, scale and technology to deliver solutions that efficiently meet customers' strategic business needs. The company was founded in 1864 in Chicago by Richard Robert Donnelley, and its common stock has been publicly traded since 1956. Today, the company has approximately 26,000 employees in 19 countries on four continents. The United States print industry is a large, fragmented industry with more than 52,000 firms and over 1 million employees generating approximately $140 billion in revenue. The company has market-leading positions in five categories of the market served by its business units: Merchandise Media ($1.3 billion or 27% of 1997 consolidated net sales), which serves the catalog, retail insert and direct-mail markets; Magazine Publishing Services ($1.3 billion or 26% of 1997 consolidated net sales), which serves the consumer and the trade and specialty magazine markets; Book Publishing Services ($768 million or 16% of 1997 consolidated net sales), which serves the trade and educational book markets; Telecommunications ($789 million or 16% of 1997 consolidated net sales), which serves the domestic and international directory markets; and Financial Services ($498 million or 10% of 1997 consolidated net sales), which serves the communication needs of the capital markets and the mutual fund and healthcare industries. In addition to its domestic operations, the company has operations in Europe, Latin America and Asia. For most of 1997, the company owned approximately 80% of Stream International Holdings Inc. (SIH), which included three business units: Modus Media International (software replication, documentation, and kitting and assembly), Corporate Software & Technology (licensing and fulfillment, customized documentation, license administration and user training) and Stream International (technical and help-line support). SIH was formed in April 1995 by a merger of the company's Global Software Services business with Corporate Software Inc. In December 1997, SIH was reorganized into three separate businesses, and the company's interest was restructured such that the company now owns 87% of the common stock of Stream International Inc., 86% of the common stock of Corporate Software & Technology Holdings, Inc. (CS&T) and non-voting preferred stock of Modus Media International Holdings, Inc. (MMI). As a result of the restructuring and the company's intention to dispose of its interest in CS&T, the company has reported its interests in CS&T and MMI as discontinued operations and reclassified the prior years' consolidated financial results. The financial results of Stream International are reported in the consolidated results of the company's continuing operations. The commercial print marketplace continues to be competitive. Consolidation in the company's customer base and in the printing market has resulted in pressure on pricing and increased competition for market share. These industry trends are expected to continue. The company will manage these trends by capitalizing on its market-leading positions, by leveraging its capabilities and by controlling costs. A significant portion of the company's sales are made pursuant to term contracts with customers, with the remainder being made on a single-order basis. For some customers, the company prints and provides related services for several different publications under different contracts. The company's contracts with its larger customers normally run for a period of years (usually three to five years, but longer in the case of contracts requiring significant capital investment) or for an indefinite period subject to termination on specified notice by either party. Such sales contracts generally provide for timely price adjustments to reflect price changes for materials, wages and utilities. No single customer has a relationship with the company that accounted for 5% or more of the company's sales in 1997. The company's dependence for sales from its ten largest customers has declined in the past ten years to approximately 22% of sales in 1997, from 27% of sales in 1987. In each of the fiscal years ended December 31, 1997, 1996 and 1995, international operations represented less than 9% of consolidated net sales, less than 4% of earnings from operations (excluding 1997 and 1996 restructuring charges) and approximately 10% of consolidated assets. 3 The various phases of the commercial printing industry in which the company is involved are highly competitive. While the company has contracts with many of its customers as discussed above, there are numerous competing companies and renewal of such contracts is dependent, in part, on the ability of the company to continue to differentiate itself from the competition. Differentiation results, in part, from the company's broad range of value- added services, which include: conventional and digital preproduction, computerized printing, Selectronic(R) imaging and gathering, and sophisticated pool shipping and distribution services for printed products; information content repackaging into multiple formats, including print, magnetic and optical media; and graphic design and editorial services. Although the company believes it is the largest commercial printer in the United States, it estimates that its revenues represent approximately 6% of total sales in the commercial print industry. Although the company's plants are well located for the global, national or regional distribution of its products, competitors in some areas of the United States have a competitive advantage in some instances due to such factors as freight rates, wage scales and customer preference for local services. In addition to location, other important competitive factors are price and quality as well as the range of available services. The primary raw materials used by the company are paper and ink. In 1997, the company spent approximately $1.9 billion on raw materials. The company is a large purchaser of paper and focuses to improve materials performance and total cost management for its customers and it believes this is a competitive advantage. The company negotiates with leading suppliers to maximize its purchasing efficiencies, but does not rely on any one supplier. The company has existing paper supply contracts (at prevailing market prices) to cover substantially all of the company's requirements through 1998; and management believes extensions and renewals of these purchase contracts will provide adequate paper supplies in the future. Ink and ink materials are currently available in sufficient amounts, and the company believes that it will have adequate supplies in the future. Purchasing activity at both the local plant and corporate levels are coordinated to increase economies of scale. The company estimates that its capital expenditures in 1998 and 1999, to comply with federal, state and local provisions for environmental controls, as well as expenditures, if any, for the company's share of costs to clean hazardous waste sites that have received waste from the company, will not have a material effect upon its earnings or its competitive position. The company employed an average of approximately 25,800 persons in 1997 (26,000 persons at December 31, 1997), of whom more than 9,400 had been with the company for 10 to 24 years and more than 3,200 for 25 years or longer. As of December 31, 1997, the company employed approximately 25,000 people in the United States, approximately 800, or 3%, of whom were covered by collective bargaining agreements. In addition, the company employed approximately 1,000 people in its foreign operations, the majority of whom were covered by collective bargaining agreements, as is customary in those markets. Special Note Regarding Forward-Looking Statements. The company's Annual Report to Shareholders and this Form 10-K are among certain communications by the company that contain forward-looking statements, including statements regarding the company's financial position, results of operations, market position, product development and regulatory matters. In addition, when used in such communications, the words "believes," "anticipates," "expects" and similar expressions are intended to identify forward-looking statements. These forward-looking statements are based on the company's estimates, assumptions, projections and current expectations and are subject to a number of risks and uncertainties. Actual results in the future could differ materially from those described in the forward-looking statements as a result of many factors outside the control of the company, including, without limitation, competition with other printers based on pricing and other factors, fluctuations in the cost of paper and other raw materials used by the company, changes in postal rates, seasonal fluctuations in overall demand for printing, changes in customer demand, changes in the advertising and printing markets, changes in capital market which affect demand for commercial printing, the financial condition of the company's customers, the general condition of the United States economy, changes in the rules and regulations to which the company is subject, including environmental regulation, and other factors set forth in this Form 10-K and other company communications generally. The company does not undertake and specifically declines any obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. 4 ITEM 2. PROPERTIES The company's corporate office is located in a leased office building in Chicago, Illinois. As of December 31, 1997, the company and its subsidiaries operated 8 plants encompassing approximately 6.3 million square feet of manufacturing and warehouse space and constituting its gravure printing platform in the United States; 40 other U.S. facilities encompassing approximately 11.2 million square feet of manufacturing, operations and warehouse space; and 8 plants encompassing approximately 1.4 million square feet in Latin America, Europe and Asia. Of the total manufacturing and warehouse facilities, approximately 17.0 million square feet of space is owned by the company and its subsidiaries, while the remaining 1.9 million square feet of space is leased. In addition, the company has sales offices across the U.S., Latin America, Europe and Asia. The company has historically followed the practice of adding capacity to meet customer requirements, and has retained a substantial portion of its earnings for reinvestment in plant and equipment for this purpose. The company will continue to manage its assets in order to meet its customers' needs and growth objectives, while focusing on the generation of maximum value for its shareholders. ITEM 3. LEGAL PROCEEDINGS On November 25, 1996, a purported class action was brought against the company in federal district court in Chicago, Ill., on behalf of current and former African-American employees, alleging that the company racially discriminated against them. The complaint seeks declaratory and injunctive relief, and asks for actual, compensatory, consequential and punitive damages in an amount not less than $500 million. Although plaintiffs seek nationwide class certification, most of the specific factual assertions of the original complaint related to the closing by the company of its Chicago, Ill., catalog production operations begun in 1993. Other general claims relate to other company locations. The company has filed a motion for partial summary judgment as to all claims relating to its Chicago catalog operations on the grounds that those claims are untimely and plaintiffs have filed a motion for class certification. Both motions are pending. On December 18, 1995, a purported class action was filed against the company in federal district court in Chicago, Ill., alleging that older workers were discriminated against in selection for termination upon closing of the Chicago catalog operations. The suit also alleges that the company violated the Employee Retirement Income Security Act (ERISA) in determining benefits payable to retiring or terminating employees. On October 8, 1996, plaintiffs filed a motion to maintain the ERISA claims as a class action on behalf of all company retirement plan participants who were eligible for early retirement benefits at the time of their termination. On August 14, 1997, the court denied plaintiffs' motion and certified classes in both the age discrimination and ERISA claims limited to former employees of the Chicago catalog operations. Both cases relate at least in part to the circumstances surrounding the closure of the Chicago catalog operations. The company believes that it acted properly in the closing of the operations, has a number of valid defenses to all of the claims made and is vigorously defending its actions. However, management is unable to make a meaningful estimate of any loss that could result from an unfavorable outcome of either case. In February 1998, the company entered into a Consent Agreement and Consent Order with the U.S. EPA, settling an administrative enforcement action which was filed against the company in January 1995 for alleged violations of the Resource Conservation and Recovery Act at its Warsaw, Ind., facility. The company agreed to pay $29,000 in civil penalties and to complete designated environmental projects by year end 2000. 5 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. EXECUTIVE OFFICERS OF R. R. DONNELLEY & SONS COMPANY
NAME, AGE AND OFFICER BUSINESS EXPERIENCE DURING POSITIONS WITH THE COMPANY(1) SINCE PAST FIVE YEARS(2) - ----------------------------- ------- -------------------------- William L. Davis 1997 Management responsibilities as Chairman of the 54, Chairman Board and Chief Executive Officer. Prior of the Board and experience as Senior Executive Vice President of Chief Executive Officer(2) Emerson Electric Company, manufacturer of electrical, electronic and related products. James R. Donnelley 1983 Management responsibilities as Vice Chairman of 62, Director, Vice Chairman the Board and for Corporate Communication, of the Board Community Relations and Government Affairs. Prior management responsibility for Corporate Development. Cheryl A. Francis 1995 Management responsibilities for Corporate 44, Executive Vice President Development, Investor Relations, Treasury, and Chief Financial Officer(2) Financial Reporting and Accounting, Real Estate, Internal Audit and Taxes. Prior management responsibilities for Purchasing. Prior experience as Treasurer at FMC Corporation, a diversified manufacturer of chemicals and machinery. W. Ed Tyler 1989 Management responsibilities for Manufacturing 45, Executive Vice President and Information Technologies and Environmental and Chief Technology Officer Affairs. Prior management responsibilities for Financial Services, Telecommunications, Book Publishing Services, Global Software Services, R.R. Donnelley Europe, R.R. Donnelley Latin America and R.R. Donnelley Asia Operations; prior sales and manufacturing responsibility for Global Software Services. Jonathan P. Ward 1991 Management responsibilities for Merchandise Me- 43, President and dia, Magazine Publishing Services, Telecommuni- Chief Operating Officer cations, Financial Services, Book Publishing Services, Worldwide Procurement, Donnelley Lo- gistic Services and International Operations. Prior sales and manufacturing responsibility for Merchandise Media and Financial Services.
- -------- (1) Each officer named is a member of the company's Office of the Chairman. (2) Each officer named has carried on his principal occupation and employment in the company for more than five years with the exception of William L. Davis and Cheryl A. Francis as noted in the table above. 6 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The common stock is listed and traded on the New York Stock Exchange, Chicago Stock Exchange and Pacific Stock Exchange. As of January 30, 1998, there were 10,498 stockholders of record. Information about the quarterly prices of the common stock, as reported on the New York Stock Exchange-Composite Transactions, and dividends paid during the two years ended December 31, 1997, is contained in the chart below:
COMMON STOCK PRICES -------------------------------- DIVIDENDS PAID 1997 1996 ----------- ---------------- --------------- 1997 1996 HIGH LOW HIGH LOW ----- ----- -------- ------- ------- ------- First Quarter...................... $0.19 $0.18 $36 7/8 $29 5/8 $39 5/8 $34 1/2 Second Quarter..................... 0.19 0.18 39 3/4 32 5/8 37 1/2 34 1/8 Third Quarter...................... 0.20 0.19 41 1/16 34 3/8 35 1/8 30 1/4 Fourth Quarter..................... 0.20 0.19 37 5/8 32 5/8 34 1/8 29 5/8 Full Year.......................... 0.78 0.74 41 1/16 29 5/8 39 5/8 29 5/8
ITEM 6. SELECTED FINANCIAL DATA SELECTED FINANCIAL DATA (NOT COVERED BY AUDITORS' REPORT) (THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31 -------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- INCOME STATEMENT DATA: Net sales............... $4,850,033 $5,033,185 $5,049,597 $4,213,060 $3,861,160 Income (loss) from continuing operations*. 206,525 (71,483) 275,952 249,327 89,353 Loss on disposal of discontinued operations............. (60,000) -- -- -- -- (Loss) income from discontinued operations............. (15,894) (86,142) 22,841 19,276 20,067 Net income (loss)*...... 130,631 (157,625) 298,793 268,603 109,420 PER COMMON SHARE: Income (loss) from continuing operations*. 1.42 (0.47) 1.80 1.62 0.58 Loss on disposal of discontinued operations............. (0.41) -- -- -- -- (Loss) income from discontinued operations............. (0.11) (0.57) 0.15 0.13 0.13 Net income (loss)*...... 0.90 (1.04) 1.95 1.75 0.71 Dividends............... 0.78 0.74 0.68 0.60 0.54 DECEMBER 31 -------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- BALANCE SHEET DATA: Total assets............ $4,134,166 $4,443,828 $5,030,680 $4,318,787 $3,678,100 Noncurrent liabilities.. 1,730,047 2,044,818 2,012,635 1,669,984 1,120,382
- -------- * Net income in 1997 includes a $70.7 million restructuring and impairment charge ($42.4 million after-tax, or $0.29 per share). Net income in 1996 includes restructuring charges of $441.7 million ($374.4 million after taxes and a minority interest benefit, or $2.47 per share) and gains from partial divestitures of two subsidiaries of $80.0 million ($48.0 million after-tax, or $0.32 per share). Net income in 1993 includes the following one-time items: a restructuring charge primarily related to the closure of the company's Chicago facility ($60.8 million after-tax, or $0.39 per share), a deferred income tax charge ($6.2 million, or $0.04 per share) and the cumulative effect of accounting changes ($69.5 million after-tax, or $0.45 per share). 7 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OPERATING RESULTS Highlights--In conjunction with the company's 1997 restructuring of its ownership in SIH, the company reported its interests in CS&T and MMI as discontinued operations and recorded an after-tax provision of $60 million, to adjust the carrying cost of the businesses to their estimated net realizable value. 1997 net income was $131 million, or $0.90 per basic share, compared with a 1996 net loss of $158 million, or $1.04 per basic share. 1997 net income included a $71 million pre-tax impairment and restructuring charge ($42 million after-tax), the $60 million after-tax provision to adjust the carrying cost of discontinued operations and a $16 million after-tax loss from discontinued operations. The 1996 net loss included the effect of two restructuring charges totaling $442 million ($374 million after taxes and minority interest), $80 million in gains ($48 million after-tax) resulting from the partial divestitures of Metromail Corporation and Donnelley Enterprise Solutions Incorporated (DESI) and an $86 million after-tax loss from discontinued operations. Excluding the charges and gains, earnings from continuing operations were $249 million, or $1.71 per share in 1997, compared with 1996 net income from continuing operations of $255 million, or $1.68 per share. Net sales from continuing operations were $4.9 billion, down 4% from 1996. In the fourth quarter of 1997, the company lost $9 million, reflecting the impairment and restructuring charges and the provision to adjust the carrying value of discontinued operations discussed above, compared with 1996 earnings of $97 million, which included a $36 million pre-tax gain ($22 million after- tax) on the partial divestiture of DESI. Excluding the charges and gains, earnings from continuing operations were $88 million, a $4 million increase from 1996's fourth quarter, and earnings per share increased by $0.03, to $0.60. In 1996, the company earned $230 million, or $1.51 per share, excluding the restructuring charges and gains discussed above, compared with 1995 net income of $299 million, or $1.95 per share. 1996 earnings from continuing operations, net of restructuring charges and gains, were $255 million, or $1.68 per share, compared with 1995 net income from continuing operations of $276 million, or $1.80 per share. Net sales from continuing operations were $5 billion in 1996 and 1995. In the fourth quarter, excluding the gain from the partial divestiture of DESI, the company earned $76 million, down 21% from 1995's fourth quarter, and earnings per share declined to $0.51 cents. REVENUE Net sales for 1997 declined 4%, to $4.9 billion. Decreases in the cost of materials (primarily paper; see discussion of materials below), declines in international revenue due to the discontinuation of commercial printing in the United Kingdom ($59 million), and the deconsolidation of Metromail and DESI due to the company's reduced ownership ($206 million) following the 1996 public offerings, offset revenue gains in most business units of approximately 4%, net of the impact of paper. Driving the revenue increases in 1997 were increased advertising pages in magazines, high consumer confidence resulting in increased demand for catalogs and retail inserts, the adoption cycle for textbooks and the strength of the capital markets. Net sales for 1996 were unchanged from 1995 at $5 billion. The impact of decreased paper prices ($293 million) and the partial divestiture of Metromail ($122 million) offset increases in volume, principally in Telecommunications and Financial Services. EXPENSES Gross profit for 1997 declined 2%, to $951 million. The decline was due to the company's reduced ownership in Metromail and DESI ($70 million), price and volume declines in Telecommunications, and 8 expenses associated with developing the company's logistics and fulfillment businesses and starting up a short-run, four-color book printing facility in Roanoke, Va. In addition, the indirect costs of restructuring activities led to temporarily higher manufacturing costs in the company's gravure platform and in the United Kingdom during the first half of the year. These increased costs were partially offset by manufacturing cost improvements in most business units. Gross profit as a percentage of net sales improved to 19.6% in 1997, compared with 19.3% in 1996. The improvement was due primarily to declines in the cost of paper supplied to customers. Gross profit for 1996 declined 4%, to $971 million, reflecting lower by- product paper recovery ($60 million) and the company's reduced ownership of Metromail ($49 million), partially offset by increased volume in Financial Services and a lower LIFO inventory provision ($15 million). Gross profit as a percentage of net sales was 19.3% in 1996, compared with 20.0% in 1995. The company spent $1.9 billion, $2.1 billion and $2.2 billion on raw materials in 1997, 1996 and 1995, respectively. The primary raw materials used by the company are paper and ink. Because the price of paper is volatile, in periods of rising prices, the company's revenues increase, and in periods of falling prices, revenues decline. Paper used in the printing process is either purchased by the company or supplied by the customer. Customer-supplied paper is not reflected in the company's revenue or in the cost of sales. The cost of paper purchased for customer use is recovered as a pass-through cost, at a margin that is lower than the margin earned for printing and related services. In 1997, the average cost of paper for grades used in manufacturing (coated No. 5, uncoated supercalendered and uncoated white directory, among others) increased between 5% and 10% per short ton over 1996 prices. However, a larger portion of paper was supplied directly by the company's customers, causing an overall decline in the materials component of the cost of sales. Short-ton prices on paper grades used by the company declined between 5% and 20% in 1996. In 1995, the average cost of paper grades used rose between 20% and 40% from 1994 short-ton prices. The dramatic swing in price depressed customer demand for the company's services in 1996 (primarily in its catalog and magazine businesses). The company's results are affected by the price of scrap (by-product) paper, which it sells. In 1997, the company began to record income from the sales of by-products as a recovery of the cost of materials, and reclassified prior- years' financial results to more accurately reflect the impact of by-products on operations. In 1997, by-products recovery declined by $1 million from 1996. In 1996, by-products recovery declined by $60 million, due to the return to normal price levels following substantial increase in the price of by-products experienced during the first half of 1995. Selling and administrative expenses in 1997 declined 1%, to $511 million. Declines due to the deconsolidation of Metromail and DESI were partially offset by volume-related increases in most business units. The ratio of selling and administrative expenses to net sales increased to 10.5% from 10.3% in 1996. In 1996, selling and administrative expenses increased 4% to $518 million, primarily due to volume-related expenses in Financial Services, partially offset by the deconsolidation of Metromail. The ratio of selling and administrative expenses to net sales increased to 10.3% from 9.9% in 1995. NONOPERATING ITEMS Net interest expense for 1997 declined 5%, to $91 million, due to lower average debt balances associated with improvements in balance-sheet management, resulting in lower working capital and capital investments. In 1996, net interest expense declined 13%, to $95 million, reflecting lower average interest rates and lower average debt balances. 