SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------------
FORM 8-K/A
(AMENDMENT NO. 1)
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of report (Date of earliest event reported): January 3, 2003
R.H. DONNELLEY CORPORATION
(Exact Name of Registrant as Specified in Charter)
Delaware 1-07155 13-2740040
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(State or Other Jurisdiction (Commission (IRS Employer
of Incorporation) File Number) Identification No.)
One Manhattanville Road, Purchase, New York 10577
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(Address of Principal Executive Offices) (Zip Code)
R.H. DONNELLEY INC.*
(Exact Name of Registrant as Specified in Charter)
Delaware 333-59287 36-2467635
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(State or Other Jurisdiction (Commission (IRS Employer
of Incorporation) File Number) Identification No.)
One Manhattanville Road, Purchase, New York 10577
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(Address of Principal Executive Offices) (Zip Code)
Registrants' telephone number, including area code: (914) 933-6400
Not Applicable
(Former Name or Former Address, if Changed Since Last Report)
*R.H. Donnelley Inc. is a wholly owned subsidiary of R.H. Donnelley Corporation,
which became subject to the filing requirements of Sections 15(d) on October 1,
1998. As of March 18, 2003, 100 shares of R.H. Donnelley Inc. common stock, no
par value, were outstanding.
This Form 8-K/A is being filed to amend the Form 8-K filed on January
17, 2003 by R.H. Donnelley Corporation (the "Company") to include the financial
statements and pro forma financial information referred to in Item 7 below
relating to the SPA Acquisition (as defined below). At the time of the filing of
the Form 8-K, it was impractical for the Company to provide these financial
statements and pro forma financial information. Pursuant to the instructions to
Item 7 of Form 8-K, the Company hereby amends Item 7 to the Form 8-K to include
the previously omitted information.
On January 3, 2003, the Company completed the acquisition (the "SPA
Acquisition") from Sprint Corporation ("Sprint") of Sprint's directory
publishing business ("SPA") by purchasing the stock of two subsidiaries of
Sprint, DirectoriesAmerica, Inc. and Centel Directory Company. The acquisition
was accomplished pursuant to, and in accordance with, the terms of the Stock
Purchase Agreement, dated as of September 21, 2002 (as supplemented and amended,
the "Stock Purchase Agreement"), by and among the Company, Sprint and Centel
Directories LLC, a Delaware limited liability company ("Centel"). The parties
supplemented and amended certain of their obligations in connection with the
transactions contemplated by the Stock Purchase Agreement pursuant to the
Supplemental Agreement to Stock Purchase Agreement, dated as of December 31,
2002 (the "Supplemental Agreement").
The foregoing descriptions of all such agreements are qualified in
their entirety by the full text of each such document and are incorporated
herein by reference.
1
Item 7. Financial Statements and Exhibits.
(a) Financial Statements of the Businesses Acquired.
INDEX TO FINANCIAL STATEMENTS
Page Reference
SPRINT PUBLISHING & ADVERTISING
COMBINED CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors 3
Combined Consolidated Statements of Income for each of the three years ended December 31, 2002 4
Combined Consolidated Balance Sheets as of December 31, 2002, 2001 and 2000 5
Combined Consolidated Statements of Cash Flows for each of the three years ended December 31, 2002 6
Combined Consolidated Statements of Shareholders' Equity for each of the three years ended
December 31, 2002 7
Notes to Combined Consolidated Financial Statements 8
2
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Sprint Corporation
We have audited the accompanying combined consolidated balance sheets as of
December 31, 2002, 2001 and 2000, of the directory publishing operations of
Sprint Corporation (Sprint Publishing & Advertising), as described in Note 1,
and the related combined consolidated statements of income, shareholders'
equity, and cash flows for the years then ended. These financial statements are
the responsibility of Sprint Publishing & Advertising's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the combined consolidated financial position of Sprint
Publishing & Advertising at December 31, 2002, 2001 and 2000, and the combined
consolidated results of its operations and its cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States.
Ernst & Young LLP
Kansas City, Missouri
January 31, 2003
3
COMBINED CONSOLIDATED STATEMENTS OF INCOME Sprint Publishing & Advertising
(thousands)
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Years Ended December 31, 2002 2001 2000
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NET OPERATING REVENUES $ 545,604 $ 555,637 $ 459,426
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OPERATING EXPENSES
Costs of services and products 202,481 210,762 187,199
Selling, general and administrative 50,663 65,761 54,940
Depreciation 8,604 8,051 8,016
Amortization - 850 850
Restructuring charge 180 1,588 -
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Total operating expenses 261,928 287,012 251,005
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OPERATING INCOME 283,676 268,625 208,421
Interest expense 1,875 4,890 1,141
Equity in earnings of CenDon Partnership - - 7,777
Minority interest in loss/(income) 282 (561) 978
Priority distributions 17,703 18,436 6,999
Gain on sale of Midwest Operations - - 45,528
Other income, net 1,523 7,433 2,608
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Income before income taxes 265,903 252,171 257,172
Income taxes 103,763 98,446 102,194
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NET INCOME $ 162,140 $ 153,725 $ 154,978
==============================================
See accompanying Notes to Combined Consolidated Financial Statements.
4
COMBINED CONSOLIDATED BALANCE SHEETS Sprint Publishing & Advertising
(thousands)
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December 31, 2002 2001 2000
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ASSETS
Current assets
Cash $ 1,691 $ - $ -
Accounts receivable
Billed 55,300 57,957 65,592
Unbilled 263,779 261,480 267,681
Allowance for doubtful accounts and
deferred revenue credits (35,073) (26,322) (36,130)
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Accounts receivable, net 284,006 293,115 297,143
Deferred directory costs 97,190 101,721 98,540
Advances to parent company 4,538 13,090 26,289
Deferred income taxes 35,697 21,320 23,274
Prepaid expenses and other 3,899 2,825 6,509
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Total current assets 427,021 432,071 451,755
Property, plant and equipment
Data processing 30,669 30,341 30,359
Other 11,216 10,807 12,108
Accumulated depreciation (29,906) (24,069) (18,088)
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Net property, plant and equipment 11,979 17,079 24,379
Deferred income taxes 6,568 3,829 2,193
Goodwill and other assets 1,299 1,320 2,178
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Total $ 446,867 $ 454,299 $ 480,505
===============================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 8,555 $ 4,919 $ 7,270
Accrued printing 8,809 12,007 14,184
Deferred revenue 292,775 288,564 287,547
Payroll and employee benefits 5,341 3,364 4,625
Affiliated payables 4,603 3,559 4,012
Other 11,587 15,632 14,494
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Total current liabilities 331,670 328,045 332,132
Noncurrent liabilities
Long-term obligation 16,110 14,872 13,746
Post retirement, pension and other benefits obligations 19,040 18,950 17,452
Other - - 10
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Total noncurrent liabilities 35,150 33,822 31,208
Minority interest (5,555) (5,030) 1,428
Shareholders' equity
Common stock
DirectoriesAmerica, Inc. par value $1 per share, 10,000
shares authorized, and 1,004 shares issued and
outstanding 1 1 1
Centel Directory Company, no par value per share, 10
shares authorized, issued and outstanding - - -
Capital in excess of par value 176 176 176
Combined retained earnings 85,425 97,285 115,560
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Total shareholders' equity 85,602 97,462 115,737
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Total $ 446,867 $ 454,299 $ 480,505
===============================================
See accompanying Notes to Combined Consolidated Financial Statements.
