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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
------------------
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 001-07155
R.H. DONNELLEY CORPORATION
--------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-2740040
- ---------------------------------------- --------------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
One Manhattanville Road, Purchase N.Y. 10577
- ---------------------------------------- --------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 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 whether registrant is an accelerated filer (as defined in
Rule 12b-2 of the Exchange Act) Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Title of Class Shares Outstanding at November 1, 2003
-------------- --------------------------------------
Common Stock, par value $1 per share 31,015,569
Commission file number 333-59287
R.H. DONNELLEY INC. *
---------------------
(Exact name of registrant as specified in its charter)
Delaware 36-2467635
- ----------------------------------------- -------------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
One Manhattanville Road, Purchase N.Y. 10577
- ----------------------------------------- -------------------------------------
(Address of principal executive offices) (Zip Code)
Registrants' telephone number, including area code (914) 933-6400
--------------
* R.H. Donnelley Inc. is a wholly owned subsidiary of R.H. Donnelley
Corporation. R.H. Donnelley Inc. meets the conditions set forth in General
Instructions H (1)(a) and (b) of Form 10-Q and is therefore filing this report
with respect to R.H. Donnelley Inc. with the reduced disclosure format. R.H.
Donnelley Inc. became subject to the filing requirements of Section 15(d) on
October 1, 1998 in connection with the public offer and sale of its 9 1/8%
Senior Subordinated Notes. In addition, R.H. Donnelley Inc. is the obligor of 8
7/8% senior notes due 2010 and 10 7/8% senior subordinated notes due 2012 and is
now subject to the filing requirements of Section 15(d) as a result of such
notes. As of November 1, 2003, 100 shares of R.H. Donnelley Inc. common stock,
no par value, were outstanding.
R.H. DONNELLEY CORPORATION
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
- ------------------------------- ----
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at September 30, 2003 and December 31, 2002..... 3
Consolidated Statements of Operations for the three and nine months ended 4
September 30, 2003 and 2002.................................................
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2003 and 2002................................................. 5
Notes to Consolidated Financial Statements.................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 22
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 33
Item 4. Controls and Procedures............................................................. 34
PART II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings................................................................... 34
Item 6. Exhibits and Reports on Form 8-K.................................................... 38
SIGNATURES..................................................................................... 47
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
R.H. Donnelley Corporation and Subsidiaries
Consolidated Balance Sheets (Unaudited)
September 30, December 31,
(in thousands, except share and per share data) 2003 2002
- ------------------------------------------------------------------------------------------- ----------------- ----------------
Assets
Current Assets
Cash and cash equivalents........................................................... $ 5,802 $ 7,787
Restricted cash..................................................................... -- 1,928,700
----------------- ----------------
Total cash, cash equivalents and restricted cash............................... 5,802 1,936,487
Accounts receivable
Billed............................................................................ 51,580 --
Unbilled.......................................................................... 196,590 31,978
Allowance for bad debts and sales claims.......................................... (27,393) (4,772)
----------------- ----------------
Net accounts receivable........................................................ 220,777 27,206
Deferred directory costs............................................................ 52,011 --
Other current assets................................................................ 7,813 4,981
----------------- ----------------
Total current assets........................................................... 286,403 1,968,674
Fixed assets and computer software - net............................................ 20,215 12,008
Partnership investment.............................................................. 182,005 202,236
Other non-current assets............................................................ 87,643 40,457
Intangible assets, net.............................................................. 1,877,625 --
Goodwill............................................................................ 97,040 --
----------------- ----------------
Total Assets................................................................... $ 2,550,931 $ 2,223,375
----------------- ----------------
Liabilities, Redeemable Convertible Preferred
Stock and Shareholders' Deficit
Current Liabilities
Accounts payable and accrued liabilities............................................ $ 18,277 $ 9,043
Deferred directory revenue.......................................................... 217,417 --
Accrued interest payable............................................................ 30,037 11,218
Current portion of long-term debt................................................... 57,540 13,780
----------------- ----------------
Total current liabilities...................................................... 323,271 34,041
Long-term debt...................................................................... 2,057,821 2,075,470
Deferred income taxes - net......................................................... 21,254 60,783
Other non-current liabilities....................................................... 15,783 20,222
----------------- ----------------
Total liabilities.............................................................. 2,418,129 2,190,516
Commitments and contingencies
Redeemable convertible preferred stock (redemption value at
September 30, 2003, $212,743).............................................. 193,968 63,459
Shareholders' Deficit
Common stock, par value $1 per share, authorized -
400,000,000 shares; issued - 51,621,894 shares for 2003 and 2002.................. 51,622 51,622
Additional paid-in capital.......................................................... 134,555 63,586
Warrants outstanding................................................................ 13,758 5,330
Accumulated (deficit) earnings...................................................... (95,803) 13,605
Other comprehensive loss............................................................ (1,525) --
Treasury stock, at cost, 20,620,602 shares for 2003 and 21,900,818 shares for 2002.. (163,773) (164,743)
----------------- ----------------
Total shareholders' deficit.................................................... (61,166) (30,600)
----------------- ----------------
Total Liabilities, Redeemable Convertible Preferred
Stock and Shareholders' Deficit....................................... $ 2,550,931 $ 2,223,375
----------------- ----------------
The accompanying notes are an integral part of the consolidated
financial statements.
3
R.H. Donnelley Corporation and Subsidiaries
Consolidated Statements of Operations (Unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------------------- ----------------------------
(amounts in thousands, except per share data) 2003 2002 2003 2002
- --------------------------------------------------- ---------------- ------------ ------------- --------------
Net revenue.................................. $ 89,309 $ 21,376 $ 140,363 $ 60,098
Expenses
Operating expenses........................ 39,674 11,528 106,467 37,666
General and administrative expenses....... 14,825 3,109 37,041 12,491
Depreciation and amortization............. 16,576 1,553 49,047 4,718
---------------- ------------ ------------- --------------
Total expenses.......................... 71,075 16,190 192,555 54,875
Partnership income........................... 32,606 40,806 91,580 108,818
---------------- ------------ ------------- --------------
Operating income........................ 50,840 45,992 39,388 114,041
Interest expense, net........................ (45,531) (5,248) (137,460) (17,442)
Other income................................. -- -- 1,523 --
---------------- ------------ ------------- --------------
Income (loss) before income taxes....... 5,309 40,744 (96,549) 96,599
Provision (benefit) for income taxes......... 1,406 15,685 (40,355) 37,190
---------------- ------------ ------------- --------------
Net income (loss)....................... 3,903 25,059 (56,194) 59,409
Preferred dividend........................... 5,082 -- 53,214 --
---------------- ------------ ------------- --------------
Net (loss) income available to common
shareholders.......................... $ (1,179) $ 25,059 $(109,408) $ 59,409
---------------- ------------ ------------- --------------
(Loss) earnings per share
Basic................................... $ (0.04) $ 0.84 $ (3.58) $ 2.01
---------------- ------------ ------------- --------------
Diluted................................. $ (0.04) $ 0.83 $ (3.58) $ 1.96
---------------- ------------ ------------- --------------
Weighted average shares outstanding
Basic................................... 30,850 29,707 30,571 29,618
---------------- ------------ ------------- --------------
Diluted................................. 30,850 30,269 30,571 30,262
---------------- ------------ ------------- --------------
Comprehensive (Loss) Income:
Net income (loss)............................ $ 3,903 $ 25,059 $ (56,194) $ 59,409
Unrealized gain (loss) on interest rate swaps,
net of tax ............................. 1,732 192 (1,525) (1,369)
---------------- ------------ ------------- --------------
Comprehensive income (loss).................. $ 5,635 $ 25,251 $ (57,719) $ 58,040
---------------- ------------ ------------- --------------
The accompanying notes are an integral part of the consolidated
financial statements.