9 Other income for 1997 increased $9 million, to $26 million. The increase is due to lower corporate-owned life insurance (COLI) expense, partially offset by lower gains on the sale of investments in the company's venture capital portfolio and the decision by Metromail, in which the company has a 37% ownership interest, to expense as in-process research and development $23 million pre-tax ($14 million after-tax) of the purchase price of Saxe, Inc., which Metromail acquired in the third quarter. This charge resulted in a $5 million reduction in the equity earnings reported by the company during 1997. Other income for 1996 increased by $23 million, primarily due to a $13 million increase in gains on the sale of investments, mainly in the company's venture capital portfolio. EVENTS AFFECTING COMPARABILITY Restructuring/Impairment Charges--On December 16, 1997, the company announced a $71 million pre-tax restructuring and impairment charge to cover the cessation of activities no longer aligned with the company's strategic focus, including the development of certain manufacturing information systems, the pending sale of its Coris content-management software subsidiary, the shutdown of its book fulfillment operations and the closing of a development office in Singapore. Cash outlays associated with this charge are expected to total approximately $18 million, of which $1 million was incurred in 1997. During 1996, the company recorded two restructuring charges to continuing operations, totaling $442 million ($374 million after taxes and minority interest benefit), to restructure various operations and write down certain impaired assets, including equipment, intangibles and investments in non-core businesses. Approximately $195 million of the charges were related to the restructuring and realignment of gravure operations in North America, including the costs of closing facilities in Newton, N.C., and Casa Grande, Ariz. Approximately $122 million was related to other manufacturing restructuring, including: the discontinuation of catalog and magazine printing in the United Kingdom, leading to the consolidation of two facilities into a single directory printing facility; the discontinuation of book prepress operations in Barbados; and the consolidation of a stand-alone book bindery in Scranton, Pa., into an existing facility. The charges include $125 million in write-downs of equipment, intangibles and investments in non-core businesses in accordance with SFAS 121, Accounting for Impairment of Long-Lived Assets. Pre-tax cash outlays associated with the 1996 restructuring and realignment charges are expected to be $110 million (approximately $71 million of this amount has been paid through December 31, 1997). The remaining $39 million is expected to be incurred in 1998. Divestitures--On June 19, 1996, Metromail completed an initial public offering of its common stock. As a result of the offering, the company's interest in Metromail was reduced to approximately 38% (37% as of December 31, 1997). The transaction resulted in a pre-tax gain of approximately $44 million ($26 million after-tax). Metromail had net sales and operating earnings of $126 million and $13 million, respectively, through the date of the public offering. In 1995, Metromail had net sales and operating earnings of $247 million and $36 million, respectively. As a result of the initial public offering, the company received $250 million in proceeds that were used to repurchase its shares. On November 4, 1996, DESI completed an initial public offering of its common stock. As a result of the offering, the company's interest in DESI was reduced to approximately 43%. The transaction resulted in a pre-tax gain of $36 million ($22 million after-tax). DESI's net sales and operating earnings were not material to the consolidated results of the company. Prior to the initial public offerings, the company accounted for Metromail and DESI under the consolidation method. Following these offerings, the company accounts for them under the equity method. Under the equity method, the company recognizes its proportionate share of any income or loss from both entities. COLI--In 1996, the United States Health Care Reform Act was passed, eliminating the deduction for interest from loans borrowed against COLI programs. The company has used COLI to fund employee benefits for several years and expects the company's effective tax rate to rise over the next two years. 10 The Internal Revenue Service (IRS) has disallowed the interest deductions claimed by other corporate taxpayers that have COLI programs similar to the company's. Although the IRS has not taken an official position regarding the COLI program of the company, it is expected that it will disallow the company's past interest deduction. However, the company would challenge such a position and would expect to resolve the issue in a manner that does not materially impact its financial position and results of operations. Share Repurchases--In January 1998, the board of directors authorized a program to repurchase up to $500 million of the company's common stock in privately negotiated or open-market transactions over an 18-month period. The program will include shares purchased for issuance under various stock option plans. In 1997, the company purchased approximately 2.3 million shares for issuance under various stock option plans. The number of shares outstanding at December 31, 1997, was 145 million, with an average outstanding number of shares for the year of 146 million. In 1996, the company announced and completed the repurchase of $250 million, or 7.7 million shares of its common stock, which was in addition to the company's ordinary purchases of approximately 2.3 million shares for issuance under various stock option plans. The number of shares outstanding at December 31, 1996, was 146 million, with an average outstanding number of shares for the year of 152 million. In 1995, the average outstanding number of shares was 153 million. EARNINGS FROM CONTINUING OPERATIONS Net income from continuing operations for 1997 was $1.42 per share, including the effects of the restructuring and impairment charge taken in the fourth quarter. Excluding the charge, the company earned $249 million, or $1.71 per share, compared with 1996 net income from continuing operations of $255 million (excluding restructuring charges and divestiture gains discussed below), or $1.68 per share. In 1996, the net loss from continuing operations was $71 million, or $0.47 per share, including the effects of restructuring charges, as well as the gains resulting from the partial divestitures of Metromail and DESI. Excluding the restructuring charges and the gains, the company earned $255 million from continuing operations, or $1.68 per share, compared with 1995 net income from continuing operations of $276 million, or $1.80 per share. DISCONTINUED OPERATIONS The operating results of MMI and CS&T are reported as discontinued operations in conjunction with the restructuring of the company's ownership interest in SIH, discussed above. The net assets of CS&T were included in net assets of discontinued operations as of December 31, 1997 and 1996. The non- voting preferred stock in MMI was included in other noncurrent assets as of December 31, 1997; the net assets of MMI were reclassified to net assets of discontinued operations for periods prior to December 1997. After-tax losses from discontinued operations in 1997 were $76 million, or $0.52 per share, including the effects of a $60 million after-tax provision to adjust the carrying value of the businesses to their estimated net realizable value. Excluding the provision, losses from discontinued operations were $16 million, or $0.11 per share, compared with a 1996 net loss from continuing operations of $25 million (net of restructuring charges), or $0.17 per share. The improvement reflects increased volume in both the MMI and CS&T businesses and an improved cost structure due to the restructuring activities initiated in 1996, offset by the increased cost of managing the businesses as separate entities. In 1996, losses from discontinued operations were $86 million, or $0.57 per share, including the effects of two restructuring charges. In March 1996, an $86 million pre-tax charge ($44 million after taxes and a minority interest benefit) was recorded to reposition the worldwide operations of MMI and CS&T, including the closing of a plant in Wetherby, England, as well as MMI's Crawfordsville, Ind., documentation printing and diskette replication operations. In July 1996, an additional $33 million pre-tax charge ($17 million after taxes and a 11 minority interest benefit) was taken to further restructure MMI's operations. Excluding the restructuring charges, losses from discontinued operations in 1996 were $25 million, or $0.17 per share, compared with 1995 net income from discontinued operations of $23 million, or $0.15 per share. The 1997 fourth-quarter net income (excluding the provision to adjust the carrying value of the businesses) from discontinued operations was $6 million, or $0.04 per share, compared with the 1996 fourth-quarter net loss from discontinued operations of $8 million, or $0.06 per share. CASH FLOW Operating Activities--The company's main source of liquidity is cash from operating activities. In 1997, cash provided from operating activities was $742 million, a 31% increase from 1996. The increase was principally due to favorable changes in working capital, which provided cash of $117 million in 1997, versus using cash of $20 million in 1996. The decrease in working capital in 1997 was a result of increased focus throughout the organization. The net cash conversion cycle (days sales outstanding plus days inventory on hand minus days purchases outstanding) decreased by four days to 43 days. In 1996, cash provided by operating activities was $568 million, a 38% increase from 1995. The improvement was primarily due to favorable changes in working capital, which used only $20 million of cash in 1996 versus $195 million in 1995. Investing Activities--The principal recurring investing activities for the company are capital expenditures to restructure and improve the productivity of operations and to expand in specific markets. In 1997, capital expenditures totaled $360 million, an $11 million decline from 1996. Expenditures included $114 million for the restructuring of the gravure platform and $45 million for the Roanoke facility. In 1996, capital expenditures were $371 million, a $66 million decline from 1995. In 1998, the company currently expects to spend between $325 million and $350 million, including capital expenditures associated with the company's Year 2000 compliance effort. During 1997 and 1996, the company initiated activities to sell operations and assets no longer aligned with its strategic priorities. In 1997, the company generated $51 million from these actions, including $21 million from the sale of the company's interests in three European joint ventures and $13 million from the disposition of interests from the company's venture capital portfolio. In 1996, the company generated $249 million and $52 million from transactions related to its partial disposition of its ownership in Metromail and DESI, respectively, and an additional $32 million from other dispositions. Financing Activities--Financing activities include net borrowings, share repurchases and dividend payments. The company's net borrowings declined by $226 million and $160 million in 1997 and 1996, respectively, and increased by $196 million in 1995. The decline in 1997 was a result of strong working capital management, lower capital spending and cash generated from the disposition of assets no longer aligned with the company's strategic priorities. Commercial paper is the company's primary source of short-term financing. On December 31, 1997, the company had $258 million outstanding in commercial paper borrowings. In addition, at December 31, 1997 and 1996, the company had an unused revolving credit facility of $550 million with a number of banks. This facility provides support for the issuance of commercial paper and other credit needs. Management believes the company's cash flow and borrowing capacity are sufficient to fund its operations. Net cash used to purchase common stock for treasury, primarily to cover options granted to employees, was $36 million in 1997. In 1996, $274 million net cash was used to repurchase shares. 12 Dividends to shareholders totaled $115 million, $113 million and $104 million in 1997, 1996 and 1995, respectively. FINANCIAL CONDITION The financial position of the company is strong, as evidenced by the December 31, 1997, balance sheet. The company's total assets are $4.1 billion, a $310 million decline from 1996, due to the increased focus on managing working capital and reducing capital expenditures, as well as the disposition of assets no longer aligned with the strategic focus of the organization. 1997 average invested capital (total debt and equity, computed on a 12-month average) was $3 billion, a $258 million decline from 1996. Increased earnings from continuing operations (net of impairment and restructuring charges and one-time gains) in conjunction with decreased invested capital have contributed to a 180-basis point improvement in return on invested capital to 11.4%. At year-end 1997, the total debt-to-capital ratio decreased to 43%, from 47% at year-end 1996, and the overall debt-to-total-market-value of the company declined to 22% from 27%. Over longer periods of time, the goal of the company is to manage the ratio within a range of 20% to 25%. OTHER INFORMATION Human Resources--As of December 31, 1997, the company employed approximately 26,000 people worldwide in its continuing operations. Of that number, approximately 96% were employed in the United States, approximately 3% of whom are covered by collective bargaining agreements. Of the total, the company employed approximately 1,000 people in its foreign operations, the majority of whom were covered by collective bargaining agreements, as is customary in those markets. From 1996 to 1997, the number of domestic employees in continuing operations decreased by 8%. Despite this decline, minority representation increased as a percentage of total employees by 1%, to 14%, and increased as a percentage of managers and professionals by 2%, to 11%. Females represent 31% of total employees and 32% of managers and professionals. Minorities represent 16% of the female workforce and 13% of female managers and professionals. Technology--The company remains a technology leader, investing not only in print-related technologies, such as computer-to-plate and digital printing, but also in areas such as distribution of content and images over the Internet. Technology is applied to enhance customers' products across the entire manufacturing process. The company's recent investments have been focused on a digital infrastructure to support the movement of work from customers' desktops across the company's manufacturing process, enabling output in multiple media. The company is focused on investing in technologies that contribute to its financial performance and help it deliver products, services and solutions its competitors cannot easily duplicate. Process control and information systems are becoming increasingly important to the effective management of the company. Increased spending on new systems and updating of existing systems will be necessary. In the near term, these efforts will be focused on ensuring that processes and systems are Year 2000 compliant, and the company will defer other infrastructure and systems initiatives that would support continuous productivity improvements and enhanced service capabilities until after the company is Year 2000 compliant. The Year 2000 compliance issues stem from the computer industry's practice of conserving data storage by using two digits to represent a year. Systems and hardware using this format may process data incorrectly or fail with the use of dates in the next century. These types of failures can influence applications that rely on dates to perform calculations (such as an accounts receivable aging report), as well as systems such as building security and heating. The company's effort to address Year 2000 compliance issues is under way. The effort consists of evaluating internal computing infrastructure, business applications and shop-floor systems for Year 2000 compliance and replacing or renovating systems and applications as necessary to assure such compliance. This 13 effort will be completed by mid-1999. In addition, the company will evaluate compliance by external companies and systems that interact with those of the company, and test to ensure all systems work together. Company employees, assisted by the expertise of external consultants where necessary, staff the Year 2000 compliance effort. Management believes currently that the cost of the Year 2000 initiative is not a material issue that would cause reported financial information not to be indicative of future operating results or financial condition. Litigation--On November 25, 1996, a purported class action was brought against the company in federal district court in Chicago, Ill., on behalf of current and former African-American employees, alleging that the company racially discriminated against them. The complaint seeks declaratory and injunctive relief, and asks for actual, compensatory, consequential and punitive damages in an amount not less than $500 million. Although plaintiffs seek nationwide class certification, most of the specific factual assertions of the complaint relate to the closing by the company of its Chicago catalog production operations begun in 1993. Other general claims relate to other company locations. The company has filed a motion for partial summary judgment as to all claims relating to its Chicago catalog operations on the grounds that those claims are untimely and plaintiffs have filed a motion for class certification. Both motions are pending. On December 18, 1995, a purported class action was filed against the company in federal district court in Chicago alleging that older workers were discriminated against in selection for termination upon closing of the Chicago catalog operations. The suit also alleges that the company violated the Employee Retirement Income Security Act (ERISA) in determining benefits payable to retiring or terminating employees. On October 8, 1996, plaintiffs filed a motion to maintain the ERISA claims as a class action on behalf of all company retirement plan participants who were eligible for early retirement benefits at the time of their termination. On August 14, 1997, the court denied plaintiffs' motion and certified classes in both the age discrimination and ERISA claims limited to former employees of the Chicago catalog operations. Both pending cases relate at least in part to the circumstances surrounding the closing of the Chicago catalog operations. The company believes that it acted properly in the closing of the operations, has a number of valid defenses to all of the claims made and is vigorously defending its actions. However, management is unable to make a meaningful estimate of any loss that could result from an unfavorable outcome of either pending case. Environmental Regulations--The company is subject to various laws and regulations relating to employee health and safety and to environmental protection. The company's policy is to be in compliance with all such laws and regulations that govern protection of the environment and employee health and safety. The company does not anticipate that compliance with such environmental, safety and health laws and regulations will have a material adverse effect upon the company's competitive or consolidated financial position. Outlook--The commercial printing business in North America (the company's primary geographic market) is highly competitive in most product categories and geographic regions. Industry analysts consider most of the commercial printing markets to suffer from overcapacity, and competition, therefore, is fierce. Competition is based largely on price, quality and servicing the special needs of customers. The company is a large consumer of paper, acquired for customers and by customers. The cost and supply of certain paper grades consumed in the manufacturing process will continue to affect the company's financial results. However, management currently does not foresee any disruptive conditions affecting prices and supply of paper in 1998. Postal costs are a significant component of the cost structure of the customers of the company. Changes anticipated in postal rates in 1998, however, are expected to be manageable for most key customer segments, and favorable U.S. Postal Service financial performance could possibly delay the implementation of any new rates beyond 1998. 14 Additionally, proposed changes to the Postal Service's legislative charter also could affect the postal communication and commerce environment. While the proposed legislative changes are controversial, aspects of the proposal could strengthen the company's position as a postal intermediary. Even in the absence of legislative reform, the company's ability to improve the cost efficiency of mail processing and distribution will enhance its positioning in the postal business marketplace. In addition to paper and postage costs, consumer confidence and economic growth are key drivers of print demand. Most experts expect continued strength in the domestic economy; however, a significant change in the economic outlook could affect demand for the company's products, particularly in the financial printing market. Management believes the company's competitive strengths--including its comprehensive service offerings, depth of customer relationships, technology leadership, management experience and economies of scale--should result in profitable growth throughout the next year and well into the future. ITEM 7A. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to market risk from changes in interest rates and foreign exchange rates. However, since approximately 70% of the company's debt is at fixed interest rates, the company's exposure to interest rate fluctuations is immaterial to the consolidated financial statements of the company as a whole. The company's exposure to adverse changes in foreign exchange rates is also immaterial to the consolidated financial statements of the company as a whole, although the company occasionally enters into financial instruments to hedge what exposure to foreign exchange rate changes it may have. The company does not use financial instruments for trading purposes and is not a party to any leveraged derivatives. Further disclosure relating to financial instruments is included in the Debt Financing and Interest Expense note in the Notes to Consolidated Financial Statements. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial information required by Item 8 is contained in Item 14 of Part IV and listed on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning the directors and officers of the company is contained on pages 2-6 and 8 of the company's definitive Proxy Statement dated February 18, 1998, and is incorporated herein by reference. See also the list of the company's executive officers and related information under "Executive Officers of R. R. Donnelley & Sons Company" at the end of Part I of this Report. ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation for the year ended December 31, 1997, and, with respect to certain of such information, prior years, is contained on pages 8-16 of the company's definitive Proxy Statement dated February 18, 1998, and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning the beneficial ownership of the company's common stock is contained on pages 6-8 of the company's definitive Proxy Statement dated February 18, 1998 and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None 15 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)1. Financial Statements The financial statements listed in the accompanying index (page F-1) to the financial statements are filed as part of this annual report. 2. Financial Statement Schedule The financial statement schedule listed in the accompanying index (page F-1) to the financial statements is filed as part of this annual report. 3. Exhibits The exhibits listed on the accompanying index to exhibits (pages E-1 through E-2) are filed as part of this annual report. (b)Reports on Form 8-K A Current Report on Form 8-K was filed on December 15, 1997, and included Item 5, "Other Events" and Item 7, "Financial Statements, Pro Forma Financial Information and Exhibits." An amendment to such Current Report on Form 8-K/A was filed on February 18, 1998. (c)Exhibits The exhibits listed on the accompanying index (Pages E-1 through E-2) are filed as part of this annual report. (d)Financial Statements omitted-- Separate financial statements of the parent company have been omitted since it is primarily an operating company and the minority interest and indebtedness to persons other than the parent of the subsidiaries included in the consolidated financial statements are less than 5% of total consolidated assets. Certain schedules have been omitted because the required information is included in the consolidated financial statements or notes thereto or because they are not applicable or not required. 16 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) 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, ON THE 4TH DAY OF MARCH, 1998. R. R. DONNELLEY & SONS COMPANY /s/ Peter F. Murphy By __________________________________ Peter F. Murphy, Vice President and Controller PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED, ON THE 4TH DAY OF MARCH, 1998. SIGNATURE AND TITLE SIGNATURE AND TITLE /s/ William L. Davis /s/ Thomas S. Johnson - ------------------------------------- ------------------------------------- William L. Davis Thomas S. Johnson Chairman of the Board and Director Chief Executive Officer, Director (Principal Executive Officer) /s/ George A. Lorch ------------------------------------- /s/ Cheryl A. Francis George A. Lorch - ------------------------------------- Director Cheryl A. Francis Executive Vice President and /s/ M. Bernard Puckett Chief Financial Officer ------------------------------------- (Principal Financial Officer) M. Bernard Puckett Director /s/ Peter F. Murphy - ------------------------------------- /s/ William D. Sanders Peter F. Murphy ------------------------------------- Vice President and Controller William D. Sanders (Principal Accounting Officer) Director /s/ Martha Layne Collins /s/ Oliver R. Sockwell - ------------------------------------- ------------------------------------- Martha Layne Collins Oliver R. Sockwell Director Director /s/ James R. Donnelley /s/ Bide L. Thomas - ------------------------------------- ------------------------------------- James R. Donnelley Bide L. Thomas Director Director /s/ Charles C. Haffner III /s/ Stephen M. Wolf - ------------------------------------- ------------------------------------- Charles C. Haffner III Stephen M. Wolf Director Director /s/ Judith H. Hamilton - ------------------------------------- Judith H. Hamilton Director 17 ITEM 14(A). INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
PAGE(S) ------- Consolidated Statements of Income for each of the three years ended December 31, 1997..................................................... F-2 Consolidated Balance Sheets at December 31, 1997 and 1996.............. F-3 Consolidated Statements of Cash Flows for each of the three years ended December 31, 1997..................................................... F-4 Consolidated Statements of Shareholders' Equity for each of the three years ended December 31, 1997......................................... F-5 Notes to Consolidated Financial Statements............................. F-6 Report of Independent Public Accountants............................... F-18 Unaudited Interim Financial Information................................ F-19 Report of Independent Public Accountants on Financial Statement Schedule.............................................................. F-20 Financial Statement Schedule II--Valuation and Qualifying Accounts................................ F-21