5
COMBINED CONSOLIDATED STATEMENTS OF CASH FLOWS Sprint Publishing & Advertising
(thousands)
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Years Ended December 31, 2002 2001 2000
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OPERATING ACTIVITIES
Net income $ 162,140 $ 153,725 $ 154,978
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for bad debts 26,521 42,613 30,576
Depreciation and amortization 8,604 8,901 8,866
Deferred income taxes (17,116) 318 (2,935)
Minority interest in earnings in
CenDon, L.L.C. (282) 561 (978)
Priority distributions to minority interest 17,703 18,436 6,999
Gain on sale of Midwest Operations - - (45,528)
Changes in assets and liabilities:
Accounts receivable (17,412) (38,585) (93,032)
Deferred directory costs 4,531 (3,181) (6,577)
Other current assets (1,074) 3,684 (9,567)
Accounts payable 3,636 (2,351) 819
Deferred revenue 4,211 1,017 73,326
Accrued expenses and other current liabilities (5,266) (2,300) 8,043
Affiliated receivables and payables, net 1,044 (453) 6,954
Noncurrent assets and liabilities 111 1,496 1,696
Other, net (650) 717 (159)
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Net cash provided by operating activities 186,701 184,598 133,481
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INVESTING ACTIVITIES
Capital expenditures (1,616) (342) (1,485)
Changes in advances to parent company 8,552 13,199 3,556
Return of investment in CenDon Partnership - - 6,070
Contributions to CenDon Partnership - - (437)
Proceeds from the sale of Midwest Operations - - 46,843
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Net cash provided by investing activities 6,936 12,857 54,547
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FINANCING ACTIVITIES
Distributions paid to minority interest, net (17,946) (25,455) (14,884)
Dividends paid (174,000) (172,000) (173,144)
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Net cash used by financing activities (191,946) (197,455) (188,028)
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INCREASE IN CASH AND EQUIVALENTS 1,691 - -
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD - - -
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CASH AND EQUIVALENTS AT END OF PERIOD $ 1,691 $ - $ -
===============================================
CASH RECEIVED FOR INTEREST $ 967 $ 2,262 $ 3,248
===============================================
CASH PAID FOR TAXES $ 117,813 $ 95,665 $ 108,287
===============================================
See accompanying Notes to Combined Consolidated Financial Statements.
6
COMBINED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' Sprint Publishing &
EQUITY Advertising
(thousands)
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Centel Combined
Directory Retained
DirectoriesAmerica, Company Earnings Total
Inc.
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Beginning 2000 balance $ 166 $ 11 $ 133,726 $ 133,903
Common stock dividends - - (173,144) (173,144)
Net income - - 154,978 154,978
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Ending 2000 balance 166 11 115,560 115,737
Common stock dividends - - (172,000) (172,000)
Net income - - 153,725 153,725
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Ending 2001 balance 166 11 97,285 97,462
Common stock dividends - - (174,000) (174,000)
Net income - - 162,140 162,140
- ---------------------------------------------------------------------------------------------------------------
Ending 2002 balance $ 166 $ 11 $ 85,425 $ 85,602
=========================================================================
See accompanying Notes to Combined Consolidated Financial Statements.
7
NOTES TO COMBINED CONSOLIDATED Sprint Publishing &
FINANCIAL STATEMENTS Advertising
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF COMBINATION AND PRESENTATION
The combined consolidated financial statements include the accounts of
DirectoriesAmerica, Inc. with its wholly owned subsidiary Sprint Publishing and
Advertising, Inc. (SPA, Inc.) and Centel Directory Company (CDC), collectively
referred to as Sprint Publishing & Advertising. All significant intercompany
amounts have been eliminated. Investments in entities in which Sprint Publishing
& Advertising exercises significant influence, but does not control, are
accounted for using the equity method (see Note 3). DirectoriesAmerica, Inc. and
CDC are wholly owned by Sprint Corporation (Sprint). On January 3, 2003, Sprint
completed the sale of Sprint Publishing and Advertising (See Note 12).
The combined consolidated financial statements are prepared using accounting
principles generally accepted in the United States. These principles require
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities, and
the reported amounts of revenues and expenses. Actual results could differ from
those estimates.
Certain prior-year amounts have been reclassified to conform to the current-year
presentation. These reclassifications had no effect on the results of operations
or shareholders' equity as previously reported.
SPRINT CORPORATION
Sprint is a global communications company and a leader in integrating
long-distance, local service, and wireless communications. Sprint's business is
divided into three main lines of business: the global markets division, the
local division and the PCS wireless telephony products and services business.
The FON common stock is intended to reflect the financial results and economic
value of the global markets division, the local telecommunications division and
other businesses consisting primarily of wholesale distribution and
telecommunications products. Sprint Publishing & Advertising is reported as
discontinued operations of the FON Group. The PCS common stock is intended to
reflect the financial results and economic value of the PCS wireless telephony
products and services business.
OPERATIONS
Sprint Publishing & Advertising publishes and markets approximately 260 revenue
producing white and yellow pages directories primarily in territories served by
Sprint's local telecommunications division. Prior to June 2000 the business also
included approximately 55 directories outside Sprint's local territories (see
Note 5).
MATERIAL AGREEMENTS
Sprint Publishing & Advertising entered into Sales Agency Agreements with R.H.
Donnelley Inc. Under the agreements, R.H. Donnelley Inc. provides sales
management services and sales forces for certain directories and receives a
commission based on certain advertising revenues sold into those directories.
The agreement with CDC has an expiration date of January 1, 2009 (this agreement
has an automatic two-year extension through January 1, 2011) and the agreement
with SPA, Inc. expires on December 31, 2004.
SPA, Inc. has entered into a Directory Manufacturing Agreement with R.R.
Donnelley and Sons Company for the printing of substantially all of its
directories. This agreement has an expiration date for print and binding
services of December 31, 2007.
8
CDC and SPA, Inc. have entered into Production Agreements with R.H. Donnelley
Inc. for the production of and pre-press graphic services for the CenDon, L.L.C.
and Central Florida directories, respectively. These agreements have an
expiration date of December 31, 2003.
In conjunction with the CenDon Partnership restructuring, CDC has agreed to
priority distributions, which accrue to R.H. Donnelley Inc. through 2004 (see
Note 3). These priority distributions approximate the partnership distributions
anticipated under the initial CenDon Partnership agreement.
Sprint Publishing & Advertising and CenDon, L.L.C. have entered into a Directory
Agreement with Sprint's local telecommunications companies. This agreement
provides Sprint Publishing & Advertising with access to the customer listings
for the local territories and the right to use the listings in the directories.
The local telephone companies receive a fee based on the number of listings in
each directory. The initial term of this agreement expires on December 31, 2004
and automatically renews for successive one-year terms, unless either party
provides notice of termination.
Pursuant to the Sales Agency Agreement, CDC is obligated to replace the
Directory Agreements so that CDC's right to publish the directories is extended
through the term of the Sales Agency Agreement. In the event CDC fails to
replace each Directory Agreement by January 1, 2004, then, at any time prior to
April 30, 2004, R.H. Donnelley Inc. may require CDC to purchase for cash R.H.
Donnelley Inc.'s rights under the Sales Agency Agreement at fair market values
determined in accordance with the Sales Agency Agreement.
The material agreements with R.H. Donnelley Inc. no longer apply effective
January 3, 2003 as a result of the change in control (See Note 12).
INCOME TAXES
Sprint Publishing & Advertising's operations are included in the consolidated
income tax return of Sprint Corporation. Income tax is recognized by the
entities that comprise Sprint Publishing & Advertising on the basis of each
entity filing separate returns.
Sprint Publishing & Advertising records deferred income taxes based on temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and their tax bases.
REVENUE RECOGNITION AND DEFERRED DIRECTORY COSTS
Revenues from the sale of advertising placed in each directory are deferred and
amortized over the life of the directory, generally one year. Expenditures
directly related to sales, production, printing and distribution of directories
are deferred and amortized over the same period as the related revenues.
ADVERTISING EXPENSE
Sprint Publishing & Advertising recognizes advertising expense as incurred.
These expenses include production, media and other promotional and sponsorship
costs. Total advertising expenses were approximately $4,514,000 in 2002,
approximately $8,658,000 in 2001 and approximately $8,901,000 in 2000.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. The cost of property, plant
and equipment is depreciated on a straight-line basis over estimated economic
useful lives. Repair and maintenance costs are expensed as incurred.
9
GOODWILL
Goodwill represents the excess of the purchase price over the fair value of the
net assets acquired in business combinations accounted for as purchases. Prior
to adoption of SFAS No. 142, goodwill was amortized over five years using the
straight-line method. Goodwill net of accumulated amortization included in the
combined consolidated balance sheet was $1,275,000 in 2001 and $2,125,000 in
2000.
