-----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, T/EzCY5817Dthqm9Ec+p48FKa6rRh1hbTbFlN3JfxxrXTfiAXpdmXyvvzIJeyO7/ 6vrxsuoiFPYxq3KP2SpxQw== 0000947871-97-000112.txt : 19970701 0000947871-97-000112.hdr.sgml : 19970701 ACCESSION NUMBER: 0000947871-97-000112 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970331 FILED AS OF DATE: 19970630 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SULLIVAN COMMUNICATIONS INC /DE/ CENTRAL INDEX KEY: 0000856710 STANDARD INDUSTRIAL CLASSIFICATION: COMMERCIAL PRINTING [2750] IRS NUMBER: 621395968 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 033-97090-01 FILM NUMBER: 97633083 BUSINESS ADDRESS: STREET 1: 225 HIGH RIDGE RD CITY: STAMFORD STATE: CT ZIP: 06905 BUSINESS PHONE: 6153770377 MAIL ADDRESS: STREET 1: 100 WINNERS CIRCLE CITY: BRENTWOOD STATE: TN ZIP: 37027 FORMER COMPANY: FORMER CONFORMED NAME: SULLIVAN HOLDINGS INC DATE OF NAME CHANGE: 19920703 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SULLIVAN GRAPHICS INC CENTRAL INDEX KEY: 0000856709 STANDARD INDUSTRIAL CLASSIFICATION: COMMERCIAL PRINTING [2750] IRS NUMBER: 161003976 STATE OF INCORPORATION: NY FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 033-97090 FILM NUMBER: 97633084 BUSINESS ADDRESS: STREET 1: 100 WINNERS CIRCLE CITY: BRENTWOOD STATE: TN ZIP: 37027 BUSINESS PHONE: 6153770377 MAIL ADDRESS: STREET 1: 100 WINNERS CIRCLE CITY: BRENTWOOD STATE: TN ZIP: 37027 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended March 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 33-97090 SULLIVAN COMMUNICATIONS, INC. (Exact name of registrant as specified in its charter) Delaware 62-135968 (State or other jurisdiction of (I.R.S. employer identification number) incorporation or organization) 225 High Ridge Road Stamford, Connecticut 06905 (203) 977-8101 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) SULLIVAN GRAPHICS, INC. (Exact name of registrant as specified in its charter) New York 16-1003976 (State or other jurisdiction of (I.R.S. employer identification number) incorporation or organization) 100 Winners Circle Brentwood, Tennessee 37027 (615) 377-0377 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants' knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X Sullivan Communications, Inc. has 123,889 shares outstanding of its Common Stock, $.01 Par Value, as of May 31, 1997 (all of which are privately owned and not traded on a public market). DOCUMENTS INCORPORATED BY REFERENCE None INDEX Page Referenced Form 10-K --------- PART I ITEM 1. BUSINESS...................................................... 2 ITEM 2. PROPERTIES.................................................... 9 ITEM 3. LEGAL PROCEEDINGS............................................. 9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........................................... 10 ITEM 6. SELECTED FINANCIAL DATA....................................... 10 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS .......................... 14 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 26 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........................... 58 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.............................. 58 ITEM 11. EXECUTIVE COMPENSATION........................................ 59 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................................... 64 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 65 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K...................................................... 67 SIGNATURES.................................................... 77 PART I Special Note Regarding Forward Looking Statements This Annual Report on Form 10-K (the "Report") contains forward-looking statements within the meaning of Section 21E of the Securities Act of 1934. Discussions containing such forward-looking statements may be found in Items 1, 3 and 7 hereof, as well as within this Report generally. In addition, when used in this Report, the words "believes," "anticipates," "expects" and similar expressions are intended to identify forward-looking statements. Such statements 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 Sullivan Communications, Inc. ("Communications"), together with its wholly-owned subsidiary, Sullivan Graphics, Inc. ("Graphics"), collectively (the "Company"), including fluctuations in the cost of paper and other raw materials used by the Company, changes in the advertising and printing markets, actions by the Company's competitors, particularly with respect to pricing, the financial condition of the Company's customers, the financial condition and liquidity of the Company, the general condition of the United States economy, demand for the Company's products and services and the matters set forth in this Report generally. Consequently, such forward- looking statements should be regarded solely as the Company's current plans, estimates and beliefs. 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. ITEM 1. BUSINESS General The Company is a successor to a business that commenced operations in 1926, and is one of the largest national diversified commercial printers in North America with ten printing plants in eight states and Canada and fifteen prepress facilities located throughout the United States. The Company operates primarily in two business sectors of the commercial printing industry: printing (which accounted for approximately 86% of total sales during the fiscal year ended March 31, 1997 ("Fiscal Year 1997")) and digital imaging and prepress services conducted through its American Color division (which accounted for approximately 14% of total sales in Fiscal Year 1997). Partnerships affiliated with Morgan Stanley, Dean Witter, Discover & Co. currently own 66.8% of the outstanding common stock and 72% of the outstanding preferred stock of Communications. On April 8, 1993 (the "Acquisition Date"), pursuant to an Agreement and Plan of Merger dated March 12, 1993, as amended (the "Merger Agreement"), between Communications and SGI Acquisition Corp. ("Acquisition Corp."), Acquisition Corp. was merged with and into Communications (the "1993 Acquisition"). Acquisition Corp. was formed by The Morgan Stanley Leveraged Equity Fund II, L.P., certain institutional investors and certain members of management (the "Purchasing Group") for the purpose of acquiring a majority interest in Communications. Acquisition Corp. acquired a substantial and controlling majority interest in Communications in exchange for $40 million in cash. In the 1993 Acquisition, Communications continued as the surviving corporation and the separate corporate existence of Acquisition Corp. was terminated. On August 15, 1995, the Company completed a merger transaction (the "Shakopee Merger") with Shakopee Valley Printing Inc. ("Shakopee"). Shakopee was formed to effect the purchase of certain assets and assumption of certain liabilities of Shakopee Valley Printing, a division of Guy Gannett Communications. On December 22, 1994, pursuant to an Agreement for the Purchase of Assets between Guy Gannett Communications (the "Seller") and Shakopee (the "Buyer"), the Seller agreed to sell (effective at the close of business on December 22, 1994) certain assets and transfer certain liabilities of Shakopee Valley Printing to the Buyer for a total purchase price of approximately $42.6 million, primarily financed through the issuance of 35,000 shares of common stock and bank borrowings. The 35,000 shares were purchased by Morgan Stanley Capital Partners III, L.P., Morgan Stanley 2 Capital Investors, L.P. and MSCP III 892 Investors, L.P. (collectively, the "MSCP III Entities"), together with First Plaza Group Trust and Leeway & Co. The general partner of each of the MSCP III Entities is affiliated with Morgan Stanley, Dean Witter, Discover & Co. In addition, the other stockholders of Shakopee were also stockholders of the Company. On March 11, 1996, Graphics sold its 51% interest in National Inserting Systems, Inc. ("NIS") for approximately $2.5 million in cash and a note for approximately $0.2 million. The proceeds from the sale were used to repay indebtedness under the Bank Credit Agreement (as defined below). On March 12, 1996, Graphics acquired the assets of Gowe, Inc., a Medina, Ohio regional printer of newspapers, T.V. books and retail advertising inserts and catalogs ("Gowe") for approximately $6.7 million in cash and assumption of certain liabilities of Gowe, Inc. (the "Gowe Acquisition"). During March 1996, the Company completed the construction of and start-up of a plant in Hanover, Pennsylvania ("Flexi-Tech"). Flexi-Tech is dedicated to the production of commercial flexi books (a form of advertising inserts) serving various segments of the retail advertising market and the production of T.V. listing guides serving the newspaper market. In February of Fiscal Year 1997, the Company made a strategic decision to shut down the operations of its wholly-owned subsidiary Sullivan Media Corporation ("SMC"). SMC's shut down has been accounted for as a discontinued operation, and accordingly, SMC's operations are segregated in the Company's consolidated financial statements. Sales, costs of sales and selling, general and administrative expenses attributable to SMC for the fiscal year ended March 31, 1996 ("Fiscal Year 1996") and the fiscal year ended March 31, 1995 ("Fiscal Year 1995") have been reclassified to discontinued operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Discontinued Operations" and note 5 of the Company's consolidated financial statements. Market data used throughout this report was obtained from industry publications and internal Company estimates. While the Company believes such information is reliable, the accuracy of such information has not been independently verified and cannot be guaranteed. Printing The Company's printing business, which accounted for approximately 86% of the Company's sales in Fiscal Year 1997, produces retail advertising inserts, comics (newspaper Sunday comics, comic insert advertising and comic books), and other publications. Retail Advertising Inserts (80% of printing sales in Fiscal Year 1997). The Company believes that it is one of the largest printers of retail advertising inserts in the United States. Retail advertising inserts are preprinted advertisements, generally in color, that display products sold by a particular retailer or manufacturer. Advertising inserts are used extensively by many retailers and are an important and cost effective means of advertising for these merchants. Advertising inserts are primarily distributed through insertion in newspapers but are also distributed by direct mail or in-store by retailers. They generally advertise for a specific, limited sale period. The Company prints advertising inserts for approximately 310 retailers. Comics (14% of printing sales in Fiscal Year 1997). The Company believes that it is one of the largest printers of comics in the United States. The Company prints Sunday comics for approximately 330 newspapers in the United States and Canada and prints the majority of the annual comic book requirements of Marvel Entertainment Group, Inc. ("Marvel"). Other Publications (6% of printing sales in Fiscal Year 1997). The Company prints local newspapers, T.V. guide listings and other publications. 3 Printing Production There are three printing processes that may be used to produce advertising inserts and newspaper supplements: offset lithography (heatset and cold), rotogravure and flexography. The Company principally uses heatset offset and flexographic web printing equipment in its printing business. The Company owns the majority of its printing equipment, including, at May 31, 1997, 36 web heatset offset presses, 13 flexographic presses and 5 multi-unit web coldset offset presses. Most of the Company's advertising inserts and all of its other publications and comic books are printed using the offset process. Some advertising inserts and substantially all of the Company's newspaper Sunday comics and comic insert advertising are printed using the flexographic process. In the offset process, images are distinguished chemically from non-image areas of a metal plate and transferred from the plate to a rubber blanket and then to the paper surface; furthermore, in the heatset offset process, the printed web goes through an oven which dries the solvents from the ink, thereby setting the ink on the paper. In the cold offset process, the ink solvents are absorbed into the paper. Because heatset offset presses can print on a wide variety of papers and produce sharper reproductions, the heatset offset process provides a more colorful and attractive product than cold offset presses. The flexographic process differs from offset printing in that it utilizes flexible plates and rapid-drying, water-based (as opposed to solvent-based) inks. The flexographic image area results from a raised surface on a polymer plate which is transferred directly to the paper surface. Flexography is used extensively in printing high quality consumer goods packaging. The Company's flexographic printing generally provides vibrant color reproduction at lower cost than heatset offset printing. The strengths of flexography compared with the rotogravure and offset processes are faster press set up times, brighter colors, reduced paper waste, reduced energy use and maintenance costs, and environmental advantages due to the use of water-based inks. Faster set up times make the process suited to commercial customers with shorter runs and extensive regional versioning. In addition to advertising insert capacity, certain equipment parameters are critical to competing in the advertising insert market, including cut-off length, folding capabilities and in-line finishing. Cut-off length is one of the determinants of the size of the printed page. Folding capabilities for advertising inserts must include a wide variety of page sizes, page counts and special paper folding effects. Finally, many advertising inserts require gluing or stitching of the product, adding cards, trimming and numbering. These production activities generally are done in-line with the press to meet the expedited delivery schedules and pricing required by many customers. The Company believes that its mix and configuration of presses and press services allows for efficient tailoring of printing services to customers' product needs. American Color The Company's digital imaging and prepress services business is conducted by its American Color division, which the Company believes is one of the largest full-service providers of digital imaging, prepress and color separation services in the United States and a technological leader in its industry. American Color commenced operations in 1975 and accounted for approximately 14% of the Company's sales in Fiscal Year 1997. American Color assists its customers in the capture, manipulation, transmission and distribution of images. The majority of its work leads to the production of four-color separations in a format appropriate for use by printers. In recent years, technological advances have made it possible to replace largely manual and photography-based production methods with computer-based, electronic means for producing four-color films faster and at lower costs. American Color makes page changes, including typesetting, and combines digital page layout information with electronically scanned and color- corrected four-color images. From these digital files; proofs, final corrections and, finally, four-color films or digital output are produced for each advertising or editorial page. The final four-color films or digital output enable printers to prepare plates for each color resulting in the appearance of full color in the printed image. American Color has been a leader in implementing these new technologies, which has enabled American Color to reduce unit costs and effectively service the increasingly complex demands of its customers more quickly than many 4 of its competitors and has also resulted in an expanded customer base. In the late 1980s, the Company installed a nationwide data communications network. This was initially accomplished via a satellite system, but has been converted to a telecommunications based network offering greater flexibility at a reduced cost. This wide area network links American Color's locations with the Company's printing operations, as well as to several customer sites. The system reduces communication time and enables American Color to better serve those customers with time-sensitive production requirements. This system also allows American Color to utilize its offices in different locations to service business generated in other areas, thereby improving customer service and response time while increasing capacity utilization among its various facilities. In addition, American Color has been one of the leaders in the integration of electronic page make-up, microcomputer-based design and layout and digital cameras into prepress production. The Company has capitalized on these technological changes and has added additional revenue sources from digital image storage, telecommunications, design and layout, consulting and training services, facilities management (operating digital imaging and prepress service facilities at a customer location), and software and data management. The digital imaging and prepress services industry is highly fragmented, primarily consisting of smaller local and regional companies, with only a few national full-service digital imaging and prepress companies such as American Color, none of which has a significant nationwide market share. Many smaller digital imaging and prepress companies have left the industry in recent years due to their inability to keep pace with technological advances in the industry. In April 1995, the Company implemented a plan for its American Color division designed to improve productivity, increase customer service and responsiveness, and provide increased growth in this business. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Restructuring Costs and Other Special Charges" and note 18 to the Company's consolidated financial statements. Competitive Advantages and Strategy Competitive Advantages. The Company believes that it has the following competitive advantages in its printing and digital imaging and prepress services businesses: Modern Equipment. The Company believes that its web heatset offset and flexographic web printing equipment is among the most advanced in the industry and that the average age of its equipment is significantly less than the majority of its regional competitors and is comparable to its major national competitors. The Company is also committed to a comprehensive, long-term maintenance program which not only enhances the reliability of its production equipment, but also extends the life of the machines. It also believes that its digital imaging and prepress equipment is significantly more advanced than many of its smaller regional competitors, many of whom have not incorporated digital prepress technologies to the same extent as the Company, nor adopted an open systems environment which allows greater flexibility and more efficient maintenance. Strong Customer Base. The Company provides printing services to a diverse base of customers, including approximately 310 retailers and approximately 330 newspapers in the United States and Canada. The customer base includes a significant number of the major national retailers and larger newspaper chains as well as numerous smaller regional retailers. The Company's consistent focus on providing high quality printing products and strong customer service at competitive prices has resulted in long-term relationships with many of these customers. American Color's customer base includes large and medium-sized customers in the retail, publishing and catalog businesses, many of whom have long-term relationships with the Company. Although the digital imaging and prepress services business has generally been on a spot bid basis in the past, the Company has been successful in increasing the proportion of its business under long-term contracts. Competitive Cost Structure. The Company has reduced the variable and fixed costs of production at its printing facilities over the last three years and believes it is well positioned to maintain its competitive cost structure 5 in the future due to economies of scale. The Company has also reduced both labor and material costs (the principal variable production costs) in its digital imaging and prepress services business over the past several years, primarily through the adoption of new digital prepress production methodologies. Strong Management Team. Since the 1993 Acquisition, the Company has strengthened its printing management group by hiring experienced managers with a clear focus on growth and continued cost reduction, resulting in an improved cost structure and a well-defined strategy for future expansion. The Company also has strengthened its management group in its digital imaging and prepress services business, filling a number of senior, regional and plant management positions with individuals who the Company believes will manage the digital imaging and prepress services business for growth and profitability and will continue to upgrade its capabilities. National Presence. The Company's nine printing plants in the United States and one plant in Canada provide the Company with distribution efficiencies, strong customer service, flexibility and short turnaround times, all of which are instrumental in the Company's continued success in servicing its large national and regional retail accounts. The Company's expanded sales and marketing groups provide greater customer coverage and enable it to more successfully penetrate regional markets. The Company believes that its fifteen digital imaging and prepress facilities provide it with contingency capabilities, increased capacity during peak periods, access to top quality internal technical personnel throughout the country, short turnaround time and other customer service advantages. Strategy. The Company's objective is to increase profitability by growing its revenues, increasing its market share and reducing costs. The Company's strategy to achieve this objective is as follows: Grow Unit Volume. Management believes that the Company's level of national sales coverage, when coupled with its significant industry experience and customer-focused sales force, will result in unit growth. In an effort to stimulate unit volume growth, the Company has strengthened and expanded its printing sales management group. Unit volume growth is also expected to result from continued capital expansion and selective printing acquisitions. In addition, in its digital imaging and prepress services business, the Company has expanded its sales force, strengthened training, more closely focused its marketing efforts on new, larger customers and implemented a revised incentive program. Continue to Improve Product Mix. The Company intends to increase its share of the retail advertising insert market. In addition, the Company expects to continue to adjust the mix of its customers and products within the retail advertising insert market to those that are more profitable and less seasonable and to maximize the use of the Company's equipment. The Company is also continuing expansion of its printing facilities' capabilities for in-plant prepress and postpress services. The Company's digital imaging and prepress services business will continue to focus on high value-added new business opportunities, particularly large-scale projects that will best utilize the breadth of services and technologies the Company has to offer. Additionally, the Company will continue to pursue large facilities management opportunities as well as national and large regional customers that require more sophisticated levels of service and technologies. Continue to Reduce Manufacturing Costs and Improve Quality. The Company intends to further reduce its production costs at its printing facilities through its Total Quality Management Process, an ongoing cost reduction and continuous quality improvement process. Additionally, the Company plans to continue to maximize scale advantages in the purchasing, technology and engineering areas. The Company also intends to continue to gain variable cost efficiencies in its digital imaging and prepress services business by using its technical resources to improve digital prepress workflows at its various facilities. The Company also believes it will be able to reduce its per unit technical, sales and management costs as its sales volumes increase in this business. Continue to Make Opportunistic Acquisitions. An integral part of the Company's long-term growth strategy includes a plan to selectively assess and acquire other printing and digital imaging and prepress services companies that the Company believes will enhance its leadership position in these industries. 6 Customers and Distribution Customers. The Company sells its printing products and services to a large number of customers, primarily retailers and newspapers, and all of the products are produced in accordance with customer specifications. The Company performs a portion of its printing work, primarily the printing of Sunday comics and comic books, under long-term contracts with its customers. The contracts vary in length and many of the contracts automatically extend for one year unless there has been notice to the contrary from either of the contracting parties within a certain number of days before the end of any term. For the balance of its printing work, the Company obtains varying time commitments from its customers ranging from job to job to annual allocations. Printing prices are generally fixed during such commitments; however, the Company's standard terms of trade call for the pass through of changes in the cost of raw materials, primarily paper and ink. American Color's customers consist of retailers, magazine publishers, newspaper publishers, printers, catalog sales organizations, advertising agencies and direct mail advertisers. Its customers typically have a need for high levels of technical expertise, short turnaround times and customer service. In addition to its historical regional customer base, American Color is increasingly focused on larger, national accounts that have a need for a broad range of fully integrated services and communication capabilities requiring leading edge technology. This includes an increasing amount of contractual business related to facilities management arrangements with customers, which contracts typically extend from three to five years in length. The printing and American Color divisions have historically had certain common customers and their ability to cross-market is an increasingly valuable tool as desktop publishing, electronic digital imaging and facilities management become more important to their customers. This enables the Company to provide more comprehensive solutions to customers' digital imaging and prepress and printing needs. New customers of either the printing or American Color divisions often become customers of both businesses. During Fiscal Year 1997, approximately 39% of the digital imaging and prepress sector's sales were to customers of the Company's printing sector. No single customer accounted for sales in excess of 10% of the Company's consolidated sales in Fiscal Year 1997. The Company's top ten customers accounted for approximately 35% of consolidated sales in Fiscal Year 1997. Distribution. The Company distributes its printing products primarily by truck to customer designated locations, primarily newspapers. Costs of distribution are generally paid by the customers, and most shipping is by common carrier. American Color generally distributes its products by courier or overnight express, or other methods of personal delivery or electronic transmission. Competition Commercial printing in the United States is a large, highly fragmented, capital-intensive industry and the Company competes with numerous national, regional and local printers. Customer preferences for larger printers with a greater range of services and more flexibility, capital requirements and competitive pricing pressures have led to a trend of industry consolidation in recent years. The Company believes that competition in the printing business is based primarily on quality, customer service, price and timeliness of delivery. The advertising insert business is a large, fragmented industry in which the Company competes for national accounts with several large national printers, several of whom are larger and better capitalized than the Company. In addition, the Company also competes with numerous regional printers for the printing of advertising inserts. Although the Company faces competition principally from one other company (Big Flower Press Holdings, Inc.) in the printing of Sunday newspaper comics in the United States, there are numerous newspapers that print their own Sunday comics. The Company's other publication business competes with many large national and regional commercial printers. 7 American Color competes with numerous digital imaging and prepress service firms on both a national and regional basis. The industry is highly fragmented, primarily consisting of smaller local and regional companies, with only a few national full-service digital imaging and prepress companies such as American Color, none of which has a significant nationwide market share. Many smaller digital imaging and prepress companies have left the industry in recent years due to their inability to keep pace with technological advances required to service increasingly complex customer demands. The Company believes that the digital imaging and prepress services sector will continue to be subject to high levels of ongoing technological change and the need for capital expenditures to keep up with such change. Raw Materials The primary raw materials used in the Company's printing business are paper and ink. The Company purchases substantially all of its ink and related products under a long-term ink supply contract between the Company and CPS Corp. Throughout Fiscal Year 1995 and the majority of Fiscal Year 1996, the printing industry experienced substantial increases in the cost of paper. In late Fiscal Year 1996 and throughout Fiscal Year 1997, however, the overall cost of paper declined. Management expects that as a result of the Company's strong relationship with key suppliers that its material costs will remain competitive within the industry. In accordance with industry practice, the Company generally passes through increases in the cost of paper to its customers in the cost of its printed products while decreases in costs generally result in lower prices to customers. The primary inputs in prepress services processes are film and proofing materials. In both of the Company's business sectors, there is an adequate supply of the necessary materials available from multiple vendors. The Company is not dependent on any single supplier and has had no significant problems in the past obtaining necessary materials. Backlog Because the Company's printing, digital imaging and prepress services products are required to be delivered soon after final customer orders are received, the Company does not experience any backlog of unfilled customer orders. Employees As of April 30, 1997, the Company had a total of approximately 2,880 employees, of which approximately 200 employees are represented by a collective bargaining agreement that will expire on December 31, 2001. The Company considers its relations with its employees to be excellent. Governmental and Environmental Regulations The Company is subject to regulation under various federal, state and local laws relating to employee safety and health, and to the generation, storage, transportation, disposal and emission into the environment of hazardous substances. The Company believes that it is in material compliance with such laws and regulations. Although compliance with such laws and regulations in the future is likely to entail additional capital expenditures, the Company does not anticipate that such expenditures will be material. See "Legal Proceedings - Environmental Matters." 8 ITEM 2. PROPERTIES The Company operates in 25 locations in 15 states and Canada. The Company owns seven printing plants in the United States and one in Canada and leases two printing plants in California and Pennsylvania. The American Color division of the Company has 15 production locations, 13 of which are leased by American Color. The American Color division also operates digital imaging and prepress facilities on the premises of several of its customers ("facilities management"). In addition, the Company maintains one small executive and two divisional headquarter facilities, two of which are leased and one which is owned. The Company believes that its plants and facilities are adequately equipped and maintained for present and planned operations. ITEM 3. LEGAL PROCEEDINGS The Company has been named as a defendant in several legal actions arising from its normal business activities. In the opinion of management, any liability that may arise from such actions will not have a material adverse effect on the financial condition of the Company. Environmental Matters Graphics, together with over 300 other persons, has been designated by the U.S. Environmental Protection Agency as a potentially responsible party (a "PRP") under the Comprehensive Environmental Response Compensation and Liability Act ("CERCLA," also known as "Superfund") at one Superfund site. Although liability under CERCLA may be imposed on a joint and several basis and the Company's ultimate liability is not precisely determinable, the PRPs have agreed that Graphics' share of removal costs is approximately 0.46% and therefore Graphics believes that its share of the anticipated remediation costs at such site will not be material to its business or financial condition. Based upon an analysis of Graphics' volumetric share of waste contributed to the site and the agreement among the PRPs, the Company has a reserve of approximately $0.1 million in connection with this liability on its consolidated balance sheet at March 31, 1997. The Company believes this amount is adequate to cover such liability. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders of the registrant during the fourth quarter of Fiscal Year 1997. 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information There is no established public market for the common stock of either Communications or Graphics. Holders There are approximately 89 shareholders of Communications' common stock. Communications is the sole shareholder of Graphics' common stock. Dividends There have been no cash dividends declared on any class of common equity for the two most recent fiscal years. ITEM 6. SELECTED FINANCIAL DATA Set forth below is selected financial data for and as of the year ended December 31, 1992 (pre-1993 Acquisition), for and as of the three months ended March 31, 1993 (pre-1993 Acquisition) and for and as of the fiscal years ended March 31, 1994, 1995, 1996 and 1997 (post-1993 Acquisition). The balance sheet data as of December 31, 1992 and March 31, 1993, 1994, 1995, 1996 and 1997 and the statement of operations data for the year ended December 31, 1992, the three months ended March 31, 1993, and the fiscal years ended March 31, 1994, 1995, 1996 and 1997 are derived from the audited consolidated financial statements for such periods and at such dates. The selected financial data below also reflects the Company's discontinued coupon free standing insert ("FSI") operation and it's discontinued wholly-owned subsidiary, SMC. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Discontinued Operations" and note 5 of the Company's consolidated financial statements. As a result of the 1993 Acquisition, the Company's consolidated financial statements for the periods subsequent to March 31, 1993 are presented on the Company's new basis of accounting, while the consolidated financial statements for March 31, 1993 and December 31, 1992 are presented on the Company's historical cost basis of accounting. The consolidated results of operations of the Company for the fiscal years ended March 31, 1994, 1995, 1996 and 1997 are not directly comparable to the consolidated pre-1993 Acquisition results of operations due to the effects of the 1993 Acquisition. In connection with the 1993 Acquisition, the Company elected to change its fiscal year end from December 31 to March 31 beginning March 31, 1993 in order to have the Company's fiscal year more closely match the Company's operating cycle. This change was made on the effective date of the 1993 Acquisition; accordingly, the three-month period ended March 31, 1993 constituted a transition period. This data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements appearing elsewhere in this annual report. 10 SELECTED FINANCIAL DATA SULLIVAN COMMUNICATIONS, INC.