4
R.H. Donnelley Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
Nine months ended
September 30,
-----------------------------------
(amounts in thousands) 2003 2002
- ------------------------------------------------------------------------------- ----------------- -----------------
Cash Flows from Operating Activities
Net (loss) income........................................................ $ (56,194) $ 59,409
Reconciliation of net income to net cash provided by operating activities:
Depreciation and amortization....................................... 49,047 4,718
Deferred income tax................................................. (39,529) 4,745
(Benefit) provision for bad debt.................................... (3,201) 2,528
Other noncash charges............................................... 11,950 1,344
Cash in excess of partnership income................................ 3,966 1,346
Changes in assets and liabilities, net of effects from acquisition:
Decrease (increase) in accounts receivable.......................... 69,269 (4,247)
Increase in other current assets.................................... (36,990) --
Increase in non-current assets...................................... (1,665) (187)
Increase (decrease) in accounts payable and accrued liabilities..... 9,421 (13,050)
Increase in deferred revenue........................................ 217,417 --
Increase (decrease) in other non-current liabilities................ 2,606 (153)
----------------- -----------------
Net cash provided by operating activities.................... 226,097 56,453
Cash Flows from Investing Activities
Additions to fixed assets and computer software.......................... (7,900) (2,496)
Purchase of SPA and payment of related costs............................. (2,259,633) --
Decrease in restricted cash - funds held in escrow at year-end........... 1,825,000 --
Decrease in restricted cash - other ..................................... 69,300 --
----------------- -----------------
Net cash used in investing activities........................ (373,233) (2,496)
Cash Flows from Financing Activities
Proceeds from the issuance of debt, net of costs......................... 461,307 --
Proceeds from the issuance of Redeemable Convertible Preferred
Stock and warrants, net of costs.................................... 125,683 --
Pre-acquisition debt refinanced with proceeds from new debt.............. (243,005) --
Debt repayments.......................................................... (257,239) (62,500)
Borrowings under the Revolver............................................ 37,600 --
Proceeds from employee stock option exercises............................ 20,805 3,667
----------------- -----------------
Net cash provided by (used in) financing activities.......... 145,151 (58,833)
Decrease in cash and cash equivalents.................................... (1,985) (4,876)
Cash and cash equivalents, beginning of year............................. 7,787 14,721
----------------- -----------------
Cash and cash equivalents, end of period................................. $ 5,802 $ 9,845
----------------- -----------------
Supplemental Information:
Cash used to pay:
Interest.............................................................. $ 105,795 $ 15,565
----------------- -----------------
Income taxes.......................................................... $ -- $ 26,845
----------------- -----------------
The accompanying notes are an integral part of the consolidated
financial statements.
5
R.H. Donnelley Corporation and Subsidiaries Notes to Consolidated Financial
Statements (Unaudited) (amounts in thousands, except per share data)
1. Basis of Presentation
The interim financial statements of R.H. Donnelley Corporation and its direct
and indirect wholly owned subsidiaries (the "Company," "we," "us" and "our")
have been prepared in accordance with the instructions to Quarterly Report on
Form 10-Q and should be read in conjunction with the financial statements and
related notes included in our Annual Report on Form 10-K for the year ended
December 31, 2002. The results of interim periods are not necessarily indicative
of results for the full year or any subsequent period. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation of financial position, results of operations
and cash flows at the dates and for the periods presented have been included.
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
2. Business Combination
On January 3, 2003, we acquired Sprint Corporation's directory publishing
business, Sprint Publishing & Advertising ("SPA"), for $2,229,763 and are now
the publisher of 260 revenue-generating Sprint Yellow Pages (R) directories in
18 states. Prior to the acquisition, we served as the exclusive sales agent and
pre-press publishing vendor for SPA directories in certain markets. This
acquisition transformed us from a sales agent and pre-press vendor into a
leading publisher of yellow pages directories. The results of the SPA business
are included in our consolidated results from and after January 3, 2003, the
acquisition closing date. SPA is now being operated as R.H. Donnelley Publishing
& Advertising, Inc. ("RHDPA"), an indirect, wholly owned subsidiary of the
Company.
The acquisition was accounted for as a purchase business combination in
accordance with SFAS 141 "Business Combinations." The purchase price was
allocated to the tangible and identifiable intangible assets acquired and
liabilities assumed based on their respective estimated fair values on the
acquisition date. The fair value of certain long-term intangible assets and
their respective useful lives were determined by an independent third party with
expert knowledge in the area of valuing acquired businesses and our industry.
Management believes that the allocation of the purchase price to the assets
acquired and liabilities assumed is final; however, additional information could
come to our attention that would require us to revise the purchase price
allocation. Identifiable intangible assets acquired included directory services
agreements entered into between Sprint and us, customer relationships and
acquired trade names (see Note 4). A summarized unaudited condensed balance
sheet of the consolidated Company at January 3, 2003 is presented below.
Liabilities, Redeemable Convertible Preferred
Assets Stock and Shareholders' Equity
- ----------------------------------- --------------- ----------------------------------------------- ---------------
Cash and cash equivalents...... $ 23,986 Current liabilities......................... $ 46,101
Other current assets........... 308,852 Current portion long-term debt.............. 58,668
--------------- ---------------
Total current assets...... 332,838 Total current liabilities............ 104,769
Partnership investment......... 185,969 Long-term debt.............................. 2,297,577
Other non-current assets....... 124,140 Other non-current liabilities............... 73,956
Intangible assets.............. 1,915,000
Goodwill....................... 77,953 Redeemable convertible preferred stock...... 143,553
Shareholders' equity........................ 16,045
--------------- ---------------
Total Liabilities, Redeemable Convertible
Total assets................... $ 2,635,900 Preferred Stock and Shareholders' Equity.... $ 2,635,900
--------------- ---------------
6
Summarized unaudited condensed pro forma information for the three and nine
months ended September 30, 2002 assuming the SPA acquisition occurred on January
1, 2002 is presented below.
Three months ended Nine months ended
September 30, 2002 September 30, 2002
---------------------- -----------------------
Net revenue........................................... $142,318 $ 429,365
Operating income...................................... 93,428 256,424
Net income............................................ 29,777 74,322
Preferred dividend.................................... 4,162 74,616
Net income (loss) available to common shareholders.... 25,616 (294)
3. Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements include the
accounts of R.H. Donnelley Corporation and its direct and indirect wholly owned
subsidiaries. All intercompany transactions and balances have been eliminated.
See "Equity Method Accounting" below for a discussion of unconsolidated
operations.
Revenue Recognition. We earn revenue from the sale of advertising into our
Sprint Yellow Pages directories, pre-press publishing services and miscellaneous
revenue from the sale of directories and finance charges on past due accounts.
Revenue from the sale of advertising is deferred when a directory is published
and recognized ratably over the life of a directory, which is typically twelve
months (the "deferral and amortization method"). Revenue from the sale of
advertising is recorded net of an allowance for sales claims, estimated based on
historical experience on a directory-by-directory basis. We increase or decrease
this estimate from time to time as information or circumstances indicate that
the estimate may no longer adequately represent the amount of claims we may
incur for a directory in the future. We provide pre-press publishing services to
SBC Communications Inc. ("SBC") for those directories in the DonTech (as defined
below) markets. Revenue from pre-press publishing services is recognized as
services are performed. Miscellaneous revenue is recognized when earned and
comprises less than 2% of our total revenue.
Deferred Directory Costs. Deferred directory costs include the direct costs for
the selling and production of our directories - sales commissions, printing,
paper and initial distribution, as well as an allowance for sales claims and an
allowance for bad debts. Deferred directory costs are initially deferred when
incurred and recognized ratably over the life of a directory.
Equity Method Accounting. The DonTech Partnership ("DonTech") is a 50/50
perpetual partnership in which the Company and an operating unit of SBC are the
partners. DonTech is a separate legal entity that provides its services with its
own employees and stand-alone management team. No employees of either RHD or SBC
are involved in the day-to-day operations of DonTech and, because the partners
share equally in the net profits and each has one voting member on the DonTech
Board, neither partner has the unilateral ability to control or influence the
operations of DonTech. Accordingly, we account for DonTech under the equity
method and do not consolidate the DonTech results in our financial statements.
We recognize our 50% share of the net income of DonTech as partnership income in
our consolidated statements of operations. Partnership income also includes
revenue participation income from SBC. Revenue participation income is based on
DonTech advertising sales and is recognized when a sales contract is executed
with a customer. Our investment in DonTech and the revenue participation
receivable from SBC is reported as partnership investment on the consolidated
balance sheet.
Derivative Financial Instruments. At September 30, 2003, we had interest rate
swap agreements with a total notional value of $255,000. These agreements
effectively convert $255,000 of variable rate debt to fixed rate debt,
mitigating our exposure to changes in interest rates on variable rate debt.
Under the terms of the swap agreements, we receive variable interest based on
three-month LIBOR and pay a fixed rate of 2.85%. The swaps mature on March 31,
2007.