Sprint Publishing & Advertising adopted SFAS No. 142, "Goodwill and Other
Intangible Assets" on January 1, 2002. This standard prescribes the accounting
treatment for both identifiable intangibles and goodwill after initial
recognition. Upon adoption of the standard, amortization of goodwill and
indefinite life intangibles ceased and accumulated amortization as of December
31, 2001 reduced the carrying value of these assets. Periodic impairment testing
of these assets is now required. Concurrent with adoption, Sprint Publishing &
Advertising evaluated for impairment its goodwill and indefinite life
intangibles in accordance with the standard's guidance and determined these
assets were not impaired.
Stock-based Compensation
Sprint Publishing & Advertising accounts for their stock-based employee
compensation plans under the recognition and measurement principles of APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. Based on the additional disclosure requirements of SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure," the
following table illustrates the effect on net income if the company had applied
the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation." (See Note 11 for additional information regarding
SFAS No. 148).
Year Ended December 31,
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(thousands) 2002 2001 2000
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Net income, as reported $ 162,140 $ 153,725 $ 154,978
Add: Stock-based
employee compensation
expense included in
reported net income,
net of related tax effects 34 9 291
Deduct: Total stock-based
employee compensation
expense determined
under fair value based
methods for all awards,
net of related tax effects (1,628) (3,483) (5,640)
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Pro forma net income $ 160,546 $ 150,251 $ 149,629
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2. RELATED PARTY TRANSACTIONS AND ALLOCATIONS
Sprint directly assigns, where possible, certain general and administrative
costs to Sprint Publishing & Advertising based on its actual use of those
services. Where direct assignment of costs is not possible, or practical, Sprint
uses other indirect methods, including time studies, to estimate the allocation
of costs to each operating unit. Cost allocation methods other than time studies
include factors (general, marketing or headcount) derived from the operating
unit's relative share of the predefined category referenced (e.g. headcount).
Costs for shared services allocated to Sprint Publishing & Advertising totaled
approximately $16,161,000 in 2002, $12,775,000 in 2001 and $11,648,000 in 2000.
The allocation of shared services may change at the discretion of Sprint's
Board.
Financing activities are managed by Sprint on a centralized basis. Debt has not
been incurred by Sprint on behalf of Sprint Publishing & Advertising and is
therefore, not reflected in the financial statements of Sprint Publishing &
Advertising.
Under Sprint's centralized cash management program, Sprint and Sprint Publishing
& Advertising may advance funds to each other. These net advances are classified
as a current asset and bear an interest rate that is substantially equal to the
rate that Sprint, as a whole, obtains on a short-term basis.
The allocation of financing activities may change at the discretion of Sprint's
Board and does not require shareholder approval.
Sprint files a consolidated federal income tax return and certain state income
tax returns, which include Sprint Publishing & Advertising results. Tax payments
due to or from divisions within the FON Group are satisfied on the date Sprint's
related tax payment is due to or the refund is received from the applicable tax
authority.
10
Sprint Publishing & Advertising's related party transactions with Sprint and its
affiliates were as follows (in thousands):
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Transaction Description 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------
EXPENSES
Shared services $ 16,161 $ 12,775 $ 11,648
Local and interexchange telephone service 1,174 1,245 1,419
Facility leases 117 103 191
Telecommunications equipment, materials and supplies
purchased 9 4 28
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REVENUES
Interest income from Sprint, net $ 967 $ 2,262 $ 3,248
Revenues from directories 2,237 2,193 1,809
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3. INVESTMENTS
INVESTMENTS IN AND ADVANCES TO AFFILIATES
Through June 30, 2000, the investment accounted for using the equity method was
CDC's 50 percent investment in the CenDon Partnership, which was restructured to
CenDon, L.L.C. effective July 1, 2000. The CenDon Partnership recognized 100% of
revenues and expenses for a directory at its publication date. As part of the
partnership restructuring, CDC assumed management control requiring the L.L.C.
to be consolidated beginning July 1, 2000.
Unaudited, summarized financial information (100% basis) of the CenDon
Partnership was as follows:
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Six months
ended
June 30, 2000
- ---------------------------------------------------------------------
(thousands)
Results of operations
Net operating revenues $ 71,452
=============
Operating income $ 65,377
=============
Net loss $ 6,158
=============
Financial position
Current assets $ 46,088
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Total $ 46,088
=============
Current liabilities $ 16,749
Noncurrent liabilities 13,305
Owners' equity 16,033
- --------------------------------------------------------------------
Total $ 46,088
=============
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4. RESTRUCTURING CHARGE
In the fourth quarter of 2001, Sprint announced plans to take steps to improve
its competitive position and reduce operating costs in the business units that
comprise its FON Group. These efforts included consolidation and streamlining of
marketing and network operations, as well as streamlining of corporate support
functions. This decision resulted in the allocation of a one-time charge to
Sprint Publishing & Advertising of $1,588,000, predominately associated with the
severance costs of work force reductions.
In 2002, Sprint performed an analysis to finalize the restructuring estimates
recorded in the 2001 fourth quarter. This analysis resulted in an additional
charge of $180,000. At December 31, 2002, substantially all amounts have been
paid.
5. GAIN ON SALE OF MIDWEST OPERATIONS
Effective May 31, 2000, Sprint Publishing & Advertising sold the assets
associated with the publication of approximately 55 telephone directories in
Illinois and Wisconsin to a non-affiliated company. Proceeds from the sale
totaled $46,843,000 and resulted in a pre-tax gain on sale of $45,528,000.
In connection with the asset sale, Sprint signed a three-year non-compete
agreement, which expires May 31, 2003 and SPA, Inc. signed a five-year
non-compete agreement, which expires May 31, 2005. These non-compete agreements
prohibit Sprint and SPA, Inc. from engaging in directory publishing activities
in areas in and around Chicago, Illinois, and Milwaukee, Wisconsin.
6. EMPLOYEE BENEFIT PLANS
DEFINED BENEFIT PENSION PLAN
Most Sprint Publishing & Advertising employees are covered by Sprint's
noncontributory defined benefit pension plan. Pension benefits are based on
years of service and the participants' compensation.
Sprint's policy is to make plan contributions equal to an actuarially determined
amount consistent with federal tax regulations. The funding objective is to
accumulate funds at a relatively stable rate over the participants' working
lives so benefits are fully funded at retirement.
Net pension costs or credits are determined for Sprint Publishing & Advertising
based on a direct calculation of service costs and interest on projected benefit
obligations, and an appropriate allocation of unrecognized prior service costs,
amortization of unrecognized transition assets, actuarial gains and losses, and
expected return on plan assets. Amounts included for the plan in the Combined
Consolidated Balance Sheets include accrued pension expense of approximately
$11,639,000 at year-end 2002, approximately $10,127,000 at year-end 2001, and
approximately $8,608,000 at year-end 2000. Sprint Publishing & Advertising
recorded net pension expense of approximately $1,512,000 in 2002, approximately
$1,519,000 in 2001, and approximately $1,515,000 in 2000.
DEFINED CONTRIBUTION PLANS
Sprint sponsors defined contribution employee savings plans covering most Sprint
Publishing & Advertising employees. Participants may contribute portions of
their pay to the plans. For union employees, Sprint matches contributions based
on negotiated amounts. Sprint Publishing & Advertising does not have any union
employees. Sprint also matches contributions of non-union employees in FON stock
and PCS stock. The matching is equal to
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50% of participants' contributions up to 6% of their pay. In addition, Sprint
may, at the discretion of its Board of Directors, provide additional matching
contributions based on the performance of FON stock and PCS stock compared to
other telecommunications companies' stock. At year-end 2002, the plans held 42
million FON shares with a market value of $608 million and dividends reinvested
into the plan of $20 million. At year-end 2002, the plans held 52 million PCS
shares with a market value of $227 million. Amounts directly allocated to Sprint
Publishing & Advertising for matching contributions and expenses were
approximately $905,000 in 2002, approximately $986,000 in 2001 and approximately
$1,169,000 in 2000.
POSTRETIREMENT BENEFITS
Sprint provides postretirement benefits (mainly medical and life insurance) to
most Sprint Publishing & Advertising employees. Employees retiring before
certain dates are eligible for benefits at no cost, or at a reduced cost.