F-1 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME THOUSANDS OF DOLLARS
YEAR ENDED DECEMBER 31 ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- Net sales................................. $4,850,033 $5,033,185 $5,049,597 Cost of sales............................. 3,899,428 4,062,259 4,037,525 ---------- ---------- ---------- Gross profit.............................. 950,605 970,926 1,012,072 Selling and administrative expenses....... 511,115 518,288 497,402 Restructuring and impairment charges...... 70,702 441,709 -- ---------- ---------- ---------- Earnings from operations.................. 368,788 10,929 514,670 Other income (expense): Interest expense........................ (90,765) (95,482) (109,759) Gain on stock offerings of subsidiaries. -- 80,041 -- Other, net.............................. 25,742 16,821 (5,871) ---------- ---------- ---------- Earnings from continuing operations before income taxes............................. 303,765 12,309 399,040 Income taxes.............................. 97,240 83,792 123,088 ---------- ---------- ---------- Income (loss) from continuing operations.. 206,525 (71,483) 275,952 Loss on disposal of discontinued operations, net of income taxes.......... (60,000) -- -- (Loss) income from discontinued operations, net of income taxes.......... (15,894) (86,142) 22,841 ---------- ---------- ---------- Net Income (Loss)..................... $ 130,631 $ (157,625) $ 298,793 ========== ========== ========== Income (Loss) from Continuing Operations per Share of Common Stock Basic................................... $ 1.42 $ (0.47) $ 1.80 Diluted................................. 1.40 (0.47) 1.77 Net Income (Loss) per Share of Common Stock Basic................................... $ 0.90 $ (1.04) $ 1.95 Diluted................................. 0.89 (1.04) 1.92
See accompanying Notes to Consolidated Financial Statements. F-2 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS THOUSANDS OF DOLLARS
DECEMBER 31 ---------------------- 1997 1996 ---------- ---------- Assets Cash and equivalents................................. $ 47,814 $ 21,317 Receivables, less allowances for doubtful accounts of $16,259 in 1997 and $14,205 in 1996................. 814,664 919,042 Inventories.......................................... 201,402 197,905 Prepaid expenses..................................... 82,691 87,807 ---------- ---------- Total Current Assets............................... 1,146,571 1,226,071 Net property, plant and equipment, at cost, less accumulated depreciation of $2,426,649 in 1997 and $2,228,378 in 1996.................................. 1,788,116 1,836,620 Goodwill and other intangibles, net of accumulated amortization of $149,782 in 1997 and $108,194 in 1996................................................ 385,512 436,306 Other noncurrent assets.............................. 659,260 558,698 Net assets of discontinued operations................ 154,707 386,133 ---------- ---------- Total Assets....................................... $4,134,166 $4,443,828 ========== ========== Liabilities Accounts payable..................................... $ 291,666 $ 285,416 Accrued compensation................................. 152,235 121,889 Short-term debt...................................... 45,000 33,296 Current and deferred income taxes.................... 58,888 53,766 Other accrued liabilities............................ 264,833 273,362 ---------- ---------- Total Current Liabilities.......................... 812,622 767,729 ---------- ---------- Long-term debt....................................... 1,153,226 1,430,671 Deferred income taxes................................ 229,538 256,819 Other noncurrent liabilities......................... 347,283 357,328 ---------- ---------- Total Noncurrent Liabilities....................... 1,730,047 2,044,818 ---------- ---------- Shareholders' Equity Common stock at stated value ($1.25 par value) Authorized shares: 500,000,000; Issued: 150,889,050 in 1997 and 1996.................................... 320,962 320,962 Retained earnings, net of cumulative translation adjustments of $45,782 in 1997 and $26,580 in 1996.. 1,482,624 1,486,215 Unearned compensation................................ (9,414) (5,402) Reacquired common stock, at cost..................... (202,675) (170,494) ---------- ---------- Total Shareholders' Equity......................... 1,591,497 1,631,281 ---------- ---------- Total Liabilities and Shareholders' Equity......... $4,134,166 $4,443,828 ========== ==========
See accompanying Notes to Consolidated Financial Statements. F-3 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS THOUSANDS OF DOLLARS
YEAR ENDED DECEMBER 31 ------------------------------- 1997 1996 1995 --------- --------- --------- Cash flows provided by (used for) operating activities: Net income (loss)........................... $ 130,631 $(157,625) $ 298,793 Loss (income) from discontinued operations, net of income taxes........................ 15,894 86,142 (22,841) Loss on disposal of discontinued operations, net of income taxes........................ 60,000 -- -- Restructuring and impairment charges, net of tax and minority interest.................. 42,421 374,449 -- Depreciation................................ 327,770 316,290 298,879 Amortization................................ 42,675 43,205 57,798 Gain on stock offerings of subsidiaries..... -- (80,041) -- Gain on sale of assets...................... (16,028) (17,758) -- Net change in operating working capital..... 117,386 (20,355) (194,784) Net change in other assets and liabilities.. 27,508 36,516 (21,080) Other....................................... (6,019) (12,856) (5,813) --------- --------- --------- Net Cash Provided by Operating Activities. 742,238 567,967 410,952 --------- --------- --------- Cash flows provided by (used for) investing activities: Capital expenditures........................ (360,195) (370,906) (436,730) Proceeds from collection of advances to affiliates................................. -- 277,013 -- Proceeds from sale of DESI shares........... -- 23,492 -- Other investments, including acquisitions, net of cash acquired....................... (47,526) (24,165) (68,216) Disposition of assets....................... 51,276 31,563 -- --------- --------- --------- Net Cash Used for Investing Activities.... (356,445) (63,003) (504,946) --------- --------- --------- Cash flows provided by (used for) financing activities: Net (decrease) increase in borrowings....... (225,967) (160,329) 195,637 Disposition of reacquired common stock...... 45,762 53,058 45,597 Acquisition of common stock................. (82,041) (327,130) (34,429) Cash dividends paid......................... (114,934) (112,645) (104,364) --------- --------- --------- Net Cash (Used for) Provided by Financing Activities............................... (377,180) (547,046) 102,441 --------- --------- --------- Effect of exchange rate changes on cash and equivalents.................................. (775) (395) (230) --------- --------- --------- Net Increase (Decrease) in Cash and Equivalents from Continuing Operations....... 7,838 (42,477) 8,217 Net Increase (Decrease) in Cash from Discontinued Operations...................... 18,659 41,551 (11,680) Cash and Equivalents at Beginning of Year..... 21,317 22,243 25,706 --------- --------- --------- Cash and Equivalents at End of Year........... $ 47,814 $ 21,317 $ 22,243 ========= ========= ========= Changes in operating working capital, net of acquisitions and divestitures: 1997 1996 1995 --------- --------- --------- Decrease (increase) in assets: Receivables--net............................ $ 103,077 $ 149,048 $(249,372) Inventories--net............................ (3,496) 42,919 (20,429) Prepaid expenses............................ 5,116 (78,086) 18,659 Increase (decrease) in liabilities: Accounts payable............................ 6,249 (81,477) 52,147 Accrued compensation........................ 30,347 17,606 12,562 Other accrued liabilities................... (23,907) (70,365) (8,351) --------- --------- --------- Net Change in Operating Working Capital... $ 117,386 $ (20,355) $(194,784) ========= ========= =========
See accompanying Notes to Consolidated Financial Statements. F-4 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY THOUSANDS OF DOLLARS
REACQUIRED UNEARNED COMMON STOCK COMMON STOCK COMPENSATION --------------------- --------------------- RESTRICTED RETAINED SHARES AMOUNT SHARES AMOUNT STOCK EARNINGS TOTAL ----------- -------- ---------- --------- ------------ ---------- ---------- Balance at December 31, 1994................... 158,608,800 $330,612 (5,523,482) $(155,020) $ -- $1,802,777 $1,978,369 Net income.............. 298,793 298,793 Treasury stock purchases.............. (996,464) (34,429) (34,429) Cash dividends.......... (104,364) (104,364) Cost of common shares issued under stock programs............... 1,863,685 47,206 (9,297) 7,688 45,597 Translation adjustments. (10,796) (10,796) ----------- -------- ---------- --------- ------- ---------- ---------- Balance at December 31, 1995................... 158,608,800 330,612 (4,656,261) (142,243) (9,297) 1,994,098 2,173,170 Net loss................ (157,625) (157,625) Treasury stock purchases.............. (2,333,691) (77,131) (77,131) Cash dividends.......... (112,645) (112,645) Cost of common shares issued under stock programs............... 1,654,697 48,880 3,895 283 53,058 Cost of common shares retired under repurchase plan........ (7,719,750) (9,650) (240,349) (249,999) Translation adjustments. 2,453 2,453 ----------- -------- ---------- --------- ------- ---------- ---------- Balance at December 31, 1996................... 150,889,050 320,962 (5,335,255) (170,494) (5,402) 1,486,215 1,631,281 Net income.............. 130,631 130,631 Treasury stock purchases.............. (2,293,757) (82,041) (82,041) Cash dividends.......... (114,934) (114,934) Cost of common shares issued under stock programs............... 1,857,792 49,860 (4,012) (86) 45,762 Translation adjustments. (19,202) (19,202) ----------- -------- ---------- --------- ------- ---------- ---------- Balance at December 31, 1997................... 150,889,050 $320,962 (5,771,220) $(202,675) $(9,414) $1,482,624 $1,591,497 =========== ======== ========== ========= ======= ========== ==========
See accompanying Notes to Consolidated Financial Statements. F-5 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Consolidation--The consolidated financial statements include the accounts of the company and its majority-owned subsidiaries. Minority interests in the income (loss) of consolidated subsidiaries ($6 million of expense, $2 million of income and $5 million of expense in 1997, 1996 and 1995, respectively) are included in other expense on the Consolidated Statements of Income. Intercompany items and transactions are eliminated in consolidation. The company held investments in unconsolidated affiliates of $275 million and $218 million at Dec. 31, 1997 and 1996, respectively. Nature of Operations--The company provides a wide variety of print and print-related services and products for specific customers, virtually always under contract. Some contracts provide for progress payments from customers as certain phases of the work are completed; however, revenue is not recognized until the earnings process has been completed in accordance with the terms of the contracts. Some customers furnish paper for their work, while in other cases the company purchases and sells the paper. Cash and Equivalents--The company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents. Inventories--Inventories include material, labor and factory overhead and are stated at the lower of cost or market. The cost of approximately 80% and 84% of the inventories at Dec. 31, 1997 and 1996, respectively, has been determined using the Last-In, First-Out (LIFO) method. This method reflects the effect of inventory replacement costs in earnings; accordingly, charges to cost of sales reflect recent costs of material, labor and factory overhead. The remaining inventories are valued using the First-In, First-Out (FIFO) or specific identification methods. Foreign Currency Translation--Gains and losses arising from the translation of the company's international subsidiaries' financial statements are reflected in retained earnings. Capitalization, Depreciation and Amortization--Property, plant and equipment are stated at cost. Depreciation is computed principally on the straight-line method based on useful lives of 15 to 33 years for buildings and 3 to 15 years for machinery and equipment. Maintenance and repair costs are charged to expense as incurred. Major overhauls are capitalized as reductions to accumulated depreciation. When properties are retired or disposed, the costs and accumulated depreciation are eliminated and the resulting profit or loss is recognized in income. Goodwill ($145 million and $147 million, net of accumulated amortization, at Dec. 31, 1997 and 1996, respectively) is amortized over periods ranging from 10 to 40 years. Other intangibles represent primarily the cost of acquiring print contracts and volume guarantees and are amortized over the periods in which benefits will be realized. Use of Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and of the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. DISCONTINUED OPERATIONS Effective April 1, 1995, the company merged its Global Software Services business (GSS) with Corporate Software Inc. (CSI) and formed Stream International Holdings Inc. (SIH), a software manufacturer, distributor and technical-support organization. From the date of the merger through Dec. 15, 1997, the company owned F-6 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) approximately 80% of the capital stock of SIH. The remaining 20% was owned by the former owners of CSI and management. During 1996, SIH reorganized into three independent businesses: Stream International, which provides outsource technical support services; Corporate Software & Technology (CS&T), a software distribution company; and Modus Media International (MMI), a global manufacturing and fulfillment business. CS&T and MMI comprise the majority of the company's investment and net income in SIH. On Dec. 15, 1997, SIH's businesses became separate companies and the company's ownership interest in SIH was restructured. The company converted its equity and debt positions in Stream International into 87% of the common stock of that business. Additionally, the company converted its equity and debt positions in CS&T into 86% of the common stock of CS&T and sold its equity and debt positions in MMI for non-voting preferred stock of MMI. The disposition of the company's interest in CS&T will be effected through the sale of the business, which is planned to occur during 1998. In connection with the planned disposition of CS&T and the restructuring of the company's interest in MMI, the company has reported its interests in CS&T and MMI as discontinued operations. The net assets of CS&T were included in net assets of discontinued operations, as of Dec. 31, 1997. The non-voting preferred stock in MMI was included in other noncurrent assets as of Dec. 31, 1997; and the net assets of MMI were reclassified to net assets of discontinued operations for periods prior to December 1997. Additionally, the company recorded a fourth-quarter 1997 charge for the loss on disposal of discontinued operations of $60 million ($40 million net of taxes) to adjust the carrying cost of these businesses to their estimated net realizable values. Summary financial information of discontinued operations was as follows:
1997 1996 1995 ---------- ---------- ---------- THOUSANDS OF DOLLARS Net sales.............................. $1,546,211 $1,526,369 $1,363,616 (Loss) income before income taxes...... (22,216) (122,789) 40,492 (Loss) Income.......................... (15,894) (86,142) 22,841 Net current assets..................... $ 44,269 $ 146,968 Net noncurrent assets.................. 110,438 239,165 ---------- ---------- Total Net Assets....................... $ 154,707 $ 386,133 ========== ==========
As part of the restructuring program announced in the first half of 1996, the company recorded pre-tax charges of $119 million ($61 million after-tax) for discontinued operations. The charges primarily related to the repositioning of MMI and CS&T's worldwide operations and the restructuring of its software manufacturing, printing, kitting and fulfillment operations. The SIH merger, which was effective April 1, 1995, was accounted for using the purchase method. Accordingly, amounts assigned in the net assets of discontinued operations to the assets and liabilities of CS&T were based on their estimated fair market values. The cost in excess of net assets acquired of $109 million is being amortized on a straight-line basis over 15 years. No gain or loss was recognized on the merger, as the book value of GSS approximated its fair market value on the date of the transaction. Liabilities incurred and assumed in connection with acquisitions totaled $387 million for the year ended Dec. 31, 1995. F-7 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DIVESTITURES On June 19, 1996, Metromail Corporation (the company's previously wholly- owned subsidiary, which is a leading provider of market-oriented consumer information and reference services) completed an initial public offering of 13.8 million shares of its common stock at $20.50 per share. As a result of the offering, the company's interest in Metromail was reduced to approximately 38% (37% as of Dec. 31, 1997). Approximately $250 million of the proceeds from the completed offering were used by Metromail to retire certain indebtedness owed to the company. The company in turn used the payment from Metromail to pay down debt and for general corporate purposes. The transaction resulted in a pre-tax gain for the company of $44 million and a tax provision of $18 million. As a result of this transaction, the company changed its method of accounting for Metromail from consolidation to the equity method, effective July 1, 1996. Under the equity method, the company recognizes in income its proportionate share of the net income of Metromail. Metromail's 1996 net sales and operating earnings were $126 million and $13 million, respectively, through the date of the initial public offering. Metromail had net sales and operating earnings of $247 million and $36 million, respectively, in 1995. On Nov. 4, 1996, Donnelley Enterprise Solutions Incorporated (DESI), formerly a wholly-owned subsidiary of the company and a single-source provider of integrated information-management services to professional service organizations, completed an initial public offering of 2.9 million shares of its common stock at $25.00 per share, of which 1.0 million were offered by the company. As a result of the offering, the company's interest in DESI was reduced to approximately 43%. The company received approximately $52 million from the net proceeds of the shares sold and from repayment of amounts owed by DESI, which was used for general corporate purposes. The transaction resulted in a pre-tax gain of $36 million, or $22 million after taxes. As a result of this transaction, the company changed its method of accounting for DESI from consolidation to the equity method, effective Nov. 1, 1996. DESI's net sales and operating earnings were not material to the consolidated operating results or financial condition of the company. RESTRUCTURING AND IMPAIRMENT CHARGES In December 1997, the company provided for the impairment of assets and restructuring costs related to the elimination of activities that no longer support the company's strategic focus. These included the development of certain manufacturing systems, the pending sale of Coris, the company's content-management software subsidiary and the shutdown of book fulfillment operations in Crawfordsville, Ind. These actions resulted in pre-tax charges of $71 million ($42 million after taxes). Pre-tax cash outlays associated with the charges are expected to total approximately $18 million, of which $1 million was incurred in 1997. The remaining $17 million is expected to be incurred in 1998. In the first half of 1996, the company provided for the restructuring and realignment of its gravure printing operations in North America, the repositioning of other businesses, the write-down of certain equipment and the impairment of intangible assets and investments in non-core businesses. These actions resulted in pre-tax charges of $442 million ($374 million after taxes and a minority interest benefit). Approximately $195 million of the charges were related to its gravure platform realignment and approximately $122 million were related to other manufacturing restructuring. The charges also included $125 million in write-downs of equipment, intangibles and investments in non-core businesses. Pre-tax cash outlays associated with the restructuring and realignment charges are expected to total approximately $110 million, of which $71 million was incurred through 1997 and the remaining $39 million will be incurred in 1998. Impairment losses were calculated based on the excess of the carrying amount of assets over the asset's fair values. The fair value of an asset is generally determined as the discounted estimate of future cash flows generated by the asset. F-8 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The following table presents the components of the company's restructuring reserves along with charges against these reserves, from their establishment until Dec. 31, 1997:
WRITE-DOWN OF RESTRUCTURING INITIAL PROPERTY AND RESERVES AS OF RESTRUCTURING INVESTMENTS CASH DECEMBER 31, RESERVES TO FAIR VALUE PAYMENTS 1997 ------------- ------------- -------- -------------- THOUSANDS OF DOLLARS Restructuring loss on write-down of property, plant and equipment, and other assets............ $220,323 $(220,323) $ -- $ -- Restructuring expenditures to reposition operations and close facilities.... 127,922 -- (72,055) 55,867 Impairment loss on intangible assets and investments............. 164,166 (164,166) -- -- -------- --------- -------- ------- Total Restructuring Reserves............ $512,411 $(384,489) $(72,055) $55,867 ======== ========= ======== =======
INVENTORIES The components of the company's inventories were as follows:
DECEMBER 31 ------------------ 1997 1996 -------- -------- THOUSANDS OF DOLLARS Raw materials and manufacturing supplies.............. $123,280 $128,445 Work in process....................................... 153,142 153,451 Finished goods........................................ 1,047 155 Progress billings..................................... (31,715) (40,132) LIFO reserve.......................................... (44,352) (44,014) -------- -------- Total............................................. $201,402 $197,905 ======== ========
The company's cost of sales was increased by LIFO provisions of $0.6 million in 1997 and $7.7 million in 1995, and decreased by $7.5 million in 1996. In the third quarter of 1995, the company changed from the double-extension method of valuing LIFO inventories to the external-index method. The company believes that this change will result in a better measurement of operating results by properly reflecting the effect of productivity improvements in the company's cost of sales. Because the cumulative effect of this change on periods prior to 1995 cannot be determined, the impact has been reflected in 1995 operations. This accounting change was adopted effective Jan. 1, 1995. Net income for 1995 was approximately $22 million ($0.15 per basic share) higher than it would have been had the change not been made. PROPERTY, PLANT AND EQUIPMENT The following table summarizes the components of property, plant and equipment (at cost):
DECEMBER 31 --------------------- 1997 1996 ---------- ---------- THOUSANDS OF DOLLARS Land................................................ $ 33,755 $ 34,032 Buildings........................................... 634,114 584,734 Machinery and equipment............................. 3,546,896 3,446,232 ---------- ---------- Total........................................... $4,214,765 $4,064,998 ========== ==========
F-9 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) COMMITMENTS AND CONTINGENCIES As of Dec. 31, 1997, authorized expenditures on incomplete projects for the purchase of property, plant and equipment totaled $161 million. Of this total, $73 million has been contractually committed. The company has a variety of commitments with suppliers for the purchase of paper, ink and other materials for delivery in future years at prevailing market prices. The company has operating lease commitments totaling $281 million extending through various periods to 2009. The lease commitments total $42 million for 1998, range from $26 million to $35 million in each of the years 1999-2002 and total $117 million for years 2003 and thereafter. The company is not exposed to significant accounts receivable credit risk, due to the diversity of industry classification, distribution channels and geographic location of its customers. On Nov. 25, 1996, a purported class action was brought against the company in federal district court in Chicago, Ill., on behalf of all current and former African-American employees, alleging that the company racially discriminated against them. The complaint seeks declaratory and injunctive relief, and asks for actual, compensatory, consequential and punitive damages in an amount not less than $500 million. Although plaintiffs seek nationwide class certification, most of the specific factual assertions of the complaint relate to the closing by the company of its Chicago catalog production operations in 1993. Other general claims relate to other company locations. The company has filed a motion for partial summary judgment as to all claims relating to its Chicago catalog operations on the grounds that those claims are untimely and plaintiffs have filed a motion for class certification. Both motions are pending. On Dec. 18, 1995, a purported class action was filed against the company in federal district court in Chicago alleging that older workers were discriminated against in selection for termination upon the closing of the Chicago catalog operations. The suit also alleges that the company violated the Employee Retirement Income Security Act (ERISA) in determining benefits payable to retiring or terminated employees. On Oct. 8, 1996, plaintiffs filed a motion to maintain the ERISA claims as a class action on behalf of all company retirement plan participants who were eligible for early retirement benefits at the time of their termination. On Aug. 14, 1997, the court denied plaintiff's motion and certified classes in both the age discrimination and ERISA claims limited to former employees of the Chicago catalog operations. Both pending cases relate at least in part to the circumstances surrounding the closure of the Chicago catalog operations. The company believes that it acted properly in the closing of the operations, has a number of valid defenses to all of the claims made and is vigorously defending its actions. However, management is unable to make a meaningful estimate of any loss that could result from an unfavorable outcome of either pending case. In addition, the company is a 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 condition of the company. The company also has future commitments totaling $54 million to invest in various affordable housing limited partnerships that provide cumulative annual tax benefits and credits in amounts greater than the investments. RETIREMENT BENEFIT PLAN The company's restated Retirement Benefit Plan (the Plan) is a non- contributory defined benefit plan. Substantially all U.S. employees age 21 or older are covered by the Plan. Normal retirement age is 65, but reduced early retirement benefits are paid to fully vested participants at or after age 55. As required, the company uses the projected unit credit actuarial cost method to determine pension cost for financial reporting purposes. In F-10 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) conjunction with this method, the company amortizes deferred gains and losses (using the corridor method) and prior service costs over the average remaining service life of its active employee population. In addition, a transition credit (the excess of Plan assets plus balance sheet accruals over the projected obligation as of Jan. 1, 1987) is amortized over 19 years. For tax and funding purposes, the entry age normal actuarial cost method is used. Net pension credits included in operating results for the Plan were:
1997 1996 1995 --------- --------- --------- THOUSANDS OF DOLLARS Service cost.................................. $ 31,886 $ 32,619 $ 23,393 Interest cost on the projected benefit obligation................................... 61,337 58,121 54,524 Actual return on Plan assets.................. (233,509) (169,301) (217,662) Amortization of excess Plan net assets at adoption of SFAS 87 and deferrals--net....... 119,546 63,332 120,698 --------- --------- --------- Net Pension Credit........................ $ (20,740) $ (15,229) $ (19,047) ========= ========= =========
The actuarial computations that derived the above amounts assumed a discount rate on projected benefit obligations of 7.0% (7.5% at Dec. 31, 1996, and 7.25% at Dec. 31, 1995), an expected long-term rate of return on Plan assets of 9.5% and annual salary increases averaging 4% for 1997, 1996 and 1995. Plan assets include primarily government and corporate debt securities and marketable equity securities, and, to a lesser extent, commingled funds and a group annuity contract purchased from a life insurance company. The funded status and prepaid pension cost (included in other noncurrent assets on the accompanying Consolidated Balance Sheets) are as follows:
DECEMBER 31 ---------------------- 1997 1996 ---------- ---------- THOUSANDS OF DOLLARS Fair value of Plan assets.............................. $1,421,849 $1,238,315 Actuarial present value of benefit obligations: Vested............................................... 853, 986 743,133 Non-vested........................................... 10,022 10,389 ---------- ---------- Total accumulated benefit obligations.................. 864,008 753,522 Additional amounts related to projected wage increases. 86,215 84,483 ---------- ---------- Projected benefit obligations for services rendered to date.................................................. 950,223 838,005 ---------- ---------- Excess of Plan assets over projected benefit obligations........................................... 471,626 400,310 Unrecognized net deferrals............................. (169,654) (109,228) Unrecognized net excess Plan assets to be amortized through the year 2005................................. (78,798) (88,648) ---------- ---------- Prepaid Pension Costs.................................. $ 223,174 $ 202,434 ========== ==========
In the event of Plan termination, the Plan provides that no funds can revert to the company and any excess assets over Plan liabilities must be used to fund retirement benefits. OTHER RETIREMENT BENEFITS In addition to pension benefits, the company provides certain healthcare and life insurance benefits for retired employees. Substantially all of the company's regular full-time U.S. employees become eligible for these benefits upon reaching age 55 while working for the company and having 10 years continuous service at F-11 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) retirement. The company funds a portion of the liabilities associated with these plans through a tax-exempt trust. The assets of the trust are invested primarily in life insurance covering some of the company's employees. The net (credit) expense for postretirement benefits during 1997, 1996 and 1995 included the following components:
1997 1996 1995 -------- -------- -------- THOUSANDS OF DOLLARS Service cost..................................... $ 8,585 $ 8,626 $ 9,492 Interest cost on the projected benefit obligations..................................... 16,010 14,712 17,319 Actual return on assets.......................... (43,094) (28,676) (34,626) Deferrals--net................................... 18,326 1,247 16,503 -------- -------- -------- Net Post-retirement (Credit) Cost................ $ (173) $ (4,091) $ 8,688 ======== ======== ========
The liability (included in Other Noncurrent Liabilities on the accompanying Consolidated Balance Sheets) for post-retirement benefits, net of the partial funding, is as follows:
DECEMBER 31 ------------------ 1997 1996 -------- -------- THOUSANDS OF DOLLARS Actuarial present value of benefit obligations: Retirees................ $141,807 $139,341 Fully eligible active Plan participants...... 45,019 38,819 Other active Plan participants........... 46,611 42,810 -------- -------- Total Accumulated Benefit Obligations.............. 233,437 220,970 Fair value of Plan assets. (262,813) (219,719) Unrecognized net deferrals................ 68,588 52,155 -------- -------- Excess of Accumulated Benefit Obligations Over Plan Assets.............. $ 39,212 $ 53,406 ======== ========
The actuarial computations to determine the accumulated post-retirement benefit obligation assumed a discount rate of 7.0% (7.5% at Dec. 31, 1996), an expected long-term rate of return on plan assets of 9.0% and a health-care cost trend rate of 7.8% initially, declining gradually to 5.0% in 2008 and thereafter. The medical cost trend assumed can have a significant effect on the amounts reported. A one percentage point increase in the assumed healthcare cost trend rate would increase the 1997 post-retirement benefit expense (service cost and interest cost) by $0.5 million and the accumulated post-retirement benefit obligation as of Dec. 31, 1997, by $6.1 million. INCOME TAXES Cash payments for income taxes were $60 million, $76 million and $98 million in 1997, 1996 and 1995, respectively. The components of income tax expense for the years ending Dec. 31, 1997, 1996 and 1995, were as follows:
1997 1996 1995 ------- ------- -------- THOUSANDS OF DOLLARS Federal Current............................................. $66,609 $84,340 $ 85,225 Deferred............................................ 14,725 (6,664) 16,480 State................................................. 15,906 6,116 21,383 ------- ------- -------- Total............................................. $97,240 $83,792 $123,088 ======= ======= ========
F-12 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The significant deferred tax assets and liabilities were as follows:
DECEMBER 31 ----------------- 1997 1996 -------- -------- THOUSANDS OF DOLLARS Deferred tax liabilities: Accelerated depreciation................................... $160,779 $207,001 Investments................................................ 61,303 55,471 Pensions................................................... 84,710 86,606 Other...................................................... 42,290 39,451 -------- -------- Total deferred tax liabilities........................... 349,082 388,529 -------- -------- Deferred tax assets: Post-retirement benefits................................... 15,685 21,362 Accrued liabilities........................................ 78,832 120,773 Investments................................................ 49,036 81 Other...................................................... 49,679 47,529 -------- -------- Total deferred tax assets................................ 193,232 189,745 -------- -------- Valuation allowance.......................................... 15,980 17,112 -------- -------- Net Deferred Tax Liabilities................................. $171,830 $215,896 ======== ========
The Internal Revenue Service (IRS) has disallowed the interest deductions claimed by other corporate taxpayers that have corporate-owned life insurance (COLI) programs similar to the company's. Although the IRS has not taken an official position regarding the COLI program of the company, it is expected that it will disallow the company's past interest deduction. However, the company would challenge such a position and would expect to resolve the issue in a manner that does not materially impact its financial position and results of operations. The following table outlines the reconciling of differences between the U.S. statutory tax rates and the rates used by the company in the determination of income from continuing operations:
1997 1996 1995 ---- ------ ---- Federal statutory rate..................................... 35.0% 35.0% 35.0% Restructuring and impairment charges....................... -- 696.4 -- Foreign tax rates.......................................... (1.6) 4.0 (1.2) State and local income taxes, net of U.S. federal income tax benefit............................................... 3.4 127.1 3.7 Goodwill amortization...................................... 0.2 19.1 1.3 Benefits resulting from corporate-owned life insurance programs.................................................. (4.4) (67.4) (5.7) Affordable housing investment credits...................... (6.5) (157.9) (4.3) Change in valuation allowance.............................. 1.8 10.4 0.8 Other...................................................... 4.1 14.0 1.2 ---- ------ ---- Total.................................................. 32.0% 680.7% 30.8% ==== ====== ====
F-13 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DEBT FINANCING AND INTEREST EXPENSE The company's debt consisted of the following:
DECEMBER 31 --------------------- 1997 1996 ---------- ---------- THOUSANDS OF DOLLARS Commercial paper......................................... $ 258,020 $ 404,500 Medium-term notes due 1998-2005 at a weighted average interest rate of 6.86%.................................. 409,000 500,000 9.125% debentures due Dec. 1, 2000....................... 199,790 199,718 8.875% debentures due April 15, 2021..................... 149,692 149,678 7.0% notes due Jan. 1, 2003.............................. 109,804 109,764 Other.................................................... 71,920 100,307 ---------- ---------- Total................................................ $1,198,226 $1,463,967 ========== ==========
Based upon the interest rates currently available to the company for borrowings with similar terms and maturities, the fair value of the company's debt exceeds its book value at Dec. 31, 1997, by approximately $68 million. The company's notes and debentures are not actively traded and contain no call provisions. At Dec. 31, 1997, the company had an available credit facility of $550 million with a group of domestic and foreign banks that expires Dec. 21, 1999. The credit arrangement provides support for the issuance of commercial paper and other credit needs. Borrowings under the facility (none during the past two years) bear interest at various rates not exceeding the banks' prime rates. The company pays an annual fee of 0.08% on the total unused credit facility. At Dec. 31, 1997, the company had $345 million of commercial paper and short-term debt outstanding, of which $300 million is classified as long-term since the company has the ability and intent to maintain such debt on a long- term basis. The weighted average interest rate on all commercial paper debt outstanding during 1997 was 5.48% (5.63% at Dec. 31, 1997). Annual maturities of long-term debt (excluding commercial paper and short-term debt) are as follows: 1999--$111 million, 2000--$246 million, 2001--$3 million, 2002--$68 million and thereafter $425 million. The following table summarizes interest expense included in the Consolidated Statements of Income:
1997 1996 1995 -------- -------- -------- THOUSANDS OF DOLLARS Interest incurred................................ $100,724 $107,198 $120,658 Amount capitalized as property, plant and equipment....................................... (9,959) (11,716) (10,899) -------- -------- -------- Total........................................ $ 90,765 $ 95,482 $109,759 ======== ======== ========
Interest paid, net of capitalized interest, was $90 million, $93 million and $102 million in 1997, 1996 and 1995, respectively. F-14 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) EARNINGS PER SHARE In accordance with SFAS 128, Earnings per Share, the company has computed basic and diluted earnings per share (EPS), using the treasury stock method:
1997 1996 1995 -------- --------- -------- IN THOUSANDS (EXCEPT PER SHARE DATA) Average shares outstanding....................... 145,929 151,830 153,483 Effect of dilutive securities--options........... 1,579 1,811 2,452 -------- --------- -------- Average shares outstanding, adjusted for dilutive effects......................................... 147,508 153,641 155,935 ======== ========= ======== Income (loss) from continuing operations......... $206,525 $ (71,483) $275,952 Basic EPS...................................... 1.42 (0.47) 1.80 Diluted EPS.................................... 1.40 (0.47) 1.77 (Loss) income from discontinued operations....... $(15,894) $ (86,142) $ 22,841 Loss on disposal of discontinued operations...... (60,000) -- -- Basic EPS...................................... (0.52) (0.57) 0.15 Diluted EPS.................................... (0.51) (0.57) 0.15 Net income (loss)................................ $130,631 $(157,625) $298,793 Basic EPS...................................... 0.90 (1.04) 1.95 Diluted EPS.................................... 0.89 (1.04) 1.92
STOCK AND INCENTIVE PROGRAMS FOR EMPLOYEES Restricted Stock Awards--At Dec. 31, 1997 and 1996, the company had outstanding 542,000 and 301,000, respectively, restricted shares of its common stock granted to certain officers. These shares are registered in the names of the recipients, but are subject to conditions of forfeiture and restrictions on sale or transfer for one to seven years from the grant date. Dividends on the restricted shares are paid currently to the recipients and, accordingly, the restricted shares are treated as outstanding shares. The expense of the grant is recognized evenly over the vesting period. The value of the restricted stock awards was $20 million and $9 million, based upon the closing price of the company's stock at each year end ($37.25 and $31.38 at Dec. 31, 1997 and 1996, respectively). During 1997, a total of 328,000 shares of restricted stock were issued with a grant date fair value of $10 million. Charges to expense for this stock plan were $5 million, $2 million and $1 million in 1997, 1996 and 1995, respectively. Stock Purchase Plan--The company has a stock purchase plan for selected managers and key staff employees. Under the plan, the company is required to contribute an amount equal to 70% of participants' contributions, of which 50% is applied to the purchase of stock and 20% is paid in cash. In 1996 and 1997, the company failed to meet performance targets required under the plan, and no contributions were incurred. Amounts charged to expense for this plan were $6 million in 1995. Incentive Compensation Plans--The company has incentive compensation plans covering selected officers. Amounts charged to expense for supplementary compensation ($2 million in 1997, $4 million in 1996 and $4 million in 1995) are determined from the level of achievement of performance measures related to earnings, margins and returns applied to the participants' base salaries. Similar incentive and gainsharing compensation plans exist for other officers, managers, supervisors and production employees. Stock Options--The company has incentive stock option plans for its employees. Under these plans, the options vest from three to nine and one-half years after date of grant and may be exercised, once vested, up to F-15 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 10 years from the date of grant. Under authorized Stock Incentive Plans, a maximum of 4.1 million shares were available for future grants of stock options and restricted stock awards as of Dec. 31, 1997. The company accounts for employee stock options under APB Opinion No. 25, Accounting for Stock Issued to Employees, under which no compensation cost has been recognized. Had compensation cost been determined consistent with SFAS 123, Accounting for Stock-Based Compensation, the company's net income from continuing operations and respective earnings per share would have been reduced to the following pro forma amounts:
1997 1996 1995 -------- -------- -------- Income (loss) from continuing operations (thousands): As reported..................................... $206,525 $(71,483) $275,952 Pro forma....................................... 191,331 (85,191) 267,614 Basic earnings (loss) per share: As reported..................................... $ 1.42 $ (0.47) $ 1.80 Pro forma....................................... 1.31 (0.56) 1.74 Diluted earnings (loss) per share: As reported..................................... $ 1.40 $ (0.47) $ 1.77 Pro forma....................................... 1.30 (0.56) 1.72
Because the SFAS 123 method of accounting has not been applied to options granted prior to Jan. 1, 1995, the pro forma compensation cost may not be representative of the pro forma cost to be expected in future years. A summary of the status of the company's stock option plans at Dec. 31, 1997, 1996 and 1995, and changes during the years then ended, is presented in the following table and narrative:
1997 1996 1995 -------------------- -------------------- -------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE (THOUSANDS) PRICE (THOUSANDS) PRICE (THOUSANDS) PRICE ----------- -------- ----------- -------- ----------- -------- Options outstanding at beginning of year...... 14,916 $31.68 14,246 $30.98 11,057 $25.79 Options granted......... 1,485 40.28 3,320 34.09 4,979 39.58 Options exercised....... (1,535) 25.25 (1,245) 21.41 (1,238) 19.88 Options forfeited....... (908) 35.60 (1,405) 39.39 (552) 29.57 ------ ------ ------ ------ ------ ------ Options outstanding at end of year............ 13,958 $33.05 14,916 $31.68 14,246 $30.98 ====== ====== ====== ====== ====== ====== Options exercisable at end of year............ 6,397 $28.57 6,618 $27.18 4,832 $23.52 ====== ====== ====== ====== ====== ====== Weighted average fair value of options granted with: Exercise price equal to stock price on grant date........... $11.20 $11.64 $13.42 Exercise price exceeding stock price on grant date........ $ 8.10 $ 7.74 $ 5.81
Of the options outstanding at Dec. 31, 1997, 12.4 million had exercise prices between $17.72 and $38.06, with a weighted average exercise price of $31.03 and a weighted average remaining contractual life of 6.8 years; 6.4 million of these options were exercisable at a weighted average exercise price of $28.57. The remaining 1.6 million options had exercise prices between $39.00 and $76.96, with a weighted average exercise price of $48.70 and a weighted average remaining contractual life of 8.5 years; none of these options were exercisable at Dec. 31, 1997. F-16 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED) The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model, using the following assumptions for grants in 1997, 1996 and 1995, respectively: risk-free interest rates of 6.32%, 6.39% and 6.58%; expected dividend yields of 2.24%, 2.16% and 1.89%; and expected volatility of 25.10%, 22.92% and 21.18%. A 10-year estimated life was used for all grants. Other Information--Under the stock programs, authorized unissued shares or treasury shares may be used. If authorized unissued shares are used, not more than 11.3 million shares may be issued in the aggregate. The company intends to reacquire shares of its common stock to meet the stock requirements of these programs in the future. PREFERRED STOCK The company has 2 million shares of $1.00 par value preferred stock authorized for issuance. The board of directors may divide the preferred stock into one or more series and fix the redemption, dividend, voting, conversion, sinking fund, liquidation and other rights. The company has no present plans to issue any preferred stock. One million of the shares are reserved for issuance under the Shareholder Rights Plan discussed below. SHAREHOLDER RIGHTS PLAN The company maintains a Shareholder Rights Plan (the Plan) designed to deter coercive or unfair takeover tactics, to prevent a person or group from gaining control of the company without offering fair value to all shareholders and to deter other abusive takeover tactics that are not in the best interest of shareholders. Under the terms of the Plan, each share of common stock is accompanied by one right; each right entitles the shareholder to purchase from the company one one-thousandth of a newly issued share of Series A Junior Preferred Stock at an exercise price of $140. The rights become exercisable 10 days after a public announcement that an acquiring person (as defined in the Plan) has acquired 15% or more of the outstanding common stock of the company (the Stock Acquisition Date), 10 business days after the commencement of a tender offer that would result in a person owning 15% or more of such shares or 10 business days after an adverse person (as defined in the Plan) has acquired 10% or more of such shares and such ownership interest is likely to have a material adverse impact on the company. The company can redeem the rights for $0.01 per right at any time until 10 days following the Stock Acquisition Date (under certain circumstances, the 10-day period can be shortened or lengthened by the company). The rights will expire on Aug. 8, 2006, unless redeemed earlier by the company. If, subsequent to the rights becoming exercisable, the company is acquired in a merger or other business combination at any time when there is a 15% or more holder, the rights will then entitle a holder (other than a 15% or more shareholder or an adverse person) to buy shares of the acquiring company with a market value equal to twice the exercise price of each right. Alternatively, if a 15% holder acquires the company by means of a merger in which the company and its stock survives, if any person acquires 15% or more of the company's common stock or if an adverse person acquires 10% or more of the company's common stock and such ownership is likely to have a material adverse impact on the company, each right not owned by a 15% or more shareholder or an adverse person would become exercisable for common stock of the company (or, in certain circumstances, other consideration) having a market value equal to twice the exercise price of the right. F-17 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders of R. R. Donnelley & Sons Company: We have audited the accompanying consolidated balance sheets of R. R. Donnelley & Sons Company (a Delaware corporation) and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years 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 audit 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 financial statements referred to above present fairly, in all material respects, the financial position of R. R. Donnelley & Sons Company and Subsidiaries as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years ended December 31, 1997, in conformity with generally accepted accounting principles. As explained in the Notes to Consolidated Financial Statements, effective January 1, 1995, the company changed its method of accounting for LIFO inventories. Arthur Andersen LLP Chicago, Illinois January 22, 1998 F-18 UNAUDITED INTERIM FINANCIAL INFORMATION THOUSANDS OF DOLLARS EXCEPT PER SHARE DATA
YEAR ENDED DECEMBER 31 ---------------------------------------------------------- FIRST SECOND THIRD FOURTH FULL QUARTER QUARTER QUARTER QUARTER YEAR ---------- ---------- ---------- ---------- ---------- 1997 Net sales............... $1,102,647 $1,136,775 $1,208,618 $1,401,993 $4,850,033 Gross profit............ 193,103 208,837 260,529 288,136 950,605 Income from continuing operations............. 35,078 44,958 81,305 45,184 206,525 Loss from disposal of discontinued operations............. -- -- -- (60,000) (60,000) Loss (income) from discontinued operations............. (5,737) (7,282) (9,148) 6,273 (15,894) Net income (loss)....... 29,341 37,676 72,157 (8,543) 130,631 Per common share: Income from continuing operations........... 0.24 0.31 0.56 0.31 1.42 Net income (loss)..... 0.20 0.26 0.49 (0.06) 0.90 1996 Net sales............... $1,177,622 $1,202,153 $1,248,702 $1,404,708 $5,033,185 Gross profit............ 202,144 246,333 250,746 271,703 970,926 (Loss) income from continuing operations.. (326,323) 73,368 75,893 105,579 (71,483) (Loss) from discontinued operations............. (50,596) (19,093) (8,025) (8,428) (86,142) Net (loss) income....... (376,919) 54,275 67,868 97,151 (157,625) Per common share: (Loss) income from continuing operations........... (2.12) 0.48 0.50 0.72 (0.47) Net (loss) income..... (2.45) 0.35 0.45 0.66 (1.04)
F-19 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Shareholders of R. R. Donnelley & Sons Company: We have audited, in accordance with generally accepted auditing standards, the financial statements included in the Company's Annual Report to Shareholders included in this Form 10-K, and have issued our report thereon dated January 22, 1998. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index to the financial statements and financial statement schedules is the responsibility of the Company's management and 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 audit 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 January 22, 1998 F-20 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS Transactions affecting the allowances for doubtful accounts during the years ended December 31, 1997, 1996 and 1995 were as follows:
1997 1996 1995 ------- ------- -------- THOUSANDS OF DOLLARS Allowance for trade receivable losses: Balance, beginning of year.................. $14,205 $18,059 $ 17,285 Balance, companies (sold) acquired during year....................................... -- (4,834) 1,055 Provisions charged to income................ 10,676 9,877 16,819 ------- ------- -------- 24,881 23,102 35,159 Uncollectible accounts written off, net of recoveries................................. (8,622) (8,897) (17,100) ------- ------- -------- Balance, end of year........................ $16,259 $14,205 $ 18,059 ======= ======= ========
F-21 INDEX TO EXHIBITS* DESCRIPTION EXHIBIT NO. ------- -------- Agreement between R.R. Donnelley & Sons Company and Bain Capi- 2 tal, Inc...................................................... Restated Certificate of Incorporation(1)....................... 3(i) By-Laws(2)..................................................... 3(ii) Form of Rights Agreement, dated as of April 25, 1996 between R. R. Donnelley & Sons Company and First Chicago Trust Com- pany of New York(3)........................................... 4(a) Instruments Defining the Rights of Security Holders(4)......... 4(b) Indenture dated as of November 1, 1990 between the Company and Citibank, N.A. as Trustee(5).................................. 4(c) Credit Agreement dated December 21, 1994 among R. R. Donnelley & Sons Company, the Banks named therein and Citibank, N.A., as Administrative Agent(6).................................... 4(d) Retirement Policy for Directors(7)**........................... 10(a) Directors' Deferred Compensation Agreement(8)**................ 10(b) Donnelley Shares Stock Option Plan, as amended(7).............. 10(c) 1993 Stock Ownership Plan for Non-Employee Directors, as 10(d) amended(9)**................................................... Senior Management Annual Incentive Plan, as amended(5)**....... 10(e) Form of Severance Agreement for Senior Officers, as amend- 10(f) ed(8)**....................................................... 1993 Stock Purchase Plan for Selected Managers and Key Staff Employees, as amended(9)**.................................... 10(g) 1986 Stock Incentive Plan, as amended(9)**..................... 10(h) 1991 Stock Incentive Plan, as amended(9)**..................... 10(i) 1995 Stock Incentive Plan, as amended(10)**.................... 10(j) Forms of option agreement with certain executive officers and directors, as amended(11)**................................... 10(k) Unfunded Supplemental Benefit Plan(5)**........................ 10(l) Amendment to Unfunded Supplemental Benefit Plan adopted on 10(m) April 25, 1991(12)**.......................................... Employment Agreement between R. R. Donnelley & Sons Company and William L. Davis(13)**.................................... 10(n) Premium-Priced Option Agreement between R. R. Donnelley & Sons Company and William L. Davis(13)**............................ 10(o) Employment Agreement between R. R. Donnelley & Sons Company and Cheryl A. Francis(7)**.................................... 10(p) Agreement between R. R. Donnelley & Sons Company and Steven J. 10(q) Baumgartner**................................................. Agreement between R. R. Donnelley & Sons Company and W. Ed Ty- 10(r) ler**......................................................... Subsidiaries of R. R. Donnelley & Sons Company................. 21 Consent of Independent Public Accountants dated March 4, 1998.. 23 Financial Data Schedule........................................ 27 - -------- *Filed with the Securities and Exchange Commission. Each such exhibit may be obtained by a shareholder of the Company upon payment of $5.00 per exhibit. **Management contract or compensatory plan or arrangement. (1) Filed as Exhibit to Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1996, filed on May 3, 1996, and incorporated herein by reference. E-1 (2) Filed as Exhibit to Current Report on Form 8-K filed on December 15, 1997, and incorporated herein by reference. (3) Filed as Exhibit to Form 8-A filed on June 5, 1996, and incorporated herein by reference. (4) Instruments, other than that described in 4(c) and 4(d), defining the rights of holders of long-term debt not registered under the Securities Exchange Act of 1934 of the registrant and of all subsidiaries for which consolidated or unconsolidated financial statements are required to be filed are being omitted pursuant to paragraph (4)(iii)(A) of Item 601 of Regulation S-K. Registrant agrees to furnish a copy of any such instrument to the Commission upon request. (5) Filed as Exhibit with Form SE filed on March 26, 1992, and incorporated herein by reference. (6) Filed as Exhibit to Annual Report on Form 10-K for the year ended December 31, 1994, filed on March 27, 1995, and incorporated herein by reference. (7) Filed as Exhibit to Annual Report on Form 10-K for the year ended December 31, 1996, filed on March 10, 1997, and incorporated herein by reference. (8) Filed as Exhibit to Annual Report on Form 10-K for the year ended December 31, 1993, filed on March 28, 1994. (9) Filed as Exhibit to Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996, filed on November 1, 1996, and incorporated herein by reference. (10) Filed as Exhibit to Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997, filed on August 5, 1997, and incorporated herein by reference. (11) Filed as Exhibit to Form S-3 filed on January 15, 1998, and incorporated herein by reference. (12) Filed as Exhibit with Form SE filed on May 9, 1991 and incorporated herein by reference. (13) Filed as Exhibit to Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997, filed on May 7, 1997, and incorporated herein by reference. E-2 EX-2 2 12/15/97 AGREEMENT BETWEEN RRD & BAIN CAPITAL Exhibit 2 AGREEMENT --------- AGREEMENT dated as of December 15, 1997 between R.R. Donnelley & Sons Company ("RRD") and Bain Capital, Inc. ("Bain"). WHEREAS, RRD and affiliates of Bain are principal stockholders of Stream International Holdings, Inc., a Delaware corporation ("Stream"); and WHEREAS, RRD, in its capacity as a significant stockholder and lender, and Bain, on behalf of its affiliates in their capacity as significant stockholders, desire to take steps to reorganize Stream and its subsidiaries and thus maximize potential values for all stockholders of Stream. NOW, THEREFORE, for valuable consideration, receipt of which is acknowledged, RRD and Bain agree as follows: 1. Certain Definitions. "CST" shall mean Corporate Software and Technology, Inc., a Delaware corporation and wholly-owned subsidiary of CST Holdings. "CST Assets" shall have the meaning set forth in the CST Contribution Agreement. "CST Assumed Liabilities" shall have the meaning set forth in the CST Contribution Agreement. "CST Compensation Agreement" shall have the meaning set forth in the CST Contribution Agreement. "CST Contribution Agreement" shall mean the Contribution Agreement among Stream, SII, CST and CST Holdings in the form appended hereto as Exhibit A. "CST Holdings" shall mean Corporate Software & Technology Holdings, Inc., a Delaware corporation. "CST Letter Agreement" shall mean the Letter Agreement referred to in the CST Contribution Agreement. "CST Per Share Value" shall mean the amount determined by subtracting from $150 million all Third Party Debt directly attributable to CST as of September 30, 1997 and 33.3333% of the Net RRD Debt as of September 30, 1997 and then dividing such remainder by the sum of (i) the Number of Stream Outstanding Shares as of the Effective Date, and (ii) the number of shares of non-voting Common Stock of CST Holdings to be issued to Bain pursuant to Section 4.1 of this Agreement. "Effective Date" shall mean the effective date of the MMI Drop-Down and CST Drop-Down (as defined in Subsection 3.1 and 4.1, respectively). "MMI" shall mean Modus Media International, Inc., a Delaware corporation and a wholly-owned subsidiary of MMI Holdings. "MMI Assets" shall have the meaning set forth in the MMI Contribution Agreement. "MMI Assumed Liabilities" shall have the meaning set forth in the MMI Contribution Agreement. "MMI Compensation Agreement" shall have the meaning set forth in the MMI Contribution Agreement. "MMI Contribution Agreement" shall mean the Contribution Agreement among Stream, MMI and MMI Holdings in the form appended hereto as Exhibit B. "MMI Equity Value" shall mean the amount determined by subtracting from $99 million all Third Party Debt directly attributable to MMI as of September 30, 1997 and 22.2222% of the Net RRD Debt as of September 30, 1997. "MMI Holdings" shall mean Modus Media International Holdings, Inc., a Delaware corporation. "MMI Letter Agreement" shall mean the Letter Agreement referred to in the MMI Contribution Agreement. "MMI Per Share Value" shall mean the amount determined by subtracting from $100 million all Third Party Debt directly attributable to MMI as of September 30, 1997, and 22.2222% of the Net RRD Debt as of September 30, 1997, and then dividing such remainder by the sum of (i) the Number of Stream Outstanding Shares as of the Effective Date and (ii) the number of shares of non-voting Common Stock of MMI Holdings to be issued to Bain pursuant to Section 3.1 of this Agreement. "MMI Holdings Preferred Stock" shall mean the 9.50% Series Senior Cumulative Preferred Stock of MMI Holdings established upon effectiveness of the Certificate of Designation referred to in Section 3.8. 2 "Net RRD Debt" shall mean all indebtedness of Stream and its subsidiaries to RRD and its subsidiaries, net of any indebtedness from RRD and its subsidiaries to Stream and its subsidiaries. In determining Net RRD Debt, intercompany amounts currently in dispute as detailed in the RRD mark-up of the memorandum dated August 8, 1997 from Mark Nunnelly to Steve Baumgartner and Dan Malina (totalling $25.9 million) shall be split 50/50 so that only half of all such amounts shall be included in the calculation of Net RRD Debt. No adjustments to the intercompany account will be made in respect of items arising prior to December 31, 1996 other than those items already reflected in the December 31, 1996 audit of the intercompany account, and any other adjustments shall be made to accurately reflect intercompany transactions arising in the ordinary operations of the businesses of OTS, CST and MMI after December 31, 1996. The total Net RRD Debt as of September 30, 1997 is $182,905,104, of which $81,291,259 is attributable to OTS, $40,645,538 to MMI Holdings and $60,968,307 to CST Holdings. Such determination of the amount of Net RRD Debt as of September 30, 1997 shall be final and binding on RRD, Stream, MMI Holdings, MMI, CST Holdings and CST. "Net RRD Ownership Percentage" shall mean a fraction, the numerator of which shall be the number of shares of Class A Common Stock of Stream owned by RRD and its affiliates (excluding any shares of Class A-1 Common Stock) and the denominator of which shall be the Number of Stream Outstanding Shares. "Number of Stream Outstanding Shares" shall mean the total number of outstanding shares of Class A Common Stock of Stream (excluding any shares of Class A-1 Common Stock), giving effect to the assumed mandatory conversion of all outstanding shares of Class B-V and Class B-N Common Stock of Stream into shares of Class A Common Stock at the conversion rate set forth in the Certificate of Incorporation of Stream and also giving effect to the assumed exercise of all outstanding options to purchase shares of Class B-V Common Stock of Stream. "OTS" shall mean Stream, as its business shall exist after the MMI Spin-Off and CST Spin-Off. "OTS Per Share Value" shall mean the amount determined by subtracting from $200 million all Third Party Debt (if any) directly attributable to OTS as of September 30, 1997 and 44.4445% of the Net RRD Debt as of September 30, 1997 and then dividing the remainder by the Number of Stream Outstanding Shares as of the Effective Date. "Portland Assets" shall mean those assets set forth on Exhibit C appended hereto. 3 "Reorganization" shall mean the transactions and events referred to in Sections 3, 4, 5 (other than Subsection 5.4), 6, 7, 11 and 12 of this Agreement. "SII" shall mean Stream International, Inc., a Delaware corporation and wholly-owned indirect subsidiary of Stream (the name of which shall be changed to Stream International Services Corp.). "Spin-Off Date" shall mean the date on which Stream effects the MMI Spin- Off (as defined in Section 3.3) and CST Spin-Off (as defined in Section 4.3). "Stream IPO" shall mean the initial underwritten public offering of Common Stock of Stream. "Third Party Debt" shall mean all outstanding indebtedness for borrowed money (including obligations under capital leases) of Stream and its subsidiaries, other than indebtedness to RRD and its affiliates. The amounts of Third Party Debt directly attributable to OTS, MMI Holdings and CST Holdings as of September 30, 1997 shall be as set forth on Schedule G to the MMI Letter Agreement, Schedule C to the MMI Letter Agreement and Schedule C to the CST Letter Agreement, respectively, and such determination of the amount of Third Party Debt as of September 30, 1997 shall be final and binding on RRD, Stream, MMI Holdings, MMI, CST Holdings and CST. 2. Reorganization. RRD and Bain shall each use reasonable efforts to cause Stream to effect the Reorganization and other transactions set forth herein. It is understood that Stream, MMI Holdings, MMI, CST Holdings and CST are not parties to this Agreement. Accordingly, any transactions comprising part of the Reorganization or otherwise set forth herein that require approval by the Board of Directors of Stream shall be subject to approval by the Board of Directors of Stream and, notwithstanding anything to the contrary in this Agreement, Stream shall have no obligation to effect any such transaction unless and until such approval of its Board of Directors is obtained. 3. MMI. 3.1 MMI Contribution Agreement; MMI Drop-Down. Prior to the earlier of (1) the consummation of the Stream IPO and (2) December 31, 1997, Stream, MMI Holdings and MMI shall enter into the MMI Contribution Agreement pursuant to which Stream shall transfer all of the MMI Assets and MMI Assumed Liabilities to MMI Holdings, and MMI Holdings shall issue voting common stock and preferred stock to Stream in a taxable transaction. Stream shall transfer to MMI Holdings: (i) all then outstanding Third-Party Debt directly attributable to the MMI business, and (ii) 40% of the increase in the Net RRD Debt from October 1, 1997 through the Effective Date, and MMI Holdings shall transfer to MMI the MMI Assets and the MMI Assumed 4 Liabilities (collectively, the "MMI Drop-Down"). Immediately prior to, or simultaneously with, the MMI Drop-Down, MMI Holdings shall issue to Bain, which is not, directly or indirectly a stockholder of Stream, pursuant to the MMI Compensation Agreement, a number of shares of non-voting Common Stock of MMI Holdings equal to $1 million divided by the amount determined by (i) subtracting from $99 million all Third Party Debt directly attributable to MMI as of September 30, 1997 and 22.2222% of the Net RRD Debt as of September 30, 1997 and (ii) dividing such remainder by the Number of Stream Outstanding Shares at such time. 3.2 Exchange of Net RRD Debt. Immediately following the MMI Drop-Down, RRD shall surrender to Stream 22.2222% of the Net RRD Debt as of September 30, 1997 for cancellation in exchange for a number of shares of MMI Holdings Preferred Stock determined by dividing 22.2222% of such Net RRD Debt by $1,000. 3.3 MMI Spin-Off. Prior to the earlier of (i) the consummation of the Stream IPO and (2) January 10, 1998, Stream shall distribute all of the shares of MMI Holdings Common Stock held by it to the stockholders of Stream in a taxable transaction (the "MMI Spin-Off"). Such shares shall be distributed on a pro rata basis to holders of Class A Common Stock and Class B-V and Class B-N Common Stock (collectively, "Class B Common Stock") of Stream, giving effect to the assumed mandatory conversion of all Class B Common Stock into Class A Common Stock at the conversion rate set forth in the Certificate of Incorporation of Stream. No such distribution shall be made with respect to shares of Class A-1 Common Stock of Stream. 3.4 Exchange of RRD Equity in MMI Holdings. Immediately after the MMI Spin-Off, RRD shall exchange all of the shares of Common Stock of MMI Holdings held by it and its affiliates for a number of shares of MMI Holdings Preferred Stock determined by multiplying the MMI Equity Value by the Net RRD Ownership Percentage at such time, and then dividing such product by $1,000. 3.5 Indemnification. Upon the Effective Date, all indemnification obligations of RRD set forth in the Contribution Agreement dated April 21, 1995 among RRD, Software Holdings, Inc. and others shall terminate. 3.6 Letter Agreement. Upon the Effective Date, MMI Holdings, CST Holdings and certain stockholders affiliated with Bain shall enter into a letter agreement in the form appended hereto as Exhibit Y. 3.7 Bain Management Agreement. Upon the Effective Date, MMI Holdings and an affiliate of Bain shall enter into a Management Agreement in the form appended hereto as Exhibit D. 5 3.8 Amendment to MMI Holdings Charter. Upon the Effective Date, the Certificate of Incorporation of MMI Holdings shall be amended and restated as set forth in Exhibit F-1 appended hereto, and the Certificate of Designation as set forth in Exhibit F-2 appended hereto shall have become effective. 3.9 RRD Investor Rights Agreements. Upon the Effective Date, MMI Holdings and RRD shall enter into an Investor Rights Agreement concerning information rights and quarterly reviews, in the form appended hereto as Exhibit E. 3.10 Transition Services Agreement. RRD shall use its reasonable best efforts to negotiate a transition services agreement between RRD and MMI to be executed and delivered on or prior to the Spin-Off Date. 4. CST. 4.1 CST Drop-Down. Prior to the earlier of (1) the consummation of the Stream IPO and (2) December 31, 1997 and concurrently with the MMI Drop-Down, Stream, SII, CST Holdings and CST shall enter into the CST Contribution Agreement pursuant to which SII shall transfer all of the CST Assets and CST Assumed Liabilities to CST Holdings, and CST Holdings will issue voting common stock to SII in a taxable transaction. Stream shall transfer to CST Holdings (as a deemed transfer to SII and then by SII to CST Holdings) (i) all then outstanding Third-Party Debt directly attributable to the CST business, and (ii) 60% of any increase in the Net RRD Debt from October 1, 1997 through the Effective Date, and CST Holdings shall transfer to CST the CST Assets and the CST Liabilities (collectively, the "CST Drop-Down"). Immediately prior to, or simultaneously with, the CST Drop-Down, CST Holdings shall issue to Bain, pursuant to the CST Compensation Agreement, a number of shares of non-voting Common Stock of CST Holdings equal to $1,000,000 divided by the amount determined by (i) subtracting from $149 million all Third Party Debt directly attributable to CST as of September 30, 1997 and 33.3333% of the Net RRD Debt as of September 30, 1997 and (ii) dividing such remainder by the Number of Stream Outstanding Shares at such time. SII shall then transfer to Stream all of the shares of CST Holdings Common Stock held by it. 4.2 Exchange of Net RRD Debt. Immediately following the CST Drop-Down, RRD shall surrender to Stream 33.3333% of the Net RRD Debt as of September 30, 1997 for cancellation in exchange for a number of shares of CST Holdings Common Stock equal to 33.3333% of the Net RRD Debt divided by the CST Per Share Value. 4.3 CST Spin-Off. Prior to the earlier of (1) the consummation of the Stream IPO and (2) January 10, 1998 and concurrently with the MMI Spin-Off, 6 Stream shall distribute all of its shares of CST Holdings Common Stock to the stockholders of Stream in a taxable transaction (such distribution by Stream, the "CST Spin-Off"). Such shares shall be distributed on a pro-rata basis to the holders of Class A Common Stock and Class B Common Stock, giving effect to the assumed mandatory conversion of all Class B Common Stock into Class A Common Stock at the conversion rate set forth in the Certificate of Incorporation of Stream. No such distribution shall be made with respect to shares of Class A-1 Common Stock of Stream. 4.4 Bain Management Agreement. Upon the Effective Date, CST Holdings and an affiliate of Bain shall enter into a Management Agreement in the form appended hereto as Exhibit G. 4.5 Amendment to CST Holdings Charter. Upon the Effective Date, the Certificate of Incorporation of CST Holdings shall be amended and restated, as set forth in Exhibit H appended hereto. 4.6 Irrevocable Stockholders' Voting Agreement and Proxy. Upon the Effective Date, RRD and certain stockholders shall enter into an Irrevocable Stockholders' Voting Agreement and Proxy, in the form appended hereto as Exhibit I. 4.7 RRD Investor Rights Agreement. Upon the Effective Date, CST Holdings and RRD shall enter into an Investor Rights Agreement, in the form appended hereto as Exhibit J, which shall provide for preemptive rights to RRD with respect to the issuance of any securities by CST Holdings and certain rights to information and quarterly management reviews. 4.8 CST Indemnity to RRD. Upon the Effective Date, CST shall enter into a Reimbursement Agreement with RRD in the form appended hereto as Exhibit K. 4.9 Sharing of Proceeds Upon Sale of CST. After the Effective Date, CST Holdings shall enter into an agreement with members of management of CST providing for the payment of an amount equal to 1% of any proceeds received upon a sale of all or substantially all of the business or assets of CST Holdings and its subsidiaries (by merger, sale of stock, sale of assets or otherwise) prior to June 30, 1999. Such agreement shall be in such form and upon such terms as shall be approved by the Board of Directors of CST. 5. OTS. 5.1 Exchange of RRD Debt in OTS. Upon the Effective Date, RRD shall surrender 44.4445% of any Net RRD Debt as of September 30, 1997 for cancellation in exchange for a number of shares of Class A-1 Common Stock of Stream determined by dividing 44.4445% of the Net RRD Debt as of 7 September 30, 1997 by the OTS Per Share Value. The terms of the Class A-1 Common Stock shall be as set forth in Exhibit L-1. 5.2 Amendment to Stream Charter. Upon the Effective Date, the Certificate of Incorporation of Stream shall be amended and restated substantially as set forth on Exhibit L-1 appended hereto. The Certificate of Incorporation of Stream shall be further amended and restated immediately prior to the closing of the Stream IPO as set forth on Exhibit L-2 appended hereto. 5.3 Irrevocable Stockholders' Voting Agreement and Proxy. Upon the Effective Date, RRD and certain stockholders shall enter into an Irrevocable Stockholders' Voting Agreement and Proxy in the form appended hereto as Exhibit M. 5.4 Fee Upon Stream IPO. Upon the earlier of the closing of the Stream IPO or any sale of all or substantially all of the business of Stream, MMI shall pay to Bain (or an affiliate thereof) a fee of $296,000 and CST shall pay to Bain (or an affiliate thereof) a fee of $440,000. 5.5 Shared Appreciation Agreement. Upon the Effective Date, RRD and Bain, on behalf of the Class B Holders, shall enter into a Shared Appreciation Agreement in the form appended hereto as Exhibit N. 5.6 RRD Investor Rights Agreement. Upon the Effective Date, Stream and RRD shall enter into an Investor Rights Agreement, in the form appended hereto as Exhibit O. 5.7 Working Capital. (a) Bain will use reasonable efforts to arrange for working capital and related lines of credit (the "Credit Lines") for each of MMI, CST and OTS on or prior to the Effective Date. The Credit Lines shall be in full force and effect upon the Effective Date. (b) Prior to the Effective Date, the businesses of MMI, CST and OTS will be operated in the ordinary course. (c) Upon the Effective Date and immediately prior to the events set forth in Sections 3.2 and 4.2, all cash of MMI, CST and OTS in excess of $25,000,000 in the aggregate, as reflected on the Stream balance sheet as of October 31, 1997, shall be applied toward the repayment of the Net RRD Debt. 8 (d) From and after the Effective Date, RRD shall have no obligation to advance funds to MMI, CST or OTS to finance their respective businesses. In addition, upon the Effective Date, RRD, Stream, MMI, and R.R. Donnelley Receivables, Inc. ("DRI"), shall enter into an agreement relating to the Operating Agreement dated as of April 21, 1995, among Stream, RRD and DRI in the form set forth on Exhibit T. 5.8 Potential Surrender of Class A-1 Common Stock. Pursuant to Section 5.1 hereof, RRD shall receive shares of Class A-1 Common Stock of Stream prior to the Spin-Off Date. The percentage ownership interest in Stream represented by such shares of Class A-1 Common Stock is intended to represent an interest solely in OTS, and not in MMI or CST. Accordingly, if all or substantially all of the business of Stream is sold to a third party (by merger, sale of assets or otherwise) prior to such time as Stream has distributed to its stockholders or otherwise disposed of all of the outstanding shares of common stock of MMI and CST held directly or indirectly by Stream, RRD agrees that it shall, immediately prior to such sale, surrender to Stream for cancellation, without consideration, a number of shares of Class A-1 Common Stock such that the consideration otherwise to be received by RRD with respect to its shares of Class A-1 Common Stock upon such sale does not include the portion of any such consideration attributable to the value of Stream's then ownership interest in MMI and/or CST, as the case may be. The portion of any such consideration attributable to the value of MMI and/or CST shall be determined by agreement of RRD and the Board of Directors of Stream and, if the parties are unable to agree upon such portion, the matter shall be submitted to an investment banking firm mutually selected by RRD and the Board of Directors of Stream, whose determination shall be final and binding on RRD and the Board of Directors of Stream. 6. Post-Effective Date Adjustment for Net RRD Debt. (a) Within 60 days following the Effective Date, RRD and Bain shall determine the amount of any indebtedness incurred by Stream and its subsidiaries, including MMI and CST, to RRD and its subsidiaries from October 1, 1997 through the Effective Date ("Debt to RRD") and the amount of any indebtedness incurred by RRD and its subsidiaries to Stream and its subsidiaries, including MMI and CST, from October 1, 1997 through the Effective Date ("Debt to Stream"). If the parties are unable to agree upon the amount of such indebtedness, the amount of such indebtedness shall be determined by Arthur Andersen, whose determination shall be binding on the parties. 