The interest rate swaps have been designated as cash flow hedges to hedge
three-month LIBOR-based interest payments
7
on $255,000 of bank debt. To the extent the swaps provide an effective hedge,
changes in the fair value of the swaps are recorded in other comprehensive
income, a component of shareholders' equity. Any ineffectiveness is recorded
through earnings.
On October 6, 2003, we executed an additional interest rate swap agreement with
a notional value of $150,000. Under the terms of this agreement, we receive
variable interest based on three-month LIBOR and pay a fixed rate of 1.959%.
This swap has also been designated as a cash flow hedge to hedge three-month
LIBOR-based interest payments on $150,000 of bank debt. This swap matures
October 9, 2005.
Earnings per Share. Basic earnings per common share (EPS) are generally
calculated by dividing net income available to common shareholders by the
weighted average number of common shares outstanding. However, because our
redeemable convertible cumulative preferred stock ("Preferred Stock") contains
certain participation rights, EITF Topic D-95, "Effect of Participating
Securities on the Computation of Basic Earnings Per Share," ("Topic D-95"),
requires that the dilutive effect of those securities be included in the
weighted average number of shares outstanding. Furthermore, Topic D-95 requires
that the dilutive effect to be included in basic EPS may be calculated using
either the if-converted method or the two-class method. However, the dilutive
effect of the Preferred Stock cannot be less than that which would result from
the application of the two-class method. We have elected to use the if-converted
method in calculating basic EPS. Diluted EPS equals net income divided by the
weighted average common shares outstanding plus common share equivalents. Common
share equivalents include stock options and warrants, the dilutive effect of
which is calculated using the treasury stock method, and Preferred Stock, the
potential dilutive effect of which is calculated using the if-converted method.
The calculation of basic and diluted EPS for the quarter and nine months ended
September 30, 2003 is presented below.
Three months Nine months
ended ended
September 30, September 30,
2003 2003
- ----------------------------------------------------------------------- ---------------- -----------------
Basic EPS - If-Converted Method
Loss available to common shareholders........................ $ (1,179) $(109,408)
Preferred Stock dividend..................................... 5,082 53,214
---------------- -----------------
Net income (loss)............................................ $ 3,903 $ (56,194)
---------------- -----------------
Weighted average common shares outstanding................... 30,850 30,571
Weighted average common shares from assumed conversion
of Preferred Stock......................................... 8,846 8,674
---------------- -----------------
Weighted average common shares outstanding assuming
conversion of Preferred Stock.............................. 39,696 39,245
---------------- -----------------
Basic earnings (loss) per share - if-converted method........... $ 0.10 $(1.43)
---------------- -----------------
Basic EPS - Two-Class Method
Loss available to common shareholders........................ $ (1,179) $(109,408)
Amount allocable to common shares (1)........................ 78% 78%
---------------- -----------------
Rights to undistributed losses............................... (920) (85,338)
Weighted average common shares outstanding................... 30,850 30,571
---------------- -----------------
Basic loss per share - two-class method (2).................. $ (0.04) $ (3.58)
---------------- -----------------
(1) 30,850 / (30,850 + 8,846) for the three months ended September 30, 2003 and
30,571 / (30,571 + 8,674) for the nine months ended September 30, 2003.
(2) Basic EPS calculated under the two-class method was a loss of $0.03 and
$2.79 for the three and nine months ended September 30, 2003, respectively.
However, when there is a net loss in a period, the application of the
two-class method is anti-dilutive. Accordingly, reported basic EPS are
calculated as loss available to common shareholders divided by the weighted
average basic shares outstanding.
8
Diluted EPS
Loss available to common shareholders........................... $(1,179) $(109,408)
---------------- -----------------
Weighted average common shares outstanding...................... 30,850 30,571
Dilutive effect of stock options (3)............................ -- --
Dilutive effect of Preferred Stock assuming conversion (3)...... -- --
---------------- -----------------
Weighted average diluted shares outstanding..................... 30,850 30,571
---------------- -----------------
Diluted EPS..................................................... $(0.04) $ (3.58)
---------------- -----------------
(3) The effect of stock options and the assumed conversion of the Preferred
Stock were anti-dilutive and are not included in the calculation of diluted
EPS.
For the three and nine months ended September 30, 2002, basic EPS equals net
income divided by the weighted average common shares outstanding and diluted EPS
equals net income divided by the weighted average common shares outstanding plus
potentially dilutive common shares, primarily stock options.
Concentration of Credit Risk. Approximately 85% of our advertising revenue is
derived from the sale of advertising to local small- and medium-sized
businesses. These advertisers typically enter into twelve-month advertising
sales contracts and typically make monthly payments over the term of the
contract. Some advertisers pre-pay the full amount or a portion of the contract
value. Many new advertisers are subject to a credit review. If the advertisers
qualify, we may extend credit to them for their advertising purchase. Small- and
medium-sized businesses tend to have fewer financial resources and higher
financial failure rates than large businesses. In addition, full collection of
delinquent accounts can take an extended period of time and involve significant
costs. While we do not believe that extending credit to our local advertisers
will have a material adverse effect on our results of operations or financial
condition, no assurances can be given. We do not require collateral from our
advertisers, although we do charge interest to advertisers who do not pay within
specified due dates.
The remaining 15% of our advertising revenue is derived from the sale of
advertising to national or large regional chains, such as rental car companies,
automobile repair shops and pizza delivery businesses. Substantially all of the
revenue derived through national accounts is serviced through Certified
Marketing Representatives ("CMRs"), with which we contract. CMRs are independent
third parties that act as agents for national companies. The CMRs are
responsible for billing the national customers for their advertising. We receive
payment for the value of advertising placed in our directory, net of the CMR's
commission, directly from the CMR. While we are still exposed to credit risk,
the amount of losses from these accounts have historically been less than the
local accounts as the advertisers, and in some cases, the CMRs tend to be larger
companies with greater financial resources than the local advertisers.
We maintain a significant receivable balance with SBC for revenue participation
and pre-press publishing services fees. The revenue participation receivable is
subject to adjustment, based on collections by SBC from individual advertisers;
however, the adjustment is limited based on contractual provisions. The
receivable is recorded at net realizable value. We do not currently foresee a
material credit risk associated with this receivable, although there can be no
assurance that full payment will be received on a timely basis.
At September 30, we had interest rate swap agreements with major financial
institutions with a notional value of $255,000. We are exposed to credit risk in
the event that one or more of the counterparties to the agreements does not, or
cannot meet their obligation. The notional amount is used to measure interest to
be paid or received and does not represent the amount of exposure to credit
loss. The loss would be limited to the amount that would have been received, if
any, over the remaining life of the swap agreement. The counterparties to the
swap agreements are major financial institutions with credit ratings of A or
higher. We do not currently foresee a material credit risk associated with these
swap agreements; however, no assurances can be given.
Employee Stock Options. We follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for our stock option plan. Compensation expense
related to the issuance of stock options to employees or non-employee directors
is only recognized if the exercise price of
9
the stock option is less than the fair market value of the underlying stock at
the grant date.
The following table reflects the pro forma net income and earnings per share
assuming we applied the fair value method of SFAS No. 123 "Accounting for
Stock-Based Compensation." The pro forma disclosures shown are not necessarily
representative of the effects on income and earnings per share in future years.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- ---------------------------
2003 2002 2003 2002
------------- ------------ -------------- ------------
Net income (loss), as reported................... $ 3,903 $25,059 $ (56,194) $59,409
Add: Stock based compensation expense
included in reported net income, net of
related tax effects......................... 258 93 876 178
Less: Stock based compensation expense
that would have been included in the
determination of net income if the fair value
method had been applied to all awards,
net of related tax effects................. (604) (656) (4,179) (1,966)
------------- ------------ -------------- ------------
Pro forma net income (loss)...................... $ 3,557 $24,496 $ (59,497) $57,621
Preferred dividend............................... 5,082 -- 53,214 --
------------- ------------ -------------- ------------
Pro forma net income (loss) available to
common shareholders......................... $ (1,525) $24,496 $(112,711) $57,621
------------- ------------ -------------- ------------
Basic (loss) earnings per share
As reported................................... $ (0.04) $ 0.84 $ (3.58) $ 2.01
Pro forma..................................... (0.05) 0.82 (3.69) 1.95
Diluted (loss) earnings per share
As reported................................... $ (0.04) $ 0.83 $ (3.58) $ 1.96
Pro forma..................................... (0.05) 0.81 (3.69) 1.90
The pro forma information was determined based on the fair value of stock
options issued to employees and non-employee directors calculated using the
Black-Scholes option-pricing model with the following assumptions:
2003 2002
-------------- --------------
Dividend yield................................................. 0% 0%
Expected volatility............................................ 35% 35%
Risk-free interest rate........................................ 2.6% 3.1%
Expected holding period........................................ 4 years 4 years
10
4. Identifiable Intangible Assets
As a result of the SPA acquisition, certain long-term intangible assets and
their respective useful lives were identified and valued by an independent third
party. The net book value of intangible assets at September 30, 2003 was
$1,877,625. Amortization expense was $37,375 for the nine months ended September
30, 2003. Amortization expense for intangible assets for 2003 through 2008 will
be approximately $50,000 per year.