Employees retiring after certain dates are eligible for benefits on a
shared-cost basis. Sprint funds the accrued costs as benefits are paid.
In the 2001 third quarter, Sprint adopted amendments to two postretirement
benefit plans. As a result of the amendments, the life insurance benefit is
eliminated for employees retiring after 2003 and the postretirement medical
insurance plan is replaced with a Sprint-funded account to be managed by the
employee. The plan amendment to the Sprint retiree medical insurance plan
reduced the accumulated postretirement benefit obligation and reduced employee
benefits attributed to employee service already rendered. Sprint Publishing &
Advertising recognized a curtailment loss from this amendment of $189,000.
The amount of accrued postretirement benefit costs included in the combined
consolidated balance sheets were $6,629,000 at year-end 2002, $7,357,000 at
year-end 2001 and $7,492,000 at year-end 2000.
Net postretirement benefits costs are determined for Sprint Publishing &
Advertising based on direct calculation of service costs and interest on
accumulated postretirement benefit obligations and an appropriate allocation of
unrecognized prior service costs and actuarial gains. Sprint Publishing &
Advertising recorded a net periodic benefit credit of $491,000 in 2002 and
$98,000 in 2001 and net periodic benefit costs of $51,000 in 2000.
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7. INCOME TAXES
Income tax expense consists of the following:
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2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------
(thousands)
Current income tax expense
Federal $ 103,404 $ 82,299 $ 86,752
State 17,475 15,829 18,377
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Total current 120,879 98,128 105,129
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Deferred income tax expense (benefit)
Federal (15,889) 740 (2,801)
State (1,227) (422) (134)
- ---------------------------------------------------------------------------------------------------------------
Total deferred (17,116) 318 (2,935)
- ---------------------------------------------------------------------------------------------------------------
Total $ 103,763 $ 98,446 $ 102,194
=================================================
The differences that caused Sprint Publishing & Advertising's effective income
tax rates to vary from the 35% federal statutory rate for income taxes related
to continuing operations were as follows:
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2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
(thousands)
Income tax expense at the federal statutory rate $ 93,066 $ 88,260 $ 90,010
Effect of:
State income taxes, net of federal income tax effect 10,561 10,015 11,858
Other, net 136 171 326
- ----------------------------------------------------------------------------------------------------------------
Income tax expense $ 103,763 98,446 102,194
==================================================
Effective income tax rate 39.0% 39.0% 39.7%
==================================================
14
Sprint Publishing & Advertising recognizes deferred income taxes for the
temporary differences between the carrying amounts of its assets and liabilities
for financial statement purposes and their tax bases. The sources of the
differences that give rise to the deferred income tax assets and liabilities at
year-end 2002, 2001 and 2000, along with the income tax effect of each, were as
follows:
- ---------------------------------------------------------------------------------------------------------------
2002 Deferred Income Tax 2001 Deferred Income 2000 Deferred Income
Tax Tax
------------------------- ------------------------ -----------------------
Assets Liabilities Assets Liabilities Assets Liabilities
- ---------------------------------------------------------------------------------------------------------------
(thousands)
Property, plant
and equipment $ - $ 2,638 $ - $ 4,318 $ - $ 5,894
Intangibles 1,859 - 2,092 - 1,973 -
Deferred revenue 23,424 - 12,609 - 8,876 -
Postretirement and
other benefits 7,307 - 7,021 - 6,555 -
Accrued expenses 1,535 3,921 - 7,465 -
Reserves and
allowances 13,808 - 4,790 - 6,932 -
Other, net 40 - - 966 - 440
- ---------------------------------------------------------------------------------------------------------------
Total $ 46,438 $ 4,173 $ 30,433 $ 5,284 $ 31,801 $ 6,334
=====================================================================================
Management believes it is more likely than not that these deferred income tax
assets will be realized based on current income tax laws and expectations of
future taxable income stemming from the reversal of existing deferred tax
liabilities or ordinary operations. Uncertainties surrounding income tax law
changes, shifts in operations between state taxing jurisdictions and future
operating income levels may, however, affect the ultimate realization of all or
some of these deferred income tax assets.
8. LONG-TERM OBLIGATION
In 1990, the CenDon Partnership entered into Directory Agreements with various
Sprint local telephone companies, which includes termination fees. Initial
installments were paid by the partnership in 1990. The remaining installment
payments are due quarterly in 2005 and total approximately $19,730,000. At
year-end 2002, the long-term obligation recorded in Sprint Publishing &
Advertising's Combined Consolidated Balance Sheet is approximately $16,110,000,
which represents the present value of the termination fees per the various
Directory Agreements.
Interest is accrued on this present value liability at 10% per annum. Interest
expense on these obligations totaled $1,238,000 in 2002, $1,126,000 in 2001 and
$1,002,000 in 2000. Prior to the partnership restructuring at July 1, 2000, the
interest expense was included in Equity in earnings of CenDon Partnership.
The estimated fair value of the long-term obligation was $18,078,000 at December
31, 2002 and $16,632,000 at December 31, 2001. This estimated fair value of the
long-term obligation was based on quoted market prices for publicly traded
issues.
See Note 12 for treatment subsequent to the change in control.
15
9. COMMITMENTS AND CONTINGENCIES
LITIGATION, CLAIMS AND ASSESSMENTS
From time to time various lawsuits arise in the ordinary course of business
against Sprint Publishing & Advertising.
Management cannot predict the final outcome of these actions but believes they
will not be material to Sprint Publishing & Advertising's combined consolidated
financial statements.
OPERATING LEASES
Sprint Publishing & Advertising's minimum rental commitments at year-end 2002
for all noncancelable operating leases, consisting mainly of leases for data
processing equipment, are as follows:
- --------------------------------------------
(thousands)
2003 $ 2,528
2004 1,468
2005 768
2006 430
2007 430
Thereafter 1,791
- --------------------------------------------
Sprint Publishing & Advertising's gross rental expense totaled $1,837,000 in
2002, $2,574,000 in 2001 and $3,503,000 in 2000. Rental commitments for
subleases, contingent rentals and executory costs were not significant.
10. ADDITIONAL FINANCIAL INFORMATION
Printing costs paid to one vendor represent approximately 17% of Sprint
Publishing & Advertising's net operating expenses in 2002, 18% in 2001 and 20%
in 2000.
Sales agency and directory production services paid to one vendor represent
approximately 21% of Sprint Publishing & Advertising's net operating expenses in
2002, 20% in 2001 and 9% in 2000. Prior to the CenDon Partnership restructuring
no payments were made to this vendor.
11. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In April 2002, the FASB issued Statement No. 145, "Recission of FASB Statements
No. 4, 44, and 64, Amendment to FASB Statement No. 13, and Technical
Corrections". The provisions related to Statement No. 4 are effective for fiscal
years beginning after May 15, 2002. The provisions related to Statement No. 13
are effective for transactions occurring after May 15, 2002. All other
provisions of this statement are effective for financial statements issued on or
after May 15, 2002. The recission of Statement No. 4, "Reporting Gains and
Losses from Extinguishment of
16
Debt", and Statement No. 64, "Extinguishment of Debt to Satisfy Sinking-Fund
Requirements", requires that gains and losses from the extinguishment of debt be
reported in other income or expense. The gains and losses would be reported as
extraordinary items only if they are unusual in nature and occur infrequently.
The amendment to Statement No. 13, "Accounting for Leases", requires that
modifications to capital leases that give rise to operating lease classification
be treated as a sale-leaseback. Sprint Publishing & Advertising will adopt this
statement as the provisions become effective. Sprint Publishing & Advertising
has determined that there will be no material impact of adopting this standard.
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." The objective of this statement is to provide accounting guidance
for legal obligations associated with the retirement of long-lived assets by
requiring the fair value of a liability for the asset retirement obligation to
be recognized in the period in which it is incurred. When the liability is
initially recognized, the asset retirement costs should also be capitalized by
increasing the carrying amount of the related long-lived asset. The liability is
then accreted to its present value each period and the capitalized costs are
depreciated over the useful life of the associated asset. Sprint Publishing &
Advertising has assessed its legal obligations and, accordingly, has determined
that there will be no material impact of adopting this standard. This statement
is effective for fiscal years beginning after June 15, 2002. Sprint Publishing &
Advertising intends to adopt this standard on January 1, 2003.