Post-1993 Acquisition (a) Pre-1993 Acquisition (b) -------------------------------------- ------------------------ Three Months Ended Year Ended Fiscal Year Ended March 31, March 31, December 31, -------------------------------------- 1997 1996 1995(c) 1994 1993(d) 1992 ---- ---- ------- ---- ------- ---- Statement of Operations Data: (dollars in thousands) Sales $524,551 529,523 433,198 414,673 101,601 395,420 Cost of sales 459,880 465,110 370,267 369,520 95,078 357,831 -------- ------- ------- ------- ------- ------- Gross profit 64,671 64,413 62,931 45,153 6,523 37,589 Selling, general and administrative expenses (e) 51,418 44,164 41,792 39,343 10,047 40,661 Restructuring costs and other special charges (f) 2,881 7,533 -- -- -- -- Gain from curtailment and establishment of defined benefit pension plans, net (g) -- -- (3,311) -- -- -- -------- ------- ------- ------- ------- ------- Operating income (loss) 10,372 12,716 24,450 5,810 (3,524) (3,072) Interest expense, net 36,132 32,425 25,334 23,737 6,862 27,021 Other expense (income) 245 1,722 985 2,369 204 3,793 Income tax expense (benefit) 2,591 4,874 2,552 2,380 (3,848) (14,601) -------- ------- ------- ------- ------- ------- Loss from continuing operations before extraordinary items and cumulative effect of changes in accounting principles (28,596) (26,305) (4,421) (22,676) (6,742) (19,285) -------- ------- ------- ------- ------- ------- Discontinued operations: (h) Loss from operations, net of tax (1,557) (1,364) (912) (23,272) (1,897) (3,689) Estimated (loss) on shut down and gain on settlement, net of tax (1,550) 2,868 18,495 (38,412) -- -- Loss on early extinguishment of debt (i) -- (4,526) -- -- -- -- Cumulative effect of changes in accounting principles, net of tax (j) -- -- -- -- 646 (4,436) -------- ------- ------- ------- ------- ------- Net (loss) income $(31,703) (29,327) 13,162 (84,360) (7,993) (27,410) ======== ======= ======= ======= ======= ======= Balance Sheet Data (at end of period): Cash and cash equivalents $ 0 0 4,635 8,839 7,129 2,167 Working capital (deficit) (8,598) 9,612 4,958 6,956 (17,327) (4,138) Total assets 333,975 351,181 328,368 305,521 274,812 271,219 Long-term debt and capitalized leases, including current installments (k) 312,309 297,617 258,201 250,439 245,382 247,362 Stockholders' deficit (76,318) (44,396) (14,970) (45,485) (85,194) (77,762) Other Data: Net cash provided (used) by operating activities $ 24,313 (4,187) 30,510 (27,329) 11,437 11,831 Net cash used by investing activities (10,997) (24,436) (17,580) (1,332) (4,500) (10,144) Net cash (used) provided by financing activities (13,312) 23,982 (17,527) 23,113 (1,980) (12,939) Capital expenditures (including lease obligations entered into) 37,767 28,022 20,415 15,722 4,888 12,029 EBITDA (l) $ 46,972 46,847 51,719 33,068 4,080 34,517
11 NOTES TO SELECTED FINANCIAL DATA (a) References to "post-1993 Acquisition" refer to the successor company that resulted from the 1993 Acquisition. The 1993 Acquisition was accounted for as a purchase. As a result of the 1993 Acquisition, Communications' consolidated financial statements for the periods subsequent to March 31, 1993 are presented on Communications' new basis of accounting, while the consolidated financial statements for March 31, 1993 and December 31, 1992 are presented on Communications' historical cost basis of accounting. The consolidated results of operations of Communications for the post-1993 Acquisition periods are not directly comparable to the consolidated pre-1993 Acquisition results of operations due to the effects of the 1993 Acquisition and related refinancing. (b) References to "pre-1993 Acquisition" refer to the predecessor company that existed before the 1993 Acquisition. (c) On August 15, 1995, Shakopee was merged with and into Graphics. The merger has been accounted for as a combination of entities under common control (similar to a pooling-of-interests), and accordingly, the consolidated financial statements give retroactive effect to the Shakopee Merger and include the combined operations of Communications and Shakopee subsequent to December 22, 1994 (the date on which Shakopee became under common control with the Company). Shakopee's financial results are not reflected in periods prior to December 22, 1994 as these periods were prior to common control ownership. (d) In connection with the 1993 Acquisition, the Company elected to change its fiscal year end from December 31 to March 31 beginning March 31, 1993 in order to have the Company's fiscal year more closely match the Company's operating cycle. This change was made on the effective date of the 1993 Acquisition; accordingly, the three-month period ended March 31,1993 constituted a transition period. (e) Fiscal Year 1997 selling, general and administrative expenses include $2.5 million of non-recurring employee termination expenses (including $1.9 million related to the resignation of the Company's Chief Executive Officer--see note 20 to the Company's consolidated financial statements). (f) In April 1995, the Company implemented a restructuring plan for its American Color division which was designed to improve productivity, increase customer service and responsiveness, and provide increased growth in the business. The Company recognized $0.9 million and $4.1 million of costs under such plan in Fiscal Year 1997 and Fiscal Year 1996, respectively. In addition, the Company recorded $1.9 million and $3.4 million of other special charges related to asset write-offs and write-downs in its Print and American Color divisions in Fiscal Year 1997 and Fiscal Year 1996, respectively (see note 18 to the Company's consolidated financial statements). (g) In October 1994, the Company amended its defined benefit pension plans, which resulted in the freezing of additional defined benefits for future services under the plans effective January 1, 1995. The Company recognized a curtailment gain of $3.7 million as a result of freezing such benefits. Also in October 1994, the Board of Directors approved a new Supplemental Executive Retirement Plan ("SERP"), which is a defined benefit plan, for certain key executives. The Company recognized a $0.4 million expense associated with the establishment of the SERP. (h) In February of Fiscal Year 1997, the Company made a strategic decision to shut down the operation of its wholly-owned subsidiary SMC. SMC's shut down has been accounted for as a discontinued operation, and accordingly, SMC's operations are segregated in the Company's consolidated financial statements. Sales, costs of sales and selling, general and administrative expenses attributable to SMC for Fiscal Years 1997, 1996 and 1995 have been reclassified to discontinued operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Discontinued Operations" and note 5 of the Company's consolidated financial statements. 12 On February 16, 1994, the Company assigned the coupon FSI contracts of its subsidiary, Sullivan Marketing, Inc. ("SMI"), to News America FSI, Inc. ("News America"). In June 1994, the Company recorded income from the settlement of a lawsuit entitled Sullivan Marketing, Inc. and Sullivan Graphics, Inc. v. Valassis Communications, Inc., News America FSI Inc. and David Brandon (the "SMI Settlement") of $18.5 million, net of taxes, and when coupled with settlement expenses which had previously been accrued, the net cash proceeds resulting from this settlement were approximately $16.7 million. In Fiscal Year 1996, the Company recognized settlement of a complaint naming SMI, News America and two packaged goods companies as defendants of (the "EPI lawsuit") and reversed certain accruals related to the estimated loss on shut down of SMI. The resulting effect reflected in the Fiscal Year 1996 consolidated statement of operations was $2.9 million income in discontinued operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Discontinued Operations" and note 5 of the Company's consolidated financial statements. (i) As part of the Shakopee Merger and the refinancing transactions (the "Refinancing"), collectively (the "Transactions"), the Company recorded an extraordinary loss related to early extinguishment of debt of $4.5 million, net of zero taxes. This extraordinary loss primarily consisted of the early redemption premium on Graphics' 15% Senior Subordinated Notes due 2000 (the "15% Notes") and the write-off of deferred financing costs related to refinanced indebtedness partially offset by the write-off of a bond premium associated with the 15% Notes. (j) Effective January 1, 1993, the Company changed its method of accounting for income taxes to Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). The cumulative effect of adopting SFAS 109, as of January 1, 1993 was a decrease in net loss by $0.6 million. In 1992, the Company elected to adopt the provisions of Statement of Financial Accounting Standards No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions." This resulted in a charge to earnings net of related tax benefits of $4.4 million. (k) The balance of long-term debt outstanding at March 31, 1995 and 1994 includes an additional $9.7 million and $11.3 million, respectively, relating to a purchase accounting adjustment to the 15% Notes resulting from the 1993 Acquisition. The principal amount payable at maturity of the 15% Notes remained at $100 million. The 15% Notes were redeemed in connection with the Refinancing. (l) EBITDA is included in the Selected Financial Data because management believes that investors regard EBITDA as a key measure of a leveraged company's performance and ability to meet its future debt service requirements. EBITDA is defined as earnings before net interest expense, income tax expense (benefit), depreciation, amortization, other special charges related to asset write-offs and write-downs, other income (expense), the cumulative effect of changes in accounting principles, discontinued operations and extraordinary items. EBITDA is not a measure of financial performance under generally accepted accounting principles and should not be considered an alternative to net income (or any other measure of performance under generally accepted accounting principles) as a measure of performance or to cash flows from operating, investing or financing activities as an indicator of cash flows or as a measure of liquidity. Certain covenants in the Indenture dated as of August 15, 1995 (the "Indenture") and the Company's Credit Agreement with BT Commercial Corporation (the "Bank Credit Agreement") are based on EBITDA, subject to certain adjustments. EBITDA includes non-recurring employee termination expenses of $2.5 million in Fiscal Year 1997 (including $1.9 million related to the resignation of the Company's Chief Executive Officer - see note 20 to the Company's consolidated financial statements). 13 EBITDA includes $0.9 million and $4.1 million of restructuring costs related to its American Color division in Fiscal Year 1997 and Fiscal Year 1996, respectively (see note 18 to the Company's consolidated financial statements). EBITDA in Fiscal Year 1995 includes a $3.3 million net gain related to a change in the Company's defined benefit pension plans (see note 11 to the Company's consolidated financial statements). ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview On August 15, 1995, Shakopee was merged with and into Graphics. The merger has been accounted for as a combination of entities under common control (similar to a pooling-of-interests), and accordingly, the consolidated financial statements give retroactive effect to the Shakopee Merger and include the combined operations of Communications and Shakopee subsequent to December 22, 1994 (the date on which Shakopee became under common control with the Company). Shakopee's financial results are not reflected in periods prior to December 22, 1994 as these periods were prior to common control ownership. This affects the comparability of the financial results after the date of common control with the financial results prior to common control. On March 11, 1996, the Company sold its 51% interest in NIS for approximately $2.5 million in cash and a note for approximately $0.2 million. This transaction resulted in a net gain on disposal of approximately $1.3 million, which is classified as other, net in the consolidated statement of operations. The proceeds of the sale were used to repay indebtedness under the Bank Credit Agreement. On March 12, 1996, Graphics acquired the assets of Gowe, Inc., a Medina, Ohio based regional printer of newspapers, T.V. books and retail advertising inserts and catalogs for approximately $6.7 million in cash and assumption of certain liabilities of Gowe, Inc. The Gowe Acquisition was accounted for under the purchase method of accounting applying the provisions of Accounting Principles Board Opinion No. 16 ("APB 16"). Pursuant to the requirements of APB 16, the purchase price was allocated to the tangible assets and identifiable intangible assets and liabilities assumed based upon their respective fair values. Gowe's results of operations are included in the Company's consolidated financial statements subsequent to March 11, 1996. During March 1996, the Company completed the construction and start-up of Flexi-Tech, a new plant in Hanover, Pennsylvania. Flexi-Tech is dedicated to the production of commercial flexi books (a form of advertising inserts) serving various segments of the retail advertising market and the production of T.V. listing guides serving the newspaper market. In Fiscal Year 1997, the Company began to present certain costs of its American Color production facilities within cost of sales rather than as selling, general and administrative expenses. This new presentation is consistent with the Company's presentation of the printing sector's financial information, and the Company believes that this is a more accurate measure of the gross margin of the business. The financial information for Fiscal Year 1996 and Fiscal Year 1995 has been reclassified to conform with this presentation. In February of Fiscal Year 1997, the Company made a strategic decision to shut down the operations of its wholly-owned subsidiary SMC. SMC's shut down has been accounted for as a discontinued operation, and accordingly, SMC's operations are segregated in the Company's consolidated financial statements. Sales, cost of sales and selling, general and administrative expenses attributable to SMC for Fiscal Year 1996 and Fiscal Year 1995 have been reclassified to discontinued operations. 14 Printing. In recent years, the Company has taken a number of steps which have resulted in improved printing sector performance including the hiring of several key managers in the manufacturing, purchasing, quality, technical services, production planning and customer service departments (see "EBITDA" at page 24). Comprehensive quality improvement and cost reduction programs have also been implemented for all the Company's printing processes. As a result of these measures, the Company has been successful in lowering its manufacturing costs within the printing sector, while improving product quality. Additionally, in order to grow sales and improve gross margins, the Company increased the size, and geographic and industry scope of its sales force and shifted the mix of its business toward retail customers and away from the printing of certain lower margin publications. The Shakopee Merger, Gowe Acquisition and Flexi-Tech operations (see "Business - Printing") are consistent with the Company's overall strategy to continue to increase profitability by growing its revenues, increasing its market share and reducing costs. Commercial Printing in the United States is highly competitive. The significant capital required to keep pace with changing technology and competitive pricing trends has led to a trend of industry consolidation in recent years. In addition, customers' preference for larger printers, such as the Company, with a wider variety of services, greater distribution capabilities and more flexibility have also contributed to consolidation within the industry. The industry is expected to remain competitive in the near future and the Company's sales will continue to be subject to changes in retailers' demands for printed products. The cost of paper is a principal factor in the Company's overall pricing to its customers. The level of paper costs also has a significant impact on the Company's reported sales. Beginning in Fiscal Year 1994 and throughout Fiscal Year 1995 and the majority of Fiscal Year 1996, the paper industry experienced increased demand and high capacity utilization in various grades of paper. This led to a global tightening of the paper supply, and as a result, the printing industry experienced substantial increases in the cost of paper. In late Fiscal Year 1996 and throughout Fiscal Year 1997, the overall cost of paper declined. In accordance with industry practice, the Company generally passes through increases to its customers in the cost of its printed products while decreases in costs generally result in lower prices to customers. Although the Company has been successful in passing through paper price increases to its customers in the past, significant increases in paper prices and continuing price competition resulted in pressure by certain customers to reduce selling prices and to reduce sizes/pages in order to mitigate the effect of increased paper costs during these periods. In addition, there can be no assurances that the Company will be able to pass through future paper price increases. American Color. The digital imaging and prepress services industry has experienced significant technological advances as electronic digital prepress systems have replaced the largely manual and photography-based methods utilized in the past. This shift in technology (which improved process efficiencies and decreased processing costs) produced increased unit growth for American Color as the demand for color pages increased. However, American Color's selling price levels per page have declined because of greater efficiencies resulting from increased use of technology. American Color's revenue from traditional services are now supplemented by new revenue sources from electronic digital imaging and prepress services such as digital image storage, facilities management, telecommunications, design and layout, consulting and training services. In April 1995, the Company implemented a plan for its American Color division which was designed to improve productivity, increase customer service and responsiveness, and provide increased growth in this business. The cost of this plan was accounted for in accordance with the guidelines set forth in Emerging Issues Task Force Issue 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF 94-3") (see "Restructuring Costs and Other Special Charges" below). 15 The following table summarizes the Company's historical results of continuing operations for Fiscal Year 1997, 1996 and 1995. Fiscal Year Ended March 31, ---------------------------------- 1997 1996 1995 ---- ---- ---- (dollars in thousands) Sales: Printing $ 449,924 $ 453,381 $ 353,123 American Color 74,627 72,461 76,070 Other (a) -- 3,681 4,005 --------- --------- --------- Total $ 524,551 $ 529,523 $ 433,198 ========= ========= ========= Gross Profit: Printing $ 49,469 $ 49,015 $ 43,212 American Color 15,133 13,687 17,936 Other (a) 69 1,711 1,783 --------- --------- --------- Total $ 64,671 $ 64,413 $ 62,931 ========= ========= ========= Gross Margin: Printing 11.0% 10.8% 12.2% American Color 20.3% 18.9% 23.6% Total 12.3% 12.2% 14.5% Operating Income (Loss): Printing (b) $ 25,858 $ 28,239 $ 24,683 American Color (b) (c) (1,576) (3,975) 7,855 Other (a) (d) (13,910)(f) (11,548) (8,088)(e) --------- --------- --------- Total $ 10,372 $ 12,716 $ 24,450 ========= ========= ========= - ---------- (a) Other operations in Fiscal Year 1996 and Fiscal Year 1995 include revenues and expenses associated with the Company's 51% owned subsidiary, NIS (sold on March 11, 1996, see note 4 to the Company's consolidated financial statements). (b) Printing operating income includes the impact of $0.4 million and $2 million in Fiscal Year 1997 and 1996, respectively, of other special charges related to fixed asset write-offs and write-downs. American Color's operating loss includes the impact of $1.5 million and $1.4 million in Fiscal Year 1997 and 1996, respectively, of other special charges related to fixed asset write-offs and write-downs (see note 18 to the Company's consolidated financial statements). (c) Includes the impact of restructuring costs of $0.9 million in Fiscal Year 1997 and $4.1 million in Fiscal Year 1996 (see note 18 to the Company's consolidated financial statements). (d) Also includes corporate selling, general and administrative expenses, and amortization expense. (e) Includes the net gain of $3.3 million in Fiscal Year 1995 from the curtailment and establishment of defined benefit pension plans (see discussion below). (f) Also reflects non-recurring employee termination expenses of $2.5 million in Fiscal Year 1997 (including $1.9 million related to the resignation of the Company's Chief Executive Officer-see note 20 to the Company's consolidated financial statements). 16 Historical Results of Operations Fiscal Year 1997 vs. Fiscal Year 1996 The Company's sales decreased 0.9% to $524.6 million in Fiscal Year 1997 from $529.5 million in Fiscal Year 1996. This decrease includes a decrease in printing sales of $3.5 million, or 0.8%, an increase in American Color sales of $2.2 million, or 3%, and a $3.7 million decrease in other sales. The Company's gross profit increased to $64.7 million or 12.3% of sales in Fiscal Year 1997 from $64.4 million or 12.2% of sales in Fiscal Year 1996. The Company's operating income decreased to $10.4 million or 2% of sales in Fiscal Year 1997 from $12.7 million or 2.4% of sales in Fiscal Year 1996. See the discussion of these changes by sector below. Printing Sales. Printing sales decreased to $449.9 million in Fiscal Year 1997 from $453.4 million in Fiscal Year 1996. This decrease includes a decrease in paper prices and the effect of an increase in customer supplied paper. These decreases were partially offset by $46.2 million of incremental sales from Gowe and Flexi-Tech and an increase in production volume of approximately 3% (excluding Gowe and Flexi-Tech). Gross Profit. Printing gross profit increased $0.5 million, or 0.9%, to $49.5 million in Fiscal Year 1997 from $49 million in Fiscal Year 1996. Printing gross margin increased to 11% in Fiscal Year 1997 from 10.8% in Fiscal Year 1996. The increase in gross profit primarily reflects incremental gross profit from Gowe and an increase in production volume. In addition, the gross profit improvement includes reduced variable production and certain other manufacturing costs due to continued cost containment programs at the printing plants. These gains were partially offset by an increase in depreciation expense, a reduction in the price of scrap paper and incremental costs related to the start-up of Flexi-Tech. The increase in gross margin as a percentage of sales is due primarily to the impact of the above described items and the impact of lower paper prices on sales in Fiscal Year 1997. Selling, General and Administrative Expenses. Printing selling, general and administrative expenses increased 23.2% to $23.1 million, or 5.1% of printing sales, in Fiscal Year 1997 from $18.8 million, or 4.1% of printing sales, in Fiscal Year 1996. The increase in Fiscal Year 1997 was primarily the result of increased sales and marketing expenses and incremental selling, general and administrative costs at Gowe and Flexi-Tech. Operating Income. As a result of the above factors and the incurrence of other special charges related to fixed asset write-offs and write-downs of $0.4 million and $2 million in Fiscal Year 1997 and 1996, respectively (see "Restructuring Costs and Other Special Charges" below), operating income from the printing business decreased to $25.9 million in Fiscal Year 1997 from $28.2 million in Fiscal Year 1996. American Color Sales. American Color's sales increased 3% to $74.6 million in Fiscal Year 1997 from $72.5 million in Fiscal Year 1996. The increase in Fiscal Year 1997 was primarily the result of higher digital imaging and prepress production volume due to American Color's implementation of various digital prepress technologies, including facilities management and software and image management services and increases in digital visual effects work partially offset by lower equipment sales. Gross Profit. American Color's gross profit increased $1.4 million to $15.1 million in Fiscal Year 1997 from $13.7 million in Fiscal Year 1996. American Color's gross margin was 20.3% in Fiscal Year 1997, up from 18.9% in Fiscal Year 1996. These increases were primarily the result of increased volume and material cost savings offset in part by increased facilities management costs. 17 Selling, General and Administrative Expenses. American Color's selling, general and administrative expenses increased 18% to $14.3 million or 19.2% of American Color sales in Fiscal Year 1997 from $12.1 million or 16.7% of American Color sales in Fiscal Year 1996, primarily as a result of the addition of sales and marketing and administrative support personnel and related expenses, including expenses related to its digital visual effects group. Operating Loss. As a result of the above factors and the restructuring costs associated with the American Color restructuring plan of $0.9 million in Fiscal Year 1997 and $4.1 million in Fiscal Year 1996 and the incurrence of other special charges related to fixed asset write-offs and write-downs of $1.5 million and $1.4 million in Fiscal Year 1997 and 1996, respectively (see "Restructuring Costs and Other Special Charges" below), operating loss at American Color decreased to $1.6 million in Fiscal Year 1997 from $4 million in Fiscal Year 1996. Fiscal Year 1996 vs. Fiscal Year 1995 The Company's sales increased $96.3 million to $529.5 million in Fiscal Year 1996 from $433.2 million in Fiscal Year 1995, reflecting a $100.3 million increase in printing sales, a $3.6 million decrease in American Color sales and a $0.3 million decrease in other sales. The Company's gross profit increased to $64.4 million or 12.2% of sales in Fiscal Year 1996 from $62.9 million or 14.5% of sales in Fiscal Year 1995. The Company's operating income decreased to $12.7 million or 2.4% of sales in Fiscal Year 1996 from $24.5 million or 5.6% of sales in Fiscal Year 1995. See the discussion of these changes by sector below. Printing Sales. Printing sales increased $100.3 million to $453.4 million in Fiscal Year 1996 from $353.1 million in Fiscal Year 1995. This increase includes $53.8 million of increased sales by Shakopee. In addition, the increase in sales includes the impact of increased paper prices and a slight increase in overall production volume (excluding Shakopee). These increases were partially offset by an increase in sales to customers that supply their own paper and the impact of continued competitive pricing pressure. Production volume is primarily dependent on economic activity in general and the level of advertising by retailers in particular. In the last quarter of Fiscal Year 1996, the Company experienced lower than expected production volume and a higher level of price competition than anticipated as a result of a weak retail environment in the last quarter of calendar year 1995. Gross Profit. Printing gross profit increased $5.8 million to $49 million in Fiscal Year 1996 from $43.2 million in Fiscal Year 1995. Printing gross margin decreased to 10.8% in Fiscal Year 1996 from 12.2% in Fiscal Year 1995. The increase in gross profit primarily reflects incremental gross profit from Shakopee. In addition, the gross profit improvement includes reduced variable production and certain other manufacturing costs due to continued cost containment programs at the printing plants. These gains were partially offset by continued competitive pricing pressure. The decrease in gross margin as a percentage of sales is due primarily to the impact of increased paper prices. Selling, General and Administrative Expenses. Printing selling, general and administrative expenses increased to $18.8 million or 4.1% of printing sales in Fiscal Year 1996 from $18.5 million or 5.2% of printing sales in Fiscal Year 1995. This increase includes incremental Shakopee expenses and additional administrative support expenses offset in part by a reduction in certain employee related costs. Operating Income. As a result of these factors, and the incurrence of other special charges related to fixed asset write-offs and write-downs of $2 million in Fiscal Year 1996 (see "Restructuring Costs and Other Special Charges" below), operating income from the printing business increased to $28.2 million in Fiscal Year 1996 from $24.7 million in Fiscal Year 1995. 