Directory
Services Local customer National CMR
Agreements relationships relationships Trade names Total
----------------- ------------------ ------------------ -------------- ----------------
Estimated useful life........ 50 years 15 years 30 years 15 years
----------------- ------------------ ------------------ --------------
Initial fair value........... $1,625,000 $200,000 $60,000 $30,000 $1,915,000
Accumulated amortization.... (24,375) (10,000) (1,500) (1,500) (37,375)
----------------- ------------------ ------------------ -------------- ----------------
Net intangible assets........ $1,600,625 $190,000 $58,500 $28,500 $1,877,625
----------------- ------------------ ------------------ -------------- ----------------
Directory services agreements between Sprint and the Company includes a
directory services license agreement, a trademark license agreement and a
non-competition agreement (collectively "Directory Services Agreements") with
SPA. The directory services license agreement gives us the exclusive right to
produce, publish and distribute directories for Sprint in the markets where
Sprint provided local telephone service at the time of the agreement. The
trademark license agreement gives us 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. The fair value of these agreements was
determined based on the present value of estimated future cash flows and is
being amortized under the straight-line method over 50 years.
The fair value of local and national customer relationships was determined based
on the present value of estimated future cash flows and historical attrition
rates and is 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. The weighted average useful life of these
relationships is 18 years.
The fair value of acquired trade names was determined 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. These assets are being amortized under the straight-line method over 15
years.
5. Goodwill
Goodwill represents the excess of the purchase price for SPA over the net
tangible and identified intangible assets acquired. In accordance with SFAS 142
"Goodwill and Other Intangible Assets," goodwill is not amortized, but is
subject to impairment testing. No impairment losses were recorded during the
period. All goodwill is included in the Donnelley segment (see Note 10 for
segment information). Below is a rollforward of the goodwill balance from the
beginning of the year through September 30, 2003.
Balance January 1, 2003...................................................... $ --
Goodwill recognized January 3, 2003 from SPA acquisition..................... 77,953
Severance for certain SPA executive management............................... 696
Working capital payment to Sprint in accordance with purchase agreement......... 16,288
Exit costs associated with the shutdown of SPA publishing facility............... 2,182
Other........................................................................ (79)
------------------
Balance September 30, 2003................................................... $ 97,040
------------------
The excess of the purchase price for SPA over the net tangible and identified
intangible assets acquired on the date of acquisition was $77,953. Additionally,
we acquired a liability of $696 for the severance obligation of certain SPA
executive managers. We also made an additional payment of $16,288 in the second
quarter for an adjustment to the purchase price in accordance with the terms of
the purchase agreement. In the third quarter, we established a liability of
11
$2,182 for the amount of remaining lease payments, net of estimated sublease
income, for the publishing facility that is being shutdown.
6. Partnership Income
Partnership income in 2003 includes our 50% share of the net income of DonTech
and revenue participation income from SBC. Partnership income in 2002 also
included a priority distribution on our membership interest in CenDon, LLC,
which as a result of the SPA acquisition, is no longer recognized. Partnership
income for the three and nine months ended September 30, 2003 and 2002 consisted
of the following:
Three Months ended Nine months ended
September 30, September 30,
---------------------------- ---------------------------
2003 2002 2003 2002
------------- -------------- ------------- -------------
Revenue participation income.............................. $ 26,539 $ 27,784 $ 75,539 $ 77,084
50% share of DonTech net income........................... 6,067 6,646 16,041 15,878
Priority distribution income.............................. -- 6,376 -- 15,856
------------- -------------- ------------- -------------
Partnership income........................................ $ 32,606 $ 40,806 $ 91,580 $ 108,818
------------- -------------- ------------- -------------
Summarized combined financial information for DonTech is shown in the table
below.
Three months ended Nine months ended
September 30, September 30,
---------------------------- ---------------------------
2003 2002 2003 2002
------------- -------------- ------------- -------------
Net revenue............................................... $ 27,840 $ 29,098 $ 79,710 $ 81,383
Operating income.......................................... 12,109 13,249 32,248 31,846
Net income................................................ 12,134 13,291 32,081 31,755
Total assets of DonTech were $122,087 at September 30, 2003 and $128,914 at
December 31, 2002.
7. Long-term Debt and Credit Facilities
Long-term debt at September 30, 2003 and December 31, 2002 consisted of the
following:
September 30, 2003 December 31, 2002
-------------------- -------------------
8 7/8% Senior Notes due 2010................................ $ 325,000 $ 325,000
10 7/8% Senior Subordinated Notes due 2012.................. 600,000 600,000
Senior Secured Credit Facilities............................ 1,169,116 900,000
9 1/8% Senior Subordinated Notes due 2008................... 21,245 150,000
Pre-acquisition Senior Secured Term Facilities.............. -- 114,250
-------------------- -------------------
Total................................................... 2,115,361 2,089,250
Less current portion........................................ 57,540 13,780
-------------------- -------------------
Long-term debt.......................................... $ 2,057,821 $ 2,075,470
-------------------- -------------------
In connection with the SPA acquisition, we entered into a $1,525,000 Credit
Facility ("Credit Facility"), consisting of a $500,000 Term Loan A, a $900,000
Term Loan B and a $125,000 Revolving Credit Facility (the "Revolver") and issued
$325,000 8 7/8% Senior Notes due 2010 ("Senior Notes") and $600,000 10 7/8%
Senior Subordinated Notes due 2012 ("Subordinated Notes," and collectively with
the Senior Notes, the "Notes"). By December 31, 2002, we had issued the Notes
and borrowed $900,000 under the Term Loan B. The gross proceeds of $1,825,000
were held in escrow pending the SPA acquisition closing. On January 3, 2003, we
borrowed $500,000 under the Term Loan A and the $1,825,000 of gross proceeds
from the Notes and Term Loan B were released from escrow. These funds were used
to acquire SPA, refinance existing debt and pay transactions costs. Amounts
outstanding prior to the acquisition under our former senior secured term
facilities of $114,250 were refinanced and in connection with a tender offer and
exit consent solicitation, we repurchased $128,755 of the 9 1/8% Senior
Subordinated Notes due 2008 ("Pre-acquisition Notes").
The Term Loan A and Term Loan B require quarterly principal payments and mature
in December 2008 and September
12
2010, respectively. There were no outstanding borrowings under the Revolver at
September 30, 2003.
8. Redeemable Convertible Preferred Stock and Warrants
We have authorization to issue up to 10,000 shares of preferred stock. At
September 30, 2003, 200,604 shares of Preferred Stock were outstanding. On
January 3, 2003, we issued 130 shares of Preferred Stock and warrants to
purchase 1,072.5 shares of our common stock to investment partnerships
affiliated with The Goldman Sachs Group, Inc. (collectively, the "GS Funds") for
gross proceeds of $130,000. This investment by the GS Funds represented the
remaining investment amount of their $200,000 commitment. On January 3, 2003,
the 70.0 shares of Series B-1 Preferred Stock purchased by the GS Funds in
November 2002 automatically converted into 70.6 shares of Preferred Stock. The
Preferred Stock (and any accrued but unpaid dividends) is convertible by the GS
Funds at any time into common stock at a price of $24.05 per share and earns a
cumulative dividend of 8% compounded quarterly. We cannot pay Preferred Stock
dividends in cash until October 2005; therefore, the dividend will accrete
through September 2005. Beginning in October 2005, we can pay the Preferred
Stock dividend in cash or allow it to accrete, at our option. We may redeem the
Preferred Stock in cash at any time on or after January 3, 2006 if the market
price (as defined) of our common stock exceeds 200% of the conversion price for
30 trading days. The Preferred Stock is redeemable in cash by us at any time on
or after January 3, 2013. The Preferred Stock is redeemable in cash at the
option of the GS Funds in the event of a change in control (as defined). At
September 30, 2003, the redemption value of the Preferred Stock was $212,743 and
at December 31, 2002, the redemption value of the Preferred Stock was $70,544.