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which is effective for financial
statements where exit or disposal activities are initiated after December 31,
2002. This statement nullifies EITF Issue 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity",
which allowed recognition of a liability for exit and disposal activities upon
management's intent to exit or dispose of an activity. This statement requires
that a liability for costs associated with an exit or disposal activity be
recognized when the liability is incurred. Sprint Publishing & Advertising will
adopt this statement for exit or disposal activities initiated after December
31, 2002.
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure". This statement amends Statement No.
123, "Accounting for Stock-Based Compensation". The provisions of this statement
are effective for interim and annual financial statements for fiscal years
ending after December 15, 2002. This statement provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. Also, this statement amends the
disclosure requirements of Statement No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. Sprint Publishing & Advertising has not adopted the fair value
recognition method, but will adopt the disclosure requirements of this
statement.
12. SUBSEQUENT EVENTS
On January 3, 2003, Sprint completed the sale of its directory publishing
business to R.H. Donnelley Inc. for $2.23 billion in cash. As part of this stock
sale agreement, the long-term obligation will be settled with a $14 million
payment from R.H. Donnelley Inc. and a payment from SPA for the remainder of the
future value of the obligation as part of settling intercompany accounts.
Concurrent with the sale transaction, the entities comprising SPA underwent a
name change. Sprint Publishing & Advertising, Inc., changed its name to R.H.
Donnelley Publishing & Advertising, Inc. and Centel Directory Company changed
its name to R.H. Donnelley Directory Company.
17
(b) Pro Forma Financial Information
The following unaudited pro forma combined financial statements, or pro forma
statements, give effect to the acquisition by R.H. Donnelley Corporation
("Donnelley") of the directory publishing business ("SPA") of Sprint Corporation
("Sprint") and related financings on the historical financial position and
results of operations of Donnelley and SPA. The historical financial information
set forth below has been derived from, and should be read in connection with,
the financial statements of Donnelley and SPA.
Donnelley's financial statements are included in Donnelley's Annual Report on
Form 10-K for the year ended December 31, 2002. SPA's financial statements for
the year ended December 31, 2002 are included elsewhere in this Current Report
on Form 8-K.
The pro forma statements give effect to the SPA acquisition and the related
financings as if the transactions had been consummated for the combined income
statement on January 1, 2002 and for the combined balance sheet on December 31,
2002 under the purchase method of accounting.
The pro forma statements are provided for informational purposes only and do not
purport to represent what the combined financial position or results of
operations actually would have been had the SPA acquisition and related
financings and other pro forma adjustments occurred on the dates indicated.
Additionally, the pro forma statements are not necessarily indicative of the
future financial condition or results of operations of Donnelley.
THE ACQUISITION
On January 3, 2003, Donnelley completed the acquisition of SPA by
purchasing the stock of two subsidiaries of Sprint, DirectoriesAmerica, Inc. and
Centel Directory Company for $2.2 billion in cash, after a preliminary working
capital adjustment. The ultimate purchase price is subject to a final working
capital adjustment. The acquisition was accounted for as a purchase business
combination. Under the purchase method of accounting, the costs to acquire SPA,
including certain transaction costs, were allocated to the underlying net assets
in proportion to their respective estimated fair values. Any excess of the
purchase price over the estimated fair value of the net assets acquired,
including identifiable intangible assets, was allocated to goodwill. A
preliminary allocation of the purchase price to the net assets acquired,
including identifiable intangible assets, has been made based on the best
information currently available. Donnelley's analysis of the fair value of net
assets acquired is not yet complete. Finalization of this purchase price
allocation could materially affect the fair value assigned to the net assets
acquired, including identifiable intangible assets and/or estimates of their
useful lives.
Management expects that the SPA acquisition will result in increased
efficiencies and cost savings opportunities for the combined company. These
opportunities include, but are not limited to, information technology cost
savings from the elimination and consolidation of publishing, sales and other
systems, rationalization and increased utilization of pre-press publishing
facilities, and the rationalization of administrative and other support
functions. Management also expects that the combined company will incur certain
general and administrative costs above the amounts historically allocated to SPA
by its parent company. In addition, certain adjustments will be made to the
assets acquired to be consistent with the application of Donnelley's policies.
Sprint has also agreed to purchase a minimum of $3.0 million in advertising per
year through 2006 and to reimburse Donnelley for any incremental costs resulting
from any new regulatory requirements. However, the net financial impact of these
matters has not been reflected in the accompanying pro forma statements.
REVENUE AND EXPENSE RECOGNITION
As the result of the acquisition of SPA, Donnelley is the publisher of
260 revenue-generating yellow pages directories. Donnelley will recognize
revenue and certain direct costs related to the publication of these yellow
pages directories under the deferral and amortization method. Under this method,
revenue from advertising sales and costs directly related to the sales, printing
and distribution are initially deferred and recognized ratably over the life of
a directory, which is typically twelve months. Subsequent to the acquisition,
Donnelley will continue to
18
recognize revenue for pre-press publishing services as these services are
performed.
The DonTech Partnership ("DonTech"), our 50/50 perpetual partnership
with an affiliate of SBC Communications Inc. ("SBC"), has historically been, and
will continue to be, accounted for under the equity method. The results of
DonTech are not consolidated in Donnelley's financial statements; rather
Donnelley recognizes revenue participation income from SBC and its share of
DonTech's net profits as partnership income in the consolidated statement of
operations. Donnelley records its interest in the net assets of DonTech as
partnership and joint venture investments in the consolidated balance sheet.
EFFECTS OF PURCHASE ACCOUNTING
SPA's deferred revenue balance at January 3, 2003 was $292.8 million
representing revenue that in the absence of purchase accounting would have been
recognized in 2003 under Donnelley's deferral and amortization revenue
recognition method. Under purchase accounting, Donnelley reduced this $292.8
million liability for pre-acquisition deferred revenue to zero. Accordingly,
Donnelley will never record revenue associated with directories that published
prior to the acquisition. The impact of this purchase accounting adjustment has
not been reflected on the pro forma income statement. Although the deferred
revenue balance was eliminated, Donnelley retained all the rights associated
with the collection of amounts due under and obligations under the advertising
contracts executed prior to the SPA acquisition. As a result, SPA's billed and
unbilled accounts receivable balances remain assets of Donnelley.
Additionally, we did not assume deferred directory costs on the SPA
balance sheet at January 3, 2003 related to those directories that were
published prior to the acquisition. These costs, which totaled $89.5 million,
represent costs that in the absence of purchase accounting would have been
recognized in 2003 under Donnelley's deferral and amortization method.
Accordingly, Donnelley will never record expense associated with directories
published prior to the acquisition. The impact of this purchase accounting
adjustment has not been reflected on the pro forma income statement. Donnelley's
post-acquisition policy of deferring direct costs attributable to a directory is
different than the policy followed by SPA prior to the acquisition. Accordingly,
of the $89.5 million of costs deferred by SPA at January 3, 2003, approximately
$40.0 million represent the types of costs that would have been deferred and
amortized under Donnelley's policy of deferring costs, but will never be
recognized by Donnelley. The remaining $49.5 million of these deferred costs
represent the types of costs that would have been treated as period costs under
Donnelley's policy and would have been recognized by Donnelley as expense in the
periods incurred. These purchase accounting adjustments are non-recurring and
have no future cash impact.
Deferred directory costs on SPA's balance sheet at January 3, 2003
related to those directories that will publish subsequent to the acquisition
were $7.8 million. These costs were assumed by Donnelley. Under purchase
accounting rules, these deferred costs are recorded at their fair value,
which is determined as the estimated value of the published directory less the
expected costs to complete plus a normal profit margin. The fair value of these
costs was determined to be $8.3 million higher than their carrying value.
Accordingly, Donnelley increased these costs by $8.3 million to reflect their
fair value.