18 American Color Sales. American Color's sales decreased $3.6 million to $72.5 million in Fiscal Year 1996 from $76.1 million in Fiscal Year 1995. The decrease is primarily the result of decreased selling prices and lower prepress production volume due in part to American Color's restructuring efforts during Fiscal Year 1996 (see note 18 to the Company's consolidated financial statements). Gross Profit. American Color's gross profit decreased $4.2 million to $13.7 million in Fiscal Year 1996 from $17.9 million in Fiscal Year 1995. American Color's gross margin decreased to 18.9% in Fiscal Year 1996 from 23.6% in Fiscal Year 1995. These decreases in Fiscal Year 1996 are primarily the result of decreases in both prepress production volume and selling prices, as well as increased depreciation expense. Selling, General and Administrative Expenses. American Color's selling, general and administrative expenses increased to $12.1 million or 16.7% of American Color's sales in Fiscal Year 1996 from $10.1 million or 13.3% of American Color's sales in Fiscal Year 1995. These increases are a result of increased sales and marketing expenses and additional administrative support personnel. Operating Income (Loss). As a result of these factors and the incurrence of $4.1 million of restructuring costs related primarily to employee termination and other expenses associated with the American Color restructuring plan and other special charges related to fixed asset write-downs of $1.4 million (see "Restructuring Costs and Other Special Charges" below), operating income at American Color decreased to a loss of $4 million in Fiscal Year 1996 from income of $7.9 million in Fiscal Year 1995. Other Operations (Fiscal Year 1997 vs. Fiscal Year 1996 and Fiscal Year 1996 vs. Fiscal Year 1995) Other operations consist primarily of revenues and expenses associated with the Company's 51% owned subsidiary, NIS (sold on March 11, 1996), corporate selling, general and administrative expenses, other expenses and amortization expense. Amortization expenses for other operations, including goodwill amortization (see below), were $8.4 million, $8.7 million and $8.4 million in Fiscal Year 1997, 1996 and 1995, respectively. Operating losses from other operations increased $2.4 million to a loss of $13.9 million in Fiscal Year 1997 from a loss of $11.5 million in Fiscal Year 1996. This increase primarily reflects non-recurring employee termination expenses of $2.5 million in Fiscal Year 1997 (including $1.9 million related to the resignation of the Company's Chief Executive Officer - see note 20 to the Company's consolidated financial statements). Operating losses from other operations increased $3.4 million to a loss of $11.5 million in Fiscal Year 1996 from a loss of $8.1 million in Fiscal Year 1995. The primary reasons for this change include the recognition of a net gain of $3.3 million recorded in Fiscal Year 1995 resulting from a change in the Company's defined benefit pension plans (see discussion below), and increased amortization expenses. Goodwill Amortization Amortization expense associated with goodwill was $8.3 million, $8.6 million and $8.4 million for Fiscal Year 1997, 1996 and 1995, respectively. Restructuring Costs and Other Special Charges In April 1995, the Company implemented a plan for its American Color division which was designed to improve productivity, increase customer service and responsiveness, and provide increased growth in the digital imaging and prepress services business. The cost of this plan was accounted for in accordance with the guidance set forth in EITF 94-3. The pretax costs of $5 million which were incurred as a part of this plan represent employee termination, goodwill write-down and other related costs that were incurred as a direct result of the plan. Approximately $0.9 million of restructuring costs primarily related to relocation expenses were recognized in Fiscal Year 1997. In Fiscal Year 1996 the Company recognized $4.1 million of such restructuring charges, which included $0.9 million of goodwill write-down, and $3.2 million primarily for severance and other personnel related costs. The goodwill written down was the portion related to certain facilities that were either shut down or relocated in conjunction with the American Color restructuring. 19 During Fiscal Year 1997 and Fiscal Year 1996, the Company recorded special charges totaling $1.9 million and $3.4 million, respectively, for impaired long-lived assets and to adjust the carrying values of idle, disposed and under performing assets to estimated fair values. The provisions were based on a review of long-lived assets in connection with the adoption of Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("FASB 121"). Of the Fiscal Year 1997 total of long-lived assets that were adjusted based on being idle, disposed of or under performing, approximately $0.4 million and $1.5 million related to the print and American Color sectors, respectively. Fair value was based on the Company's estimate of held and used and idle assets based on current market conditions using the best information available. Approximately $2 million of the Fiscal Year 1996 total related to the print sectors long-lived assets that were adjusted based on being idle, disposed of or under performing. The remaining $1.4 million of the Fiscal Year 1996 total related to the American Color sector. The estimated undiscounted future cash flows attributable to certain American Color division identifiable long-lived assets held and used was less than their carrying value principally as a result of high levels of ongoing technological change. The methodology used to assess the recoverability of the American Color sector long-lived assets involved projecting aggregate cash flows. Based on this evaluation, the Company determined in Fiscal Year 1996 that long-lived assets with a carrying amount of $2.2 million were impaired and wrote them down by $1.4 million to their fair value. Fair value was based on Company estimates and appraisals. Such special charges are classified as restructuring costs and other special charges in the consolidated statement of operations. Changes in Defined Benefit Pension Plans, Net In October 1994, the Board of Directors approved an amendment to the Company's defined benefit pension plans which resulted in the freezing of additional defined benefits for future services under the plans effective January 1, 1995. The Company recognized a curtailment gain of $3.7 million as a result of freezing such benefits. Also in October 1994, the Board of Directors approved a new SERP, which is a defined benefit plan, for certain key executives. The Company recognized a $0.4 million expense associated with the establishment of the SERP. The net effect of the above, a $3.3 million gain, is reflected in the Company's consolidated statement of operations for Fiscal Year 1995. Interest Expense Interest expense increased 11% to $36.3 million in Fiscal Year 1997 from $32.7 million in Fiscal Year 1996. This increase includes the impact of increased average indebtedness levels including indebtedness related to the Transactions and obligations under capital leases. Interest expense increased 26.9% to $32.7 million in Fiscal Year 1996 from $25.8 million in Fiscal Year 1995. This increase includes the impact of increased indebtedness levels and increases in prevailing market interest rates associated with the Company's floating rate debt. The increased indebtedness includes the additional indebtedness related to the Shakopee Merger and indebtedness incurred to fund the fees and expenses associated with the Refinancing (see notes 2 and 9 to the Company's consolidated financial statements). Nonrecurring Charges Related to Terminated Merger The Company recognized $1.5 million of expenses related to a terminated merger in Fiscal Year 1996. 20 Other Expense (Income) and Taxes Other expense, net, remained relatively unchanged at $0.2 million in both Fiscal Year 1997 and Fiscal Year 1996. Other expense, net, decreased to $0.2 million in Fiscal Year 1996 from $1 million in Fiscal Year 1995. This decrease includes a $1.3 million net gain realized on the disposal of the Company's 51% interest in NIS in Fiscal Year 1996 (see note 4 to the Company's consolidated financial statements), offset in part by incremental expenses associated with an employee benefit program also recorded in Fiscal Year 1996. Income tax expense decreased to $2.6 million in Fiscal Year 1997 from $4.9 million in Fiscal Year 1996. This change is primarily due to smaller amounts of taxable income in foreign jurisdictions, the Shakopee Merger and the sale of NIS, partially offset by an increase in the deferred tax valuation allowance. During Fiscal Year 1997, the Company increased its valuation allowance by $8.9 million to $30.1 million. The increase in the valuation allowance during Fiscal Year 1997 resulted primarily from the loss incurred during this period for which a tax benefit will not be recorded. Income tax expense increased to $4.9 million in Fiscal Year 1996 from $2.6 million in Fiscal Year 1995. This change is primarily due to larger amounts of taxable income in foreign jurisdictions and the inclusion of Shakopee in Fiscal Year 1996. During Fiscal Year 1996, the Company increased its valuation allowance by $7.4 million to $21.2 million. The increase in the valuation allowance during Fiscal Year 1996 resulted primarily from the loss incurred during this period for which a tax benefit will not be recorded. Discontinued Operations Sullivan Media Corporation The Company's net loss in Fiscal Year 1997, Fiscal Year 1996 and Fiscal Year 1995 includes the loss from operations of its discontinued wholly-owned subsidiary SMC of approximately $1.6 million, $1.4 million and $0.9 million, respectively. The Company's Fiscal Year 1997 net loss also includes the estimated net loss on shut down of approximately $1.5 million. See note 5 to the Company's consolidated financial statements. SMI Settlement On June 29, 1994, Graphics and SMI settled the lawsuit they initiated in federal court against Valassis Communications, Inc., News America and David Brandon. The Company recorded income from the SMI Settlement of $18.5 million net of taxes in Fiscal Year 1995 and when coupled with settlement expenses which had previously been accrued, the net cash proceeds resulting from this settlement were approximately $16.7 million. Proceeds received were primarily used in July 1994 to reduce borrowings under the Company's old bank credit agreement which primarily related to SMI losses prior to the shut down. In Fiscal Year 1996, the Company recognized settlement of the EPI lawsuit and reversed certain accruals related to the estimated loss on shut down of SMI. The resulting effect reflected in the Fiscal Year 1996 consolidated statement of operations was $2.9 million income in discontinued operations. Loss on Early Extinguishment of Debt, Net of Tax As part of the Shakopee Merger and the Refinancing in Fiscal Year 1996 (see notes 2 and 9 to the Company's consolidated financial statements), the Company recorded an extraordinary loss related to early extinguishment of debt of $4.5 million, net of zero taxes. This extraordinary loss primarily consisted of the early redemption premium on the 15% Notes and the write-off of deferred financing costs related to refinanced indebtedness partially offset by the write-off of a bond premium associated with the 15% Notes. 21 Net Income (Loss) As a result of the factors discussed above, the Company's net loss increased to a loss of $31.7 million in Fiscal Year 1997 from a loss of $29.3 million in Fiscal Year 1996. As discussed above, Fiscal Year 1997 includes $0.9 million of expense related to the American Color restructuring, $1.9 million of other special charges related to fixed asset write-offs and write-downs, $2.5 million of non-recurring employee termination expenses and approximately a $3.1 million loss from discontinued operations related to SMC. The Company's net loss was $29.3 million in Fiscal Year 1996 and its net income was $13.2 million in Fiscal Year 1995. As discussed above, Fiscal Year 1996 includes $4.1 million of expense related to the American Color restructuring, $3.4 million of other special charges related to fixed asset write-offs and write-downs, a $1.5 million non-recurring expense associated with a terminated merger, a $4.5 million extraordinary loss on early extinguishment of debt and approximately $2.9 million of income and a $1.4 million loss from discontinued operations related to SMI and SMC, respectively. The Company's net income for Fiscal Year 1995 includes a $3.3 million gain from the curtailment and establishment of defined benefit pension plans, net and approximately $18.5 million of income and a $0.9 million loss from discontinued operations of SMI and SMC, respectively. Liquidity and Capital Resources In August 1995, the Company refinanced substantially all of its existing indebtedness (see note 9 to the Company's consolidated financial statements). The primary objectives of the Refinancing were to gain greater financial and operating flexibility, to facilitate the merger with Shakopee, to refinance near-term debt service requirements and to provide further opportunity for internal growth and growth through acquisitions. As part of the Refinancing, the Company received gross proceeds of $185 million from the sale of 12 3/4% Senior Subordinated Notes Due 2005 (the "Notes"). The gross proceeds of the offering of the Notes, together with $85.6 million in borrowings under the Bank Credit Agreement, and existing cash balances were used (i) to redeem all $100 million principal amount of the 15% Notes at a redemption price of $105.6 million (plus $1.8 million of accrued interest to September 15, 1995, the redemption date), (ii) to repay all $126.5 million of indebtedness outstanding under Graphics' old bank credit agreement (plus $2.3 million of accrued interest at the repayment date), (iii) to repay all $24.6 million of indebtedness assumed in the Shakopee Merger (plus $0.1 million of accrued interest at the repayment date) and (iv) to fund approximately $11.8 million of fees and expenses incurred in connection with the Transactions. The Bank Credit Agreement includes a revolving credit facility which matures on September 30, 2000 (the "Revolving Credit Facility") providing for a maximum of $75 million of borrowing availability, subject to a borrowing base requirement. As of May 31, 1997, the Company had borrowings of $38.2 million outstanding under the Revolving Credit Facility and $12.3 million of additional borrowing availability. On June 30, 1997, the Company entered into a $25 million term loan facility which matures on March 31, 2001 (the "Term Loan Facility") (see note 9 to the Company's consolidated financial statements). Net proceeds received under this facility of $23 million were used to reduce outstanding borrowings under the Revolving Credit Facility. Based upon activity through June 27, 1997 and after giving pro forma effect to receipt and application of the above $23 million Term Loan Facility net proceeds, the Company had additional borrowing availability under the Revolving Credit Facility of approximately $25.8 million at June 27, 1997. The Bank Credit Agreement also provides for a $60 million amortizing term loan with a final maturity on September 30, 2000 (the "Term Loan"). At May 31, 1997, $47.1 million of the Term Loan was outstanding. Scheduled Term Loan payments due over the upcoming fiscal year ending March 31, 1998 ("Fiscal Year 1998") approximate $10.6 million. Capital lease obligation repayments will be approximately $6.4 million in Fiscal Year 1998. In Fiscal Year 1997, net cash from operating activities and net borrowings under the Revolving Credit Facility (see the consolidated statements of cash flows) were used to pay $13.6 million in scheduled principal payments on indebtedness (including capital lease obligations). Additionally, these cash sources were used to fund the Company's Fiscal Year 1997 cash capital expenditures of $10.8 million and meet additional investing and financing needs of $1.1 million. The Company plans to continue its program of upgrading its printing and prepress equipment and expanding production capacity and currently anticipates that Fiscal Year 1998 cash capital expenditures will approximate $11.1 million and equipment acquired under capital leases will approximate $14.6 million during Fiscal Year 1998. The Company had zero cash on hand at March 31, 1997 due to a requirement under the Bank Credit Agreement that the Company's daily available funds be used to reduce borrowings under the Revolving Credit Facility. 22 At March 31, 1997, the Company had total indebtedness outstanding of $312.3 million, including capital lease obligations. Of the total debt outstanding at March 31, 1997, $87.8 million was outstanding under the Bank Credit Agreement at a weighted average interest rate of 8.45%. Indebtedness under the Bank Credit Agreement bears interest at floating rates, causing the Company to be sensitive to prevailing interest rates. At March 31, 1997, the Company had indebtedness other than obligations under the Bank Credit Agreement of $224.5 million (including $185 million of the Notes). In connection with the Term Loan Facility, the Company obtained amendments with respect to certain financial covenants and an amendment that decreased the Borrowing Base through March 31, 1998, in the Bank Credit Agreement and after giving effect to such amendments, the Company is currently in compliance with all financial covenants set forth in the Bank Credit Agreement, as amended. See note 9 to the Company's consolidated financial statements. 23 EBITDA Fiscal Year Ended March 31, ------------------------------------- 1997 1996 1995 ---- ---- ---- EBITDA: (dollars in thousands) Printing $ 46,755 $ 46,597 $ 38,357 American Color(a) 5,770 2,907 12,662 Other (b) (c) (5,553)(e) (2,657) 700(d) -------- -------- -------- Total $ 46,972 $ 46,847 $ 51,719 ======== ======== ======== EBITDA Margin: Printing 10.4% 10.3% 10.9% American Color 7.7% 4.0% 16.6% Total 9.0% 8.8% 11.9% - ---------- (a) American Color EBITDA for Fiscal Year 1997 and 1996 includes the impact of restructuring costs of $0.9 million and $4.1 million, respectively (see note 18 to the Company's consolidated financial statements and discussion above). (b) Other operations in Fiscal Year 1996 and Fiscal Year 1995 include revenues and expenses associated with the Company's 51% owned subsidiary, NIS (sold on March 11, 1996; see note 4 to the Company's consolidated financial statements). (c) Also includes corporate selling, general and administrative expenses. (d) Includes a net gain of $3.3 million in Fiscal Year 1995 from the curtailment and establishment of defined benefit pension plans (see discussion above). (e) Also reflects non-recurring employee termination expenses of $2.5 million in Fiscal Year 1997 (including $1.9 million related to the resignation of the Company's Chief Executive Officer - see note 20 to the Company's consolidated financial statements). EBITDA is presented and discussed because management believes that investors regard EBITDA as a key measure of a leveraged company's performance and ability to meet its future debt service requirements. EBITDA is defined as earnings before net interest expense, income tax expense (benefit), depreciation, amortization, other special charges related to asset write-offs and write-downs, other income (expense), discontinued operations and extraordinary items. "EBITDA Margin" is defined as EBITDA as a percentage of net sales. EBITDA is not a measure of financial performance under generally accepted accounting principles and should not be considered an alternative to net income (or any other measure of performance under generally accepted accounting principles) as a measure of performance or to cash flows from operating, investing or financing activities as an indicator of cash flows or as a measure of liquidity. Certain covenants in the Indenture and the Bank Credit Agreement are based on EBITDA, subject to certain adjustments. Printing. As a result of the reasons previously described under "--Printing" (excluding the increase in depreciation expense), printing EBITDA increased to $46.8 million in Fiscal Year 1997 from $46.6 million in Fiscal Year 1996, representing an increase of $0.2 million. The Company's printing sector EBITDA increased to $46.6 million in Fiscal Year 1996 from $38.4 million in Fiscal Year 1995, representing an increase of $8.2 million. Printing EBITDA Margin increased to 10.4% in Fiscal Year 1997 from 10.3% in Fiscal Year 1996 and decreased to 10.3% in Fiscal Year 1996 from 10.9% in Fiscal Year 1995. American Color. As a result of the reasons previously described under "--American Color," American Color's EBITDA increased to $5.8 million in Fiscal Year 1997 from $2.9 million in Fiscal Year 1996, representing an increase of $2.9 million. EBITDA Margin increased to 7.7% in Fiscal Year 1997 from 4% in Fiscal Year 1996. American Color EBITDA decreased to $2.9 million in Fiscal Year 1996 from $12.7 million in Fiscal Year 1995, representing a reduction of $9.8 million. EBITDA Margin decreased to 4% in Fiscal Year 1996 from 16.6% in Fiscal Year 1995. Included in the Fiscal Year 1996 EBITDA and EBITDA Margin is $4.1 million of restructuring costs related to the American Color restructuring plan (see discussion above). 24 Other Operations. As a result of the reasons previously described under "--Other Operations," excluding changes in amortization expense, other operations negative EBITDA increased to negative EBITDA of $5.6 million in Fiscal Year 1997 from negative EBITDA of $2.7 million in Fiscal Year 1996. EBITDA from other operations decreased to a negative EBITDA of $2.7 million in Fiscal Year 1996 from EBITDA of $0.7 million in Fiscal Year 1995. Negative EBITDA for Fiscal Year 1997 includes the impact of non-recurring employee termination expenses of $2.5 million (including $1.9 million related to the resignation of the Company's Chief Executive Officer - see note 20 to the Company's consolidated financial statements). EBITDA in Fiscal Year 1995 includes the net gain of $3.3 million relating to a change in the Company's defined benefit plans (see discussion above). Amortization of Goodwill The goodwill is amortized on a straight-line basis by business sector. Goodwill amortization expense will be approximately $8.4 million for Fiscal Year 1998 and approximately $2.3 million annually thereafter. Impact of Inflation Generally, the Company believes it has been able to pass along increases in its costs to its customers (primarily paper and ink) through increased prices of its printed products. Throughout the majority of Fiscal Year 1996, the printing industry experienced substantial increases in the cost of paper. In late Fiscal Year 1996, however, the overall cost of paper began to decline and that decline continued throughout Fiscal Year 1997. Management expects that as a result of the Company's strong relationship with key suppliers that its material costs will remain competitive within the industry. Seasonality Some of the Company's printing and digital imaging and prepress services business is seasonal in nature, particularly those revenues derived from advertising inserts. Generally, the Company's sales from advertising inserts are highest during periods prior to the following advertising periods: Spring advertising season (March 15 -- May 15); Back-to- School (July 15 -- August 15); and Thanksgiving/Christmas (October 15 -- December 15). One of the reasons the Company chose to enter the comic book printing market is that it is not subject to significant seasonal fluctuations. Sales of Sunday comics and magazine products are also not subject to significant seasonal fluctuations. The Company's strategy has been and will continue to be to try to mitigate the seasonality of its printing business by increasing its sales to food and drug companies whose own sales are less seasonal. Environmental Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations and which do not contribute to current or future period revenue generation are expensed. Environmental liabilities are recorded when assessments and/or remedial efforts are probable and the related costs can be reasonably estimated. The Company believes that environmental liabilities, currently and in the prior periods discussed herein, are not material. The Company has recorded an environmental reserve of approximately $0.1 million in connection with a Superfund site in its consolidated statement of financial position at March 31, 1997 which the Company believes to be adequate. See "Legal Proceedings - Environmental Matters." The Company does not anticipate receiving insurance proceeds related to this potential settlement. Management does not expect that any identified matters, individually or in the aggregate, will have a material adverse effect on the consolidated financial position or results of operations of the Company. Accounting There are no pending accounting pronouncements that, when adopted, are expected to have a material effect in the Company's results of operations or its financial position. 25 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page No. -------- The following consolidated financial statements of Sullivan Communications, Inc. are included in this report: Report of Independent Auditors........................................................................... 27 Consolidated balance sheets - March 31, 1997 and 1996................................................... 28 For the Years Ended March 31, 1997, 1996 and 1995: Consolidated statements of operations........................................................... 30 Consolidated statements of stockholders' deficit................................................ 31 Consolidated statements of cash flows........................................................... 32 Notes to Consolidated Financial Statements............................................................... 34