At September 30, 2003, the Preferred Stock was convertible into 8,846 shares of
common stock.
In addition to the stated 8% annual dividend, the Preferred Stock dividend for
the nine months ended September 30, 2003 includes a deemed dividend for a
beneficial conversion feature ("BCF") of $38,216 recognized at the time of
issuance, as the fair market value of the underlying common stock on the date of
issuance was greater than the conversion price. Also, because we cannot
currently pay cash dividends on the Preferred Stock, an additional BCF of $910
and $2,798 was recognized in the three and nine months ended September 30, 2003,
respectively.
The net proceeds received were allocated to the Preferred Stock and warrants
based on their relative fair values. The fair value of the Preferred Stock was
based on an independent valuation of the security. The fair value of the
warrants issued January 3, 2003 was $10.43 based on the Black-Scholes model and
the following assumptions:
Dividend yield................................................. 0%
Expected volatility............................................ 35%
Risk-free interest rate........................................ 2.9%
Expected holding period........................................ 5 years
9. Restructuring Charge
As a result of the acquisition, we have announced plans to shutdown one of our
publishing facilities in Tennessee by year-end and to relocate the corporate
headquarters functions in Overland Park, Kansas and Purchase, New York to the
Raleigh, North Carolina area by the end of the first quarter 2004 (collectively
the "2003 Restructuring Actions"). Approximately 140 positions are affected by
the shutdown of the Tennessee publishing facility and have been included in the
restructuring reserve. In addition, approximately 140 positions will be affected
by the relocation of the corporate headquarters functions in Overland Park,
Kansas and Purchase, New York, of which 80 positions have been included in the
restructuring reserve. The remaining 60 positions are presently expected to
relocate and remain with the Company.
The 2001 restructuring actions related to the elimination of certain pre-press
publishing positions resulting from the expiration of a third-party pre-press
publishing contract. At September 30, 2003, these restructuring actions were
completed and the remaining balance of $513 was reversed into earnings.
13
The table below shows the activity in our restructuring reserves during 2003.
2001 2003
Restructuring Restructuring
Actions Actions
------------------ ------------------
Balance at January 1, 2003....................... $ 1,675 $ --
Additions to reserve charged to goodwill......... -- 2,878
Additions to reserve charged to earnings......... -- 8,103
Payments......................................... (1,162) (2,308)
Reserve reversal................................. (513) --
------------------ ------------------
Balance at September 30, 2003.................... $ -- $ 8,673
------------------ ------------------
The $2,878 charged to goodwill represents a severance accrual of $696 for
certain SPA executive management and an accrual of $2,182 for the remaining
lease payments, net of estimated sublease income, for the shutdown of one of our
publishing facilities. The $8,103 charged to expense primarily represents
estimated severance and other costs related to the 2003 Restructuring Actions.
10. Business Segments
We have revised our historical segment reporting to reflect the change in the
business that resulted from the SPA acquisition and to reflect the way
management now reviews and analyzes the business. Our reportable operating
segments are Donnelley and DonTech. Donnelley includes the revenue from our
Sprint Yellow Pages directories, pre-press publishing services and miscellaneous
revenue and all operating and administrative expenses. The DonTech segment
includes revenue participation income and our 50% interest in the net profits of
DonTech. Although DonTech provides advertising sales of yellow pages and other
directory products similar to Donnelley, the partnership is considered a
separate operating segment since, among other things, it has its own Board of
Directors and the employees of DonTech, including officers and managers, are not
employees of the Company.
We evaluate the performance of our segments based primarily on operating income
and earnings before interest, taxes, depreciation and amortization ("EBITDA").
We evaluate and report the performance of our segments based on EBITDA because
we believe that EBITDA is a useful measure of our underlying operating
performance and ability to satisfy our significant debt service requirements.
Segment information for the three and nine months ended September 30, 2002 has
been adjusted to be comparable to the 2003 presentation. Segment information for
the three and nine months ended September 30, 2003 and 2002 is as follows:
2003 Three Months Ended September 30 Nine Months Ended September 30
------------------------------------------ -----------------------------------------
Donnelley DonTech Total Donnelley DonTech Total
-------------- -------------- ------------ -------------- ------------- ------------
Net revenue.................. $ 89,309 $ -- $ 89,309 $140,363 $ -- $140,363
Operating income (loss)...... 18,234 32,606 50,840 (52,192) 91,580 39,388
EBITDA (1)................... 34,810 32,606 67,416 (1,622) 91,580 89,958
Total assets................. 2,368,926 182,005 2,550,931
2002 Three Months Ended September 30 Nine Months Ended September 30
------------------------------------------ -----------------------------------------
Donnelley DonTech Total Donnelley DonTech Total
-------------- -------------- ------------ -------------- ------------- ------------
Net revenue.................. $ 21,376 $ -- $ 21,376 $ 60,098 $ -- $ 60,098
Operating income (loss)...... 11,562 34,430 45,992 21,079 92,962 114,041
EBITDA (1)................... 13,115 34,430 47,545 25,797 92,962 118,759
Total assets................. 99,669 190,798 290,467
(1) EBITDA is not a measurement of operating performance computed in accordance
with generally accepted accounting principles and should not be considered
as a substitute for operating income or net income prepared in conformity
with generally accepted accounting principles. In addition, EBITDA may not
be comparable to similarly titled measures of other companies. In
accordance with guidance from the United States
14
Securities and Exchange Commission, the most comparable GAAP measure for
EBITDA is net income. The reconciliation of net income to EBITDA is as
follows:
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------- ------------------------------------
2003 2002 2003 2002
---------------- ---------------- ----------------- ------------------
Net (loss) income.................. $ 3,903 $ 25,059 $ (56,194) $ 59,409
+ tax expense (benefit)........... 1,406 15,685 (40,355) 37,190
+ interest expense, net........... 45,531 5,248 137,460 17,442
+ depreciation and amortization... 16,576 1,553 49,047 4,718
---------------- ---------------- ----------------- ------------------
EBITDA............................. $ 67,416 $ 47,545 $ 89,958 $ 118,759
---------------- ---------------- ----------------- ------------------
We also evaluate the performance of Donnelley and DonTech based on advertising
sales. Advertising sales are a critical measure of performance that we review
and it plays an important role in our decision to allocate financial resources
between our segments. For a discussion of advertising sales, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Results of Operations."
11. Litigation
We are involved in various legal proceedings arising in the ordinary course of
our business, as well as certain extraordinary litigation and tax matters
described below. We periodically assess our liabilities and contingencies in
connection with these matters based upon the latest information available to us.
For those matters where it is probable that we have incurred a loss and the loss
or range of loss can be reasonably estimated, we record reserves in our
consolidated financial statements. In other instances, we are unable to make a
reasonable estimate of any liability because of the uncertainties related to
both the probable outcome and amount or range of loss. As additional information
becomes available, we adjust our assessment and estimates of such liabilities
accordingly.
Based on our review of the latest information available, we believe our ultimate
liability in connection with pending legal proceedings, including the
extraordinary litigation and tax matters described below, will not have a
material adverse effect on our results of operations, cash flows or financial
position, as described further below.
In order to understand our potential exposure under the extraordinary litigation
and tax matters described below under the captions "Information Resources, Inc."
and "Tax Matters," one needs to understand the relationship between us and The
Dun & Bradstreet Corporation, and certain of its predecessors and affiliates
that, through various corporate reorganizations and contractual commitments,
have assumed varying degrees of responsibility with respect to such matters.