Prior to the acquisition, Donnelley provided sales agency and pre-press
publishing services for SPA directories in certain markets for which Donnelley
received commission and pre-press publishing revenue from SPA. Donnelley also
received a priority distribution from CenDon, L.L.C., a joint venture between
Donnelley and SPA ("CenDon"). Similarly, SPA incurred expenses for the services
provided by Donnelley. As a result of the acquisition, Donnelley is now the
publisher of these directories. Accordingly, had the SPA acquisition occurred on
January 1, 2002, all subsequent transactions between Donnelley and SPA would
have been intercompany transactions. Accordingly, the transactions between
Donnelley and SPA have been eliminated in the pro forma statements.
19
DONNELLEY PRO FORMA COMBINED BALANCE SHEET (Unaudited)
AS OF DECEMBER 31, 2002
DONNELLEY SPA PRE-ACQUISITION ACQUISITION
HISTORICAL HISTORICAL ADJUSTMENTS ADJUSTMENTS PRO FORMA
----------- ---------- ----------- ----------- ---------
(in thousands, except per share data)
ASSETS:
Cash and cash equivalents..... $ 7,787 $ 1,691 $ (1,691)(1) $ (2,556)(11) $ 5,231
Restricted cash............... 1,928,700 -- -- (1,928,700)(11) --
Accounts receivable, net...... 28,788 284,006 (27,206)(2) -- 285,588
Deferred directory costs...... -- 97,190 -- (89,503)(4)
8,300 (4) 16,177
Advances to parent company.... -- 4,538 (4,538)(1) -- --
Deferred income taxes......... -- 35,697 -- (35,697)(4) --
Prepaid expenses and other.... 3,399 3,899 -- -- 7,108
----------- --------- ------------ ----------- -----------
Total current assets..... 1,968,674 427,021 (33,435) (2,048,156) 314,104
Fixed assets and computer
software, net.............. 12,008 11,979 -- -- 23,987
Partnership and joint venture
investments................. 202,236 -- (16,266)(2) -- 185,970
Prepaid pension............... 22,748 -- -- -- 22,748
Deferred income taxes......... -- 6,568 (6,568)(4) --
Other non-current assets...... 17,709 -- -- 72,942 (5)
(2,394)(7)
(12,934)(10) 75,323
Intangible assets............. -- -- -- 1,915,000 (4) 1,915,000
Goodwill and other assets..... -- 1,299 74,460 (4)
(1,275)(4) 74,484
----------- --------- ------------ ----------- -----------
Total assets............... $ 2,223,375 $ 446,867 $ (49,701) $ (8,925) $ 2,611,616
=========== ========= ============ =========== ===========
LIABILITIES AND REDEEMABLE
CONVERTIBLE PREFERRED STOCK
Accounts payable and
accrued liabilities....... $20,261 $ 34,292 $ (7,936)(2) $ (1,161)(7) $45,456
Affiliated payables........... -- 4,603 (4,603)(1) -- --
Deferred revenue.............. -- 292,775 -- (292,775)(4) --
Current portion of
long-term debt............ 13,780 -- -- (4,780)(7) 9,000
----------- --------- ------------ ------------ -----------
Total current liabilities... 34,041 331,670 (12,539) (298,716) 54,456
Long-term debt................ 2,075,470 -- -- (238,225)(7)
488,755 (5) 2,326,000
Deferred income taxes - net 60,783 -- -- -- 60,783
Pension and postretirement
benefits...................... 7,264 19,040 (19,040)(1) -- 7,264
Other non-current liabilities. 12,958 16,110 (2,110)(1) (14,000)(8) 5,909
(7,049)(2)
Minority interest............. -- (5,555) -- 5,555 (4) --
----------- --------- ------------ ----------- -----------
Total liabilities.......... 2,190,516 361,265 (40,738) (56,631) 2,454,412
Redeemable convertible preferred
stock...................... 63,459 -- -- 80,095 (6) 143,554
20
DONNELLEY SPA PRE-ACQUISITION ACQUISITION
HISTORICAL HISTORICAL ADJUSTMENTS ADJUSTMENTS PRO FORMA
---------- ---------- ----------- ----------- ---------
SHAREHOLDERS' EQUITY
Preferred stock............... -- -- -- -- --
Common stock.................. 51,622 1 -- (1)(9) 51,622
Additional paid-in capital.... 63,913 176 -- 38,216 (6)
(176)(9) 102,129
Warrants outstanding.......... 5,330 -- -- 8,428 (6) 13,758
Unamortized restricted stock.. (327) -- -- -- (327)
Retained earnings............. 13,605 85,425 (8,963)(3) (76,462)(9)
(2,394)(7) 11,211
Treasury stock................ (164,743) -- -- -- (164,743)
----------- ---------- ----------- ----------- -----------
Total shareholders' equity.... (30,600) 85,602 (8,963) (32,389) 13,650
----------- ---------- ----------- ----------- -----------
Total liabilities, redeemable
convertible preferred stock
and shareholders' equity.. $ 2,223,375 $ 446,867 $ (49,701) $ (8,925) $ 2,611,616
=========== ========== =========== =========== ===========
- ----------
(1) Pursuant to the terms of the stock purchase agreement by and among
Donnelley, Sprint and Centel Directories LLC, prior to the closing, SPA
settled its intercompany receivables and payables with Sprint and
dividended excess cash to Sprint. The stock purchase agreement further
provided that Donnelley would not assume SPA's existing post-retirement
and other benefit obligations. The effect of these adjustments increased
net assets acquired by $19,524.
(2) These adjustments eliminate the payables and receivables between SPA and
Donnelley, which as a result of the acquisition, became intercompany
balances. The effect of these adjustments was to reduce net assets
acquired by $28,487.
(3) Represents the net adjustment to shareholders' equity for adjustments (1)
and (2) above.
(4) The SPA acquisition was accounted for as a purchase business combination
in accordance with Statement of Financial Accounting Standards No. 141,
Business Combinations. Accordingly, the purchase price was allocated to
the tangible and identified intangible assets acquired and the
liabilities assumed on the acquisition date, as adjusted to eliminate
intercompany items. The preliminary allocation of the purchase price to
the assets acquired and liabilities assumed has been performed using a
third party valuation, as follows:
21
CALCULATION OF ALLOCABLE PURCHASE PRICE:
Cash................................................................... $ 2,213,475
Allocable transaction costs............................................ 15,101
-------------
Total allocable purchase price......................................... $ 2,228,576
=============
Estimated allocation of allocable purchase price:
SPA net assets acquired................................................ $ 85,602
Directory Services Agreements (a)...................................... 1,625,000
Customer relationships (b)............................................. 260,000
Acquired trade names (c) .............................................. 30,000
Estimated profit on acquired sales contracts (d)....................... 8,300
Fair value adjustments
Reverse pre-acquisition deferred revenue (e)........................ 292,775
Reverse deferred directory costs associated with
directories published pre-acquisition (e)....................... (89,503)
Eliminate SPA deferred tax and goodwill (e)......................... (43,540)
Other............................................................... (14,518)
-------------
Fair value of assets acquired.......................................... 2,154,116
Goodwill (f)........................................................... 74,460
-------------
Total allocable purchase price......................................... $ 2,228,576
=============
- ----------
(a) Commercial agreements between Sprint and Donnelley include a
directory services license agreement, a trademark license
agreement and a non-competition agreement (collectively "Directory
Services Agreements"). The directory services license agreement
gives Donnelley the exclusive right to produce, publish and
distribute directories for Sprint in the markets where Sprint
currently provides local telephone service. Should Sprint sell any
of the service areas covered by the agreement, the purchaser would
be bound by all rights and obligations under this agreement. The
trademark license agreement gives Donnelley the exclusive right to
use certain specified Sprint trademarks, including the Sprint
diamond logo, in those markets and the non-competition agreement
prohibits Sprint from producing, publishing and distributing print
directories or selling local advertising in those markets, with
certain limited exceptions. These agreements are all interrelated
and each has an initial term of 50 years, subject to earlier
termination under specified circumstances. The fair value assigned
to these agreements of $1,625,000 was based on the present value
of estimated future cash flows.
(b) Donnelley also acquired the established local and national
customer relationships of SPA. The value of these relationships
was determined based on the present value of estimated future cash
flows and an analysis of historical attrition rates. A value of
$200,000 was assigned to the relationships with local customers
and a value of $60,000 was assigned to the relationships with
national customers.