The following consolidated financial statement schedules of Sullivan Communications, Inc. are included in Part IV, Item 14: I. Condensed Financial Information of Registrant Condensed Consolidated Financial Statements (parent company only) for the years ended March 31, 1997, 1996, and 1995, and as of March 31, 1997 and 1996 II. Valuation and qualifying accounts All other schedules specified under Regulation S-X for Sullivan Communications, Inc. have been omitted because they are either not applicable, not required, or because the information required is included in the financial statements or notes thereto. 26 Report of Independent Auditors The Board of Directors Sullivan Communications, Inc. We have audited the accompanying consolidated balance sheets of Sullivan Communications, Inc. as of March 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' deficit, and cash flows for each of the three fiscal years in the period ended March 31, 1997. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sullivan Communications, Inc. at March 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three fiscal years in the period ended March 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in Note 18 to the consolidated financial statements, in fiscal year 1996 the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." Ernst & Young LLP Nashville, Tennessee May 23, 1997, except as to Note 9, as to which the date is June 30, 1997 27 SULLIVAN COMMUNICATIONS, INC. Consolidated Balance Sheets (Dollars in thousands, except par values) March 31, --------- 1997 1996 ---- ---- Assets Current assets: Cash $ 0 0 Receivables: Trade accounts, less allowance for doubtful accounts of $5,879 and $4,830 at March 31, 1997 and 1996, respectively 53,510 64,465 Other 3,252 3,588 --------- --------- Total receivables 56,762 68,053 Inventories 9,711 13,181 Prepaid expenses and other current assets 3,604 4,285 --------- --------- Total current assets 70,077 85,519 Property, plant and equipment: Land and improvements 3,278 3,259 Buildings and improvements 17,837 16,346 Machinery and equipment 175,196 169,375 Furniture and fixtures 3,625 3,212 Leased assets under capital leases 35,113 8,606 Equipment installations in process 3,118 6,466 --------- --------- 238,167 207,264 Less accumulated depreciation (71,270) (51,103) --------- --------- Net property, plant and equipment 166,897 156,161 Excess of cost over net assets acquired, less accumulated amortization of $33,523 and $25,269 at March 31, 1997 and 1996, respectively 81,964 89,324 Other assets 15,037 20,177 --------- --------- Total assets $ 333,975 351,181 ========= ========= See accompanying notes to consolidated financial statements. 28 SULLIVAN COMMUNICATIONS, INC. Consolidated Balance Sheets (Dollars in thousands, except par values)
March 31, --------- 1997 1996 ---- ---- Liabilities and Stockholders' Deficit Current liabilities: Current installments of long-term debt and capitalized leases $ 18,252 11,490 Trade accounts payable 29,364 35,931 Accrued expenses 30,037 27,271 Income taxes 1,022 1,215 --------- --------- Total current liabilities 78,675 75,907 Long-term debt and capitalized leases, excluding current installments 294,057 286,127 Deferred income taxes 8,713 7,801 Other liabilities 28,848 25,742 --------- --------- Total liabilities 410,293 395,577 Stockholders' deficit: Common stock, voting, $.01 par value, 5,852,223 shares authorized, 123,889 shares issued and outstanding 1 1 Series A convertible preferred stock, $.01 par value, 4,000 shares authorized, issued and outstanding, $40,000,000 liquidation preference -- -- Series B convertible preferred stock, $.01 par value, 1,750 shares authorized, issued and outstanding, $17,500,000 liquidation preference -- -- Additional paid-in capital 57,499 57,499 Accumulated deficit (132,228) (100,525) Cumulative translation adjustment (1,590) (1,371) --------- --------- Total stockholders' deficit (76,318) (44,396) --------- --------- Commitments and contingencies Total liabilities and stockholders' deficit $ 333,975 351,181 ========= =========
See accompanying notes to consolidated financial statements. 29 SULLIVAN COMMUNICATIONS, INC. Consolidated Statements of Operations (In thousands)
Year ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Sales $ 524,551 529,523 433,198 Cost of sales 459,880 465,110 370,267 --------- --------- --------- Gross profit 64,671 64,413 62,931 Selling, general and administrative expenses 43,164 35,533 33,406 Amortization of goodwill 8,254 8,631 8,386 Restructuring costs and other special charges 2,881 7,533 -- Gain from curtailment and establishment of defined benefit pension plans, net -- -- (3,311) --------- --------- --------- Operating income 10,372 12,716 24,450 --------- --------- --------- Other expense (income): Interest expense 36,289 32,688 25,752 Interest income (157) (263) (418) Nonrecurring charge related to terminated merger -- 1,534 -- Other, net 245 188 985 --------- --------- --------- Total other expense 36,377 34,147 26,319 --------- --------- --------- Loss from continuing operations before income taxes and extraordinary item (26,005) (21,431) (1,869) Income tax expense (2,591) (4,874) (2,552) --------- --------- --------- Loss from continuing operations before extraordinary item (28,596) (26,305) (4,421) Discounted operations: Loss from operations, net of tax (1,557) (1,364) (912) Estimated (loss) on shut down and gain on SMI settlement, net of tax (1,550) 2,868 18,495 --------- --------- --------- (Loss) income before extraordinary item (31,703) (24,801) 13,162 Loss on early extinguishment of debt, net of tax -- (4,526) -- --------- --------- --------- Net (loss) income $ (31,703) (29,327) 13,162 ========= ========= =========
See accompanying notes to consolidated financial statements. 30 SULLIVAN COMMUNICATIONS, INC. Consolidated Statements of Stockholders' Deficit (In thousands)
Series A and B Voting Convertible Additional Cumulative common preferred paid-in Accumulated translation stock stock capital deficit adjustment Total ----- ----- ------- ------- ---------- ----- Balances, March 31, 1994 $ 1 -- 39,999 (84,360) (1,125) (45,485) Pooling accounting -- -- 17,500 -- -- 17,500 -------- ------- -------- -------- -------- -------- Balances, December 23, 1994 $ 1 -- 57,499 (84,360) (1,125) (27,985) Change in cumulative translation adjustment - exchange rate fluctuations -- -- -- -- (147) (147) Net income -- -- -- 13,162 -- 13,162 -------- ------- -------- -------- -------- -------- Balances, March 31, 1995 $ 1 -- 57,499 (71,198) (1,272) (14,970) Change in cumulative translation adjustment - exchange rate fluctuations -- -- -- -- (99) (99) Net loss -- -- -- (29,327) -- (29,327) -------- ------- -------- -------- -------- -------- Balances, March 31, 1996 $ 1 -- 57,499 (100,525) (1,371) (44,396) Change in cumulative translation adjustment - exchange rate fluctuations -- -- -- -- (219) (219) Net loss -- -- -- (31,703) -- (31,703) -------- ------- -------- -------- -------- -------- Balances, March 31, 1997 $ 1 -- 57,499 (132,228) (1,590) (76,318) ======== ======= ======== ======== ======== ========
See accompanying notes to consolidated financial statements. 31 SULLIVAN COMMUNICATIONS, INC. Consolidated Statements of Cash Flows (In thousands)
Year ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Cash flows from operating activities: Net (loss) income $(31,703) (29,327) 13,162 Adjustments to reconcile net (loss) income to cash provided (used) by operating activities: Extraordinary item - non cash -- (1,912) -- Other special charges - non cash 1,944 4,306 -- Depreciation 25,282 21,385 18,327 Depreciation and amortization related to SMC 251 932 638 Amortization of goodwill 8,254 8,631 8,386 Amortization of other assets 1,120 680 555 Amortization of deferred financing costs and bond premium 1,784 1,469 485 Gain on shut down of SMI, net of tax - non cash -- (1,480) -- Loss on shut down of SMC - non cash 1,550 -- -- Loss on sales and write-downs of property, plant and equipment 6 350 72 Gain from curtailment and establishment of defined benefit pension plans, net -- -- (3,311) Deferred income tax expense 911 595 1,560 Changes in assets and liabilities, net of effects of shut down of SMI and SMC and acquisition of Gowe: Decrease (increase) in receivables 11,262 (12,870) 11,456 Decrease (increase) in inventories 3,453 (1,744) 1,534 (Decrease) increase in trade accounts payable (6,528) 11,571 (15,026) Increase (decrease) in accrued expenses 1,226 981 (8,489) Decrease (increase) in current income taxes payable (193) 195 592 Other 5,694 (7,949) 569 -------- -------- -------- Total adjustments 56,016 25,140 17,348 -------- -------- -------- Net cash provided (used) by operating activities 24,313 (4,187) 30,510 -------- -------- --------
See accompanying notes to consolidated financial statements. 32 SULLIVAN COMMUNICATIONS, INC. Consolidated Statements of Cash Flows (In thousands)
Year ended March 31 ------------------- 1997 1996 1995 ---- ---- ---- Cash flows from investing activities: Purchases of property, plant and equipment (10,810) (20,276) (19,601) Proceeds from sales of property, plant and equipment 63 36 2,137 Gowe acquisition -- (6,682) -- Proceeds from sale of NIS -- 2,550 -- Other (250) (64) (116) -------- -------- -------- Net cash used by investing activities (10,997) (24,436) (17,580) -------- -------- -------- Cash flows from financing activities: Debt: Proceeds 1,162 280,451 -- Payments (10,374) (242,970) (16,329) Increase in deferred financing costs (827) (12,095) (1,052) Repayment of capital lease obligations (3,212) (591) (140) Other (61) (813) (6) -------- -------- -------- Net cash (used) provided by financing activities (13,312) 23,982 (17,527) -------- -------- -------- Effect of exchange rates on cash (4) 6 1 -------- -------- -------- Decrease in cash 0 (4,635) (4,596) Cash: Beginning of period 0 4,635 9,231 -------- -------- -------- End of period $ 0 0 4,635 ======== ======== ======== Supplemental disclosure of cash information: Cash paid for: Interest $ 34,284 30,581 26,416 Income taxes, net of refunds 1,863 3,964 1,904 Exchange rate adjustment to long-term debt (61) 53 (54) Non cash investing activities: Lease obligations $ 26,957 7,746 814
See accompanying notes to consolidated financial statements. 33 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (1) Summary of Significant Accounting Policies Sullivan Communications, Inc. ("Communications"), together with its wholly-owned subsidiary, Sullivan Graphics, Inc. ("Graphics"), collectively the ("Company"), was formed in April 1989 under the name GBP Holdings, Inc. to effect the purchase of all the capital stock of GBP Industries, Inc. from its stockholders in a leveraged buyout transaction. In October 1989, GBP Holdings, Inc. changed its name to Sullivan Holdings, Inc. and GBP Industries, Inc. changed its name to Sullivan Graphics, Inc. Effective June 1993, Sullivan Holdings, Inc. changed its name to Sullivan Communications, Inc. On August 15, 1995, the Company completed a merger transaction with Shakopee Valley Printing Inc. ("Shakopee") (the "Shakopee Merger"). Shakopee was formed to effect the purchase of certain assets and assumption of certain liabilities of Shakopee Valley Printing, a Guy Gannett Communications division. On December 22, 1994, Morgan Stanley Capital Partners III, L.P., Morgan Stanley Capital Investors, L.P., and MSCP III 892 Investors, L.P. (collectively the "MSCP III Entities"), together with First Plaza Group Trust and Leeway & Co. purchased 35,000 shares of common stock of Shakopee. On December 22, 1994, pursuant to an Agreement for the Purchase of Assets between Guy Gannett Communications (the "Seller") and Shakopee (the "Buyer"), the Seller agreed to sell (effective at the close of business on December 22, 1994) certain assets and transfer certain liabilities of Shakopee Valley Printing to the Buyer for a total purchase price of approximately $42.6 million, primarily financed through the issuance of 35,000 shares of Common Stock and bank borrowings. Each of the MSCP III Entities is affiliated with Morgan Stanley, Dean Witter, Discover & Co., the parent company of the general partner of the Company's majority stockholder. In addition, the other stockholders of Shakopee were also stockholders of the Company. See note 2 for a description of the specific terms of the Shakopee Merger. Communications has no operations or significant assets other than its investment in Graphics. Communications is dependent upon distributions from Graphics to fund its obligations. Under the terms of its debt agreements at March 31, 1997, Graphics' ability to pay dividends or lend to Communications was either restricted or prohibited, except that Graphics may pay specified amounts to Communications (i) to pay the repurchase price payable to any officer or employee (or their estates) of Communications, Graphics or any of their respective subsidiaries in respect of their stock or options to purchase stock in Communications upon the death, disability or termination of employment of such officers and employees (so long as no default, or event of default, as defined, has occurred under the terms of the Bank Credit Agreement, as defined below, and provided the aggregate amount of all such repurchases does not exceed $2 million) and (ii) to fund the payment of Communications' operating expenses incurred in the ordinary course of business, other corporate overhead costs and expenses (so long as the aggregate amount of such payments does not exceed $250,000 in any fiscal year) and Communications' obligations pursuant to a tax sharing agreement with Graphics. Substantially all of Graphics' long-term obligations have been fully and unconditionally guaranteed by Communications. The two business sectors of the commercial printing industry in which the Company operates are printing and digital imaging and prepress services conducted by its American Color division. Significant accounting policies are as follows: 34 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (a) Basis of Presentation The consolidated financial statements include the accounts of Communications and all greater than 50% owned subsidiaries which are consolidated under generally accepted accounting principles. All significant intercompany transactions and balances have been eliminated in consolidation. The Shakopee Merger has been accounted for as a combination of entities under common control (similar to a pooling-of-interests). The consolidated financial statements give retroactive effect to the merger of the Company and Shakopee and include the combined operations of the Company and Shakopee for the fiscal year ended March 31, 1995 ("Fiscal Year 1995"). Shakopee was not under common control until December 22, 1994, and, accordingly, the consolidated financial statements reflect Shakopee as under common control subsequent to such date. Earnings per share data has not been provided since Communications' common stock is closely held. (b) Revenue Recognition In accordance with trade practices of the printing industry, printing revenues are recognized upon the completion of production. Shipment of printed material generally occurs upon completion of this production process. Materials are printed to unique customer specifications and are not returnable. Credits relating to specification variances and other customer adjustments are not significant. (c) Inventories Inventories are valued at the lower of first-in, first-out ("FIFO") cost or market (net realizable value) (see note 6). (d) Property, Plant and Equipment Property, plant and equipment is stated at cost. Depreciation, which includes amortization of assets under capital leases, is based on the straight-line method over the estimated useful lives of the assets or the remaining terms of the leases. (e) Excess of Cost Over Net Assets Acquired The excess of cost over net assets acquired (or "goodwill") is amortized on a straight-line basis over a range of 5 to 40 years for each of its principal business sectors. The carrying value of goodwill is reviewed if facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the estimated undiscounted future cash flows of the assets acquired, the Company's carrying amount of the goodwill is reduced by the estimated shortfall of such cash flows. In addition, the Company assesses long-lived assets for impairment under Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to be Disposed Of" ("FASB 121"). Under these rules, goodwill associated with assets acquired in a purchase business combination is included in impairment evaluations when assets or circumstances exist that indicate the carrying amount of these assets may not be recoverable. 35 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (f) Other Assets Financing costs related to the Bank Credit Agreement (as defined herein) are deferred and amortized over the term of the five-year loan agreement. Costs related to the Notes (as defined herein) are deferred and amortized over the ten-year term of the Notes. The covenants not to compete are amortized over the three and five year terms of the respective underlying agreements. (g) Income Taxes Income taxes have been provided using the liability method in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). (h) Foreign Currency Translation The assets and liabilities of the Company's Canadian facility, which include interdivisional balances, are translated at year-end rates of exchange while revenue and expense items are translated at average rates for the year. Translation adjustments are recorded as a separate component of stockholders' deficit. Since the transactions of the Canadian facility are denominated in its functional currency and the interdivision accounts are of a long-term investment nature, no transaction adjustments are included in operations. (i) Reclassifications Certain prior period amounts have been reclassified to conform with the most recent period presentation. (j) Environmental Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future period revenue generation, are expensed. Environmental liabilities are provided when assessments and/or remedial efforts are probable and the related amounts can be reasonably estimated. (k) Fair Value of Financial Instruments The Company discloses the estimated fair values of its financial instruments together with the related carrying amount. The Company is not a party to any financial instruments with material off-balance-sheet risk. (l) Concentration of Credit Risk Financial instruments which subject the Company to credit risk consist primarily of trade accounts receivable. Concentration of credit risk with respect to trade accounts receivable are generally diversified due to the large number of entities comprising the Company's customer base and their geographic dispersion. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses. 36 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (m) Use of Estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. (n) Stock Based Compensation In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. SFAS 123 is effective for transactions entered into in fiscal years beginning after December 15, 1995. The Company has accounted for stock-based compensation awards under the provisions of Accounting Principles Board Opinion No. 25 ("APB 25"), as permitted by SFAS 123, and intends to continue to do so. (2) The Shakopee Merger On August 15, 1995, the Shakopee Merger was consummated and each outstanding share of the Common Stock of Shakopee was converted into one share of the New Common Stock of the Company and 1/20 of one share of Series B Preferred Stock of the Company. Also on August 15, 1995, concurrent with the Shakopee Merger, the Company sold $185 million of 12 3/4% Senior Subordinated Notes Due 2005. Also on August 15, 1995, the Company repaid all amounts outstanding under the Old Bank Credit Agreement (as defined herein) which included the Series A Term Loan and Revolving Credit Facility Borrowings and all amounts due on the 15% Senior Subordinated Notes Due 2000 (the "Refinancing"). Additionally, on August 15, 1995, the Company entered into a $75 million revolving credit facility maturing in 2000 and a $60 million amortizing term loan with a final maturity in 2000. The Shakopee Merger was accounted for under the purchase method of accounting applying the provisions of Accounting Principles Board Opinion No. 16 ("APB 16"). Pursuant to the requirements of APB 16, the purchase price was allocated to the tangible assets and identifiable intangible assets and liabilities assumed based upon their respective fair values. The allocation of the purchase price is set forth below (in thousands): Total purchase price $ 42,631 Allocation of the purchase price: Current assets acquired (10,007) Property, plant, and equipment acquired (24,960) Other long-term assets (686) Current liabilities assumed 5,050 Other adjustments related to the acquisition 187 -------- Excess of cost over net assets acquired $ 12,215 ======== 37 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements The Shakopee Merger has been accounted for as a combination of entities under common control (similar to a pooling-of-interests), and accordingly, the consolidated financial statements give retroactive effect to the Shakopee Merger and include the combined operations of Communications and Shakopee subsequent to December 22, 1994. The following is a summary of the results of operations of the separate entities for Fiscal Year 1995 (in thousands):
Sullivan Communications Inc. (prior to Shakopee Valley Pooling Shakopee Merger) Printing Inc. Adjustments Combined ---------------- ------------- ----------- -------- Sales $ 419,054 14,144 -- $ 433,198 Income (loss) from continuing operations $ (4,445) 24 -- $ (4,421) Net income $ 13,138 24 -- $ 13,162
Pooling adjustments have been recorded to eliminate income and expenses associated with a management agreement between Graphics and Shakopee. In addition, $0.8 million of costs reflected in Shakopee's selling, general and administrative expenses has been reclassified to cost of sales in conformity with the Company's reporting policies. (3) The Gowe Acquisition On March 12, 1996, Graphics acquired the assets of Gowe, Inc., a Medina, Ohio based regional printer of newspapers, T.V. books and retail advertising inserts and catalogs ("Gowe"), for approximately $6.7 million in cash and assumption of certain liabilities of Gowe, Inc., pursuant to an Asset Purchase Agreement, among Graphics, Gowe, Inc. and ComCorp, Inc., the parent company of Gowe, Inc. (the "Gowe Acquisition"). The Gowe Acquisition was accounted for under the purchase method of accounting applying the provisions of APB 16. Pursuant to the requirements of APB 16, the purchase price was allocated to the tangible assets and identifiable intangible assets and liabilities assumed based upon their respective fair values. Gowe's results of operations are included in the Company's consolidated financial statements subsequent to March 11, 1996. The Company's pro forma unaudited results of operations for the fiscal year ended March 31, 1996 ("Fiscal Year 1996"), assuming that the Gowe Acquisition occurred as of April 1, 1995, were $561.6 million in sales, a $25.9 million loss from continuing operations before extraordinary item and a $28.9 million net loss. The Company's pro forma unaudited results of operations for the Fiscal Year 1995, assuming that the Refinancing, Shakopee Merger and Gowe Acquisition occurred as of April 1, 1994, were $503.4 million in sales, a $6.0 million loss from continuing operations before extraordinary item and $7.5 million in net income. (4) Disposal of 51% Interest in National Inserting Systems, Inc. On March 11, 1996, the Company sold its 51% interest in National Inserting Systems, Inc. ("NIS") for approximately $2.5 million in cash and a note for approximately $0.2 million under the terms of a Stock Redemption Agreement between NIS and Graphics. This transaction resulted in a net gain on disposal of approximately $1.3 million, which is classified as other, net in the consolidated statement of operations. The proceeds of the sale were used to repay indebtedness under Graphics' Bank Credit Agreement (as defined herein). 38 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (5) Discontinued Operations Sullivan Media Corporation In February 1997, the Company made a strategic decision to shut down the operations of its wholly-owned subsidiary Sullivan Media Corporation ("SMC"). This resulted in an estimated net loss on shut down of approximately $1.5 million, which is net of zero income tax benefits. The shut down of SMC has been accounted for as a discontinued operation, and accordingly, its operating results are segregated and reported as a discontinued operation in the accompanying consolidated statements of operations. The assets of SMC and any resulting gain or loss on the disposal of those assets, is immaterial to the results of operations and financial position of the Company. The condensed consolidated statements of operations relating to the discontinued SMC operation follows: Year Ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Sales $ 9,786 6,819 1,670 Cost and expenses 11,343 8,183 2,582 -------- -------- -------- Loss before income taxes (1,557) (1,364) (912) Income taxes -- -- -- -------- -------- -------- Net loss $ (1,557) (1,364) (912) ======== ======== ======== SMI Settlement On June 29, 1994, Graphics and Sullivan Marketing, Inc. ("SMI") settled the lawsuit pending in the United States District Court for the Southern District of New York entitled Sullivan Marketing, Inc. and Sullivan Graphics, Inc. v. Valassis Communications, Inc., News America FSI, Inc. and David Brandon (the "SMI Settlement"). All claims and counterclaims in such litigation were dismissed. The Company recorded income from the SMI Settlement of $18.5 million, net of $1.5 million in taxes in Fiscal Year 1995, and when coupled with settlement expenses which had previously been accrued, the net cash proceeds resulting from this settlement were approximately $16.7 million. Proceeds received were principally used in July 1994 to reduce borrowings under the Revolving Credit Facility (defined herein) which were incurred primarily to fund SMI losses prior to the shut down. In Fiscal Year 1996, the Company recognized settlement of the EPI Group Limited ("EPI") complaint naming SMI, News America FSI, Inc. ("News America") and two packaged goods companies as defendants ("EPI Lawsuit") and reversed certain accruals related to the estimated loss on shut down of SMI. The resulting effect reflected in the Fiscal Year 1996 consolidated statement of operations was $2.9 million income in discontinued operations. 