In November 1996, the company then known as The Dun & Bradstreet Corporation
("D&B1") separated (the "1996 Distribution") through a spin-off into three
separate public companies: D&B1, ACNielsen Corporation ("ACNielsen") and
Cognizant Corporation ("Cognizant"). In June 1998, D&B1 separated (the "1998
Distribution") through a spin-off into two separate public companies: D&B1,
which changed its name to R.H. Donnelley Corporation ("Donnelley"), and a new
company named The Dun & Bradstreet Corporation ("D&B2"). Later in 1998,
Cognizant separated (the "Cognizant Distribution") through a spin-off into two
separate public companies: IMS Health Incorporated ("IMS") and Nielsen Media
Research, Inc. ("NMR"). In September 2000, D&B2 separated (the "2000
Distribution") through a spin-off into two separate public companies: D&B2,
which changed its name to Moody's Corporation ("Moody's"), and a new company
named The Dun & Bradstreet Corporation ("D&B3," and together with D&B1 and D&B2,
also referred to elsewhere in this Quarterly Report on Form 10-Q as "D&B"). As a
result of the form of our separation from D&B, we are the corporate successor
of, and technically the defendant and taxpayer referred to below as D&B.
Rockland Yellow Pages
In 1999, Sandy Goldberg, Dellwood Publishing, Inc. and Rockland Yellow Pages
initiated a lawsuit against the Company and Bell Atlantic Corporation in the
United States District Court for the Southern District of New York. The Rockland
Yellow Pages is a proprietary directory that competes against a Bell Atlantic
directory in the same region, for which we served as Bell Atlantic's advertising
sales agent through June 30, 2000. The complaint alleged that the defendants
disseminated false information concerning the Rockland Yellow Pages, which
resulted in damages to the Rockland Yellow Pages. In May 2001, the District
Court dismissed substantially all of plaintiffs' claims, and in August 2001, the
remaining claims were either withdrawn by the plaintiffs or dismissed by the
District Court. The plaintiffs then filed a complaint against the same
defendants in New York State Supreme Court, in Rockland County, alleging
15
virtually the same state law tort claim previously dismissed by the District
Court and seeking unspecified damages. In October 2001, defendants filed a
motion to dismiss this complaint. In May 2002, the Court granted defendants'
motion to dismiss the complaint. Plaintiffs filed an appeal of this dismissal.
In April 2003, the Appellate Division dismissed all but one count of the
complaint, which count alleges immaterial compensatory damages with respect to
only one advertiser. Accordingly, we presently do not believe that the final
outcome of this matter will have a material adverse effect on our results of
operations or financial condition.
Information Resources, Inc.
In 1996, Information Resources, Inc. ("IRI"), filed a complaint in the United
States District Court for the Southern District of New York, naming as
defendants the Company, as successor of D&B, ACNielsen Company and IMS
International Inc., at the time of the filing, all wholly owned subsidiaries of
D&B. IRI alleges, among other things, various violations of the antitrust laws,
including alleged violations of Sections 1 and 2 of the Sherman Act. The
complaint also alleges a claim of tortious interference with a contract and a
claim of tortious interference with a prospective business relationship. These
claims relate to the acquisition by defendants of Survey Research Group Limited
("SRG"). IRI alleges SRG violated an alleged agreement with IRI when it agreed
to be acquired by the defendants and that the defendants induced SRG to breach
that agreement. IRI is seeking damages in excess of $350,000, which amount IRI
seeks to treble under antitrust laws. IRI is also seeking punitive damages of an
unspecified amount. No trial date has been set, and discovery is ongoing. Under
the agreements relating to the 1996 Distribution, Cognizant, AC Nielsen and D&B
agreed to conduct a joint defense and allocated liabilities amongst themselves.
Under the agreements relating to the 1998 Distribution, D&B assumed the defense
and agreed to indemnify us against any payments that we may be required to make,
including related legal fees. As required by those agreements, Moody's
Corporation, which subsequently separated from D&B in the 2000 Distribution, has
agreed to be jointly and severally liable with D&B for the indemnity obligation
to us. At this stage in the proceedings, we are unable to predict the outcome of
this matter. While we cannot assure you as to any outcome, management presently
believes that D&B and Moody's have sufficient financial resources, borrowing
capacity and indemnity rights against IMS and NMR (who succeeded to Cognizant's
indemnity obligations under the Cognizant Distribution) to reimburse us for any
payments we may be required to make and related costs we may incur in connection
with this matter.
Tax Matters
D&B entered into global tax planning initiatives in the normal course of its
business, principally through tax-free restructurings of both their foreign and
domestic operations. The status of Internal Revenue Service ("IRS") reviews of
these initiatives is summarized below.
Pursuant to a series of agreements relating to the 1996, 1998, Cognizant and
2000 Distributions, IMS and NMR are jointly and severally liable for, and must
pay one-half, and D&B and Moody's are jointly and severally liable for, and must
pay the other half, of any payments over $137,000 for taxes, accrued interest
and other amounts resulting from unfavorable IRS rulings on the tax matters
summarized below (other than the matter summarized below as "Amortization
Expense Deductions - 1997 - 2002," for which D&B and Moody's, jointly and
severally, are solely responsible). D&B, on our behalf, was contractually
obligated to pay, and did pay, the first $137,000 of tax liability in connection
with the matter summarized below as "Utilization of Capital Losses - 1989 -
1990." Under the agreements relating to the 1998 Distribution, D&B agreed to
assume the defense and to indemnify us for any tax liability that may be
assessed against us and any related costs and expenses that we may incur in
connection with any of these tax matters. Also, as required by those agreements,
Moody's has agreed to be jointly and severally liable with D&B for the indemnity
obligation to us. Under the agreements relating to the 2000 Distribution, D&B
and Moody's have, between each other, agreed to each be financially responsible
for 50% of any potential liabilities that may arise to the extent such potential
liabilities are not directly attributable to each party's respective business
operations.
While we cannot assure you as to any outcome in these matters, management
presently believes that D&B and Moody's have sufficient financial resources,
borrowing capacity and indemnity rights against IMS and NMR (who succeeded to
Cognizant's indemnity obligations under the Cognizant Distribution) to reimburse
us for any payments we may be required to make and related costs we may incur in
connection with these tax matters. We understand that D&B has reserved $100,000
in its financial statements with respect to these matters.
Utilization of Capital Losses - 1989 - 1990
- -------------------------------------------
In 2000, D&B filed an amended tax return with respect to the utilization of
capital losses in 1989 and 1990 in response
16
to a formal IRS assessment. The amended tax return reflected an additional
$561,600 of tax and interest due. In 2000, D&B paid the IRS $349,300 while IMS
(on behalf of itself and NMR) paid $212,300 to the IRS. We understand that these
payments were made under dispute in order to stop additional interest from
accruing, that D&B is contesting the IRS's formal assessment and would also
contest the assessment of amounts, if any, in excess of the amounts paid, and
that D&B has filed a petition for a refund in the United States District Court.
This case is expected to go to trial in 2004.
Subsequent to making its payment to the IRS in 2000, IMS sought to obtain
partial reimbursement from NMR under the terms of the agreements relating to the
Cognizant Distribution. NMR paid IMS less than IMS sought. Accordingly, in 2001,
IMS filed an arbitration proceeding against NMR claiming that NMR underpaid to
IMS its proper allocation of the above tax payments as provided by the
agreements relating to the Cognizant Distribution. Neither D&B nor we were party
to the Cognizant Distribution. IMS nonetheless sought to include us in this
arbitration, arguing that if NMR should prevail in its interpretation against
IMS, then IMS could seek to enforce the same interpretation against us (as
successor to D&B) under the agreements relating to the 1996 Distribution. The
arbitration panel ruled that we were a proper party to this arbitration
proceeding. In April 2003, the arbitration panel dismissed all claims against us
and found for IMS. If, on appeal of that ruling, NMR should prevail against IMS
and, in turn, IMS should prevail against us, then we believe that our additional
liability would be approximately $15,000, net of tax benefits. As noted above,
D&B and Moody's would be jointly and severally obligated to indemnify us against
any such additional liability and related costs.
We believe the fact that D&B and IMS have already paid the IRS a substantial
amount of additional taxes with respect to the contested tax planning strategies
significantly mitigates our risk. While no assurances can be given, we currently
believe that D&B and Moody's have sufficient financial resources, borrowing
capacity and indemnity rights against IMS and NMR to reimburse us for any
payments we may be required to make and related costs we may incur with respect
to this matter.
Royalty Expense Deductions - 1994 - 1996
- ----------------------------------------
During the second quarter of 2003, D&B received on our behalf an IRS agent's
examination report with respect to a partnership transaction entered into by D&B
in 1993. Specifically, the IRS is disallowing certain royalty expense deductions
claimed by D&B on its 1993 through 1996 tax returns. D&B estimates that the
disallowance of the 1995 and 1996 royalty expense deductions would require
payment of up to $43,000 (tax, interest and penalties, net of associated tax
benefits).