9 (b) To the extent the Debt to Stream exceeds the Debt to RRD, (i) RRD shall pay 60% of such excess to CST Holdings in cash or, at its election, surrender to CST Holdings for cancellation a number of shares of CST Holdings Common Stock equal to such excess divided by the CST Per Share Value, and (ii) RRD shall pay 40% of such excess to MMI Holdings in cash or, at its election, surrender to MMI Holdings for cancellation a number of shares of MMI Holdings Preferred Stock equal to such excess divided by $1,000. (c) To the extent the Debt to RRD exceeds the Debt to Stream (such excess being referred to as the "Excess Debt"), (i) CST Holdings shall, in exchange for the cancellation of 60% of the Excess Debt, at its election, pay to RRD an amount in cash equal to 60% of the Excess Debt or issue to RRD a number of shares of CST Holdings Common Stock equal to 60% of the Excess Debt divided by the CST Per Share Value, and (ii) MMI Holdings shall, in exchange for the cancellation of 40% of the Excess Debt, agree to reduce the purchase price payable by RRD for the Portland Assets pursuant to Section 9 by an amount equal to 40% of the Excess Debt and, to the extent 40% of the Excess Debt exceeds such reduction, issue to RRD a number of shares of MMI Holdings Preferred Stock equal to such remaining excess divided by $1,000. (d) RRD's sole right with respect to any Excess Debt shall be as set forth in Subsection 6(c) above, and, from and after the Effective Date, Stream shall have no liability for any Debt to RRD. 7. Options. (a) The options for shares of Common Stock of Stream held by employees and others (other than options held by Messrs. Leahy, Moore, Rosenthal and Cowan and certain options held by Mr. Morphis) shall be amended as of the Effective Date so that the exercise price of such options shall equal the sum of the CST Per Share Value, MMI Per Share Value and OTS Per Share Value, provided that options with an exercise price lower than such sum shall not be so amended. (b) After the CST Spin-Off and the MMI Spin-Off, each holder of an option to purchase shares of Stream Common Stock outstanding immediately thereto shall receive options for an 10 equal number of shares of MMI Holdings and CST Holdings, and the exercise prices of the options held by each employee for the purchase of shares of Common Stock of MMI Holdings, CST Holdings and Stream shall be equal to the MMI Per Share Value, CST Per Share Value and OTS Per Share Value, respectively. 8. Tax Loans. MMI and CST will offer to make tax loans in an aggregate amount of not more than $7,500,000 to employee stockholders of Stream in order to enable such stockholders to pay taxes incurred by them in connection with the CST Spin-Off and MMI Spin-Off. Such loans shall be made on a non-recourse basis, secured by the shares of Common Stock of CST Holdings, MMI Holdings and OTS held by such stockholders, and shall bear interest at a rate not less than 5% (which such interest shall accrue until the principal is due and payable). The terms of such loans shall otherwise be determined by the Board of Directors of OTS. 9. Portland Assets. Upon the Effective Date, R.R. Donnelley Norwest, Inc. and Stream shall enter into the Portland Asset Purchase Agreement, in the form set forth on Exhibit U, and effect the transactions contemplated thereby. The proceeds of the sale of assets effected thereby shall be distributed 60% to CST Holdings and 40% to MMI Holdings. 10. RRD, CST and MMI Covenants. 10.1 Indemnity. On the Effective Date, RRD and Stream shall enter into Guaranties and a Tax Reimbursement Agreement, in the forms attached hereto as Exhibits P, Q and R, respectively. 10.2 Sale of Shares. In the Stream IPO, RRD will sell sufficient shares of its Stream Common Stock so that its beneficial ownership of Stream Common Stock after such offering shall be below 50%, on a primary basis. 10.3 Standstill. RRD agrees that, from the effective date of the Stream IPO until the third anniversary of such effective date, RRD and its affiliates will not purchase or otherwise acquire any securities that would cause RRD or its affiliates to beneficially own (within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934) more than 49.9%, by voting power, of the outstanding capital stock of Stream. 11 11. Bain Purchase Option. RRD hereby grants to Bain an option to acquire from RRD all of the indebtedness which it holds in Stream and all of its (and its affiliates') shares of Class A Common Stock and Class A-1 Common Stock of Stream for the Option Price. The Option Price shall be paid in cash. Such option must be irrevocably exercised prior to the earlier of (i) the first date on which preliminary prospectuses for the Stream IPO are circulated to prospective investors and (ii) January 20, 1998 and, if such option is exercised, the closing of the purchase must take place no later than March 31, 1998. The exercise of such option must be without any financing condition, but the exercise may be conditioned upon the satisfaction of conditions in any financing relating to force majeure events, a material decline in the stock market and any material adverse change in the business of Stream and its subsidiaries. The Option Price shall be equal to the sum of: (A) the amount of the Net RRD Debt as of the closing date, plus (B) the amount determined by subtracting from $450,000,000 the then Net RRD Debt and the then Third Party Debt and by multiplying such remainder by the Net RRD Ownership Percentage. At the closing of any such option exercise, RRD shall assign and deliver to Bain all its rights to the Net RRD Debt and certificates representing all of its (and its affiliates') shares of Class A Common Stock and Class A-1 Common Stock of Stream, against payment of the Option Price by certified check or wire transfer to RRD. RRD shall make customary representations and warranties to Bain as to the amount of the Net RRD Debt and its ownership of its shares of Class A Common Stock and Class A-1 Common Stock. 12. Reorganization Documents. The consummation of the MMI Drop-Down and CST Drop-Down shall be subject to the execution and delivery of (i) a Contribution Agreement among Stream, SII, CST Holdings and CST, in the form appended hereto as Exhibit A; (ii) a Contribution Agreement among Stream, MMI Holdings and MMI in the form appended hereto as Exhibit B; (iii) a Tax Sharing Agreement among Stream, MMI Holdings, and MMI, CST Holdings in the form appended hereto as Exhibit S, and (iv) the other exhibits hereto to be executed and delivered on or prior to the Effective Date, in each case with such changes as may be approved by RRD and the other parties thereto. The MMI Drop-Down and CST Drop-Down shall be subject to such other documentation as shall be approved by the Boards of Directors of Stream, MMI and CST. 13. Coris. On or after the Effective Date, MMI and RRD shall enter into an agreement with respect to Coris upon the terms set forth on Exhibit X hereto. 13.A Insurance. Following the Effective Date, RRD, Stream, MMI Holdings and CST Holdings will negotiate in good faith an agreement regarding insurance generally in accordance with the provisions of the draft Insurance Claims Processing Agreement attached hereto as Exhibit W. Prior to, or in the absence of, the execution of such an agreement, Stream, MMI and CST shall 12 continue to pay RRD for its actual losses and premium expenses for workers' compensation claims made in respect of their employees prior to the Spin-Off Date, such payments to be in accordance with current practice in effect on the date hereof except that payments shall be in cash instead of as adjustments to inter-company accounts. 14. Miscellaneous. 14.1 Rules of Construction. In the event and to the extent there shall be any conflict between the provisions of this Agreement and the provisions of any of the agreements appended hereto as Exhibits, the terms of such Exhibits, as executed by the parties, shall govern and control. 14.2 Governing Law. This Agreement shall be governed by and construed in accordance with the domestic substantive laws of the State of Delaware. 14.3 Notices. Any notice, request, demand, claim or other communication hereunder shall be in writing and shall be delivered by registered or certified mail, return receipt requested, and shall be deemed to have been duly given three days after mailing if sent to the following addresses: If to Stream: ------------ Stream International Inc. 245 Dan Road Canton, MA 02021 Attn: President If to RRD: --------- R.R. Donnelley & Sons Company 77 West Wacker Drive Chicago, IL 60601 Attn: Corporate Secretary If to Bain: ---------- Bain Capital, Inc. Two Copley Place Boston, MA 02116 Attn: Jonathan S. Lavine Notwithstanding the foregoing, any party may send any notice, request, demand, claim or other communication hereunder to the intended recipient at the address set forth above using any other means (personal delivery, expedited 13 courier, messenger service, telecopy, ordinary mail or electronic mail), but no such notice, request, demand, claim or other communication shall have been deemed to have been duly given unless and until it is actually received by the intended recipient. 14.4 Amendments. This Agreement may not be modified or amended, except by an agreement in writing, signed by RRD and Bain. 14.5 Third Party Beneficiaries. This Agreement is solely for the benefit of the parties hereto and shall not be deemed to confer upon any third party any remedy, claim, liability, reimbursement, claim or other right in excess of those existing without reference to this Agreement, provided that, after the Effective Date, Stream, CST and MMI may enforce the provisions of Section 6 and the provisions set forth on the definition of "Net RRD Debt" and Stream may enforce the provisions of Section 5.8. 14.6 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be original, and all of which together shall be deemed to be one and the same instrument. 14.7 Entire Agreement. This Agreement represents the entire agreement between the parties with respect to the subject matter hereof and supersedes both the Agreement in Principle between the parties dated April 17, 1997 and the Agreement in Principle between the parties dated September 17, 1997. R.R. DONNELLEY & SONS COMPANY By: /s/ C. A. Francis ---------------------------------------- Title: Executive Vice President & CFO BAIN CAPITAL, INC. By: /s/ Jonathan S. Lavine ---------------------------------------- Title: Principal 14 EX-10.(Q) 3 AGREEMENT BETWEEN RRD & STEVEN J. BAUMGARTNER Exhibit 10(q) SEPARATION AND RELEASE AGREEMENT This Agreement is made and entered into on this 19th day of November, 1997 between Steven J. Baumgartner of 1247 Hinman, Evanston, Illinois 60202 (the "Executive") and R. R. Donnelley & Sons Company, a Delaware corporation, with its principal office at 77 West Wacker Drive, Chicago, Illinois 60601 (the "Company"). W I T N E S S E T H: WHEREAS, the Executive is an Executive Vice President and Sector President of the Company; and WHEREAS, the Company and the Executive have agreed to end the Executive's active employment relationship, to provide for a leave of absence, to secure the Executive's availability in the future to assist in the prosecution or defense of matters in which the Executive has been involved, to limit certain competitive activities, and to settle potential claims, all on the terms and conditions and for the consideration stated in this Agreement; NOW, THEREFORE, the Executive and the Company, in consideration of the agreements, covenants and conditions contained herein, hereby agree as follows: 1. Leave of Absence and Termination of Employment. ---------------------------------------------- The Executive hereby resigns as a Sector President, effective upon his execution of this Agreement, but he shall continue to serve as an Executive Vice President of the Company with such responsibilities as may be assigned to him from time to time by the Chairman of the Company. Effective upon the close of business on December 31, 1997, or such earlier date as may be agreed to by the Executive and the Company (the "Leave Date"), the Executive shall resign as an Executive Vice President of the Company but shall remain an employee of the Company and shall commence a paid leave of absence which shall continue through December 31, 1999. The Executive's employment relationship with the Company shall terminate as of the close of business on December 31, 1999 (the "Termination Date"). The Executive's compensation and benefits for the period from the date hereof through the Termination Date shall be as described in Section 2, below. Effective upon the Leave Date, or such respective later date or dates as the Company may from time to time specify, the Executive shall also resign from any directorships or other positions with other organizations which the Executive currently holds as a designated representative of the Company. 2. Consideration. ------------- In consideration of the covenants and commitments of the Executive in this Agreement, including but not by way of limitation the release set forth in Section 5, below, the Company agrees to provide the Executive with the following compensation and benefits, with all of the payments and benefits described below being subject to tax withholding to the extent required by law and to all applicable benefit expense withholding and to all other withholding elections made by the Executive, to the extent that such elections remain in effect: (a) From the date hereof through the Termination Date, the Executive shall continue to receive base salary at his current rate of $368,004 annually, payable in accordance with the regular payroll practices of the Company. (b) Except as otherwise specifically provided in this Agreement, the Executive shall continue to participate through the Termination Date in all of those employee benefit plans of the Company (including, but not by way of limitation, the health insurance plan) in which the Executive was participating immediately prior to the Leave Date; provided, however, that the Executive shall participate in such plans on the same basis as active employees who are then participating in the plans, including making any applicable employee contributions; and provided further that such continued participation by the Executive shall be subject to termination or modification, in the same manner and to the same extent as the participation of then active employees, in the event that the Company terminates or modifies any of such plans prior to the Termination Date. However, while the Executive shall, in accordance with the applicable plans, retain the executive life and disability insurance policies currently in effect for him, the Company shall not, after the Leave Date, pay any further premiums on those policies. (c) As soon as practical after the Leave Date, the Company shall pay to the Executive the amount of $29,723 for 21 days of vacation accrued but not taken by the Executive to and through the Leave Date. No further vacation shall accrue for the Executive after the Leave Date. (d) For the period from the Leave Date through the Termination Date, the Executive shall continue to vest in the outstanding options to purchase shares of the Company as set forth in Exhibit A attached hereto and the outstanding restricted stock awards as set forth in Exhibit A attached hereto, except that the restricted stock award of 15,000 shares which was granted in 1995 and would not vest until after the Termination Date shall be canceled immediately upon the execution of this Agreement and shall be replaced by a new restricted stock award of 6,000 shares which shall vest on the Termination Date. The rights of the Executive with respect to that new restricted stock award and with respect to his other outstanding option awards and restricted stock awards shall be as provided by the respective plans under which they were granted; provided, however, that any of such outstanding options (other than the options identified in Exhibit A as granted on January 1, 1995 or on January 1, 1997) which have not otherwise vested shall in any event fully vest on the Termination Date. In accordance with the applicable plans, options which are outstanding and vested as of the Termination Date shall remain exercisable for ninety (90) days thereafter, after which time any unexercised options shall be canceled. (e) If the Executive remains actively employed by the Company until the Leave Date, the Company shall grant to the Executive a special restricted stock award of 1,500 shares which shall vest 2 on the Termination Date if the Executive fulfills his obligations under Sections 4, 5 and 12 of this Agreement. (f) Without regard to whether the Leave Date precedes January 1, 1998, the Company shall pay the Executive a bonus for 1997 which shall be determined and paid in accordance with the criteria, procedures and time schedule applicable to other senior officer bonuses for 1997, which shall be applied to the Executive as if he were actively employed by the Company through December 31, 1997. The Executive shall not receive an annual bonus for any period after 1997. (g) Without regard to whether the Leave Date precedes January 1, 1998, the Company shall pay to the Executive the amount, if any, which may be earned under the Long-Term Incentive Plan award which was granted to the Executive for the 1995-97 performance period. However, the Executive acknowledges that, based on performance to date, no payout has been earned with respect to that award and further acknowledges that no payment is expected to be earned for the 1995-97 performance period applicable to that award. (h) Subsequent to the Leave Date, the Executive shall not be eligible to make further purchases under the Employee Stock Purchase Plan of the Company. The rights and benefits of the Executive under that plan shall, after the Leave Date, be determined in accordance with the provisions of that plan which are applicable to employees whose employment has terminated. (i) Any benefits accrued under the Section 401(k) plan of the Company as of the Termination Date shall be paid to the Executive in accordance with the terms of that plan. To the maximum extent permitted under the qualified retirement benefit plan of the Company, the benefits payable to the Executive under that plan shall take into account the compensation paid to the Executive by the Company through the Termination Date and shall treat the Executive's period of service as continuing through the Termination Date. To the extent that any portion of the benefits calculated on that basis under the said qualified plan cannot be paid under that plan, the Company shall pay to the Executive, as a nonqualified supplemental retirement benefit, the difference between the benefits so calculated and the benefits which are permitted to be paid to the Executive under the qualified retirement benefit plan of the Company. The time and manner of payment of such benefits shall be determined in accordance with the terms of the said qualified retirement plan. (j) The Executive may use the remaining balance in his financial planning account (which was $21,832.50 as of October 27, 1997, based upon all charges posted to the account by that date) for fees incurred prior to the Termination Date, but the Company shall make no further contributions to that account after the Leave Date. (k) To the same extent that the Company has previously provided outplacement services to other senior executives, the Company shall pay the fees of an outplacement service provider selected jointly by the Company and the Executive for assistance to the Executive in obtaining new employment. 3 (l) The Company shall reimburse the Executive for the attorneys' fees incurred by him, up to a maximum of $10,000, in connection with the review of this Agreement. (m) As soon as practical after the Leave Date, the Executive shall submit all expense account records and vouchers relating to his active employment with the Company, and the Company shall reimburse the Executive in accordance with its standard practices and procedures for such expenses. (n) The Executive shall be entitled to retain, without any payment therefor, the laptop computer and the desktop computer which have been provided to him by the Company and the standard software which has been installed on those computers (except to the extent, if any, that the Company is prohibited, by agreement with any third party, from permitting such retention of that software), but after the Leave Date the Executive shall no longer have access to the computer system of the Company or to any customized software developed for use by the Company. Upon the death of the Executive, any benefits payable with respect to the Executive's participation in any employee benefit plans or programs shall be paid in accordance with the applicable terms of such plans and programs, and any other payment remaining to be made pursuant this Section 2 shall be paid to such person(s) or trust(s) as shall have been designated by written notice delivered to the Company by the Executive. If no such person(s) or trust(s) have been so designated, such payments shall be made to the Executive's estate. 3. Cooperation During Leave of Absence. From the Leave Date through the Termination Date, the Executive shall cooperate with the Company in the truthful and honest prosecution and/or defense of any claim in which the Released Company Parties (as defined in Section 5, below) may have an interest (subject to reasonable limitations concerning time and place), which may include without limitation making himself available to participate in any proceeding involving any of the Released Company Parties, allowing himself to be interviewed by representatives of the Company, appearing for depositions and testimony without requiring a subpoena, and producing and/or providing any documents or names of other persons with relevant information. The Executive shall provide such services during the period from the Leave Date through the Termination Date for up to two hundred (200) hours without additional compensation, and thereafter at the rate of $1,500 per day, but the Company shall in any event pay the Executive's expenses incurred at the Company's prior and specific request. 4. Confidentiality, Non-Solicitation and Non-Competition. (a) Executive reaffirms and agrees to comply with the terms of the Agreement Regarding Confidential Information, Intellectual Property and Non- Solicitation of Employees signed by the Executive, a copy of which is attached hereto as Exhibit B and incorporated herein by reference. Executive represents that he has delivered (or will as requested, but no later than the Leave Date, 4 deliver) all Company papers, books, records, computer programs, or like materials in his possession or control and all copies thereof to the Company. (b) In consideration of the covenants and agreements of the Company herein contained, the payments to be made by the Company pursuant to this Agreement, the positions of trust and confidence he has occupied with the Company and the information of a highly sensitive and confidential nature he has received as a result of such positions, the Executive agrees that he will not, during the period commencing on the date of this Agreement and ending on the Termination Date, without the prior written consent of the Company, either directly or indirectly accept employment by or serve as a consultant, agent, substantial stockholder, corporate officer, or director of, or in any other representative capacity for, any entity which is engaged in a line of business in which the Company (either directly or through a subsidiary or affiliate) is engaged on the Leave Date and which is a competitor of the Company or any of its subsidiaries, or assist in the solicitation of any work or engage in any other activity in competition with the business then being conducted by the Company or any of its subsidiaries. Executive acknowledges that the business conducted by the Company is worldwide and that it is reasonably necessary for the protection of the Company and its subsidiaries and their goodwill, in view of his knowledge of its and their worldwide operations, that he not provide to competitors of the Company or any of its subsidiaries anywhere in the world the benefit of his knowledge of the Company and its subsidiaries and its and their business. Executive further acknowledges that a breach by him of his agreements contained in this Section 4 would cause irreparable harm to the Company which is not adequately measurable by money damages and that, accordingly, in the event of such a breach, in addition to any and all other rights the Company may have, including, without limitation, rights at law and in equity, and the right of the Company to terminate certain payments to the Executive, the Company shall be entitled to equitable remedies in the nature of injunctive relief to stop any existing breaches and to prohibit any future breaches. (c) The following additional provisions shall apply to the covenants of the Executive contained in this Section 4. (i) It is the intent and understanding of each party hereto that if, in action before any court or agency legally empowered to enforce the covenants contained in this Section 4, any term, restriction, covenant or promise contained herein is found to be unreasonable and for that reason unenforceable, then such term, restriction, covenant or promise shall be deemed modified to the extent necessary to make it enforceable by such court or agency. (ii) In the event of any material breach by the Executive of any provision of this Section 4, the Company may, by written notice, elect to terminate its obligations under this Agreement. In such event, all payments and other benefits to the Executive otherwise required to be provided by the Company under the provisions of Section 2 shall immediately cease, and the Executive shall thereafter cease to be entitled to receive any amounts not already paid by the Company and he shall be required to return any payments previously received but relating to periods after the date of such breach; provided that the Executive shall be entitled to receive or retain any 5 payment or benefit which is based upon a right which had fully accrued (including any stock options or similar rights which had fully vested) as of the date of such breach. (iii) The Executive understands that, in addition to the restrictions contained herein, pursuant to the terms of the Company's retirement benefit plan, the payment of certain retirement benefits may be affected should the Executive become employed by or perform work for a competitor or supplier of the Company. 