39 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (6) Inventories The components of inventories are as follows (in thousands): March 31, --------- 1997 1996 ---- ---- Paper $7,831 11,277 Ink 324 272 Equipment held for sale 60 349 Supplies and other 1,496 1,283 ------ ----- Total $9,711 13,181 ====== ====== In the third quarter of Fiscal Year 1996, the Company changed to the FIFO method of accounting from the last-in, first-out ("LIFO") method of accounting as the principal method of accounting for inventories. The change results in a balance sheet which (1) reflects inventories at a value that more closely represents current costs which the Company believes are the primary concern of its constituents (bank lenders, financial markets, customers, trade creditors, etc.) and (2) enhances the comparability of the Company's financial statements by changing to the predominant method used by key competitors in the printing industry. The effect (approximately $0.8 million) of the change for the six months ended September 30, 1995 resulted in the retroactive restatement of the first and second quarters of Fiscal Year 1996 of approximately $0.5 million and $0.3 million, respectively, as a decrease of cost of sales and a decrease to net loss. In addition, the change resulted in the restatement of Fiscal Year 1995 by approximately $1.1 million to decrease cost of sales and increase net income. (7) Other Assets The components of other assets are as follows (in thousands): March 31, --------- 1997 1996 ---- ---- Deferred financing costs, less accumulated amortization of $2,893 in 1997 and $2,139 in 1996 $ 9,996 10,953 Spare parts inventory, net of valuation allowance of $100 in 1997 and 1996 1,699 1,071 Flexi-Tech equipment deposits -- 2,606 Other 3,342 5,547 ------- ------ Total $15,037 20,177 ======= ====== 40 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (8) Accrued Expenses The components of accrued expenses are as follows (in thousands): March 31, --------- 1997 1996 ---- ---- Compensation and related taxes $ 9,206 6,882 Employee benefits 8,353 11,204 Interest 4,445 4,435 Accrued costs related to shut down of SMC 1,046 -- Other 6,987 4,750 ------- ------- Total $30,037 27,271 ======= ======= (9) Notes Payable, Long-term Debt and Capitalized Leases Long-term debt is summarized as follows (in thousands): March 31, --------- 1997 1996 ---- ---- Bank Credit Agreement: Term Loan $ 47,088 55,902 Revolving Credit Facility Borrowings 40,710 39,548 -------- -------- 87,798 95,450 12 3/4% Senior Subordinated Note Due 2005 185,000 185,000 Capitalized leases 31,607 7,862 Other loans with varying maturities and interest rates 7,904 9,305 -------- -------- Total long-term debt 312,309 297,617 Less current installments 18,252 11,490 -------- -------- Long-term debt and capitalized leases, excluding current installments $294,057 286,127 ======== ======== 41 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements The Refinancing On August 15, 1995 the Company sold $185 million of 12 3/4% Senior Subordinated Notes Due 2005 (the "Notes"). Concurrently with the closing of the sale of the Notes, the Company entered into a series of transactions, (the "Refinancing," and together with the Shakopee Merger, the "Transactions") including the following: (i) the Company entered into a Credit Agreement with BT Commercial Corporation ("BTCC") (the "New Bank Credit Agreement"), providing for a $75 million revolving credit facility maturing in 2000 (the "Revolving Credit Facility") and a $60 million amortizing term loan with a final maturity in 2000 (the "Term Loan"); (ii) the repayment of all $126.5 million of indebtedness outstanding under the Old Bank Credit Agreement (plus $2.3 million of accrued interest to the date of repayment); (iii) the redemption of all outstanding 15% Senior Subordinated Notes due 2000 ("the 15% Notes") at an aggregate redemption price of $105.6 million (plus $1.8 million of accrued interest to the redemption date); (iv) the repayment of all $24.6 million of indebtedness, including the Shakopee Bank Credit Agreement, assumed in the Shakopee Merger (plus $0.1 million of accrued interest to the date of repayment) and (v) the payment of approximately $11.8 million of fees and expenses incurred in connection with the Transactions. As a result of the Transactions, the Company recorded an extraordinary loss related to early extinguishment of debt of $4.5 million, net of zero taxes. This extraordinary loss primarily consisted of the early redemption premium on the 15% Notes and the write-off of deferred financing costs related to refinanced indebtedness partially offset by the write-off of a bond premium associated with the 15% Notes. Borrowings under the Revolving Credit Facility are subject to a borrowing base which consists of (i) 85% of Eligible Accounts Receivable plus (ii) the lesser of (x) $15 million and (y) 60% of Eligible Inventory plus (iii) Equipment Acquisition Loans in an amount not to exceed $7.5 million outstanding at any time, each of which must be repaid within six months from the date of borrowing minus (iv) the aggregate amount of reserves against Eligible Accounts Receivable and Eligible Inventory established by BTCC. The remaining Term Loan amortizes in the following annual amounts: (i) $10.6 million in Fiscal Year 1998, (ii) $13.3 million in Fiscal Year 1999, (iii) $15.2 million in Fiscal Year 2000 and (iv) $8 million in Fiscal Year 2001. The New Bank Credit Agreement as amended (the "Bank Credit Agreement"), requires the Company to meet certain financial covenants including, but not limited to (1) Minimum EBITDA, (2) Current Ratio, (3) Fixed Charge Ratio and (4) Net Sale Proceeds. The Bank Credit Agreement requires prepayments in certain circumstances including: excess cash flows, proceeds from asset dispositions totaling prescribed levels, and changes in ownership. Graphics may also make voluntary prepayments of the amounts borrowed under the Bank Credit Agreement at any time, without premium or penalty, subject to certain notice and minimum amount restrictions. Each voluntary prepayment of Term Loans shall be applied to reduce the then remaining scheduled repayments in direct order of maturity. Amounts paid pursuant to repayments and prepayments of the Term Loan (including reductions in the face amounts of letters of credit) may not be reborrowed or, in the case of letters of credit, reutilized. Subject to the requirements set forth above and to certain requirements set forth in the Bank Credit Agreement, amounts borrowed under the Revolving Credit Facility may not exceed in an aggregate principal amount at any time outstanding, when added to the aggregate amount of Letter of Credit Obligations then outstanding, its Revolving Loan Percentage of the lesser of (x) the Total Revolving Loan Commitments then in effect and (y) the Borrowing Base then in effect. Graphics had outstanding borrowings under the Revolving Credit Facility of $40.7 million at March 31, 1997. The aggregate amount of letters of credit outstanding at March 31, 1997 was $4.9 million. Interest under the Bank Credit Agreement is floating based on prevailing market rates and is computed using various rate options over periods of 30, 60, 90 or 180 days as selected by the Company. The weighted average rate on outstanding indebtedness under the Bank Credit Agreement at March 31, 1997 was 8.45%. Graphics is required to pay a commitment fee equal to 1/2% per annum of the unused commitment under the Revolving Credit Facility. 42 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements Communications has guaranteed Graphics' indebtedness under the Bank Credit Agreement, which guarantee is secured by a pledge of all of Graphics' and its subsidiaries' stock. In addition, borrowings under the Bank Credit Agreement are secured by substantially all of the assets of Graphics. Communications is restricted under its guarantee of the Bank Credit Agreement from, among other things, entering into mergers, acquisitions, incurring additional debt, or paying cash dividends. In the event of a default under the Bank Credit Agreement the Banks have various rights and obligations under such agreement which could have an adverse impact on the Company. Should the Banks exercise their right to accelerate principal repayment as a result of an event of default, an event of default would occur under the terms of the Indenture. The Company is currently in compliance with all financial covenants set forth in the Bank Credit Agreement, as amended. On June 30, 1997, the Company entered into a $25 million term loan facility with Bankers Trust Company and a syndicate of lenders including a $5 million participation by Morgan Stanley Senior Funding, Inc., a related party, which matures on March 31, 2001 (the "Term Loan Facility"). Net proceeds of approximately $23 million were received and used to reduce outstanding borrowings under the existing Revolving Credit Facility. Interest under the Term Loan Facility is floating based upon existing market rates plus agreed upon margin levels which escalate over the initial 24 months of the facility. In addition, the Company is required to pay certain additional cash fees on the 6, 12, 18, 24 and 30 month anniversary dates of the facility based upon the then outstanding principal amounts. The obligations under this facility are guaranteed on the same basis as the New Bank Credit Agreement although such guarantees are secured by second priority security interests in the tangible and intangible assets of the Company and such guarantors. Covenants under this agreement are substantially similar to, but in certain respects are more restrictive than, existing covenants under the Senior Subordinated Notes Indenture. Morgan Stanley Senior Funding, Inc. received transaction fees of approximately $0.3 million. 43 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements The Notes bear interest at 12 3/4% and mature February 1, 2005. Interest on the Notes is payable semi-annually on February 1 and August 1. The Notes are redeemable at the option of Graphics in whole or in part after August 1, 2000 at 106.375% of the principal amount, declining to 100% of the principal amount, plus accrued interest, on or after August 1, 2002. Upon the occurrence of a change of control triggering event, as defined, each holder of a Note will have the right to require Graphics to repurchase all or any portion of such holder's Note at 101% of the principal amount thereof, plus accrued interest. The Notes are subordinate to all existing and future senior indebtedness, as defined, of Graphics, and are guaranteed on a senior subordinated basis by Communications. The amortization for total long-term debt and capitalized leases at March 31, 1997 is shown below (in thousands): Long-Term Capitalized Fiscal year Debt Leases ----------- ---- ------ 1998 $ 12,988 $ 7,949 1999 15,350 6,691 2000 15,793 6,045 2001 49,307 5,002 2002 680 4,352 Thereafter 186,584 12,550 ----------- ---------- Total $ 280,702 42,589 =========== Imputed interest (10,982) ---------- Present value of minimum lease payments $ 31,607 ========== Capital leases have varying maturity dates and interest rates which generally approximate 10%. The Company estimates that the carrying amounts of the Company's debt and other financial instruments appropriate their fair values at March 31, 1997 and 1996. 44 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (10) Income Taxes Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts as measured by tax laws and regulations. Significant components of the Company's deferred tax liabilities and assets as of March 31, 1997 and 1996 are as follows (in thousands): March 31, --------- 1997 1996 ---- ---- Deferred tax liabilities: Book over tax basis in fixed assets $31,402 $19,473 Foreign taxes 2,505 2,068 Accumulated amortization 483 -- Other, net 4,459 3,470 ------- ------- Total deferred tax liabilities 38,849 25,011 ------- ------- Deferred tax assets: Bad debts 2,197 1,825 Accrued expenses and other liabilities 24,953 13,389 Accrued loss on discontinued operations 722 79 Accumulated amortization -- 122 Net operating loss carryforwards 30,515 21,203 AMT credit carryforwards 1,262 1,262 Cumulative translation adjustment 625 540 ------- ------- Total deferred tax assets 60,274 38,420 Valuation allowance for deferred tax assets 30,138 21,210 ------- ------- Net deferred tax assets 30,136 17,210 ------- ------- Net deferred tax liabilities $ 8,713 $ 7,801 ======= ======= Management has evaluated the need for a valuation allowance for all or a portion of the deferred tax assets. A valuation allowance of $30.1 million has been recorded for the excess of net operating loss carryforwards and future deductible temporary differences over future taxable temporary differences. The valuation allowance was increased by $8.9 million during the current fiscal year. 45 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements The components of income tax expense are as follows (in thousands): Year ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Amount attributable to continuing operations $2,591 $4,874 $2,552 Amount attributable to discontinued operations -- 75 1,505 ------ ------ ------ Total expense $2,591 $4,949 $4,057 ====== ====== ====== Income tax expense attributable to loss from continuing operations consists of (in thousands): Year ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Current Federal $ -- $ 689 $ 93 State 145 618 473 Foreign 1,535 3,047 1,816 ------- ------- ------- Total current 1,680 4,354 2,382 ------- ------- ------- Deferred Federal 354 513 204 State 120 7 (34) Foreign 437 -- -- ------- ------- ------- Total deferred 911 520 170 ------- ------- ------- Provision for income taxes $ 2,591 $ 4,874 $ 2,552 ======= ======= ======= 46 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements The effective tax rates for the fiscal year ended March 31, 1997 ("Fiscal Year 1997"), Fiscal Year 1996 and Fiscal Year 1995 were (10.0%), (22.7%), and (136.5%), respectively. The difference between these effective rates relating to continuing operations and the statutory federal income tax rate is composed of the following items: Year ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Statutory tax rate 35.0% 35.0% 35.0% State income taxes, less Federal tax impact (0.7) (1.9) (15.5) Foreign taxes, less Federal tax impact (5.0) (9.4) (64.1) Amortization (11.9) (16.1) (165.4) Change in valuation allowance (28.3) (26.7) 69.8 Other, net 0.9 (3.6) 3.7 ----- ----- ------ Effective income tax rate (10.0)% (22.7)% (136.5)% ===== ===== ====== As of March 31, 1997, the Company had available net operating loss carryforwards ("NOL's") for state purposes of $71.9 million which can be used to offset future state taxable income. If these NOL's are not utilized, they will begin to expire in 1998 and will be totally expired in 2012. As of March 31, 1997, the Company had available NOL's for federal purposes of $78.6 million which can be used to offset future federal taxable income. If these NOL's are not utilized, they will begin to expire in 2006 and will be totally expired in 2012. The Company also had available an alternative minimum tax credit carryforward of $1.3 million which can be used to offset future taxes in years in which the alternative minimum tax does not apply. This credit can be carried forward indefinitely. The Company has alternative minimum tax net operating loss carryforwards in the amount of $61.2 million which will begin to expire in 2007 and will be completely expired in 2012. (11) Pension Plans The Company sponsors defined benefit pension plans covering full-time salaried employees of the Company who had at least one year of service at December 31, 1994. Benefits under these plans generally are based upon the employee's years of service and, in the case of salaried employees, compensation during the years immediately preceding retirement. The Company's general funding policy is to contribute amounts within the annually calculated actuarial range allowable as a deduction for federal income tax purposes. The plans' assets are maintained by trustees in separately managed portfolios consisting primarily of equity securities, bonds and guaranteed investment contracts. In October 1994, the Board of Directors approved an amendment to the Company's defined benefit pension plans which resulted in the freezing of additional defined benefits for future services under the plans 47 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements effective January 1, 1995. As a result, a gain of $3.7 million was recorded in the Fiscal Year 1995 pursuant to Statement of Financial Accounting Standards No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits." This curtailment gain is shown in the consolidated statement of operations net of a $0.4 million expense associated with establishing a supplemental executive retirement plan (see note 12). Total net periodic pension expense and its components for these plans during the periods indicated is as follows (in thousands): Year Ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Service cost $ 446 318 1,737 Interest cost 3,546 3,428 3,405 Actual return on assets (4,349) (6,404) 629 Net amortization and deferral 725 3,076 (3,311) ------- ------ ------ Total pension expense $ 368 418 2,460 ======= ====== ====== Funded status of the four plans sponsored by the Company is as follows (in thousands): March 31, --------- 1997 1996 ---- ---- Actuarial present value of accumulated benefit obligations: Vested $ 47,756 47,404 Non-vested 829 1,488 -------- -------- $ 48,585 48,892 ======== ======== Projected benefit obligations $ 48,585 48,892 Plan assets on deposit with trustees at fair value 41,436 38,035 -------- -------- Projected benefit obligations in excess of plan assets (7,149) (10,857) Unrecognized: Net gain (3,146) (881) Prior service cost (784) (942) -------- -------- Pension liability recognized in consolidated balance sheets $(11,079) (12,680) ======== ======== 48 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements The above pension liability balance is recorded in the consolidated balance sheets as follows (in thousands): March 31, --------- 1997 1996 ---- ---- Accrued expenses - employee benefits $ 771 4,216 Other liabilities 10,308 8,464 ---------- -------- $ 11,079 12,680 ========== ======== The pension liability at March 31, 1997 and 1996 reflects the impact of changes in certain assumptions effective during such times as follows: March 31, --------- 1997 1996 1995 ---- ---- ---- Discount rate: Pension expense 7.50% 8.75% 8.75% Funded status 7.75% 7.50% 8.75% Rate of increase in compensation levels N/A N/A 6.00% The expected long-term rate of return on plan assets was 9.25% in the Fiscal Years 1997, 1996 and 1995. (12) Other Postretirement Benefits The Company provides certain other postretirement benefits for employees, primarily life and health insurance. Full-time employees who have attained age 55 and have at least five years of service are entitled to postretirement health care and life insurance coverage. Postretirement life insurance coverage is provided at no cost to eligible retirees. Special cost sharing arrangements for health care coverage are available to employees whose age plus years of service at the date of retirement equals or exceeds 85 ("Rule of 85"). Any eligible retiree not meeting the Rule of 85 must pay 100% of the required health care insurance premium. Effective January 1, 1995, the Company amended the health care plan changing the health care benefit for all employees retiring on or after January 1, 2000. This amendment had the effect of reducing the accumulated postretirement benefit obligation by approximately $3 million. This reduction is reflected as unrecognized prior service cost and is being amortized on a straight line basis over 15.6 years, the average remaining years of service to full eligibility of active plan participants at the date of the amendment. 49 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements The following table sets forth the plan's funded status, reconciled with amounts recognized in the Company's consolidated balance sheets at March 31, 1997 and 1996 (in thousands): March 31, --------- 1997 1996 ---- ---- Accumulated postretirement benefit obligation: Retirees $2,371 3,193 Active plan participants 1,022 1,071 ------ ------ Total 3,393 4,264 Plan assets at fair value -- -- ------ ------ Accumulated postretirement benefit obligation in excess of plan assets 3,393 4,264 Unrecognized prior service cost 2,584 2,778 Unrecognized net gain 1,694 922 ------ ------ Accrued postretirement benefit cost $7,671 7,964 ====== ====== The estimated current portion of the above accrued postretirement benefit cost is $0.3 million and is included in accrued expenses in the accompanying consolidated balance sheet at March 31, 1997. The remaining $7.4 million is included in other liabilities. Net periodic postretirement benefit cost for the periods indicated included the following components (in thousands): Year ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Service cost attributed to service during the period $ 40 35 254 Interest cost in accumulated postretirement benefit 250 317 512 obligation Amortization of net gain from earlier periods (92) (67) -- Amortization of prior service cost (194) (194) (48) ----- ----- ----- Net periodic postretirement benefit cost $ 4 91 718 ===== ===== ===== 50 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements The significant assumptions used in determining postretirement benefit cost and the accumulated postretirement benefit obligation were as follows: March 31, --------- 1997 1996 1995 ---- ---- ---- Discount rate - expense 7.50% 8.75% 8.75% Discount rate - APBO 7.75% 7.50% 8.75% The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation at March 31, 1997 was 10.55% gradually declining to 5.75% in the year 2005 and forward. The effect of a one percentage point increase in the assumed health care cost trend rate would increase the accumulated postretirement benefit obligation as of March 31, 1997 by approximately 8%, and the aggregate of the service and interest cost components of net annual postretirement benefit cost by approximately 7%. Supplemental Executive Retirement Plan In October 1994, the Board of Directors approved a new Supplemental Executive Retirement Plan ("SERP"), which is a defined benefit plan, for certain key executives. Such benefits will be paid from the Company's assets. The unfunded accumulated benefit obligation under this plan is approximately $1.2 million. The Company recognized a $0.4 million expense associated with the establishment of the SERP. This expense was shown netted with the gain from curtailment of defined benefit pension plans in the consolidated statement of operations for the Fiscal Year 1995. (13) 401(k) Defined Contribution Plan Effective January 1, 1995, the Company amended its 401(k) defined contribution plan. Eligible participants may contribute up to 15% of their annual compensation subject to maximum amounts established by the Internal Revenue Service and receive a matching employer contribution on amounts contributed. The employer matching contribution is made bi-weekly and equals 2% of annual compensation for all plan participants plus 50% of the first 6% of annual compensation contributed to the plan by each employee, subject to maximum amounts established by the Internal Revenue Service. The Company's contribution under this Plan amounted to $3.9 million during Fiscal Year 1997, $3.3 million during Fiscal Year 1996 and $0.7 million during the three months ended March 31, 1995. (14) Capital Stock Stock Option Plan In 1993, the Company established the Sullivan Communications, Inc. Stock Option Plan. This plan, as amended, (the "Stock Option Plan") is administered by a committee of the Board of Directors (the "Committee") and provides for granting up to 20,841 shares of Communications Common Stock ("Common Stock"). Stock options may be granted under the Stock Option Plan to officers and other key employees of the Company (the "Participants") at the exercise price per share of Common Stock, as determined at the time of grant by the Committee in its sole discretion. All options are 25% exercisable on the first anniversary date of a grant and vest in additional 25% increments on each of the next three anniversary dates of each grant. All options expire 10 years from date of grant. 51 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements A summary of activity under the Stock Option Plan is as follows: Options ------- Outstanding at April 1, 1994 8,024 Granted 7,240 Exercised -- Canceled -- ------- Outstanding at March 31, 1995 15,264 Granted 2,497 Exercised -- Canceled (1,262) ------- Outstanding at March 31, 1996 16,499 Granted 6,015 Exercised -- Canceled (3,108) ------- Outstanding at March 31, 1997 19,406 ======= All options were granted with a $50 exercise price. The weighted average fair value of options granted at the grant date was $0 for both fiscal years ending March 31, 1997 and 1996. The weighted average remaining contractual life of the options outstanding at March 31, 1997, 1996 and 1995, is 7.6 years, 7.9 years and 8.7 years, respectively. Of the options outstanding; 9,004, 5,507 and 2,007 were exercisable at March 31, 1997, 1996 and 1995, respectively. A total of 1,435 shares of Communications Common Stock were reserved for issuance, but not granted under the Stock Option Plan at March 31, 1997. In October 1995, the Financial Accounting Standards Board issued SFAS 123. This new standard defines a fair value based method of accounting for employee stock options and other similar equity instruments. This statement gives entities a choice of recognizing related compensation expense by adopting the new fair value method or to continue to measure compensation using the intrinsic value approach under APB 25, the former standard. The Company has elected to follow APB 25 and related Interpretations in accounting for its stock compensation plans because, as discussed below, the alternative fair value accounting provided for under SFAS 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The effects of applying SFAS 123 for either recognizing compensation expense or providing pro forma disclosures are not likely to be representative of the effects on future years. 52 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements Pro forma information regarding net income and earnings per share is required by SFAS 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for Fiscal Years 1997 and 1996, respectively: risk-free interest rates of 6.5% and 6.3%; no annual dividend yield; volatility factors of 0; and an expected option life of 5 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For the purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Because the fair value of the Company's options equals $0, there is no pro forma disclosure for Fiscal Years 1997 and 1996. (15) Commitments and Contingencies The Company incurred rent expense for the Fiscal Years 1997, 1996 and 1995 of $5.4 million, $4.9 million and $4.2 million, respectively, under various operating leases. Future minimum rental commitments under existing operating lease arrangements at March 31, 1997 are as follows (in thousands): Fiscal Year ----------- 1998 $ 4,218 1999 3,612 2000 3,027 2001 2,507 2002 1,567 Thereafter 5,716 ------- Total $20,647 ======= The Company has employment agreements with one of its principal officers and four other employees. Such agreements provide for minimum salary levels as well as for incentive bonuses which are payable if specified management goals are attained. The aggregate commitment for future salaries at March 31, 1997, excluding bonuses, was approximately $2.4 million. 53 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements On December 21, 1989, Graphics sold CPS, its ink manufacturing operations and facilities. Graphics remains contingently liable under $3.7 million of industrial revenue bonds assumed by the purchaser ("CPS Buyer") in this transaction. The CPS Buyer which assumed these liabilities has agreed to indemnify Graphics for any resulting obligation and has also provided an irrevocable letter of credit in favor of the holders of such bonds. Accordingly, management believes that any obligation of Graphics under this contingency is unlikely. Concurrent with the CPS sale, Graphics entered into a long-term ink supply contract with the CPS Buyer. The supply contract requires Graphics to purchase substantially all of its ink requirements, within certain limitations and minimums, from the CPS Buyer. Graphics believes that prices for products under this contract approximate market prices at the time of purchase of such products. Graphics, together with over 300 other persons, has been designated by the U.S. Environmental Protection Agency as a potentially responsible party (a "PRP") under the Comprehensive Environmental Response Compensation and Liability Act ("CERCLA," also known as "Superfund") at one Superfund site. Although liability under CERCLA may be imposed on a joint and several basis and the Company's ultimate liability is not precisely determinable, the PRPs have agreed that Graphics' share of removal costs is 0.46% and therefore Graphics believes that its share of the anticipated remediation costs at such site will not be material to its business or financial condition. Based upon an analysis of Graphics' volumetric share of waste contributed to the site and the agreement among the PRPs, the Company has a reserve of approximately $0.1 million in connection with this liability on its consolidated balance sheet at March 31, 1997. The Company believes this amount is adequate to cover such liability. The Company has been named as a defendant in several legal actions arising from its normal business activities. In the opinion of management, any liability that may arise from such actions will not have a material adverse effect on the consolidated financial statements of the Company. (16) Significant Customers No single customer represented 10% or more of total sales in the fiscal year ended March 31, 1997. The sales of Best Buy Co. for Fiscal Year 1996 amounted to approximately 12.7% of the Company's consolidated sales. Receivables outstanding from these sales were approximately $1.1 million and $5.9 million at March 31, 1997 and March 31, 1996, respectively. No single customer represented 10% or more of total sales in the fiscal year ended March 31, 1995. 54 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (17) Interim Financial Information (Unaudited) Quarterly financial information follows (in thousands):