(c) Donnelley also acquired certain trade names historically used in
the SPA directory business. A value of $30,000 was assigned to the
acquired trade names based on the "relief from royalty" method,
which values the trade names based on the estimated amount that a
company would have to pay in an arms length transaction to use
these trade names.
(d) Represents adjustment to increase those costs incurred for
directories that will publish after the acquisition date to their
fair value.
(e) These adjustments reverse SPA's pre-acquisition deferred revenue
liability, deferred directory costs for directories published
prior to the closing date, deferred tax assets and goodwill, which
are eliminated under purchase accounting rules.
(f) Represents the excess of the purchase price over the estimated
fair value of net assets acquired.
22
(5) Represents borrowings under a new $1,525,000 senior secured credit
facility and the issuance of $325,000 of senior notes and $600,000 of
senior subordinated notes. The senior secured credit facility consists of
a $500,000 tranche A term loan, a $900,000 tranche B term loan and a
$125,000 revolving credit facility. Outstanding borrowings as of the
closing of the SPA acquisition were $2,335,000. This included $21,245 of
Donnelley's existing senior subordinated notes, which were not
repurchased in the tender offer. Donnelley received net proceeds of
$2,240,813. Total financing costs associated with these borrowings were
approximately $72,942.
On January 3, 2003, Donnelley borrowed $488,755 under the tranche A term
loan and received the proceeds of $1,825,000 from the $900,000 tranche B
term loan, $325,000 of senior notes and $600,000 of senior subordinated
notes that were held in escrow at December 31, 2002 and recorded on
Donnelley's historical balance sheet. The pro forma balance sheet
adjustment represents the additional borrowing under the tranche A term
loan that actually occurred on January 3, 2003.
Under certain circumstances, the interest rate payable under certain
borrowings may increase up to an additional 1% per annum until certain
conditions are satisfied.
(6) On November 25, 2002, investment partnerships affiliated with The Goldman
Sachs Group, Inc. (collectively, the "GS Funds") invested an initial
$70,000 of their $200,000 commitment through the purchase of Donnelley
redeemable convertible cumulative preferred stock ("Preferred Stock") and
warrants to purchase 577,500 shares of Donnelley common stock. The
$70,000 investment was made earlier than anticipated in order to
facilitate the cure of a technical default under the indenture governing
Donnelley's existing 9 1/8 % senior subordinated notes. The technical
default resulted from the inadvertent failure by Donnelley to cause
certain subsidiaries to be added as guarantors to such indenture in 2000.
The net proceeds of $69,300 were used to offset certain restricted
payments that were made by Donnelley in 2000 and 2001. The Preferred
Stock is convertible at a price of $24.05 and earns a cumulative dividend
of 8%, compounded quarterly, which we may pay in cash or allow to accrue,
at our option. The warrants to purchase 577,500 shares of common stock
have an exercise price of $26.28 per share, which was equal to the prior
30-day average of the common stock price. On January 3, 2003, the GS
Funds invested the remaining $130,000 through the purchase of Preferred
Stock and warrants to purchase 1,072,500 shares of Donnelley common
stock. These warrants have an exercise price per share of $28.62, which
was equal to the 30-day average of the common stock price prior to
closing. These warrants to purchase an aggregate of 1,650,000 shares of
common stock are exercisable at any time after the date of issuance and
expire on January 3, 2008.
The net proceeds from the issuance of Preferred Stock were allocated to
the Preferred Stock and warrants based on their relative fair value,
which was determined by a third party valuation. The fair value of the
Preferred Stock was based on a dividend discount model (using
market-based rates on comparable financial instruments). The fair value
of the warrants ($12.18) was determined using the Black-Scholes model,
with the following assumptions:
Dividend yield................................................. 0%
Expected volatility............................................ 35%
Risk-free interest rate........................................ 3.1%
Expected holding period........................................ 5 years
Because the fair market value of the underlying common stock on the date
of issuance ($29.92 at November 25, 2002 and $28.96 at January 3, 2003)
was greater than the conversion price, the Preferred Stock included a
beneficial conversion feature ("BCF"). The BCF is a function of the
conversion price of the Preferred Stock, the fair value of the warrants
and the fair market value of the underlying common stock on the date of
issuance. The BCF is recorded as a reduction to the carrying value of the
Preferred Stock and as additional paid in capital. The allocation of net
proceeds from the issuance of Preferred Stock has been reflected in the
pro forma statements as follows:
23
Preferred Stock................................................ $ 118,852
Additional paid in capital..................................... 62,374
Warrants outstanding........................................... 13,758
-----------
Net proceeds................................................... $ 194,984
===========
The $143,554 balance of Preferred Stock on the pro forma balance sheet
includes the initial allocation of $118,852 shown above plus (i) a stated
dividend of $544 (from November 25, 2002 through December 31, 2002) and
(ii) $24,158 of the total BCF shown above reflected in the historical
balance sheet of Donnelley with respect to the Preferred Stock issued in
November 2002. The Preferred Stock had a liquidation value (including
accrued dividends) of $200,604 immediately after the closing of the SPA
acquisition.
(7) At the closing of the SPA acquisition, Donnelley repaid $114,250
outstanding under its existing credit facility, repurchased $128,755
aggregate principal amount of its existing notes pursuant to a tender
offer and exit consent solicitation and paid accrued interest of $1,161.
In connection with this repayment of existing debt, unamortized deferred
financing costs of $2,394 related to the repaid debt were written off.
This write-off is non-recurring and has been reflected as an adjustment
to retained earnings on the pro forma balance sheet as of December 31,
2002.
(8) Under the terms of the stock purchase agreement, Donnelley paid $14,000
at the closing to Sprint in settlement of all amounts owed to Sprint by
Donnelley and by SPA related to the CenDon relationship.
(9) Adjustment to eliminate (i) SPA's historical common stock, additional
paid in capital and retained earnings and (ii) the effect on
shareholders' equity from the pre-acquisition adjustments.
(10) Donnelley historical amounts include $12,934 of capitalized transaction
costs paid prior to December 31, 2002. This adjustment reclasses (i)
$11,112 to deferred financing costs, which is included in the total
deferred financing costs of $72,942 and (ii) $1,822 to goodwill, which is
included in total goodwill of $74,460.
(11) Cash paid at acquisition closing of $1,931,256 represents:
- Proceeds of $488,755 from borrowings under the tranche A term loan;
- Net proceeds of $126,739 from the issuance of $130,000 of Preferred
Stock; and
- Payment of $2,546,750 to purchase the common stock of SPA, repay
existing debt and pay transaction costs.
24
DONNELLEY PRO FORMA COMBINED INCOME STATEMENT
(UNAUDITED)
FOR THE YEAR ENDED DECEMBER 31, 2002
CONFORMING
AND
DONNELLEY SPA ELIMINATION ACQUISITION
HISTORICAL HISTORICAL ADJUSTMENTS ADJUSTMENTS PRO FORMA
---------- ---------- ----------- ------------ ---------
(In thousands, except per share data)
Net revenues $ 73,806 $ 545,604 $ (49,747)(2) $ -- $ 569,663
Expenses
Operating expenses 46,421 202,481 26,521 (1) 8,300 (3)
(44,728)(2) 238,995
General & administrative expenses 16,432 50,663 (26,521)(1) -- 40,574
Depreciation and amortization 6,249 8,604 -- 49,833 (4) 64,686
Restructuring and special (benefit) charge (6,405) 180 -- -- (6,225)
Investment impairment charge 2,000 -- -- -- 2,000
---------- ---------- --------- ---------- ----------
Total expenses 64,697 261,928 (44,728) 58,133 340,030
Partnership and joint venture income 136,873 -- (17,703)(1)
(2,024)(2) -- 117,146
---------- ---------- --------- ---------- ----------
Operating income 145,982 283,676 (24,746) (58,133) 346,779
Interest expense (35,499) (1,875) -- (144,776)(5) (182,150)
Interest income 1,951 -- -- -- 1,951
Priority distribution -- (17,703) 17,703 (1) -- --
Other income, net (451) 1,523 -- -- 1,072
Minority interest -- 282 (282)(2) -- --
---------- ---------- --------- ---------- ----------
Income before taxes 111,983 265,903 (7,325) (202,909) 167,652
Provision for income taxes 44,806 103,763 (2,930)(6) (81,163)(6) 64,476
---------- ---------- --------- ---------- ----------
Net income 67,177 162,140 (4,395) (121,746) 103,176
8% cumulative dividend on Preferred Stock (544) -- -- 544 (7)
Deemed dividend on Preferred Stock (24,158) -- -- (54,702)(7) (78,860)
---------- ---------- --------- ---------- ----------
Net income available to
common shareholders $ 42,475 $ 162,140 $ (4,395) $ (175,904) $ 24,316
========== ========== ========= ========== ==========
Earnings per share (EPS)
Basic $ 1.42 $ 0.63(8)
Diluted 1.40 0.63(8)
Shares used in computing EPS
Basic 29,643 29,643(8)
Diluted 30,298 29,643(8)
(1) SPA reported bad debt expense as part of general and administrative
expenses, whereas Donnelley reports bad debt expense as operating
expense. Accordingly, to conform to Donnelley's historical financial
statements, SPA's bad debt expense of $26,521 for the year ended December
31, 2002 has been reclassified.