5. Release and Covenant Not to Sue. (a) The Executive, on behalf of himself, his heirs, executors, attorneys, administrators, successors and assigns, hereby fully and forever, to the full extent permitted by law, releases and discharges the Company, and each of its subsidiaries and affiliated companies and entities and each of their partners, principals, members, shareholders, directors, officers, trustees, employees, contractors, consultants, agents and attorneys, past, present and future, and all predecessors, successors and assigns thereof (collectively "Released Company Parties") from any and all claims, demands, agreements, actions, suits, causes of action, damages, injunctions, restraints and liabilities of whatever kind or nature, in law, equity or otherwise, whether now known or unknown or which have ever existed or which may now exist (except to enforce the terms of this Agreement), including, but not limited to, any and all claims, liabilities, demands or causes of action relating to or arising out of Executive's employment, resignation from the positions of Executive Vice President and Sector President or separation from employment with the Company, including (but not by way of limitation) claims under Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C. (S) 2000e et al., 42 U.S.C. (S) 1981, the Civil Rights Act of 1991, the Americans with Disabilities Act, the Family and Medical Leave Act, the Age Discrimination in Employment Act, as amended by the Older Workers Benefit Protection Act, the anti-trust and restraint of trade statutes and common law, the federal and state (including, without limitation, Illinois) statutes or common law, or claims for breach of contract, for misrepresentation, for violation of any other federal, state or local statute, ordinance or regulation or common law dealing in any respect with discrimination in employment or otherwise, defamation, retaliatory or wrongful discharge under the common law of any state, infliction of emotional distress or any other tort under the common law of any state or for attorney's fees. Executive acknowledges and agrees that this release and the covenant not to sue set forth in paragraph (c), below, are essential and material terms of this Agreement and that without such release and covenant not to sue no agreement would have been reached by the parties. Executive understands and acknowledges the significance and consequences of this release and this Agreement. (b) The following provisions are applicable to, and made a part of, this Agreement and the foregoing release: (i) Executive does not release or waive any right or claim that arises after the date of execution of this Agreement which he may have under the Age Discrimination in Employment Act, as amended by the Older Workers Benefits Protection Act, provided that any claim based upon his resignation from the positions of Executive Vice President and Sector President and his separation 6 from the Company has, for all purposes relating to this Agreement, arisen prior to the execution of this Agreement. (ii) Executive does not waive any right to the receipt of payments or benefits not yet due and owing, whether under this Agreement or under the Company benefit and compensation plans in which Executive is a participant or beneficiary. (iii) In exchange for the general release and waiver hereunder, Executive hereby acknowledges that he has received separate consideration beyond that to which he is otherwise entitled under the Company's policy or applicable law. (iv) The Company has advised, and hereby again expressly advises, Executive to consult with an attorney of his choosing regarding, and prior to executing, this Agreement, which contains a general release and waiver. (v) This release shall not apply to workers' compensation claims, or to claims under state and federal unemployment insurance laws. (c) To the maximum extent permitted by law, the Executive covenants not to sue or to institute or cause to be instituted any kind of claim or action (except to enforce this Agreement) in any federal, state or local agency or court against any of the Released Company Parties relating to the matters covered by the foregoing release. (d) The Company, on behalf of itself and its subsidiaries and affiliated companies and entities, hereby fully and forever, to the full extent permitted by law, releases and discharges the Executive and his heirs, executors, attorneys, administrators, successors and assigns (collectively "Released Executive Parties") from any and all claims, demands, agreements, actions, suits, causes of action, damages, injunctions, restraints and liabilities of whatever kind or nature, in law, equity or otherwise, which have ever existed or which may now exist (except to enforce the terms of this Agreement), including, but not limited to, any and all claims, liabilities, demands or causes of action relating to or arising out of the Executive's employment, resignation from the positions of Executive Vice President and Sector President or separation from employment with the Company, including (but not by way of limitation) claims under federal and state (including, without limitation, Illinois) statutes or common law, or claims for breach of contract, misrepresentation, defamation, or any other tort under the common law of any state or for attorneys' fees; provided, however, that this release and discharge does not apply to any rights or claims based upon information which is not, as of the date hereof, known to the Board of Directors of the Company, the Chief Executive Officer of the Company or legal counsel for the Company, including, but not by way of limitation, information relating to possible embezzlement, fraud or other theft from the Company by the Executive. The Company acknowledges and agrees that this release and the covenant not to sue set forth in paragraph (e), below, are essential and material terms of this Agreement and that without such release and covenant not to sue no agreement would have been reached by the parties. The Company understands and acknowledges the significance and consequences of this release and this Agreement. 7 (e) To the maximum extent permitted by law, the Company covenants not to sue or to institute or cause to be instituted any kind of claim or action (except to enforce this Agreement) in any federal, state or local agency or court against any of the Released Executive Parties relating to the matters covered by the foregoing release. (f) On or promptly after the Leave Date, (i) the Executive shall execute and deliver to the Company a further release and covenant not to sue with terms equivalent to those of paragraphs (a), (b) and (c), above, but effective through the Leave Date and (ii) the Company shall execute and deliver to the Executive a further release and covenant not to sue with terms equivalent to those of paragraphs (d) and (e), above, but effective through the Leave Date. 6. No Admission of Liability. The Executive agrees that neither this Agreement nor performance hereunder constitutes an admission by the Company of any violation of any federal, state or local law, regulation, common law, of any breach of any contract, or of any other wrongdoing of any type. 7. COBRA Rights. The Executive acknowledges that the Company has advised him that pursuant to the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA"), he has the right to elect continued coverage under the Company's group health plans, at his own expense, for a statutory period after the date of termination of his employment. Prior to or promptly after the Termination Date, the Company will advise the Executive as to the rights, if any, which the Executive then has under COBRA in light of the benefits provided by the Company under Section 2(b), above. 8. Confidentiality of Agreement. The Executive and the Company agree that they will keep confidential, to the full extent permitted by law, the terms of this Agreement, all performance hereunder and all circumstances relating to the Executive's separation from the Company; provided, however, that the Executive and the Company may disclose the same as required by law (including, but not by way of limitation, the filing of this Agreement with the Securities and Exchange Commission), for purposes of tax reporting, pursuant to legal process, in an action to enforce this Agreement, to claim benefits under this Agreement or under Company benefit plans in which the Executive is a participant or beneficiary, to members of the Executive's immediate family, legal advisors, and to persons from whom the Executive seeks financial advice. 9. Indemnification. The Company further agrees that, if the Executive is sued individually concerning any act, omission or conduct which he undertook in his capacity as an employee, officer, director or agent of the Company or any of its subsidiaries, then the Company shall defend the Executive from the claim 8 and indemnify the Executive for any judgment, fine or settlement resulting therefrom to the same extent as is then authorized by the Company's By-Laws and/or Certificate of Incorporation for employees as of that time. The Company hereby represents and warrants that the Executive is currently covered by director and officer liability insurance maintained by the Company which provides coverage on an occurrence basis. To the extent that the Company maintains director and officer liability insurance in the future, the Executive will be covered by such insurance on the same basis as and to the same extent as all other senior officers of the Company employed by the Company during the period of the Executive's employment with the Company. 10. Agreement Binding. In executing this Agreement, the Executive acknowledges that he has read this Agreement carefully, that he fully understands its terms and conditions, that he has been advised of his rights and has been advised to consult counsel prior to the execution hereof. The Executive intends that this Agreement shall be legally binding on him. 11. Approval Required. Any other provision of this Agreement notwithstanding, this Agreement shall not become effective and binding until it has been approved by the Human Resources Committee of the Board of Directors of the Company. Promptly after such approval, the Company shall provide the Executive with written notice that such approval has been obtained and that this Agreement has become fully effective and binding. 12. Revocation. The Executive acknowledges that he has had the opportunity to have at least twenty-one (21) days within which to decide whether or not to sign this Agreement. He further acknowledges having been given the right to revoke this Agreement by serving, within a seven (7)-day period after signing, a written notice of revocation. The Agreement shall become effective on the eighth day following its execution by the Executive. If the Executive revokes the Agreement, the Company shall have no obligation under it. 13. References. If any prospective employer of the Executive requests a reference, the Company shall report only the fact that the Executive worked for the Company, the positions held and salary earned. No further information will be provided unless the Company receives a written release from the Executive or is otherwise required to do so by law. Neither the Company nor the Executive shall at any time disparage the other party. 14. Notices. 9 All notices or other communications required or permitted hereunder shall be sufficient if in writing and delivered personally or by reputable commercial delivery service or sent by registered mail, return receipt requested, to the respective address hereinabove set forth or to any other address designated by the relevant party by notice similarly given. Such notice shall be deemed to have been given upon such delivery or three (3) days after deposit in the U.S. mail, as the case may be. 15. Assignment and Succession. The rights and obligations of the Company under this Agreement shall inure to the benefit of and be binding upon its successors and assigns, and the Executive's rights and obligations hereunder shall inure to the benefit of and be binding upon his legal representatives or designated beneficiaries; provided, however, that the Executive may not assign during his lifetime any of his rights and obligations hereunder. 16. Attorneys' Fees and Costs. The prevailing party (as determined by the court of adjudication) in any action or proceeding brought to enforce any provision of this Agreement or in any action or proceeding on account of the breach of any term hereof shall be paid by the non-prevailing party an amount equal to the costs and reasonable attorneys' fees incurred by the prevailing party in connection with such action or proceeding. 17. Entire Agreement. This Agreement contains the entire agreement between the Company and the Executive with respect to the subject matter contained herein and supersedes all prior oral or written communications relating thereto. This Agreement may not be changed or amended orally. 18. Applicable Law. This Agreement shall at all times be construed, interpreted and enforced in accordance with the laws of the State of Illinois as applicable to agreements entered into in, and to be performed entirely within, the State of Illinois. IN WITNESS WHEREOF, the Company has caused this Agreement to be signed by its duly authorized officer and the Executive has signed this Agreement as of the day and year first above written. /s/ Steven J. Baumgartner ---------------------------------------- Steven J. Baumgartner R.R. DONNELLEY & SONS COMPANY 10 By: /s/ William L. Davis ---------------------------------------- William L. Davis Its: Chairman and Chief Executive Officer 11 EX-10.(R) 4 AGREEMENT BETWEEN RRD & W. ED TYLER Exhibit 10(r) AGREEMENT This Agreement is made and entered into on this 13th day of February, 1998 between W. Ed Tyler of 631 North Lincoln, Hinsdale, Illinois 60521 (the "Executive") and R. R. Donnelley & Sons Company, a Delaware corporation, with its principal office at 77 West Wacker Drive, Chicago, Illinois 60601 (the "Company"). W I T N E S S E T H: WHEREAS, the Executive is an Executive Vice President and Chief Technology Officer of the Company; and WHEREAS, the Company and the Executive wish to provide for a leave of absence on certain terms and conditions in the event that the Executive's active employment relationship with the Company terminates during 1998 other than for cause; NOW, THEREFORE, the Executive and the Company, in consideration of the agreements, covenants and conditions contained herein, hereby agree as follows: 1. Continued Employment. -------------------- The Executive is currently an Executive Vice President and the Chief Technology Officer of the Company and shall continue as such during his active employment with the Company. For such service the Executive is currently receiving a base salary of $386,000, which will be subject to review and possible increase by the Company as of April 1, 1998. The Executive will also be eligible to participate in the bonus plan of the Company for senior officers and will continue to participate in the general employee benefits plans and programs of the Company in accordance with their respective terms. The Executive's active employment with the Company may be terminated at any time by either the Executive or the Company upon ten (10) days written notice to the other party. 2. Term of this Agreement. ---------------------- The term of this Agreement shall commence on the date hereof and shall end on December 31, 1998. If the Executive continues as an active employee of the Company after December 31, 1998, this Agreement shall be of no further force or effect, and any such further active service by the Executive shall be entirely as an employee at will. 3. Termination of Employment and Leave of Absence. ---------------------------------------------- (a) If the Executive's active employment with the Company is terminated during 1998 by the Executive's resignation for any reason or by the Company terminating such active employment for any reason other than Cause (as defined below), then as of the effective date of such termination (the "Leave Date"), the Executive shall remain an employee of the Company but shall commence a paid leave of absence which shall continue through the third anniversary of the Leave Date and shall be subject to extension pursuant to Section 4(c), below. The Executive's employment relationship with the Company shall terminate as of the close of business on the later of (i) the third anniversary of the Leave Date or (ii) the date to which the end of the leave of absence is extended pursuant to Section 4(c), below (such later date being hereinafter referred to as the "Termination Date"). For purposes of this Agreement, the period beginning on the Leave Date and ending on the Termination Date is referred to as the "Leave Period." The Executive's compensation and benefits for the Leave Period shall be as described in Section 4, below. Effective upon the Leave Date, or such respective later date or dates as the Company and the Executive may agree upon from time to time, the Executive shall resign from any directorships or other positions with other organizations which the Executive then holds as a designated representative of the Company. (b) For purposes of this Agreement, "Cause" for termination by the Company of the Executive's active employment with the Company shall mean (i) the Executive engages in conduct that constitutes gross neglect or willful gross misconduct in carrying out his duties as an officer of the Company or (ii) the Executive is convicted of a felony involving moral turpitude, fraud or embezzlement. 4. Consideration. In consideration of the covenants and commitments of the Executive in this Agreement, including but not by way of limitation the release referred to in Section 7, below, the Company agrees to provide the Executive during the Leave Period with the following compensation and benefits, with all of the payments and benefits described below being subject to tax withholding to the extent required by law and to all applicable benefit expense withholding and to all other withholding elections made by the Executive, to the extent that such elections remain in effect. The Executive shall not be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under this Agreement, and such amounts shall not be reduced whether or not the Executive obtains other employment, provided that the Executive fulfills his obligations under Section 6 of this Agreement. (a) For the Leave Period, the Executive shall receive salary in an aggregate amount (the "Salary Continuation Amount") equal to two (2) times his annual base salary at the rate in effect immediately prior to the Leave Date (e.g., If his annual salary rate immediately prior to the Leave Date is $386,000, then the Salary Continuation Amount payable for the Leave Period shall be $772,000.), but subject to increase pursuant to Section 4(c), below. Such salary during the Leave Period shall be payable in accordance with the regular payroll practices of the Company at the following rates: (i) the excess of the Salary Continuation Amount over $120,000 shall be payable in equal monthly installments over the first twenty-four (24) months (increased by any increase in the Leave Period to reflect available unused vacation pursuant to Section 4(c) hereof) of the Leave 2 Period and (ii) during the last twelve (12) months of the Leave Period, salary shall be paid at the rate of $10,000 per month. (b) Except as otherwise specifically provided in this Agreement, (i) the Executive shall continue to participate during the Leave Period in all of those employee benefit plans of the Company (including, but not by way of limitation, the health insurance plan) in which the Executive was participating immediately prior to the Leave Date, and (ii) the Leave Period shall constitute an additional period of employment for purposes of calculating retirement benefits and all other benefits to which the Executive would be entitled as an employee of the Company. In particular, but not by way of limitation, the Executive shall, in accordance with the applicable plans, retain the executive life and disability insurance policies currently in effect for him, and the Company shall, during the Leave Period, continue to pay premiums on those policies. (c) As soon as practical after the Leave Date, the Company shall pay to the Executive a cash lump sum for any days of vacation accrued by him as of the Leave Date but not yet available to be taken. No further vacation shall accrue for the Executive after the Leave Date. In addition, if, as of the Leave Date, the Executive has days of vacation which are available but unused, then the length of the Leave Period shall be increased by a time period equal to the calendar period of vacation which would elapse upon the Executive taking vacation equal to the number of such available but unused vacation days, and the amount of vacation pay for those available but unused vacation days shall not be paid separately but shall be added to the aggregate Salary Continuation Amount payable pursuant to Section 4(a), above. (d) For the period from the Leave Date through the Termination Date, the Executive shall continue to vest in the outstanding options to purchase shares of the Company as set forth in Exhibit A attached hereto and the outstanding restricted stock awards as set forth in Exhibit A attached hereto, and any additional stock options and/or restricted stock awards which may be granted to the Executive during 1998, except that the restricted stock award of 15,000 shares which was granted in 1995 shall be canceled immediately upon the Leave Date and shall be replaced by a new restricted stock award for a number of shares determined in accordance with the immediately following sentence and with a vesting schedule as described in the immediately following sentence. The number of shares covered by the new restricted stock award referred to in the immediately preceding sentence shall be equal to the sum of (i) 9,000 and (ii) the product obtained by multiplying (A) 200 by (B) the number of full calendar months which have elapsed from October 1, 1997 until the Leave Date; and of that total number of restricted shares, 6,000 shall vest on December 31, 2000 and the balance shall vest on the Termination Date. The rights of the Executive with respect to that new restricted stock award and with respect to his other outstanding option awards and restricted stock awards shall be as provided by the respective plans under which they were granted; provided, however, that any of such outstanding options (other than the options identified in Exhibit A as granted January 1, 1995) which have not otherwise vested shall in any event fully vest on the Termination Date. In accordance with the applicable plans, options which are outstanding and vested as of the Termination Date shall remain exercisable for ninety (90) days thereafter, after which time any unexercised options shall be canceled. 3 (e) The Company shall pay the Executive a prorated bonus for 1998 which shall be determined and paid in accordance with this paragraph (e). The total amount of that bonus for 1998 shall be determined by multiplying (i) the full bonus amount to which the Executive would be entitled for all of 1998 under the applicable bonus plan by (ii) a fraction the denominator of which is 365 and the numerator of which is the number of days which have elapsed from January 1, 1998 until the Leave Date. Fifty percent (50%) of that prorated 1998 bonus amount shall be paid to the Executive in accordance with the time schedule applicable to other senior officer bonuses for 1998, and the other fifty percent (50%) shall be paid to the Executive on the Termination Date. (f) As of the Leave Date, the Executive shall not be eligible to make further purchases under the Employee Stock Purchase Plan of the Company. The rights and benefits of the Executive under that plan shall, after the Leave Date, be determined in accordance with the provisions of that plan which are applicable to employees whose employment has terminated. (g) Any benefits accrued under the Section 401(k) plan of the Company as of the Termination Date shall be paid to the Executive in accordance with the terms of that plan. To the maximum extent permitted under the qualified retirement benefit plan of the Company, the benefits payable to the Executive under that plan shall take into account the compensation paid to the Executive by the Company through the Termination Date and shall treat the Executive's period of service as continuing through the Termination Date. To the extent that any portion of the benefits calculated on that basis under the said qualified plan cannot be paid under that plan, the Company shall pay to the Executive, as a nonqualified supplemental retirement benefit, the difference between the benefits so calculated and the benefits which are permitted to be paid to the Executive under the qualified retirement benefit plan of the Company. The time and manner of payment of such benefits shall be determined in accordance with the terms of the said qualified retirement plan. (h) During the Leave Period, the Executive may use the remaining balance in his financial planning account for fees incurred prior to the Termination Date, but the Company shall make no further contributions to that account after the Leave Date. (i) To the same extent that the Company has previously provided outplacement services to other senior executives, the Company shall pay the fees of an outplacement service provider selected jointly by the Company and the Executive for assistance to the Executive in obtaining new employment. (j) The Company shall reimburse the Executive for the attorneys' fees incurred by him, up to a maximum of $10,000, in connection with the review of this Agreement. (k) As soon as practical after the Leave Date, the Executive shall submit all expense account records and vouchers relating to his active employment with the Company, and the Company shall reimburse the Executive in accordance with its standard practices and procedures for such expenses. 4 Upon the death of the Executive, any benefits payable with respect to the Executive's participation in any employee benefit plans or programs shall be paid in accordance with the applicable terms of such plans and programs, and any other payment remaining to be made (determined as though the Executive continued to live through the remainder of the Leave Period) pursuant to this Section 4 (including but not by way of limitation any payments remaining due pursuant to Section 4(a)) shall be paid to such person(s) or trust(s) as shall have been designated by written notice delivered to the Company by the Executive. If no such person(s) or trust(s) have been so designated, such payments shall be made to the Executive's estate. 5. Cooperation During Leave of Absence. From the Leave Date through the Termination Date, the Executive shall cooperate with the Company in the truthful and honest prosecution and/or defense of any claim in which the Released Parties (as defined in the release referred to in Section 7, below) may have an interest (subject to reasonable limitations concerning time and place, and provided that such cooperation shall not unreasonably interfere with other obligations which the Executive has then undertaken), which may include without limitation making himself available to participate in any proceeding involving any of the Released Parties, allowing himself to be interviewed by representatives of the Company, appearing for depositions and testimony without requiring a subpoena, and producing and/or providing any documents or names of other persons with relevant information. The Executive shall provide such services during the period from the Leave Date through the Termination Date for up to one hundred (100) hours without additional compensation, and thereafter at the rate of $2,500 per day, but the Company shall in any event pay the Executive's expenses incurred at the Company's prior and specific request. 