(a) (b) American SMC Quarter as Color/SVP Discontinued Revised Issued Reclass Operations Quarter ------ ------- ---------- ------- Fiscal Year 1997: Quarter Ended June 30, 1996: Net Sales $ 139,704 -- (1,603) 138,101 Gross Profit $ 15,393 -- (624) 14,769 Net Loss $ (7,604) -- -- (7,604) Quarter Ended September 30, 1996: Net Sales 138,495 -- (2,705) 135,790 Gross Profit 17,490 -- (1,167) 16,323 Net Loss (7,548) -- -- (7,548) Quarter Ended December 31, 1996: Net Sales 136,472 -- (1,153) 135,319 Gross Profit 19,719 -- (159) 19,560 Net Loss (4,339) -- -- (4,339) Quarter Ended March 31, 1997: Net Sales 119,666 -- (4,325) 115,341 Gross Profit 15,915 -- (1,896) 14,019 Net Loss (12,212) -- -- (12,212) Totals: Net Sales $ 534,337 -- (9,786) 524,551 Gross Profit $ 68,517 -- (3,846) 64,671 Net Loss $ (31,703) -- -- (31,703) Fiscal Year 1996: Quarter Ended June 30, 1995: Net Sales $ 124,490 -- (258) 124,232 Gross Profit $ 19,102 (2,320) (52) 16,730 Net Loss $ (7,278) -- -- (7,278) Quarter Ended September 30, 1995: Net Sales 130,653 -- (1,404) 129,249 Gross Profit 19,020 (1,825) (571) 16,624 Loss before extraordinary item (4,945) -- -- (4,945) Net Loss (9,471) -- -- (9,471) Quarter Ended December 31, 1995: Net Sales 153,308 -- (1,344) 151,964 Gross Profit 22,415 (2,709) (416) 19,290 Net Income 73 -- -- 73 Quarter Ended March 31, 1996: Net Sales 127,891 -- (3,813) 124,078 Gross Profit 16,101 (2,421) (1,911) 11,769 Net Loss (12,651) -- -- (12,651) Totals: Net Sales $ 536,342 -- (6,819) 529,523 Gross Profit $ 76,638 (9,275) (2,950) 64,413 Loss before extraordinary item $ (24,801) -- -- (24,801) Net Loss $ (29,327) -- -- (29,327)
55 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (a) In Fiscal Year 1997, American Color began presenting certain of its costs previously classified as selling, general and administrative expenses as cost of sales to more closely conform with the print sector presentation. In Fiscal Year 1997, SVP reclassed certain of its costs between selling, general and administrative costs and cost of sales to more closely conform with the other print plants. As a result, Fiscal Year 1996 and Fiscal Year 1995 have been reclassified to conform with Fiscal Year 1997 presentation. (b) In February 1997, the Company shut down the operations of its wholly-owned subsidiary SMC. The resulting effect of this change is a retroactive restatement of Fiscal Year 1996 reclassing SMC's results of operations to Discontinued Operations (see note 5). (18) Restructuring Costs and Other Special Charges In April 1995, the Company implemented a plan for its American Color division which was designed to improve productivity, increase customer service and responsiveness, and provide increased growth in the digital imaging and prepress services business. The cost of this plan was accounted for in accordance with the guidance set forth in Emerging Issues Task Force Issue 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). The pretax costs of $5 million which were incurred as a part of this plan represent employee termination, goodwill write-down and other related costs that were incurred as a direct result of the plan. Approximately $0.9 million of restructuring costs primarily related to relocation expenses were recognized in Fiscal Year 1997. In Fiscal Year 1996 the Company recognized $4.1 million of such restructuring charges, which included $0.9 million of goodwill write-down, and $3.2 million primarily for severance and other personnel related costs. The goodwill written down was the portion related to certain facilities that were either shut down or relocated in conjunction with the American Color restructuring. During Fiscal Year 1997 and Fiscal Year 1996, the Company recorded special charges totalling $1.9 million and $3.4 million, respectively, for impaired long-lived assets and to adjust the carrying values of idle, disposed and under performing assets to estimated fair values. The provisions were based on a review of long-lived assets in connection with the adoption of FASB 121. Of the Fiscal Year 1997 total long-lived assets that were adjusted based on being idle, disposed of or under performing, approximately $0.4 million and $1.5 million related to the print and American Color sectors, respectively. Fair value was based on the Company's estimate of held and used and idle assets based on current market conditions using the best information available. Approximately $2 million of the Fiscal Year 1996 total related to the print sector's long-lived assets, respectively that were adjusted based on being idle, disposed of or under performing. The remaining $1.4 million of the Fiscal Year 1996 total related to the American Color sector. The estimated undiscounted future cash flows attributable to certain American Color division identifiable long-lived assets held and used was less than their carrying value principally as a result of high levels of ongoing technological change. The methodology used to assess the recoverability of the American Color sector long-lived assets involved projecting aggregate cash flows. Based on this evaluation, the Company determined in Fiscal Year 1996 that long-lived assets with a carrying amount of $2.2 million were impaired and wrote them down by $1.4 million to their fair value. Fair value was based on Company estimates and appraisals. Such special charges are classified as restructuring costs and other special charges in the consolidated statement of operations. 56 SULLIVAN COMMUNICATIONS, INC. Notes to Consolidated Financial Statements (19) Non-recurring Charge Related to Terminated Merger The Company recognized $1.5 million of expenses related to a terminated merger in Fiscal Year 1996. (20) Non-recurring Charge Related to Resignation of Chief Executive Officer A non-recurring charge of $1.9 million relating to the resignation of the Company's Chief Executive Officer was recorded in Fiscal Year 1997, and is classified as a selling, general and administrative expense. Payments under the related agreement continue through 2001, subject to certain requirements. (21) Summarized Financial Information of Sullivan Graphics, Inc. Summary financial information for Communications' wholly-owned subsidiary, Sullivan Graphics, Inc., which is the same as Communications is as follows (in thousands): March 31, --------- Balance sheet data: 1997 1996 --------- ------ Current assets $ 70,077 85,519 Noncurrent assets 263,898 265,662 Current liabilities 78,675 75,907 Noncurrent liabilities 331,618 319,670 Year ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Statement of operations data: Sales $ 524,551 529,523 433,198 Operating income 10,372 12,716 24,450 Net (loss) income (31,703) (29,327) 13,162 57 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The following table provides certain information about each of the current directors and executive officers of Communications and Graphics (ages as of March 31, 1997). All directors hold office until their successors are duly elected and qualified. Name Age Position with Graphics and Communications - ---- --- ----------------------------------------- Stephen M. Dyott 45 Chairman, President, Chief Executive Officer and Director Frank V. Sica 46 Director Eric T. Fry 30 Director Joseph M. Milano 44 Senior Vice President and Chief Financial Officer Timothy M. Davis 42 Senior Vice President-Administration, Secretary and General Counsel Patrick W. Kellick 39 Vice President/Controller & Assistant Secretary Stephen M. Dyott - Chairman and Chief Executive Officer of Graphics and Communications since September 1996; President of Communications since February 1995; Director of Graphics and Communications since September 1994; Chief Operating Officer of Communications from February 1995 to September 1996 and Chief Operating Officer of Graphics from 1991 to September 1996; President of Graphics since 1991; Vice President and General Manager - Flexible Packaging, American National Can Company ("ANCC") from 1988 to 1991; Vice President and General Manager - Tube Packaging, ANCC from 1985 to 1987. Frank V. Sica - Director of Graphics and Communications since April 1993. Managing Director of Morgan Stanley & Co. Incorporated ("MS&Co.") since 1988. Has been with MS&Co. since 1981, originally in the Mergers and Acquisitions Department, and since 1988, with the Merchant Banking Division. Vice Chairman and Director of the general partner of the general partner Morgan Stanley Capital Partners III, L.P. and its related investment partnerships ("MSCP III") and Director of the general partner of the MSCP III Entities. Director of ARM Financial Group, Inc., Consolidated Hydro, Inc., Fort Howard Corporation, Kohl's Corporation, Ionica Group PLC, PageMart Wireless, Inc., and CSG Systems International, Inc. Eric T. Fry - Director of Graphics and Communications since March 1996. Associate of MS&Co. and an officer of the general partner of MSLEF II and of the general partner of the general partner of the MSCP III Entities. Joined MS&Co. in 1989, initially in the Mergers and Acquisitions Department and from 1991 to 1992 in the Merchant Banking Division. From 1992 to 1994 attended Harvard Business School and received an MBA. Rejoined MS&Co.'s Merchant Banking Division in 1994. Director of Enterprise Reinsurance Holdings Corporation, Hamilton Services Limited, Risk Management Solutions, Inc. and LifeTrust America, L.L.C. Joseph M. Milano - Senior Vice President and Chief Financial Officer of Communications and Graphics since May 1994; Vice President - Finance of Communications and Graphics from 1992 to May 1994; Vice President and Chief Financial Officer, Farrel Corporation, 1989 to 1992; Vice President and Chief Financial Officer, Electronic Mail Corporation of America from 1984 to 1988. Timothy M. Davis - Senior Vice President - Administration, Secretary and General Counsel of Communications and Graphics since 1989; Vice President, Secretary and General Counsel of NHI, NCI and their subsidiaries from 1989 to 1992; Assistant General Counsel of MacMillan, Inc. and counsel to affiliates of Maxwell Communication Corporation North America, January 1989 to June 1989. Attorney in private practice from 1984 to 1989. 58 Patrick W. Kellick - Vice President/Controller of Communications and Graphics since 1989; Controller of Graphics since 1987, and Assistant Secretary of Communications and Graphics since 1995. ITEM 11. EXECUTIVE COMPENSATION Summary Compensation Table The following table presents information concerning compensation paid for services to Communications and Graphics during the fiscal years ended March 31, 1997, 1996 and 1995 to the Chief Executive Officers and the four other most highly compensated executive officers (the "Named Executive Officers") of Communications and/or Graphics.
Summary Compensation Table Annual Compensation Long-Term Compensation --------------------------------- ------------------------------------- Awards Payouts ------ ------- Other Securities Annual Restricted Underlying All Other Name and Principal Compen- Stock Options/ LTIP Compen- Position Period Salary Bonus sation Award(s) SAR's(#) Payouts sation -------- ------ ------ ----- ------ -------- -------- ------- ------ Stephen M. Dyott Fiscal Year 1997 $463,462 $350,000 -- -- 1,761 -- -- President, Chief Operating Fiscal Year 1996 $450,000 $250,000 -- -- 380 -- -- Officer & Director thru Fiscal Year 1995 $350,000 $684,250 $197,004 (a) -- 859 -- -- 09/96 Chairman, President and Chief Executive Officer & Director 09/96 forward James T. Sullivan Fiscal Year 1997 $276,936 -- -- -- -- -- $354,991 (c) Chairman, Chief Executive Fiscal Year 1996 $600,028 -- -- -- 380 -- $ 7,620 (b) Officer & Director thru Fiscal Year 1995 $600,028 $600,000 $ 61,430 (a) -- 139 -- $ 7,620 (b) 09/96 Joseph M. Milano Fiscal Year 1997 $260,097 $150,000 -- -- 760 -- -- Senior Vice President & Fiscal year 1996 $228,923 $125,000 -- -- 614 -- -- Chief Financial Officer Fiscal Year 1995 $175,423 $248,000 $ 87,494 (a) -- 688 -- -- Malcolm J. Anderson Fiscal Year 1997 $230,000 $105,000 -- -- 125 -- -- Executive Vice President Fiscal Year 1996 $212,693 $ 70,000 $ 38,504 (a) -- -- -- -- Fiscal Year 1995 $200,000 $381,000 $ 87,951 (a) -- 526 -- -- Timothy M. Davis Fiscal Year 1997 $220,562 $110,000 -- -- 290 -- -- Senior Vice President- Fiscal Year 1996 $209,923 $106,000 -- -- -- -- -- Administration, Fiscal Year 1995 $190,000 $202,750 $128,325 (a) -- 535 -- -- Secretary & General Counsel Terrence M. Ray Fiscal Year 1997 $230,000 $ 50,000 $ 14,550 (a) -- 1,447 -- -- President/Chief Operating Fiscal Year 1996 $ 20,962 6,000 -- -- -- -- -- Officer-American Color Fiscal Year 1995 -- -- -- -- -- -- --
- ---------- (a) Represents relocation expense reimbursements. (b) Represents premiums paid by Graphics with respect to a life insurance policy. (c) Represents severance and premiums paid by Graphics with respect to a life insurance policy. 59 The following table presents information concerning the options granted to the Named Executive Officers during the last fiscal year. All outstanding options issued prior to April 8, 1993 were cancelled in connection with the 1993 Acquisition. Option/SAR Grants in Last Fiscal Year(a)
Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation Individual Grants for Option Term - ----------------------------------------------------------------------------------------------- ------------------------------------ % of Total Number of Options/SAR's Securities Granted to Underlying Employees Exercise or Options/SAR's in Fiscal Year Base Price Expiration Name Granted(#) 1997 ($/sh) Date 5% ($) (b) 10% ($) (b) - --------------------- ----------------- ---------------- --------------- -------------------- ------------------- ---------------- Stephen M. Dyott 1.761 29% 50 10/01/2006 55,472 140,000 Joseph M. Milano 760 13% 50 10/01/2006 23,940 60,420 Malcolm J. Anderson 125 2% 50 10/01/2006 3,938 9,938 Timothy M. Davis 290 5% 50 10/01/2006 9,135 23,055 Terrence M. Ray 1,447 24% 50 10/01/2006 45,581 115,037
- ---------- (a) All options will become 25 percent exercisable on October 1, 1997 and are scheduled to vest in additional 25 percent increments on each of October l, 1998, October 1, 1999 and October 1, 2000. (b) The potential realizable value shown in the table is based on hypothetical increases in the estimated fair market value of the common stock of Communications ("Communications Common Stock") over the terms of the options, assuming 5% and 10% growth in such fair market value. These estimates of potential realizable value have been prepared pursuant to the rules of the Commission and are not necessarily indicative of the amount that would have been utilized upon exercise of the options had such options remained outstanding. The following table presents information concerning the fiscal year-end value of unexercised stock options held by the Named Executive Officers. No stock options were exercised by the Named Executive Officers during the last fiscal year. Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option/SAR Values
Number of Securities Value of Unexercised Underlying Unexercised In-the-Money Options/ Options/SAR's at 3/31/97 SAR's at 3/31/97 Exercisable/Unexercisable Exercisable/Unexercisable ------------------------- ------------------------- Stephen M. Dyott............................. 2,250/3,050 (a) James T. Sullivan............................ 3,520/0 (a) Joseph M. Milano............................. 574/1,590 (a) Malcolm J. Anderson.......................... 263/388 (a) Timothy M. Davis............................. 459/621 (a) Terrence M. Ray.............................. 0/1,447 (a)
- ---------- (a) Communications Common Stock has not been registered or publicly traded and, therefore, a public market price of the stock is not available. While a formal valuation of the Communications Common Stock has not been undertaken, Communications believes that the exercise price of the options held by the Named Executive Officers at March 31, 1997 was in each case greater than the fair market value of the underlying shares of Communications Common Stock as of such date. 60 Pension Plan Graphics sponsors the Sullivan Graphics, Inc. Salaried Employees' Pension Plan (the "Pension Plan"), a defined benefit pension plan covering full-time salaried employees of Graphics who had at least one year of service as of December 31, 1994. The basic benefit payable under the Pension Plan is a five-year certain single life annuity equivalent to (a) 1% of a participant's "final average monthly compensation" plus (b) 0.6% of a participant's "final average monthly compensation" in excess of 40% of the monthly maximum Social Security wage base in the year of retirement multiplied by years of credited service (not to exceed 30 years of service). For purposes of the Pension Plan, "final average compensation" (which, for the Named Executive Officers, is reflected in the salary and bonus columns of the Summary Compensation Table) means the average of a participant's five highest consecutive calendar years of total earnings (which includes bonuses) from the last 10 years of service. The maximum monthly benefit payable from the Pension Plan is $5,000. The basic benefit under the Pension Plan is payable upon completion of five years of vesting service and retirement on or after attaining age 65. Participants may elect early retirement under the Pension Plan upon completion of five years of vesting service and the attainment of age 55, and receive the basic benefit reduced by 0.4167% for each month that the benefit commencement date precedes the attainment of age 65. A deferred vested benefit is available to those participants who separate from service before retirement, provided the participant has at least five years of vesting service. In October 1994, the Board of Directors approved an amendment to the Pension Plan which resulted in the freezing of additional defined benefits for future services under such plan effective January 1, 1995 (see note 11 to the consolidated financial statements). Retirement benefits payable under qualified defined benefit plans are subject to the annual pension limitations imposed under Section 415 of the Internal Revenue Code of 1986, as amended (the "Code"), which limitations vary annually. The Section 415 limitation for 1997 and 1996 was $125,000 and $120,000. In addition, Section 401(a)(17) of the Code specifies a maximum amount of annual compensation, also adjusted annually that may be taken into account in computing benefits under a qualified defined benefit plan. The Section 401(a)(17) limitation was $160,000 and $150,000 for 1997 and 1996. The following table shows the estimated annual pension benefits payable at retirement at age 65 under the Pension Plan in the final average compensation and years of service classifications indicated. Final Average Compensation Years of Benefit Service - ------------------ ---------------------------------------------------------- 15 20 25 30 ------- ------- ------- ------- $125,000 $27,818 $37,091 $46,364 $55,637 150,000 33,818 45,091 56,364 60,000 175,000 33,818 45,091 56,364 60,000 200,000 33,818 45,091 56,364 60,000 225,000 33,818 45,091 56,364 60,000 250,000 33,818 45,091 56,364 60,000 300,000 33,818 45,091 56,364 60,000 350,000 33,818 45,091 56,364 60,000 400,000 33,818 45,091 56,364 60,000 450,000 33,818 45,091 56,364 60,000 500,000 33,818 45,091 56,364 60,000 625,000 33,818 45,091 56,364 60,000 750,000 33,818 45,091 56,364 60,000 61 At March 31, 1997, all of the Named Executive Officers with the exception of Malcolm J. Anderson have vested in the pension plan. At March 31, 1997, the Named Executive Officers had the following amounts of credited service (original hire date through January 1, 1995) under the Pension Plan: Stephen M. Dyott (3 years, 3 months), James T. Sullivan (5 years, 5 months), Joseph M. Milano (2 years, 7 months), Malcolm J. Anderson (1 year, 3 months), and Timothy M. Davis (5 years, 5 months). Compensation of Directors Directors of Communications and Graphics do not receive a salary or an annual retainer for their services but are reimbursed for expenses incurred with respect to such services. Employment Agreements In connection with the 1993 Acquisition, Graphics entered into a new employment agreement with Stephen M. Dyott (the "New Employment Agreement"). The New Employment Agreement for Mr. Dyott superseded previous employment agreements. The New Employment Agreement has been amended so that it has a term of four years commencing as of the effective time Acquisition Corp. merged with and into Communications (the "Effective Time"). The term under the New Employment Agreement is automatically extended at the end of the then current term for one-year periods absent two year's notice of an intent not to renew. The New Employment Agreement provides for the payment of an annual salary and an annual bonus pursuant to a plan adopted following the 1993 Acquisition. In addition, under the New Employment Agreement, Mr. Dyott is eligible to receive all other employee benefits and perquisites made available to Graphics' senior executives generally. Under the New Employment Agreement, if the employee's employment is terminated by Graphics "without cause" (which, as defined in the New Employment Agreement, means a material breach by the employee of his obligations under the New Employment Agreement; continued failure or refusal of the employee to substantially perform his duties to Graphics; a willful and material violation of Federal or state law applicable to Graphics or the employee's conviction of a felony or perpetration of a common law fraud; or other willful misconduct that is injurious to Graphics) or by the employee for "good reason" (which, as defined in the New Employment Agreement, means a decrease in base pay or a failure by Graphics to pay material compensation due and payable; a material diminution of the employee's responsibilities or title; a material change in the employee's principal employment location; or a material breach by Graphics of a material term of the New Employment Agreement), the employee will be entitled to salary continuation payments (and certain other benefits) through the greater of the remainder of the scheduled term and a period of two years beginning on the date of termination. The New Employment Agreement also provides for post-employment non-solicitation, non-competition and confidentiality covenants. Graphics entered into an employment agreement with Terrence M. Ray on February 19, 1996, (the "Agreement"). The Agreement has a term of three years commencing with the date of the Agreement and that term shall be automatically extended for one year periods absent one year's notice of an intent not to renew. The Agreement provides for the payment of an annual salary and an annual bonus pursuant to an executive bonus plan adopted by American Color. In addition, under the Agreement, Mr. Ray is eligible to receive all other employee benefits and perquisites made available to Graphics' senior executives generally. In addition, Graphics has entered into severance agreements with Joseph M. Milano and Timothy M. Davis. These agreements provide that if the employee's employment is terminated by Graphics "without cause", as defined above, or by the employee for "good reason", as defined above, the employee will be entitled to salary continuation payments (and certain other benefits) for up to two years beginning on the date of termination. James T. Sullivan resigned as Chairman of the Board and Chief Executive Officer and as a director and employee of Communications effective as of September 18, 1996 (the "Effective Date"). For the period commencing on the 62 Effective Date and ending on April 8, 1999, Mr. Sullivan will hold the title of Vice Chairman of Communications. Mr. Sullivan will receive salary continuation payments at an annual rate of $600,000 through April 8, 1999. For two years thereafter, Mr. Sullivan will be engaged as a consultant to Communications for which he will be paid an annual fee of $200,000. Under the terms of his resignation agreement, Mr. Sullivan will be entitled, through April 8, 1999, to continue to participate in certain employee benefit plans provided by Communications to its employees generally. Mr. Sullivan also received payment of his full supplemental retirement benefit under the Sullivan Graphics, Inc. Supplemental Executive Retirement Plan. Mr. Sullivan's resignation agreement also contains certain noncompetition and other restrictive covenants. Compensation Committee Interlocks and Insider Participation The Company has not maintained a formal compensation committee since the 1993 Acquisition. Mr. Dyott sets compensation in conjunction with the Board of Directors. Old Stock Option Plan Pursuant to the Merger Agreement, Communications canceled, as of the Effective Time and without consideration, each of the then unexpired and unexercised employee options to purchase shares of Communications Class A Common Stock and terminated the former Communications stock option plan. Key Executive Supplemental Bonus Plans As of May 5, 1994, Communications and Graphics adopted Supplemental Bonus Plans for certain key corporate and divisional executives. As such plans provided, Stephen M. Dyott, Joseph M. Milano, Malcolm J. Anderson and Timothy M. Davis received, at the end of the Fiscal Year 1995, a payment equal to a specified percentage of the excess of the EBITDA of Communications or the Printing divisions of Graphics over their respective budgeted EBITDA. Supplemental Executive Retirement Plan In October 1994, the Board of Directors approved a new SERP, which is a defined benefit plan, for the Named Executive Officers and other certain key executives. The plan provides for a basic annual benefit payable upon completion of five years vesting service (April 1, 1994 through March 31, 1999 for Messrs. Dyott, Milano, Anderson and Davis and April 1, 1996 through March 31, 2001 for Mr. Ray) and retirement on or after attaining age 65 or the present value of such benefit at an earlier date under certain circumstances, if elected. The Named Executive Officers have the following basic annual benefit payable under this plan at age 65: Stephen M. Dyott $50,000 Joseph M. Milano $50,000 Malcolm J. Anderson $50,000 Terrence M. Ray $25,000 Timothy M. Davis $50,000 Such benefits will be paid from the Company's assets (see note 12 to the Company's consolidated financial statements). 401(k) Defined Contribution Plan Effective January 1, 1995, the Company amended its 401(k) defined contribution plan. Eligible participants may contribute up to 15% of their annual compensation subject to maximum amounts established by the Internal Revenue Service and receive a matching employer contribution on amounts contributed. The employer matching contribution is made biweekly and equals 2% of annual compensation for all plan participants plus 50% of the first 6% of annual compensation contributed to the plan by each employee, subject to maximum amounts established by the Internal Revenue Service (see note 13 to the Company's consolidated financial statements). 63 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information, as of March 31, 1997, concerning the persons having beneficial ownership of more than five percent of the capital stock of Communications and the ownership thereof by each director of Communications and by all current officers of Communications as a group.