Also in the second quarter of 2003, D&B received on behalf of the partnership
associated with the above transaction an IRS agent's examination report
challenging the tax treatment of certain royalty payments received by the
partnership in which D&B was a partner. The IRS is seeking to reallocate certain
partnership income to D&B. D&B's share of this income would require an
additional payment of $20,000 (tax, interest and penalties, net of associated
tax benefits). We understand that D&B believes that this position is
inconsistent with the IRS' position with respect to the same royalty expense
deductions described above.
Again, under the agreements relating to the 1998 and 2000 Distributions, D&B and
Moody's have agreed to jointly and severally defend and indemnify us against any
such liabilities and related costs.
We understand that D&B has filed protests relating to these proposed adjustments
with the IRS Office of Appeals. If the IRS were to prevail in its position, D&B
would share responsibility for the matter with Moody's, IMS and NMR, as
disclosed above. If D&B were to challenge the assessment in U.S. District Court
rather than in U.S. Tax Court, the disputed amounts would need to be paid in
advance.
Amortization Expense Deductions - 1997 - 2002
- ---------------------------------------------
We understand that the IRS has sought certain documentation from D&B with
respect to a transaction entered into in 1997 that produces amortization expense
deductions for D&B. While we understand that D&B believes the deductions are
appropriate, the IRS could ultimately challenge them and issue an assessment. If
the IRS were to prevail or the assessment were to be challenged by us in U.S.
District Court, we understand that D&B estimates that its cash payment to the
IRS with respect to deductions claimed to date and including any potential
assessment of penalties could be up to $50,000, net of associated tax benefits.
This transaction is scheduled to expire in 2012 and, unless earlier terminated
17
by D&B, the cash exposure, based on current interest rates and tax rates, would
increase at a rate of approximately $2,100 per quarter (including potential
penalties) as future amortization expenses are deducted. Again, under the
agreements relating to the 1998 and 2000 Distributions, D&B and Moody's are
required to jointly and severally indemnify us against any such liability and
related costs.
Conclusion
- ----------
As a result of our assessment of our exposure in these matters, especially in
light of our indemnity arrangements with D&B and Moody's, and their financial
resources, borrowing capacity and indemnity rights against IMS and NMR, no
material amounts have been accrued for in our consolidated financial statements
for any of these D&B-related litigation and tax matters.
Coastal Termite and Pest Control
In 2001, Marnan Group, Inc., doing business as Coastal Termite and Pest Control
("Coastal"), filed a complaint in the United States District Court for the
Middle District of Florida against SPA. The complaint, as amended, alleged that
SPA breached certain directory advertising contracts between 1996 and 1999,
fraudulently induced Coastal to enter into another directory advertising
contract and tortiously interfered with Coastal's business relationships with
its customers. Coastal is seeking damages for lost contract benefits, lost
profits and diminution of business value in an unspecified amount, including
pre-judgment interest. In January 2002, SPA filed a motion to dismiss certain of
Coastal's claims. In September 2002, the court denied SPA's motion to dismiss.
In October 2003, the parties settled this dispute and the matter has been
dismissed. The settlement would require the Company to pay an amount that will
not exceed the amount reserved in the Company's financial statements with
respect to this matter.
Other matters
We are also involved in other legal proceedings, claims and litigation arising
in the ordinary conduct of our business. Although we cannot assure you of any
outcome, management presently believes that the outcome of such legal
proceedings will not have a material adverse effect on our results of operations
or financial condition.
18
12. Guarantees
R.H. Donnelley Inc. is a direct wholly owned subsidiary of the Company and the
issuer of the Notes and Pre-acquisition Notes. The Company and the direct and
indirect wholly owned subsidiaries of R.H. Donnelley Inc. jointly and severally,
fully and unconditionally, guarantee the Notes and Pre-acquisition Notes. At
September 30, 2003, R.H. Donnelley Inc.'s direct wholly owned subsidiaries are
R.H. Donnelley Publishing & Advertising, Inc., R.H. Donnelley APIL, Inc. and Get
Digital Smart.com Inc. R.H. Donnelley Acquisitions, Inc. is a wholly owned
subsidiary of R.H. Donnelley APIL, Inc. The following consolidating condensed
financial statements should be read in conjunction with the consolidated
financial statements of the Company.
R.H. Donnelley Corporation
Consolidating Condensed Balance Sheet
September 30, 2003
R.H. R.H.
Donnelley R.H. Donnelley Donnelley Other Consolidated
Corp. Inc. Publishing & Guarantor R.H. Donnelley
(Parent) (Issuer) Advertising subsidiaries Eliminations Corporation
------------- ---------------- ------------- ------------- --------------- --------------
Assets
Cash and cash equivalents.. $ -- $ 5,771 $ 24 $ 7 $ -- $ 5,802
Accounts receivable, net... -- -- 220,777 -- -- 220,777
Other current assets....... 4,601 53,441 1,782 -- 59,824
Fixed assets, net.......... -- 14,748 5,467 -- -- 20,215
Investment in subsidiaries. 132,802 2,451,651 -- 2,108,301 (4,510,749) 182,005
Intercompany advance....... -- -- -- 2,252,905 (2,252,905) --
Other non-current assets... -- 87,638 5 -- -- 87,643
Intangible assets.......... -- -- 1,877,625 -- -- 1,877,625
Goodwill................... -- -- 97,040 -- -- 97,040
------------- ---------------- ------------- ------------- --------------- --------------
Total assets............... $ 132,802 $ 2,564,409 $ 2,254,379 $4,362,995 $(6,763,654) $ 2,550,931
------------- ---------------- ------------- ------------- --------------- --------------
Liabilities, Redeemable
Convertible Preferred
Stock and Shareholders'
Deficit
Accounts payable and accrued
liabilities............. $ -- $ 49,439 $ (48,297) $ 81,030 $ (63,895) $ 18,277
Deferred directory revenue. -- -- 217,417 -- -- 217,417
Accrued interest payable... -- 30,037 30,037
Current portion long-term debt -- 57,540 -- -- -- 57,540
Long-term debt............. -- 2,057,821 -- -- -- 2,057,821
Other long-term liabilities... -- 77,026 1,774 -- (41,763) 37,037
Intercompany loan.......... -- -- 2,152,915 -- (2,152,915) --
Redeemable convertible
preferred stock......... 193,968 -- -- -- -- 193,968
Shareholders' (deficit) equity (61,166) 292,546 (69,430) 4,281,965 (4,505,081) (61,166)
------------- ---------------- ------------- ------------- --------------- --------------
Total liabilities, redeemable
convertible preferred
stock and shareholders' $ 132,802 $ 2,564,409 $ 2,254,379 $4,362,995 $(6,763,654) $ 2,550,931
deficit................. ------------- ---------------- ------------- ------------- --------------- --------------
19
R.H. Donnelley Corporation
Consolidating Condensed Statement of Operations
R.H. R.H.