In addition, SPA reported CenDon priority distribution expense as a
separate line item below operating income, whereas Donnelley reported
CenDon priority distribution income as part of partnership and joint
venture income above operating income. Accordingly, to conform to
Donnelley's historical financial statements, SPA's priority distribution
expense of $17,703 for the year ended December 31, 2002 has been
reclassified to partnership and joint venture income.
(2) These adjustments eliminate all revenue and expense amounts from
transactions between SPA and Donnelley as these transactions would have
been intercompany transactions.
(3) This adjustment represents additional operating expense from the fair
value adjustment to costs incurred on unpublished directories (see
note 4(d) to the pro forma balance sheet). The fair market value
adjustment of $8,300 will be recognized under the deferral and
amortization method when the related
25
directories publish.
(4) This adjustment reflects additional depreciation and amortization expense
from the amortization of acquired identifiable intangible assets over
their estimated useful lives. See note 4 to the pro forma balance sheet
for a description of identifiable intangible assets. The Directory
Services Agreements and acquired trade names are being amortized on a
straight-line basis over 50 years and 30 years, respectively. The local
customer relationships and national customer relationships are being
amortized under an accelerated method that recognizes the value derived
from customer relationships is greater in the earlier years and steadily
declines over time.
Under FAS 142, Goodwill and Other Intangible Assets, goodwill is no
longer amortized. However, the carrying value is subject to annual
impairment testing.
The final allocation of the purchase price will be determined based on
Donnelley's completion of a comprehensive analysis and evaluation of the
fair value of assets acquired and liabilities assumed. The results of
this comprehensive analysis and evaluation may result in materially
different fair values assigned to the assets acquired and liabilities
assumed, including identifiable intangible assets and their respective
useful lives.
(5) The pro forma interest expense adjustment for the year ended December 31,
2002 was as follows:
Interest expense on borrowings.................. $ 168,712
Amortization of deferred financing costs........ 9,893
-----------
Total interest expense.......................... 178,605
Eliminate historical interest on existing debt.. (33,829)
-----------
Net interest expense adjustment................. $ 144,776
===========
Deferred financing costs related to these borrowings are amortized over
the term of the associated arrangement. The pro forma statements reflect
the actual results of the tender offer and exit consent solicitation and
repayment of existing indebtedness at January 1, 2002. Accordingly,
historical interest expense has been eliminated in the pro forma
statements.
Assuming a 1/8% increase in the interest rate associated with the
variable portion of the debt, pro forma net income would have been
reduced by $1,042 for the year ended December 31, 2002.
The new senior secured credit facility requires that, within a specified
period after the closing of the SPA acquisition, Donnelley enter into
hedge agreements to provide either a fixed interest rate or interest rate
protection for a specified portion of the aggregate principal amount of
the term loans. Donnelley is currently reviewing various hedging
alternatives but has not yet executed any agreements. However, based on
current negotiations, Donnelley estimates that the cost of these hedging
arrangements will be approximately $5,000 to $6,000. This estimate of the
potential impact on interest expense from the hedge agreements has not
been included in the pro forma statements.
(6) Represents the income tax effect of the pro forma adjustments, using a
statutory tax rate of 40%.
(7) Represents the dividend on the Preferred Stock. The pro forma Preferred
Stock dividend for the year ended December 31, 2002 was $78,860. This was
comprised of the stated 8% dividend of $16,486 and a deemed dividend of
$62,374 related to a beneficial conversion feature from the issuance of
Preferred Stock (of which $24,158 was reflected in Donnelley's historical
financial statements). The pro forma amount of the BCF is recognized as a
deemed dividend in 2002 as the Preferred Stock was convertible into
common stock immediately after issuance. See footnote 6 to the pro forma
balance sheet as of December 31, 2002.
(8) The Preferred Stock is entitled to participate in any dividends declared
to common stockholders and would receive the same dividend per share as
the common stockholders on an as-converted basis. Due to this
participation feature, earnings per share, or EPS, are computed under the
two-class method. The two-class
26
method is an earnings allocation formula that calculates basic EPS for
common stockholders and preferred stockholders on an as-converted basis.
The calculation of pro forma basic EPS for common stockholders under the
two-class method for the year ended December 31, 2002 is shown below.
Basic EPS for preferred stockholders are not required to be disclosed.
Net income available to common stockholders.................. $ 24,316
Amount allocable to common shares (1)........................ 77%
Rights to undistributed earnings............................. 18,723
Weighted average common shares outstanding................... 29,643
Basic EPS.................................................... $ 0.63
(1) The amount of shares allocable to common shares is based on weighted
average common shares outstanding of 29,643 and the weighted average
equivalent common shares of 8,659 assuming the Preferred Stock was
converted as follows: 29,643 / (29,643 + 8,659)
For the year ended December 31, 2002, the calculation of pro forma
diluted EPS is anti-dilutive; therefore, diluted EPS equals basic EPS.
27
(c) Exhibits.
Exhibit
Number Description
- ----- -----------
2.1 Stock Purchase Agreement, dated as of September 21, 2002, by and among
R.H. Donnelley Corporation, Sprint Corporation and Centel Directories
LLC (incorporated by reference to Exhibit 2.1 to the Form 8-K of the
Company, filed on October 1, 2002, Commission File No. 1-07155). The
registrant agrees to furnish supplementally a copy of any omitted
schedules to the Commission upon request.
2.2 Supplemental Agreement, dated as of December 31, 2002, by and among
R.H. Donnelley Corporation, Sprint Corporation and Centel Directories
LLC (incorporated by reference to Exhibit 2.2 to the Form 8-K of the
Company, filed on January 15, 2003, Commission File No. 1-07155). The
registrant agrees to furnish supplementally a copy of any omitted
schedules to the Commission upon request.
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
R.H. DONNELLEY CORPORATION
By: /S/ ROBERT J. BUSH
------------------
Name: Robert J. Bush
Title: Vice President and General Counsel
Date: March 19 2003
R.H. DONNELLEY INC.
By: /S/ ROBERT J. BUSH
------------------
Name: Robert J. Bush
Title: Vice President and General Counsel
Date: March 19, 2003
29
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
2.1 Stock Purchase Agreement, dated as of September 21, 2002, by and among
R.H. Donnelley Corporation, Sprint Corporation and Centel Directories
LLC (incorporated by reference to Exhibit 2.1 to the Form 8-K of the
Company, filed on October 1, 2002, Commission File No. 1-07155). The
registrant agrees to furnish supplementally a copy of any omitted
schedules to the Commission upon request.
2.2 Supplemental Agreement, dated as of December 31, 2002, by and among
R.H. Donnelley Corporation, Sprint Corporation and Centel Directories
LLC (incorporated by reference to Exhibit 2.2 to the Form 8-K of the
Company, filed on January 15, 2003, Commission File No. 1-07155). The
registrant agrees to furnish supplementally a copy of any omitted
schedules to the Commission upon request.
30