Name Shares of Shares of - ---- Communications Percent Communications Percent Common Stock of Class Preferred Stock of Class ------------ -------- --------------- -------- The Morgan Stanley Leveraged Equity Fund II, L.P. 1221 Ave. of the Americas New York, NY 10020 59,450 48.0 2,973 51.7 MSCP Entities 1221 Ave. of the Americas New York, NY 10020 23,333 18.8 1,167 20.3 First Plaza Group Trust c/o Mellon Bank, N.A 1 Mellon Bank Center Pittsburgh, PA 15258 17,000 13.7 850 14.8 Leeway & Co. c/o State Street Master Trust Div. W6 One Enterprise Drive North Quincy, MA 02171 10,667 8.6 533 9.3 Stephen M. Dyott 500 0.4 25 0.4 Eric T. Fry -- -- -- -- Frank V. Sica -- -- -- -- All current directors and officers as a group 500 0.4 25 0.4
64 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The 1993 Acquisition On the Acquisition Date, MSLEF II and the Purchasing Group invested $40 million in Communications and acquired control of Communications and Graphics. Pursuant to the Merger Agreement, (i) MSLEF II and the Purchasing Group made a $40 million equity investment in Communications and acquired (a) 90% of the outstanding Communications Common Stock and (b) all the outstanding shares of the preferred stock of Communications (the "Communications Preferred Stock"), with a total preference of $40 million and which, under certain circumstances, is convertible into shares of Communications Common Stock; and (ii) GTC and its affiliates received 4,987 shares of Communications Common Stock. MSLEF II is an investment fund affiliate with Morgan Stanley, Dean Witter, Discover & Co. Morgan Stanley, Dean Witter, Discover & Co. is a holding company that, through its subsidiaries, is a major international financial services firm. In addition, two of the current directors of Communications are employees of Morgan Stanley & Co. Incorporated, an affiliate of MSLEF II and also a subsidiary of Morgan Stanley, Dean Witter, Discover & Co. As a result of these relationships, Morgan Stanley, Dean Witter, Discover & Co. may be deemed to control the management and policies of Graphics and Communications. In addition, Morgan Stanley, Dean Witter, Discover & Co. may be deemed to control matters requiring shareholders' approval, including the election of all directors, the adoption of amendments to the Certificates of Incorporation of Communications and Graphics and the approval of mergers and sales of all or substantially all of Graphics' and Communications' assets. Management Equity Participation. In connection with the 1993 Acquisition, certain members of the Company's management at that time, including James T. Sullivan and Stephen M. Dyott (collectively, the "Management Investors"), invested an aggregate of approximately $2.3 million in Communications and received an aggregate of 3,700 shares of Communications Common Stock and 185 shares of Communications Preferred Stock. Each Management Investor also entered into a Management Equity Agreement, dated as of April 8, 1993, with Communications (collectively, the "Management Agreements"), pursuant to which, if a Management Investor's employment with the Company terminates for any reason, Communications has the right to repurchase any of the shares of Communications Common Stock and Communications Preferred Stock held by such Management Investor at a price per share equal to the "Threshold Amount" (as defined in section 4.2(d)(ix) of Communications Certificate of Incorporation) applicable to such shares of such time divided by the number of shares of Communications Preferred Stock outstanding at such time. In the case of shares of Communications Common Stock held by such Management Investor, the repurchase price will be equal to fair market value. The payment of the repurchase price may be deferred (with interest) if the making of such payment would cause Communications to violate any debt covenant or provision of applicable law, or if the Board of Directors of Communications determines that Communications is not financially capable of making such payment. Stockholders' Agreement. In connection with the 1993 Acquisition, Communications, MSLEF II, each of the members of the Purchasing Group, the GTC Funds, certain other stockholders of Communications who were stockholders of Communications immediately prior to the Merger Agreement (such stockholders, together with the GTC Funds, being referred to as the "Existing Holders") and GTC entered into a Stockholders' Agreement, dated as of April 8, 1993 (the "Stockholders' Agreement"). The Stockholders' Agreement includes provisions requiring the delivery of certain shares of Communications Common Stock from the Purchasing Group to Communications, depending upon the return realized by the members of the Purchasing Group on their investment, and thereafter from Communications to the Existing Holders. Depending upon the returns realized by the members of the Purchasing Group on their investment, their interest in the Communications Common Stock could be reduced from 65 90% to 80% and the interest of the Existing Holders could be increased from 10% to 20% of the Communications Common Stock. Tax Sharing Agreement Communications and Graphics are parties to a tax sharing agreement effective July 27, 1989. Under the terms of the agreement, Graphics (whose income is consolidated with that of Communications for federal income tax purposes) is liable to Communications for amounts representing federal income taxes calculated on a "stand-alone basis". Each year Graphics pays to Communications the lesser of (i) Graphics' federal tax liability computed on a stand-alone basis and (ii) its allocable share of the federal tax liability of the consolidated group. Accordingly, Communications is not currently reimbursed for the separate tax liability of Graphics to the extent Communications' losses reduce consolidated tax liability. Reimbursement for the use of such Communications' losses will occur when the losses may be used to offset Communications' income computed on a stand-alone basis. Graphics has also agreed to reimburse Communications in the event of any adjustment (including interest or penalties) to consolidated income tax returns based upon Graphics' obligations with respect thereto. No reimbursement obligation currently exists between Graphics and Communications. Also under the terms of the tax sharing agreement, Communications has agreed to reimburse Graphics for refundable federal income tax equal to an amount which would be refundable to Graphics had Graphics filed separate federal income tax returns for all years under the agreement. Graphics and Communications have also agreed to treat foreign, state and local income and franchise taxes for which there is consolidated or combined reporting in a manner consistent with the treatment of federal income taxes as described above. Shakopee Merger In December 1994, Graphics and Shakopee entered into an agreement pursuant to which they agreed in principle to the terms of the Shakopee Merger and to negotiate definitive agreements with respect thereto. Prior to the consummation of the Shakopee Merger, the MSCP III Entities owned a majority of Shakopee's outstanding stock and the Company provided general management, supervisory and administrative services to Shakopee, pursuant to a management agreement entered into in December 1994, in exchange for an annual service fee of $0.5 million. The Shakopee Merger was consummated and the management agreement was terminated simultaneously with the consummation of the offering of the Notes. Other MS&Co. acted as placement agent in connection with the original private placement of the Notes and received a placement fee of $5.6 million in connection therewith. MS&Co. is affiliated with entities that beneficially own a substantial majority of the outstanding shares of capital stock of Communications. In addition, Morgan Stanley & Co. Incorporated has a $5 million participation in the Term Loan Facility and received fees of approximately $0.3 million in connection therewith. 66 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this report: Reports of Independent Auditors 1 and 2. Financial Statements: The following Consolidated Financial Statements of Sullivan Communications, Inc. are included in Part II, Item 8: Consolidated balance sheets - March 31, 1997 and 1996 For the Years Ended March 31, 1997, 1996 and 1995: Consolidated statements of operations Consolidated statements of stockholders' deficit Consolidated statements of cash flows Notes to Consolidated Financial Statements Financial Statement Schedules: The following financial statement schedules of Sullivan Communications, Inc. are filed as a part of this report.
Schedules Page No. --------- -------- I. Condensed Financial Information of Registrant.............................................. 70 Condensed Financial Statements (parent company only) for the years ended March 31, 1997, 1996, and 1995 and as of March 31, 1997 and 1996 II. Valuation and qualifying accounts.......................................................... 76
Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto. 3. Exhibits: The exhibits listed on the accompanying Index to Exhibits immediately following the financial statement schedules are filed as part of, or incorporated by reference into, this report. Exhibit No. Description - ----------- ----------- 3.1 Certificate of Incorporation of Graphics, as amended to date* 3.2 By-laws of Graphics, as amended to date* 3.3 Restated Certificate of Incorporation of Communications, as amended to date** 3.4 By-laws of Communications, as amended to date* 67 Exhibit No. Description - ----------- ----------- 4.1 Indenture (including the form of Note), dated as of August 15, 1995, among Graphics, Communications and NationsBank of Georgia, National Association, as Trustee** 10.1 Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto** 10.1(a) January 10, 1996, First Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto*** 10.1(b) March 6, 1996, Second Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto+++ 10.1(c) June 6, 1996, Third Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto+++ 10.1(d) August 13, 1996, Fourth Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto**** 10.1(e) February 27, 1997, Fifth Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto 10.2 Agreement and Plan of Merger, dated as of August 14, 1995, among Communications, Graphics and Shakopee** 10.3 Resignation letter, dated as of September 18, 1996, between Graphics and James T. Sullivan**** 10.4(a) Employment Agreement, dated as of April 8, 1993, between Graphics and Stephen M. Dyott* 10.4(b) Amendment to Employment Agreement, dated December 1, 1994, between Graphics and Stephen M. Dyott++ 10.4(c) Amendment to Employment Agreement, dated February 15, 1995, between Graphics and Stephen M. Dyott++ 10.4(d) Amendment to Employment Agreement, dated September 18, 1996, between Graphics and Stephen M. Dyott**** 10.5 Employment Agreement, dated as of February 19, 1996, between Graphics and Terrence M. Ray 10.6 Severance Letter, dated April 8, 1993, between Graphics and Joseph M. Milano+ 10.6(a) October 12, 1995, Amendment to Severance Letter, dated April 8, 1993, between Graphics and Joseph M. Milano*** 10.7 Severance Letter, dated April 8, 1993, between Graphics and Timothy M. Davis+ 10.7(a) October 12, 1995, Amendment to Severance Letter, dated April 8, 1993, between Graphics and Timothy M. Davis*** 10.9 Amended and Restated Stockholders' Agreement, dated as of August 14, 1995, among Communications, the Morgan Stanley Leveraged Equity Fund II, L.P., Morgan Stanley Capital Partners III, L.P. and the additional parties named therein** 10.10 Purchase Agreement between Guy Gannett Communications and Shakopee, dated November 23, 1994+ 10.11 First Amendment Agreement, dated as of December 22, 1994, between Guy Gannett, Communications and Shakopee** 10.12 Second Amendment Agreement, dated as of March 27, 1995, between Guy Gannett, Communications and Shakopee** 10.13 Stock Option Plan of Communications++ 68 10.14 Purchase Agreement between ComCorp, Inc., Graphics and Gowe Inc., dated March 12, 1996+++ 21.1 List of Subsidiaries 27.0 Financial Data Schedule - ----------- * Incorporated by reference from Amendment No. 2 to Form S-1 filed on October 4, 1993 - Registration number 33-65702. + Incorporated by reference from the Annual Report on Form 10-K for fiscal year ended March 31, 1995 - Commission file number 33-31706-01. ** Incorporated by reference from Form S-4 filed on September 19, 1995 - Registration number 33-97090. ++ Incorporated by reference from Amendment No. 2 to Form S-4 filed on November 22, 1995 - Registration number 33-97090. *** Incorporated by reference from the Quarterly Report on Form 10-Q for the quarter ended December 31, 1995 - Commission file number 33-31706-01. +++ Incorporated by reference from the Annual Report on Form 10-K for fiscal year ended March 31, 1996 - Commission file number 33-97090. **** Incorporated by reference from the Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 - Commission file number 33-97090. (b) Reports on Form 8-K: The following report on Form 8-K was filed during the fourth quarter of Fiscal Year 1997: 1. Form 8-K filed with the Securities and Exchange Commission on January 29, 1997 under Item 5 to announce the Company's EBITDA for the three months ended December 31, 1996. The Company did not file any other reports on Form 8-K during the three months ended March 31, 1997. 69 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT SULLIVAN COMMUNICATIONS, INC. Parent Company Only Condensed Balance Sheets (Dollars in thousands, except par values) March 31, --------- 1997 1996 ---- ---- Assets Current assets: Receivable from subsidiary for income taxes $128 134 ---- ---- Total assets $128 134 ==== ==== See accompanying notes to condensed financial statements. 70 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT SULLIVAN COMMUNICATIONS, INC. Parent Company Only Condensed Balance Sheets (Dollars in thousands, except par values)
March 31, --------- Liabilities and Stockholders' Deficit 1997 1996 - ------------------------------------- ---- ---- Current liabilities Income taxes payable $ 128 134 --------- --------- Total current liabilities 128 134 Liabilities of subsidiary in excess of assets 76,318 44,396 --------- --------- Total liabilities 76,446 44,530 --------- --------- Stockholders' deficit: Common stock, voting, $.01 par value, 5,852,223 shares authorized, 123,889 shares issued and outstanding 1 1 Series A convertible preferred stock, $.01 par value, 4,000 shares authorized, issued and outstanding, $40,000,000 -- -- liquidation preference Series B convertible preferred stock, $.01 par value, 1,750 shares authorized, issued and outstanding, $17,500,000 -- -- liquidation preference Additional paid-in capital 57,499 57,499 Accumulated deficit (132,228) (100,525) Cumulative translation adjustment (1,590) (1,371) --------- --------- Total stockholders' deficit (76,318) (44,396) --------- --------- Commitments and contingencies Total liabilities and stockholders' deficit $ 128 134 ========= =========
See accompanying notes to condensed financial statements. 71 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT SULLIVAN COMMUNICATIONS, INC. Parent Company Only Condensed Statements of Operations (In thousands) Year Ended March 31, -------------------- 1997 1996 1995 ---- ---- ---- Equity in (loss) income of subsidiary $(31,703) (29,327) 13,162 -------- ------- ------ Net (loss) income $(31,703) (29,327) 13,162 ======== ======= ====== See accompanying notes to condensed financial statements. 72 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT SULLIVAN COMMUNICATIONS, INC. Parent Company Only Condensed Statements of Cash Flows (In thousands) Year Ended March 31, ---------------------------- 1997 1996 1995 ------- ------ ------ Cash flows from operating activities -- -- -- ------- ------ ------ Cash flows from investing activities -- -- -- ------- ------ ------ Cash flows from financing activities -- -- -- ------- ------ ------ Net change in cash -- -- -- ======= ====== ====== See accompanying notes to condensed financial statements. 73 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT SULLIVAN COMMUNICATIONS, INC. Parent Company Only Notes to Condensed Financial Statements Description of Sullivan Communications, Inc. Sullivan Communications, Inc. ("Communications"), together with its wholly-owned subsidiary, Sullivan Graphics, Inc. ("Graphics"), collectively the ("Company"), was formed in April 1989 under the name GBP Holdings, Inc. to effect the purchase of all the capital stock of GBP Industries, Inc. from its stockholders in a leveraged buyout transaction. In October 1989, GBP Holdings, Inc. changed its name to Sullivan Holdings, Inc. and GBP Industries, Inc. changed its name to Sullivan Graphics, Inc. Effective June 1993, Sullivan Holdings, Inc. changed its name to Sullivan Communications, Inc. Communications has no operations or significant assets other than its investment in Graphics. Communications is dependent upon distributions from Graphics to fund its obligations. Under the terms of its debt agreements at March 31, 1997, Graphics' ability to pay dividends or lend to Communications is either restricted or prohibited, except that Graphics may pay specified amounts to Communications to fund the payment of Communications' obligations pursuant to a tax sharing agreement (see note 4). On April 8, 1993 (the "Acquisition Date"), pursuant to an Agreement and Plan of Merger dated as of March 12, 1993, as amended (the "Merger Agreement"), between Communications and SGI Acquisition Corp. ("Acquisition Corp."), Acquisition Corp. was merged with and into Communications (the "Acquisition"). Acquisition Corp. was formed by The Morgan Stanley Leveraged Equity Fund II, L.P., certain institutional investors and certain members of management (the "Purchasing Group") for the purpose of acquiring a majority interest in Communications. Acquisition Corp. acquired a substantial and controlling majority interest in Communications in exchange for $40 million in cash. In the Acquisition, Communications continued as the surviving corporation and the separate corporate existence of Acquisition Corp. was terminated. In connection with the Acquisition, the existing consulting agreement with the managing general partner of Communications' majority stockholder was terminated and the related liabilities of Communications were canceled. The agreement required Communications to make minimum annual payments of $1 million for management advisory services subject to limitations in Graphics' debt agreements. No amounts were paid during the periods presented in these condensed financial statements. 1. Basis of Presentation The accompanying condensed financial statements (parent company only) include the accounts of Communications and its investments in Graphics accounted for in accordance with the equity method, and do not present the financial statements of Communications and its subsidiary on a consolidated basis. These parent company only financial statements should be read in conjunction with the Company's consolidated financial statements. The Acquisition was accounted for under the purchase method of accounting applying the provisions on Accounting Principles Boards Opinion No. 16 ("APB 16"). 74 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT SULLIVAN COMMUNICATIONS, INC. Parent Company Only Notes to Condensed Financial Statements 2. Guarantees As set forth in the Company's consolidated financial statements, substantially all of Graphics' long-term obligations have been guaranteed by Communications. Communications has guaranteed Graphics' indebtedness under the Bank Credit Agreement, which guarantee is secured by a pledge of all of Graphics' stock. Borrowings under the Bank Credit Agreement are secured by substantially all assets of Graphics. Communications is restricted under its guarantee of the Bank Credit Agreement from, among other things, entering into mergers, acquisitions, incurring additional debt, or paying cash dividends. On August 15, 1995, Graphics issued $185 million of Senior Subordinated Notes (the "Notes") bearing interest at 12 3/4% and maturing August 1, 2005. The Notes are guaranteed on a senior subordinated basis by Communications and are subordinate to all existing and future senior indebtedness, as defined, of Graphics. 3. Dividends from Subsidiaries and Investees No cash dividends were paid to Communications from any consolidated subsidiaries, unconsolidated subsidiaries or investees accounted for by the equity method during the periods reflected in these condensed financial statements. 4. Tax Sharing Agreement Communications and Graphics are parties to a tax sharing agreement effective July 27, 1989. Under the terms of the agreement, Graphics (whose income is consolidated with that of Communications for federal income tax purposes) is liable to Communications for amounts representing federal income taxes calculated on a "stand-alone basis". Each year Graphics pays to Communications the lesser of (i) Graphics' federal tax liability computed on a stand-alone basis and (ii) its allocable share of the federal tax liability of the consolidated group. Accordingly, Communications is not currently reimbursed for the separate tax liability of Graphics to the extent Communications' losses reduce consolidated tax liability. Reimbursement for the use of such Communications' losses will occur when the losses may be used to offset Communications' income computed on a stand-alone basis. Graphics has also agreed to reimburse Communications in the event of any adjustment (including interest or penalties) to consolidated income tax returns based upon Graphics' obligations with respect thereto. Also, under the terms of the tax sharing agreement, Communications has agreed to reimburse Graphics for refundable federal income taxes equal to an amount which would be refundable to Graphics had Graphics filed separate federal income tax returns for all years under the agreement. Graphics and Communications have also agreed to treat foreign, state and local income and franchise taxes for which there is consolidated or combined reporting in a manner consistent with the treatment of federal income taxes as described above. 75 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS SULLIVAN COMMUNICATIONS, INC.