6. Confidentiality, Non-Solicitation and Non-Competition. (a) Executive reaffirms and agrees to comply with the terms of the Agreement Regarding Confidential Information, Intellectual Property and Non- Solicitation of Employees signed by the Executive on November 16, 1988, a copy of which is attached hereto as Exhibit B and incorporated herein by reference; provided, however, that if the Executive's active employment with the Company is terminated during 1998 by the Executive's resignation for any reason or by the Company terminating such active employment for any reason other than Cause, then paragraph 10 of the Agreement attached hereto as Exhibit B shall be deemed amended, effective as of such termination of employment, so that each reference to "competitor(s), supplier(s) or customer(s) of Donnelley" shall be deemed deleted and replaced by a reference to "Competitor(s)," as that term is defined in Section 6(b), below. Executive represents that he will, prior to the Leave Date, deliver all Company papers, books, records, computer programs, or like materials in his possession or control and all copies thereof to the Company, except that the Executive will be permitted to retain copies of documents describing the terms and conditions of those arrangements between the Executive and the Company which survive the termination of the Executive's active employment with the Company. 5 (b) In consideration of the covenants and agreements of the Company herein contained, the payments to be made by the Company pursuant to this Agreement after the Leave Date, the positions of trust and confidence he has occupied and currently occupies with the Company and the information of a highly sensitive and confidential nature he has received and will receive as a result of such positions, the Executive agrees that he will not, during the period commencing on the date of this Agreement and ending on the Termination Date, without the prior written consent of the Company, either directly or indirectly (i) 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 any Competitor (as defined below). For purposes of this Section 6, "Competitor" shall mean any entity which conducts 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 most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission prior to the Leave Date (hereinafter referred to as the "Company Business") in the United States or any other geographic area where the Company Business is being conducted as of the Leave Date or (ii) 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 6, (iii) no business, venture or activity shall be deemed to be a part of the Company Business unless not less than ten percent (10%) of the Company's consolidated gross sales or operating income is derived from, or not less than ten percent (10%) of the Company's consolidated assets are devoted to, such business, venture or activity; provided, however, that any business, venture or activity conducted by an entity (A) in which the Company holds an ownership interest as part of the 77 Capital portfolio of the Company or (B) for which the Executive has served as a director or in any other executive position as a representative of the Company, shall be deemed to be a part of the Company Business if at least ten percent (10%) of that particular entity's gross sales or operating income is derived from, or not less than ten percent (10%) of that particular entity's assets are devoted to, such business, venture or activity; and (iv) no business, venture or activity conducted by any entity which is not affiliated with the Company and by which the Executive is employed or in which the Executive is interested or with which the Executive is connected or associated shall be taken into account unless it is one from which ten percent (10%) or more of such entity's consolidated gross sales or operating income is derived, or to which ten percent (10%) 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 ten percent (10%) of the most nearly comparable figure for the Company, such business, venture or activity of such entity shall be taken into account. Further, ownership of not more than five percent (5%) of the voting stock of any publicly held corporation shall not, of itself, constitute a violation of this Section 6. Executive acknowledges that the business conducted by the Company is worldwide and that it is reasonably necessary for the protection of the Company and its subsidiaries and their goodwill, in view of his knowledge of its and their worldwide operations, that he not provide to competitors of the Company or any of its subsidiaries anywhere in the world the benefit of his knowledge of the Company and its subsidiaries and its and their business. Executive further acknowledges that a breach by him of his agreements contained in this 6 Section 6 would cause irreparable harm to the Company which is not adequately measurable by money damages and that, accordingly, in the event of such a breach, in addition to any and all other rights the Company may have, including, without limitation, rights at law and in equity, and any right of the Company to terminate certain payments to the Executive, the Company shall be entitled to equitable remedies in the nature of injunctive relief to stop any existing breaches and to prohibit any future breaches. (c) The following additional provisions shall apply to the covenants of the Executive contained in this Section 6. (i) It is the intent and understanding of each party hereto that if, in action before any court or agency legally empowered to enforce the covenants contained in this Section 6, any term, restriction, covenant or promise contained herein is found to be unreasonable and for that reason unenforceable, then such term, restriction, covenant or promise shall be deemed modified to the extent necessary to make it enforceable by such court or agency. (ii) In the event of any material breach by the Executive of any provision of this Section 6, the Company may, by written notice, elect to terminate its obligations under this Agreement; provided, however, that the Executive shall have the opportunity to cure, within five (5) business days after such notice, any inadvertent or unwillful breach by the Executive, and in the event of such a cure by the Executive, the termination by the Company pursuant to this paragraph (ii) shall not take effect. In the event that termination by the Company under this paragraph (ii) becomes effective, all payments and other benefits to the Executive otherwise required to be provided by the Company under the provisions of Section 4 shall cease, and the Executive shall thereafter cease to be entitled to receive any amounts not already paid by the Company and he shall be required to return any payments previously received but relating to periods after the date of such breach; provided that the Executive shall be entitled to receive or retain any payment of a benefit which had fully accrued as of the date of such breach. (iii) If the Executive's active employment with the Company is terminated during 1998 by the Executive's resignation for any reason or by the Company terminating such active employment for any reason other than Cause, then the Company shall waive those terms of the Company's retirement benefit plan pursuant to which the payment of certain retirement benefits can be affected adversely should a retired former employee become employed by or perform work for a competitor or supplier of the Company. 7. Releases and Covenants Not to Sue. (a) In consideration of, and as a condition of receiving, the payments and benefits described in Section 4, above, the Executive shall, on or promptly after the Leave Date, execute and deliver to the Company a release and covenant not to sue in the form attached hereto as Exhibit C. 7 (b) In consideration of the Executive's release and covenant not to sue which is referred to in Section 7(a), above, the Company shall, on or promptly after the Leave Date, execute and deliver to the Executive a release and covenant not to sue in the form attached hereto as Exhibit D. (c) The Company and the Executive acknowledge that the mutual releases and covenants not to sue which are described above will not affect adversely any rights which the Executive may have to (i) indemnification from the Company (whether under this Agreement or otherwise) or under director and officer liability insurance which is applicable to the Executive or (ii) any recovery under any benefit plan in which the Executive is participating as of the Leave Date. 8. No Admission of Liability. The Executive agrees that neither this Agreement nor performance hereunder constitutes an admission by the Company of any violation of any federal, state or local law, regulation, common law, of any breach of any contract, or of any other wrongdoing of any type. 9. COBRA Rights. The Executive acknowledges that the Company has advised him that pursuant to the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA"), he has the right to elect continued coverage under the Company's group health plans, at his own expense, for a period of eighteen (18) months from the earlier of (a) the Termination Date or (b) such earlier date as shall be the date of termination of the Executive's employment for purposes of COBRA. Prior to or promptly after the Termination Date, the Company will advise the Executive as to the rights, if any, which the Executive then has under COBRA in light of the benefits provided by the Company under Section 4(b), above. 10. Confidentiality of Agreement. The Executive and the Company agree that they will keep confidential, to the full extent permitted by law, the terms of this Agreement, all performance hereunder and all circumstances relating to the Executive's separation from the Company; provided, however, that the Executive and the Company may disclose the same as required by law (including, but not by way of limitation, the filing of this Agreement with the Securities and Exchange Commission), for purposes of tax reporting, pursuant to legal process, in an action to enforce this Agreement, to claim benefits under this Agreement or under Company benefit plans in which the Executive is a participant or beneficiary, to members of the Executive's immediate family, legal advisors, and to persons from whom the Executive seeks financial advice. 11. Indemnification. The Company further agrees that, if the Executive is sued individually concerning any act, omission or conduct which he undertook in his capacity as an employee, officer, director or agent of 8 the Company or any of its subsidiaries, then the Company shall defend the Executive from the claim and indemnify the Executive for any judgment, fine or settlement resulting therefrom to the same extent as is then authorized by the Company's By-Laws and/or Certificate of Incorporation for employees as of that time; provided, however, that during any period after the Leave Date, the protection provided for the Executive by the Company under this Section 11 shall in no event be less favorable to the Executive than that which was in effect immediately prior to the Leave Date. 12. Agreement Binding. In executing this Agreement, the Executive acknowledges that he has read this Agreement carefully, that he fully understands its terms and conditions, that he has been advised of his rights and has been advised to consult counsel prior to the execution hereof. The Executive intends that this Agreement shall be legally binding on him. 13. Revocation. The Executive acknowledges that he has had the opportunity to have at least twenty-one (21) days within which to decide whether or not to sign this Agreement. He further acknowledges having been given the right to revoke this Agreement by serving, within a seven (7)-day period after signing, a written notice of revocation. The Agreement shall become effective on the eighth day following its execution by the Executive. If the Executive revokes the Agreement, the Company shall have no obligation under it. 14. References. If, after the termination of the Executive's active employment with the Company, any prospective employer of the Executive requests a reference, the Company shall report only the fact that the Executive worked for the Company, the positions held and salary earned. No further information will be provided unless the Company receives a written release from the Executive or is otherwise required to do so by law. Neither the Company nor the Executive shall at any time disparage the other party. 15. Notices. All notices or other communications required or permitted hereunder shall be sufficient if in writing and delivered personally or by reputable commercial delivery service or sent by registered mail, return receipt requested, to the respective address hereinabove set forth or to any other address designated by the relevant party by notice similarly given. Such notice shall be deemed to have been given upon such delivery or three (3) days after deposit in the U.S. mail, as the case may be. 16. Assignment and Succession. 9 The rights and obligations of the Company under this Agreement shall inure to the benefit of and be binding upon its successors and assigns, and the Executive's rights and obligations hereunder shall inure to the benefit of and be binding upon his legal representatives or designated beneficiaries; provided, however, that the Executive may not assign during his lifetime any of his rights and obligations hereunder. 17. Interest If the Company fails to pay any amount provided under this Agreement within five (5) business days of the due date therefor, the Company shall pay interest on such amount at an annual rate of seven percent (7%), calculated from the original due date for such payment. 18. Entire Agreement. This Agreement contains the entire agreement between the Company and the Executive with respect to the subject matter contained herein and supersedes all prior oral or written communications relating thereto. This Agreement may not be changed or amended orally. 19. Applicable Law. This Agreement shall at all times be construed, interpreted and enforced in accordance with the laws of the State of Illinois as applicable to agreements entered into in, and to be performed entirely within, the State of Illinois. IN WITNESS WHEREOF, the Company has caused this Agreement to be signed by its duly authorized officer and the Executive has signed this Agreement as of the day and year first above written. /s/ W. Ed Tyler -------------------------------------------- W. Ed Tyler R.R. DONNELLEY & SONS COMPANY By: /s/ William L. Davis ---------------------------------------- William L. Davis Its: Chairman and Chief Executive Officer 10 Exhibit C --------- Release and Covenant Not to Sue ------------------------------- 1. The undersigned W. Ed Tyler (the "Executive"), on behalf of himself, his heirs, executors, attorneys, administrators, successors and assigns, hereby fully and forever, to the full extent permitted by law, releases and discharges R.R. Donnelley & Sons Company (the "Company") and each of its subsidiaries and affiliated companies and entities and each of their partners, principals, members, shareholders, directors, officers, trustees, employees, contractors, consultants, agents and attorneys, past, present and future, and all predecessors, successors and assigns thereof (collectively "Released Parties") from any and all claims, demands, agreements, actions, suits, causes of action, damages, injunctions, restraints and liabilities of whatever kind or nature, in law, equity or otherwise, whether now known or unknown or which have ever existed or which may now exist (except to enforce the terms of the agreement dated January _____, 1998 between the Executive and the Company (the "Agreement")), including, but not limited to, any and all claims, liabilities, demands or causes of action relating to or arising out of Executive's employment, resignation from the positions of Executive Vice President and Chief Technology Officer of the Company or separation from employment with the Company, including (but not by way of limitation) claims under Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C. (S) 2000e et al., 42 U.S.C. (S) 1981, the Civil Rights Act of 1991, the Americans with Disabilities Act, the Family and Medical Leave Act, the Age Discrimination in Employment Act (the "ADEA"), as amended by the Older Workers Benefit Protection Act, the anti-trust and restraint of trade statutes and common law, the federal and state (including, without limitation, Illinois) statutes or common law, or claims for breach of contract, for misrepresentation, for violation of any other federal, state or local statute, ordinance or regulation or common law dealing in any respect with discrimination in employment or otherwise, defamation, retaliatory or wrongful discharge under the common law of any state, infliction of emotional distress or any other tort under the common law of any state or for attorneys' fees. Executive acknowledges and agrees that this release and the covenant not to sue set forth in paragraph 3, below, are essential and material terms of the Agreement and that without such release and covenant not to sue the Agreement would not have been reached by the parties. Executive understands and acknowledges the significance and consequences of this release and the Agreement. 2. The following provisions are applicable to, and made a part of, the Agreement and the foregoing release: (a) Executive does not release or waive any right or claim that arises after the date of execution of this release which he may have under the ADEA, as amended by the Older Workers Benefits Protection Act, provided that any claim based upon the termination of his service in the positions of Executive Vice President and Chief Technology Officer or upon his separation from the Company has, for all purposes relating to this release, arisen prior to the execution of this release. (b) Executive does not waive any right to the receipt of payments and benefits not yet due and owing, whether under the Agreement or under the Company benefit and compensation plans in which Executive is a participant or beneficiary. (c) In exchange for the general release and waiver hereunder, Executive hereby acknowledges that he has received, or will receive, under the Agreement separate consideration beyond that to which he is otherwise entitled under the Company's policy or applicable law. (d) The Company has advised, and hereby again expressly advises, Executive to consult with an attorney of his choosing regarding, and prior to executing, this general release and waiver. (e) This release shall not apply to workers' compensation claims or to claims under state and federal unemployment insurance laws. 3. To the maximum extent permitted by law, the Executive covenants not to sue or to institute or cause to be instituted any kind of claim or action (except to enforce the Agreement) in any federal, state or local agency or court against any of the Released Parties relating to the matters covered by the foregoing release. 4. The Executive further acknowledges that (a) the Company has given him adequate time to review and consider this release; (b) the Executive understands that the terms of this release are legally enforceable; (c) the Executive has entered into this release freely and voluntarily and was in no manner coerced into signing it; (d) neither this release nor the discussion and negotiation leading to it are or were, in any manner, discriminatory; and (e) the Executive was, and hereby is, encouraged to discuss any questions, problems, or issues concerning this release with the Company before signing it. 5. The Executive further acknowledges that it is his intent that his waiver with regard to the ADEA fully complies with the Older Workers Benefit Protection Act, and, accordingly, he further acknowledges and agrees that (a) he has been given at least twenty-one (21) days within which to consider this release (but he may sign this release and return it to the Company before the end of those twenty-one (21) days if he elects to do so) and (b) he has the right to revoke this release in full within seven (7) calendar days after his execution hereof and that after such time this release shall become enforceable and irrevocable. If the Executive revokes this release, the Company shall have no obligation under the Agreement. IN WITNESS WHEREOF, the Executive has signed this Release and Covenant Not to Sue on the day and year written below. Date:__________________ ____________________________________ W. Ed Tyler 2 Exhibit D --------- Release and Covenant Not to Sue ------------------------------- 1. R.R. Donnelley & Sons Company (the "Company"), on behalf of itself and its subsidiaries and affiliated companies and entities, hereby fully and forever, to the full extent permitted by law, releases and discharges W. Ed Tyler (the "Executive") and his heirs, executors, attorneys, administrators, successors and assigns (collectively "Released Executive Parties") from any and all claims, demands, agreements, actions, suits, causes of action, damages, injunctions, restraints and liabilities of whatever kind or nature, in law, equity or otherwise, which have ever existed or which may now exist (except to enforce the terms of the agreement dated January _____, 1998 between the Company and the Executive (the "Agreement")), including, but not limited to, any and all claims, liabilities, demands or causes of action relating to or arising out of the Executive's employment, resignation from the positions of Executive Vice President and Chief Technology Officer of the Company or separation from employment with the Company, including (but not by way of limitation) claims under federal and state (including, without limitation, Illinois) statutes or common law, or claims for breach of contract, misrepresentation, defamation, or any other tort under the common law of any state or for attorneys' fees; provided, however, that this release and discharge does not apply to any rights or claims based upon (a) information which is not, as of the date hereof, known to the Board of Directors of the Company, the Chief Executive Officer of the Company or legal counsel for the Company, including, but not by way of limitation, information relating to possible embezzlement, fraud or other theft from the Company by the Executive, (b) criminal behavior or intentional wrongdoing by the Executive, or (c) reconciliation of business expenses of the Executive not yet fully substantiated as of the date hereof. The Company acknowledges and agrees that this release and the covenant not to sue set forth in paragraph 2, below, are essential and material terms of the Agreement and that without such release and covenant not to sue the Agreement would not have been reached by the parties. The Company understands and acknowledges the significance and consequences of this release and the Agreement. 2. To the maximum extent permitted by law, the Company covenants not to sue or to institute or cause to be instituted any kind of claim or action (except to enforce the Agreement) in any federal, state or local agency or court against any of the Released Executive Parties relating to the matters covered by the foregoing release. IN WITNESS WHEREOF, the Company has signed this Release and Covenant Not to Sue on the day and year written below. Date:__________________________ R.R. DONNELLEY & SONS COMPANY By:_______________________________________ Its:______________________________________ EX-21 5 RRD SUBSIDIARIES Form 10-K Year-Ended 12/31/97 Exhibit 21 SUBSIDIARIES OF R. R. DONNELLEY & SONS COMPANY (As of March 2, 1998) Subsidiaries of R. R. Donnelley & Sons Company Place of Incorporation - ---------------------------------------------- ----------------------
77 Capital Corporation Delaware 77 Capital Partners L.P. Delaware Allentown S.H. Leasing Company Delaware C & E Transport, Inc. Delaware Caslon Incorporated Delaware Chemical Equipment S.H. Leasing Company Delaware DPA Printing Company, SP. Zo.o. Poland Donnelley Caribbean Graphics, Inc. Delaware Donnelley Satellite Services, Limited Delaware Donnelley Satellite Graphics, Limited Delaware Editorial Lord Cochrane, S.A. Chile European-American Ink Sales Corporation Iowa FFH Corporation Delaware HCI Holdings Delaware Haddon Craftsmen, Inc. Delaware Heritage Preservation Corporation South Carolina Impresora Donneco Internacional, S.A. de C.V. Mexico Kittyhawk S.H. Leasing Company Delaware
Page 2 Form 10-K Year-Ended 12/31/97 Exhibit 21 Subsidiaries of R. R. Donnelley & Sons Company Place of Incorporation - ----------------------------------------------- ----------------------
Housenet, Inc. Maryland Laboratorio Lito Color S.A. de C.V. Mexico M/B Companies, Inc. Iowa Mobium Corporation Delaware Pan Associates L.P. Delaware R. R. Donnelley Far East, Limited Delaware R. R. Donnelley Deutschland GmbH Frankfort R. R. Donnelley Printing (France) SARL France R. R. Donnelley Financial (Hong Kong) Limited Hong Kong R. R. Donnelley Limited United Kingdom R. R. Donnelley Mendota, Inc. Delaware R. R. Donnelley Marketing Services Group Limited United Kingdom R. R. Donnelley Nederland B.V. The Netherlands R. R. Donnelley Norwest Inc. Oregon R. R. Donnelley Printing Company Delaware R. R. Donnelley Printing Company L.P. Delaware R. R. Donnelley Receivables, Inc. Nevada R. R. Donnelley Sales Corporation Barbados R. R. Donnelley Seymour, Inc. New Jersey R. R. Donnelley U.K. Marketing Services Limited United Kingdom
Page 3 Form 10-K Year-Ended 12/31/97 Exhibit 21 Subsidiaries of R. R. Donnelley & Sons Company Place of Incorporation - ---------------------------------------------- ----------------------
R. R. Donnelley (Chile) Holdings, Inc. Delaware R. R. Donnelley (Europe) Limited Delaware R. R. Donnelley (India) Pvt Ltd India R. R. Donnelley (Santiago) Holdings Inc. y Compania Chile R. R. Donnelley (Mauritius) Holdings Ltd Mauritius R. R. Donnelley (Mexico) S.A. de C.V. Mexico R. R. Donnelley (Santiago), Inc. Delaware R. R. Donnelley (U.K.) Limited United Kingdom Shenzhen Donnelley Bright Sun Printing Co. Republic of China Siegwerk Sales & Services L.P. Delaware Wyoming Avenue Holdings, Inc. Delaware Winfield Avenue Holdings, Inc. Delaware
EX-23 6 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS Exhibit No. 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our reports dated January 22, 1998, included in this Annual Report of R.R. Donnelley & Sons Company on Form 10-K for the year ended December 31, 1997, into the Company's previously filed Registration Statements on Form S-8 (File Nos. 33-19803, 33-43632, 33-49431, 33-49809, 33-52805 and 33-61387), Form S-3 (File Nos. 33-57807 and 333-44303) and previously filed post-effective amendments thereto. ARTHUR ANDERSEN LLP Chicago, Illinois March 4, 1998 EX-27 7 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 47,814 0 830,923 16,259 201,402 1,146,571 4,214,765 2,426,649 4,134,166 812,622 1,153,226 0 0 320,962 1,270,535 4,134,166 4,850,033 4,850,033 3,899,428 4,481,245 (25,742) 0 90,765 303,765 97,240 206,525 75,894 0 0 130,631 0.90 0.89
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