Balance Balance at Additions at Beginning of Charged to Other End of Period Expense Write-offs Adjustments Period ------ ------- ---------- ----------- ------ (in thousands) Fiscal Year ended March 31, 1997 Allowance for doubtful accounts $ 4,830 4,847 (3,798) -- 5,879 Reserve for inventory obsolescence - spare parts $ 100 -- -- -- 100 Reserve for inventory obsolescence - paper & ink $ 611 318 (45) (815) 69 Income tax valuation allowance $21,210 -- -- (a) 8,928 30,138 Fiscal Year ended March 31, 1996 Allowance for doubtful accounts $ 3,174 3,619 (1,963) -- 4,830 Reserve for inventory obsolescence - spare parts $ 100 -- -- -- 100 Reserve for inventory obsolescence - paper & ink $ 50 -- -- 561 611 Income tax valuation allowance $13,808 -- -- (a) 7,402 21,210 Fiscal Year ended March 31, 1995 Allowance for doubtful accounts $ 2,828 879 (1,402) 869 3,174 Reserve for inventory obsolescence - spare parts $ 100 -- -- -- 100 Reserve for inventory obsolescence - paper & ink $ 50 -- -- -- 50 Income tax valuation allowance $19,430 -- -- (b) (5,622) 13,808
- ---------- (a) The increase in the valuation allowance primarily relates to current year losses for which no tax benefit has been recorded. (b) The decrease in the valuation allowance primarily relates to utilization of prior year losses for which benefit was not recorded against current year income. 76 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized. Sullivan Communications, Inc. Sullivan Graphics, Inc. Date June 30, 1997 ---- ------------- /s/ Stephen M. Dyott ----------------------- Stephen M. Dyott Chairman, President and Chief Executive Officer Sullivan Communications, Inc. Chairman, President and Chief Executive Officer Sullivan Graphics, Inc. Director of Sullivan Communications, Inc. and Sullivan Graphics, Inc. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ Joseph M. Milano Senior Vice President June 30, 1997 - ------------------------------- ------------- (Joseph M. Milano) Chief Financial Officer /s/ Patrick W. Kellick Vice President June 30, 1997 - -------------------------------- ------------- (Patrick W. Kellick) Controller Assistant Secretary (Principal Accounting Officer) /s/ Frank V. Sica Director June 30, 1997 - ------------------------------- ------------- (Frank V. Sica) /s/ Eric T. Fry Director June 30, 1997 - -------------------------------- ------------- (Eric T. Fry) 77 SULLIVAN COMMUNICATIONS, INC. Annual Report on Form 10-K Fiscal Year Ended March 31, 1996 Index to Exhibits Exhibit No. Description - ----------- ----------- 3.1 Certificate of Incorporation of Graphics, as amended to date* 3.2 By-laws of Graphics, as amended to date* 3.3 Restated Certificate of Incorporation of Communications, as amended to date** 3.4 By-laws of Communications, as amended to date* 4.1 Indenture (including the form of Note), dated as of August 15, 1995, among Graphics, Communications and NationsBank of Georgia, National Association, as Trustee** 10.1 Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto** 10.1(a) January 10, 1996, First Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto*** 10.1(b) March 6, 1996, Second Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto+++ 10.1(c) June 6, 1996, Third Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto+++ 10.1(d) August 13, 1996, Fourth Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto**** 10.1(e) February 27, 1997, Fifth Amendment to Credit Agreement, dated as of August 15, 1995, among Communications, Graphics, BT Commercial Corporation, as Agent, Bankers Trust Company, as Issuing Bank, and the parties signatory thereto 10.2 Agreement and Plan of Merger, dated as of August 14, 1995, among Communications, Graphics and Shakopee** 10.3 Resignation letter, dated as of September 18, 1996, between Graphics and James T. Sullivan **** 10.4(a) Employment Agreement, dated as of April 8, 1993, between Graphics and Stephen M. Dyott* 10.4(b) Amendment to Employment Agreement, dated December 1, 1994, between Graphics and Stephen M. Dyott++ 10.4(c) Amendment to Employment Agreement, dated February 15, 1995, between Graphics and Stephen M. Dyott++ 10.4(d) Amendment to Employment Agreement, dated September 18, 1996, between Graphics and Stephen M. Dyott**** Exhibit No. Description - ----------- ----------- 10.5 Employment Agreement, dated as of February 19, 1996, between Graphics and Terrence M. Ray 10.6 Severance Letter, dated April 8, 1993, between Graphics and Joseph M. Milano+ 10.6(a) October 12, 1995, Amendment to Severance Letter, dated April 8, 1993, between Graphics and Joseph M. Milano*** 10.7 Severance Letter, dated April 8, 1993, between Graphics and Timothy M. Davis+ 10.7(a) October 12, 1995, Amendment to Severance Letter, dated April 8, 1993, between Graphics and Timothy M. Davis*** 10.9 Amended and Restated Stockholders' Agreement, dated as of August 14, 1995, among Communications, the Morgan Stanley Leveraged Equity Fund II, L.P., Morgan Stanley Capital Partners III, L.P. and the additional parties named therein** 10.10 Purchase Agreement between Guy Gannett Communications and Shakopee, dated November 23, 1994+ 10.11 First Amendment Agreement, dated as of December 22, 1994, between Guy Gannett Communications and Shakopee** 10.12 Second Amendment Agreement, dated as of March 27, 1995, between Guy Gannett Communications and Shakopee** 10.13 Stock Option Plan of Communications++ 10.14 Purchase Agreement between ComCorp, Inc., Graphics and Gowe Inc., dated March 12, 1996+++ 21.1 List of Subsidiaries 27.0 Financial Data Schedule - ----------- * Incorporated by reference from Amendment No. 2 to Form S-1 filed on October 4, 1993 - Registration number 33-65702. + Incorporated by reference from the Annual Report on Form 10-K for fiscal year ended March 31, 1995 - Commission file number 33-31706-01. ** Incorporated by reference from Form S-4 filed on September 19, 1995 - Registration number 33-97090. ++ Incorporated by reference from Amendment No. 2 to Form S-4 filed on November 22, 1995 - Registration number 33-97090. *** Incorporated by reference from the Quarterly Report on Form 10-Q for the quarter ended December 31, 1995 - Commission file number 33-31706-01. +++ Incorporated by reference from the Annual Report on Form 10-K for fiscal year ended March 31, 1996 - Commission file number 33-97090. **** Incorporated by reference from the Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 - Commission file number 33-97090. EX-10.1.E 2 EXHIBIT 10.1(E) FIFTH AMENDMENT TO CREDIT AGREEMENT FIFTH AMENDMENT TO CREDIT AGREEMENT (this "Amendment"), dated as of February 27, 1997, among SULLIVAN COMMUNICATIONS, INC. ("Communications"), SULLIVAN GRAPHICS, INC. (the "Borrower"), the financial institutions party to the Credit Agreement referred to below (the "Lenders"), BT COMMERCIAL CORPORATION, as Agent (the "Agent") for the Lenders, and BANKERS TRUST COMPANY, as Issuing Bank (the "Issuing Bank"). All capitalized terms used herein and not otherwise defined shall have the respective meanings provided such terms in the Credit Agreement. W I T N E S S E T H : - - - - - - - - - - - WHEREAS, Communications, the Borrower, the Lenders, the Agent and the Issuing Bank are parties to a Credit Agreement, dated as of August 15, 1995 (as amended, modified or supplemented to the date hereof, the "Credit Agreement"); and WHEREAS, the parties hereto wish to amend the Credit Agreement as herein provided; NOW, THEREFORE, it is agreed: 1. Section 8.9 of the Credit Agreement is hereby amended by deleting the amount "$52,100,000" set forth opposite the date March 31, 1997 appearing in the Minimum EBITDA table in said Section and inserting in lieu thereof the amount "46,600,000". 2. Section 8.11 of the Credit Agreement is hereby amended by deleting the ratio "0.75:1.00" set forth opposite the date March 31, 1997 appearing in the Fixed Charge Coverage Ratio table in said Section and inserting in lieu thereof the ratio "0.68:1.0". 3. In order to induce the Lenders to enter into this Amendment, the Borrower hereby represents and warrants that (x) no Default or Event of Default exists as of the Fifth Amendment Effective Date (as defined below), both before and after giving effect to this Amendment and (y) all of the representations and warranties contained in the Credit Agreement and the other Credit Documents are true and correct in all material respects on the Fifth Amendment Effective Date, both before and after giving effect to this Amendment, with the same effect as though such representations and warranties had been made on and as of the Fifth Amendment Effective Date (it being understood that any representation or warranty made as of a specific date shall be true and correct in all material respects as of such specific date). 4. This Amendment is limited as specified and shall not constitute a modification, acceptance or waiver of any other provision of the Credit Agreement or any other Credit Document. 5. This Amendment may be executed in any number of counterparts and by the different parties hereto on separate counterparts, each of which counterparts when executed and delivered shall be an original, but all of which shall together constitute one and the same instrument. A complete set of counterparts shall be lodged with the Borrower and the Agent. 6. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAW OF THE STATE OF NEW YORK. 7. This Amendment shall become effective on the date (the "Fifth Amendment Effective Date") when each of Communications, the Borrower and the Required Lenders shall have signed a copy hereof (whether the same or different copies) and shall have delivered (including by way of facsimile transmission) the same to the Agent at 14 Wall Street, New York, New York 10005 Attention: Bruce Addison. 8. From and after the Fifth Amendment Effective Date, all references in the Credit Agreement and each of the other Credit Documents to the Credit Agreement shall be deemed to be references to the Credit Agreement as amended hereby. * * * -2- IN WITNESS WHEREOF, the parties hereto have caused their duly authorized officers to execute and deliver this Amendment as of the date first above written. SULLIVAN COMMUNICATIONS, INC. Joseph Milano By ------------------------------ Title: CFO SULLIVAN GRAPHICS, INC. Joseph Milano By ------------------------------ Title: CFO BT COMMERCIAL CORPORATION, Individually and as Agent Bruce W. Addison By ------------------------------ Title: Vice President BTM CAPITAL CORPORATION William R. York, Jr. By ------------------------------ Title: BANK OF NEW YORK COMMERCIAL CORPORATION Stephen V. Mangiante By ------------------------------ Title: Vice President -3- DEUTSCHE FINANCIAL SERVICES HOLDING CORP. Mark Tauber By ------------------------------ Title: Vice President FINOVA CAPITAL CORPORATION Marilyn Milam By ------------------------------ Title: Vice President GIBRALTAR CORPORATION OF AMERICA Harvey Friedman By ------------------------------ Title: Executive Vice President LASALLE NATIONAL BANK Christopher G. Clifford By ------------------------------ Title: SANWA BUSINESS CREDIT CORPORATION By ------------------------------ Title: -4- HELLER BUSINESS CREDIT CORPORATION Jeff Schumacher By ------------------------------ Title: Assistant Vice President -5- EX-10.5 3 EXHIBIT 10.5 EMPLOYMENT AGREEMENT dated as of February 19, 1996 (the "Agreement"), between AMERICAN COLOR ("AC"), a division of SULLIVAN GRAPHICS, INC., a New York corporation (the "Company") and TERRENCE M. RAY (the "Executive"). WHEREAS, AC desires to employ Executive as its Executive Vice President/ Director of Operations; NOW, THEREFORE, in consideration of the covenants and agreements hereinafter set forth, the parties hereto agree as follows: 1. EMPLOYMENT AND DUTIES 1.1. General. The Company hereby employs the Executive, and the Executive agrees to serve, as Executive Vice President/Director of Operations of AC, upon the terms and conditions contained herein. The Executive shall report directly to the President of AC and shall be responsible for all pre-press operational aspects of AC. The Executive shall perform such other duties and services for the Company, commensurate with the Executive's position, as may be designated from time to time by the President of AC. The Executive agrees to serve the Company faithfully and to the best of his ability under the direction of the President of AC. 1.2. Exclusive Services. Except as may otherwise be approved in advance by the President of AC, and except during vacation periods and reasonable periods of absence due to sickness, personal injury or other disability, the Executive shall devote his full working time throughout the Employment Term (as defined in Section 1.3) to the services required of him hereunder. The Executive shall render his services exclusively to the Company during the Employment Term, and shall use his best efforts, judgment and energy to improve and advance the business and interests of the Company in a manner consistent with the duties of his position. 1.3. Term of Employment. The Executive's employment under this Agreement shall commence as of the date of this Agreement and shall terminate on the earlier of (i) the third anniversary of the date of this Agreement, or (ii) termination of the Executive's employment pursuant to this Agreement; provided, however, that the term of the Executive's employment shall be automatically extended without further action of either party for additional one year periods, unless written notice of either party's intention not to extend has been given to the other party at least one year prior to the expiration of the then effective term. The period commencing as of the date of this Agreement and ending on the third anniversary thereof or such later date to which the term of the Executive's employment under this Agreement shall have been extended is hereinafter referred to as the "Employment Term". 1.4. Reimbursement of Expenses. AC shall reimburse the Executive for reasonable travel and other business expenses incurred by him in the fulfillment of his duties hereunder upon presentation by the Executive of an itemized account of such expenditures, in accordance with AC's practices consistently applied. - 2 - 2. SALARY 2.1. Base Salary. From the date of this Agreement, the Executive shall be entitled to receive a base salary ("Base Salary") at a rate of $218,000 per annum, payable in arrears in equal installments not less frequently than biweekly in accordance with AC's payroll practices, with such increases as may be provided in accordance with the terms hereof. Once increased, such higher amount shall constitute the Executive's annual Base Salary. 2.2. Annual Review. The Executive's Base Salary shall be reviewed by the President of AC, based upon the Executive's performance, not less often than annually, and may be increased but not decreased. In addition to any increases effected as a result of such review, the President of AC at any time may in its sole discretion increase the Executive's Base Salary. 2.3. Initial Bonus. Upon the six-month anniversary of Executive's employment hereunder, Executive shall receive an initial bonus of between $20,000- 25,000. 2.4. Annual Bonus. After the date of this Agreement, AC shall annually adopt a bonus plan and performance criteria upon which the bonuses of executives of AC shall be based. During his employment under this Agreement, the Executive shall be entitled to receive a bonus under such plan of up to 40% of his Base Salary if the budget performance criteria are satisfied. 3. EMPLOYEE BENEFITS 3.1. The Executive shall, during his employment under this Agreement, be included to the extent eligible thereunder in all employee benefit plans, programs or arrangements (including, without limitation, any plans, programs or arrangements providing for retirement benefits, incentive compensation, profit sharing, bonuses, disability benefits, health and life insurance, or vacation and paid holidays) which shall be established by AC for, or made available to, its senior executives. 3.2. At such time as options are available under the Sullivan Communications, Inc. ("SCI") Stock Option Plan, but in no event later than at the time of an initial public offering of the common stock of SCI, Executive shall be granted options to purchase 500 shares of the common stock of SCI at the price determined pursuant to such Plan. 3.3. The Executive shall be entitled to participate in the Company's Supplemental Executive Retirement Plan (the "SERP") at a benefit level of $25,000 per annum upon retirement in accordance with the terms of the SERP. - 3 - 4. TERMINATION OF EMPLOYMENT 4.1. Termination Without Cause; Resignation for Good Reason. 4.1.1. General. Subject to the provisions of Sections 4.1.2 and 4.1.3, if, prior to the expiration of the Employment Term, the Executive's employment is terminated by the Company without Cause (as defined in Section 4.3), or if the Executive terminates his employment hereunder for Good Reason (as defined in Section 4.4), the Company shall (x) continue to pay the Executive the Base Salary (at the rate in effect on the date of such termination) for the greater of (i) the remainder of the Employment Term and (ii) a period of one year beginning as of the date of termination (such period being referred to hereinafter as the "Severance Period"), at such intervals as the same would have been paid had the Executive remained in the active service of AC, and (y) pay the Executive a pro rata portion of the bonus or incentive payment to which the Executive would have been entitled for the year of termination pursuant to Section 2.3 and Section 2.4 had the Executive remained employed for the entire year, which bonus shall be payable at the time payments under the applicable bonus plan or incentive program are paid to AC's executives generally. In addition, the Executive shall be entitled to continue to participate during the Severance Period in all employee benefit plans (other than equity-based plans, except to the extent otherwise provided therein, or bonus plans) that AC provides (and continues to provide) generally to its employees, provided that the Executive is entitled to continue to participate in such plans under the terms thereof. The Executive shall have no further right to receive any other compensation or benefits after such termination or resignation of employment except as determined in accordance with the terms of the employee benefit plans or programs of AC. 4.1.2. Conditions Applicable to the Severance Period. If, during the Severance Period, the Executive materially breaches his obligations under Section 7 of this Agreement, the Company may, upon written notice to the Executive, terminate the Severance Period and cease to make any further payments or provide any benefits described in Section 4.1.1. 4.1.3. Date of Termination. The date of termination of employment with Cause shall be the date specified in a written notice of termination to the Executive. The date of resignation for Good Reason shall be the date specified in the written notice of resignation from the Executive to the Company; provided, however, that no such written notice shall be effective unless the cure period specified in Section 4.4 has expired without the Company having corrected, to the reasonable satisfaction of the Executive, the event or events subject to cure. If no date of resignation is specified in the written notice from the Executive to the Company, the date of termination shall be the first day following such expiration of such cure period. 4.2. Termination for Cause; Resignation Without Good Reason. 4.2.1. General. If, prior to the expiration of the Employment Term, the Executive's employment is terminated by AC for Cause, or the Executive resigns from his employment hereunder other than for Good Reason, the Executive shall be entitled only to payment of his Base Salary as then in effect through and including the date of termination or resignation. The Executive shall have no further right to receive any other compensation or benefits after such termination or resignation of employment, except as determined in accordance with the terms of the employee benefit plans or programs of AC. - 4 - 4.2.2. Date of Termination. Subject to the proviso to Section 4.3, the date of termination for Cause shall be the date specified in a written notice of termination to the Executive. The date of resignation without Good Reason shall be the date specified in the written notice of resignation from the Executive to the Company, or if no date is specified therein, 10 business days after receipt by the Company of written notice of resignation from the Executive. 4.3. Cause. Termination for "Cause" shall mean termination of the Executive's employment because of: (i) any act or omission that constitutes a material breach by Executive of any of his obligations under this Agreement; (ii) the continued failure or refusal of the Executive to substantially perform the duties reasonably required of him as an employee of the Company; (iii) any willful and material violation by the Executive of any Federal or state law or regulation applicable to the business of the Company or any of its affiliates, or the Executive's conviction of a felony, or any willful perpetration by the Executive of a common law fraud; or (iv) any other willful misconduct by the Executive which is materially injurious to the financial condition or business reputation of, or is otherwise materially injurious to, the Company or any of its affiliates (it being understood that the good faith performance by the Executive of the duties required of him pursuant to Section 1.1 shall not constitute "misconduct" for purposes of this clause (iv)); provided, however, that if any such Cause relates to the Executive's obligations under this Agreement, the Company shall not terminate the Executive's employment hereunder unless the Company first gives the Executive notice of its intention to terminate and of the grounds for such termination, and the Executive has not, within 20 business days following receipt of the notice, cured such Cause, or in the event such Cause is not susceptible to cure within such 20 business day period, the Executive has not taken all reasonable steps within such 20 business day period to cure such Cause as promptly as practicable thereafter. 4.4. Good Reason. For purposes of this Agreement, "Good Reason" shall mean any of the following (without the Executive's prior written consent): (i) a decrease in the Executive's base rate of compensation or a failure by the Company to pay material compensation due and payable to the Executive in connection with his employment; (ii) a material diminution of the responsibilities or title of the Executive with the Company; - 5 - (iii) a material breach by the Company of any term or provision of this Agreement; provided, however, that no event or condition described in clauses (i) through (iii) of this Section 4.4 shall constitute Good Reason unless (X) the Executive gives the Company written notice of his objection to such event or condition, (Y) such event or condition is not corrected by the Company within 20 business days of its receipt of such notice (or in the event that such event or condition is not susceptible to correction within such 20 business day period, the Company has not taken all reasonable steps within such 20 business day period to correct such event or condition as promptly as practicable thereafter) and (Z) the Executive resigns his employment with the Company and its subsidiaries not more than 60 days following the expiration of the 20 business day period described in the foregoing clause (Y). 5. DEATH, DISABILITY OR RETIREMENT In the event of termination of employment by reason of death, Permanent Disability (as hereinafter defined) or retirement, the Executive (or his estate, as applicable) shall be entitled to Base Salary and benefits determined under Sections 2 and 3 hereof through the date of termination. Other benefits shall be determined in accordance with the benefit plans maintained by the AC, and the Company shall have no further obligation hereunder. For purposes of this Agreement, "Permanent Disability" means a physical or mental disability or infirmity of the Executive that prevents the normal performance of substantially all his duties as an employee of the Company, which disability or infirmity shall exist for any continuous period of 180 days. 6. MITIGATION OF DAMAGES The Executive shall be required to mitigate the amount of any payment provided for in Section 4.1 by seeking other employment, and any such payment will be reduced in the event such other employment is obtained. 7. NON-SOLICITATION; CONFIDENTIALITY; NON-COMPETITION 7.1 Non-solicitation. For so long as the Executive is employed by the Company and continuing for two years thereafter, the Executive shall not, without the prior written consent of the Company, directly or indirectly, as a sole proprietor, member of a partnership, stockholder or investor, officer or director of a corporation, or as an employee, associate, consultant or agent of any person, partnership, corporation or other business organization or entity other than the Company: (x) solicit or endeavor to entice away from the Company, SCI or any of their respective subsidiaries any person or entity who is, or, during the then most recent 12-month period, was employed by, or had served as an agent or key consultant of, the Company, SCI or any of their respective subsidiaries; or (y) solicit or endeavor to entice away from the Company, SCI or any of their respective subsidiaries any person or entity who is, or was within the then most recent 12-month period, a customer or client (or reasonably anticipated (to the general knowledge of the Executive or the public) to become a customer or client) of the Company, SCI or any of their respective subsidiaries. - 6 - 7.2 Confidentiality. The Executive covenants and agrees with the Company that he will not at any time, except in performance of his obligations to the Company hereunder or with the prior written consent of the Company, directly or indirectly, disclose any secret or confidential information that he may learn or has learned by reason of his association with the Company, SCI or any of their respective subsidiaries and affiliates. The term "confidential information" includes information not previously disclosed to the public or to the trade by the Company's management, or otherwise in the public domain, with respect to the Company's, SCI's or any of their respective affiliates' or subsidiaries', products, facilities, applications and methods, trade secrets and other intellectual property, systems, procedures, manuals, confidential reports, product price lists, customer lists, technical information, financial information (including the revenues, costs or profits associated with any of the Company's products), business plans, prospects or opportunities, but shall exclude any information which (i) is or becomes available to the public or is generally known in the industry or industries in which the Company operates other than as a result of disclosure by the Executive in violation of his agreements under this Section 7.2 or (ii) the Executive is required to disclose under any applicable laws, regulations or directives of any government agency, tribunal or authority having jurisdiction in the matter or under subpoena or other process of law. 7.3 No Competing Employment. For so long as the Executive is employed by the Company and continuing for two years thereafter (or, if the Executive is entitled to a continuation of his Base Salary under Section 4.1.1, the period during which such Base Salary is continued), the Executive shall not, directly or indirectly, as a sole proprietor, member of a partnership, stockholder or investor (other than a stockholder or investor owning not more than a 5% interest), officer or director of a corporation, or as an employee, associate, consultant or agent of any person, partnership, corporation or other business organization or entity other than the Company, SCI, or any of their respective subsidiaries, render any service to or in any way be affiliated with a competitor (or any person or entity that is reasonably anticipated (to the general knowledge of the Executive or the public) to become a competitor) of AC, the Company, SCI or any of their respective subsidiaries. 7.4. Exclusive Property. The Executive confirms that all confidential information is and shall remain the exclusive property of the Company. All business records, papers and documents kept or made by the Executive relating to the business of the Company shall be and remain the property of the Company, except for such papers customarily deemed to be the personal copies of the Executive. 7.5. Injunctive Relief. Without intending to limit the remedies available to the Company, the Executive acknowledges that a breach of any of the covenants contained in this Section 7 may result in material and irreparable injury to the Company, SCI or their respective affiliates or subsidiaries for which there is no adequate remedy at law, that it will not be possible to measure damages for such injuries precisely and that, in the event of such a breach or threat thereof, the Company shall be entitled to seek a temporary restraining order and/or a preliminary or permanent injunction restraining the Executive from engaging in activities prohibited by this Section 7 or such other relief as may be required specifically to enforce any of the covenants in this Section 7. If for any reason, it is held that the restrictions under this Section 7 are not reasonable or that consideration therefor is inadequate, such restrictions shall be interpreted or modified to include as much of the duration and scope identified in this Section 7 as will render such restrictions valid and enforceable. - 7 - 8. ENFORCEMENT OF AGREEMENT In the event that legal action is undertaken by either party to enforce any provision of this Agreement, the Company shall reimburse the Executive for any related reasonable legal fees and out-of-pocket expenses directly attributable to such action, provided that such legal fees are calculated on an hourly, and not on a contingency fee, basis and provided, further, that the Executive shall bear all such fees and out-of-pocket expenses (and reimburse the Company for its portion of such expenses) if the relevant trier- of-fact determines that the Executive's claim or position was frivolous and without reasonable foundation. 9. REPRESENTATION The Executive hereby represents that (i) he is not in possession of any documents or materials containing information constituting Confidential Information (as such term is defined in the employment agreement (the "Wace Agreement") dated October 4, 1988 between Executive and Techtron Graphic Arts, Inc. ("Wace"), (ii) he has not and will not violate the provisions of the Wace Agreement, including without limitation, Section 13 thereof and (iii) he has read and will comply with the provisions of Exhibit C attached hereto. 10. INDEMNIFICATION The Company shall indemnify the Executive and hold him harmless against any and all damages, expenses and attorney's fees relating to any Claim (as hereinafter defined). As used herein, "Claim" means any threatened, pending or completed action, suit, proceeding, alternative dispute resolution mechanism, inquiry, hearing or investigation by Wace against the Executive based on an alleged breach by the Executive of the Wace Agreement, if such alleged breach occurred after the date hereof. Notwithstanding the foregoing, no amount shall be payable to the Executive pursuant to the immediately preceding paragraph to the extent that (i) the Executive is in breach of this Agreement or (ii) the Executive enters into a settlement agreement with Wace in which he agrees to pay Wace an amount to settle such Claim. If either (i) or (ii) of the immediately preceding sentence is true, the Executive shall immediately reimburse the Company for any payment it made to him pursuant to the preceding paragraph, and the Company shall have the right to set off the amount of any such payment from any amounts it owes the Executive. 11. MISCELLANEOUS 11.1. Notices. All notices or communications hereunder shall be in writing, addressed as follows: To the Company: American Color 2340 East Polk Phoenix, AZ 85006 Telecopier No. (602) 244-1467 Attention: James A. Caccavo, President - 8 - with a copy to: Sullivan Graphics, Inc. 225 High Ridge Road Stamford, CT 06905 Telecopier No.: (203) 978-5408 Attention: Timothy M. Davis Senior Vice President, General Counsel and Secretary To the Executive: Terrence M. Ray 2 South 405 Seneca Drive Wheaton, IL 60187 with a copy to: Thomas P. Riordan, Esq. Riordan, Larson, Bruckert & Moore 208 S. LaSalle Street Suite 650 Chicago, IL 60604 Telecopier Fax: (312) 346-1168 All such notices shall be conclusively deemed to be received and shall be effective, (i) if sent by hand delivery, upon receipt, (ii) if sent by telecopy or facsimile transmission, upon confirmation of receipt by the sender of such transmission or (iii) if sent by registered or certified mail, on the fifth day after the day on which such notice is mailed. 11.2. Severability. Each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement is held to be prohibited by or invalid under applicable law, such provision will be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Agreement. 11.3. Assignment. The Company's rights and obligations under this Agreement shall not be assignable by the Company except as incident to a reorganization, merger or consolidation, or transfer of all or substantially all of the Company's business and properties (or portion thereof in which the Executive is employed). Neither this Agreement nor any rights hereunder shall be assignable or otherwise subject to hypothecation by the Executive. 11.4. Entire Agreement. This Agreement represents the entire agreement of the parties and shall supersede any and all previous contracts, arrangements or understandings between the Company and the Executive. This Agreement may be amended at any time by mutual written agreement of the parties hereto. - 9 - 11.5. Withholding. The payment of any amount pursuant to this Agreement shall be subject to applicable withholding and payroll taxes, and such other deductions as may be required under the Company's employee benefit plans, if any. 11.6. Governing Law. This Agreement shall be construed, interpreted, and governed in accordance with the laws of New York without reference to rules relating to conflict of law. IN WITNESS WHEREOF, the Company has caused this Agreement to be duly executed and the Executive has hereunto set his hand, as of the day and year first above written. AMERICAN COLOR, a Division of Sullivan Graphics, Inc. By: /s/ James A. Caccavo --------------------------------- James A. Caccavo President EXECUTIVE: /s/ Terrence M. Ray --------------------------------- Terrence M. Ray EX-21.1 4 EXHIBIT 21.1 EXHIBIT 21.1 LIST OF SUBSIDIARIES Subsidiary of Sullivan Communications, Inc.: State of Incorporation: - -------------------------------------------- ----------------------- Sullivan Graphics, Inc. New York Subsidiaries of Sullivan Graphics, Inc: Sullivan Marketing, Inc. Delaware American Images of North America, Inc. New York Sullivan Media Corporation Delaware EX-27 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SULLIVAN COMMUNICATIONS, INC.'S CONSOLIDATED FINANCIAL STATEMENTS FOR THE TWELVE MONTH PERIOD ENDED MARCH 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000856710 SULLIVAN COMMUNICATIONS, INC. 1,000 U.S. DOLLARS 12-MOS MAR-31-1997 APR-01-1996 MAR-31-1997 1 0 0 56,762 5,879 9,711 70,077 238,167 71,270 333,975 78,675 185,000 0 0 1 (76,319) 333,975 524,551 524,551 459,880 459,880 245 4,847 36,289 (26,005) 2,591 (28,596) 3,107 0 0 (31,703) 0 0
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