Donnelley R.H. Donnelley Other Consolidated
For the Three Months Ended Corp. Donnelley Inc. Publishing & Guarantor R.H. Donnelley
September 30, 2003 (Parent) (Issuer) Advertising subsidiaries Eliminations Corporation
------------- -------------- ------------- -------------- ------------- ---------------
Net revenue.............. $ -- $ 4,594 $ 84,715 $ -- $ -- $ 89,309
Expenses................. -- 21,437 49,607 31 -- 71,075
Partnership and equity income
3,798 46,898 -- 58,373 (76,463) 32,606
------------- -------------- ------------- -------------- ------------- ---------------
Operating income......... 3,798 30,055 35,108 58,342 (76,463) 50,840
Interest (expense) income.... -- (47,313) (48,169) 49,951 -- (45,531)
------------- -------------- ------------- -------------- ------------- ---------------
Pre-tax (loss) income.... 3,798 (17,258) (13,061) 108,293 (76,463) 5,309
Income tax expense (benefit). (105) (21,056) (5,146) 27,713 -- 1,406
------------- -------------- ------------- -------------- ------------- ---------------
Net (loss) income........ 3,903 3,798 (7,915) 80,580 (76,463) 3,903
Preferred Stock dividend. 5,082 -- -- -- -- 5,082
------------- -------------- ------------- -------------- ------------- ---------------
Net (loss) income available
to common shareholders.... $ (1,179) $ 3,798 $ (7,915) $ 80,580 $ (76,463) $ (1,179)
------------- -------------- ------------- -------------- ------------- ---------------
For the Three Months Ended
September 30, 2002
Net revenue.............. $ -- $ 21,376 $ -- $ -- $ -- $ 21,376
Expenses................. -- 16,175 -- 15 -- 16,190
Partnership and equity income 25,059 28,992 -- 34,274 (47,519) 40,806
------------ --------------- ------------- -------------- -------------- --------------
Operating income......... 25,059 34,193 -- 34,259 (47,519) 45,992
Interest (expense) income.... -- (7,030) -- 1,782 -- (5,248)
------------ --------------- ------------- -------------- -------------- --------------
Pre-tax income........... 25,059 27,163 -- 36,041 (47,519) 40,744
Income tax expense....... -- 2,104 -- 13,581 -- 15,685
------------ --------------- ------------- -------------- -------------- --------------
Net income............... $ 25,059 $ 25,059 $ -- $ 22,460 $ (47,519) $ 25,059
------------ --------------- ------------- -------------- -------------- --------------
For the Nine Months Ended
September 30, 2003
Net revenue.............. $ -- $ 17,597 $ 122,766 $ -- $ -- $ 140,363
Expenses................. -- 56,817 135,296 442 -- 192,555
Partnership and equity
(loss) income......... (56,649) 64,237 -- 169,911 (85,919) 91,580
------------- -------------- ------------- -------------- ------------- ---------------
Operating (loss) income.. (56,649) 25,017 (12,530) 169,469 (85,919) 39,388
Interest (expense) income.... -- (142,806) (143,079) 148,425 -- (137,460)
Other income............. -- 1,523 -- -- -- 1,523
------------- -------------- ------------- -------------- ------------- ---------------
Pre-tax (loss) income.... (56,649) (116,266) (155,609) 317,894 (85,919) (96,549)
Income tax expense (benefit). (455) (59,617) (61,310) 81,027 -- (40,355)
------------- -------------- ------------- -------------- ------------- ---------------
Net (loss) income........ (56,194) (56,649) (94,299) 236,867 (85,919) (56,194)
Preferred Stock dividend. 53,214 -- -- -- -- 53,214
------------- -------------- ------------- -------------- ------------- ---------------
Net (loss) income available
to common shareholders $(109,408) $ (56,649) $ (94,299) $ 236,867 $ (85,919) $ (109,408)
------------- -------------- ------------- -------------- ------------- ---------------
For the Nine Months Ended
September 30, 2002
Net revenue.............. $ -- $ 60,098 $ -- $ -- $ -- $ 60,098
Expenses................. -- 54,793 -- 82 -- 54,875
Partnership and equity income 59,409 76,532 -- 95,265 (122,388) 108,818
------------- -------------- ------------- -------------- ------------- ---------------
Operating income......... 59,409 81,837 -- 95,183 (122,388) 114,041
Interest (expense) income.... -- (22,789) -- 5,347 -- (17,442)
------------- -------------- ------------- -------------- ------------- ---------------
Pre-tax income........... 59,409 59,048 -- 100,530 (122,388) 96,599
Income tax expense (benefit). -- (361) -- 37,551 -- 37,190
------------- -------------- ------------- -------------- ------------- ---------------
Net income............... $ 59,409 $ 59,409 $ -- $ 62,979 $(122,388) $ 59,409
------------- -------------- ------------- -------------- ------------- ---------------
20
R.H. Donnelley Corporation
Consolidating Condensed Statement of Cash Flows
R.H. Donnelley R.H. Donnelley R.H. Donnelley Other Consolidated
For the Nine Months Ended Corp. Inc. Publishing & Guarantor R.H. Donnelley
September 30, 2003 (Parent) (Issuer) Advertising subsidiaries Corporation
---------------- -------------- ------------------ ------------------ -----------------
Cash flow from operations.... $ -- $ (129,950) $ 43,954 $ 312,093 $ 226,097
Cash flow from investing
activities................... 69,300 (410,241) (32,292) -- (373,233)
Cash flow from financing
activities................... (69,300) 538,217 (11,638) (312,128) 145,151
---------------- -------------- ------------------ ------------------ -----------------
Change in cash............... -- (1,974) 24 (35) (1,985)
Cash at beginning of period.. -- 7,745 -- 42 7,787
---------------- -------------- ------------------ ------------------ -----------------
Cash at end of period........ $ -- $ 5,771 $ 24 $ 7 $ 5,802
---------------- -------------- ------------------ ------------------ -----------------
For the Nine Months Ended
September 30, 2002
Cash flow from operations.... $ -- $ (8,526) $ -- $ 64,979 $ 56,453
Cash flow from investing
activities................... -- (2,496) -- -- (2,496)
Cash flow from financing
activities................... -- 6,081 -- (64,914) (58,833)
---------------- -------------- ------------------ ------------------ -----------------
Change in cash............... -- (4,941) -- 65 (4,876)
Cash at beginning of period.. -- 14,667 -- 54 14,721
---------------- -------------- ------------------ ------------------ -----------------
Cash at end of period........ $ -- $ 9,726 $ -- $ 119 $ 9,845
---------------- -------------- ------------------ ------------------ -----------------
13. Recent Accounting Pronouncements
In December 2002, the FASB issued FAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment to FAS 123" ("FAS 148").
This statement provides alternative methods of transition for a voluntary change
to the fair value method of accounting for stock based employee compensation. In
addition, the statement amends the disclosure requirements of FAS 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 on reported results. We have not voluntarily adopted the provisions of
FAS 123; however, we have implemented the disclosure requirements of FAS 148.
In January 2003, the FASB issued Interpretation No. 46 "Consolidation of
Variable Interest Entities" ("FIN 46"). This Interpretation addresses the
consolidation by business enterprises of variable interest entities, or
special-purposes entities. The effective date of FIN 46 has been delayed until
the fourth quarter 2003; however, we reviewed the provisions of FIN 46 and
concluded that the adoption of FIN 46 would not have a material impact on our
financial position or results of operations.
In May 2003, the FASB issued FAS 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" ("FAS 150").
This statement establishes standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. The statement was effective July 1, 2003. Our redeemable convertible
preferred stock represents a financial instrument with characteristics of both
liabilities and equity. We have applied the provisions of FAS 150 and determined
that the classification and measurement of our redeemable convertible preferred
stock is appropriate.
21
Item 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
Forward-Looking Information
Certain statements contained in this Form 10-Q regarding R.H. Donnelley's future
operating results, performance, business plans or prospects and any other
statements not constituting historical fact are "forward-looking statements"
subject to the safe harbor created by the Private Securities Litigation Reform
Act of 1995. Where possible, words such as "believe," "expect," "anticipate,"
"should," "will," "would," "planned," "estimated," "potential," "goal,"
"outlook," "could," and similar expressions, are used to identify such
forward-looking statements. All forward-looking statements reflect only our
current beliefs and assumptions with respect to our future results, business
plans, and prospects, and are based solely on information currently available to
us. Accordingly, these statements are subject to significant risks and
uncertainties and our actual results, business plans and prospects could differ
significantly from those expressed in, or implied by, these statements. We
caution readers not to place undue reliance on, and we undertake no obligation
to update, other than imposed by law, any forward-looking statements. Any
information included in the Form 10-Q is deemed to update and supercede any
identical or substantially similar information previously disclosed by the
Company. Unless otherwise indicated, the terms "Company," "we," "us" and "our"
refer to R.H. Donnelley Corporation and its direct and indirect wholly owned
subsidiaries. Such risks and uncertainties are described in detail in our Annual
Report on Form 10-K for the year ended December 31, 2002.
The Company
On January 3, 2003, we acquired Sprint Corporation's ("Sprint") directory
operations, Sprint Publishing & Advertising ("SPA") for $2,229.8 million in cash
and are now the publisher of 260 revenue-generating Sprint Yellow Pages(R)
directories in 18 states. Prior to the acquisition, we served as the exclusive
sales agent and pre-press publishing vendor for Sprint Yellow Pages directories
in certain markets. The acquisition transformed us from a sales agent and
pre-press vendor into a leading publisher of yellow pages directories. The
acquisition was accounted for as a purchase business combination and the
purchase price was allocated to the tangible and identifiable intangible assets
acquired and liabilities assumed based on their respective fair values on the
acquisition date. The results of the SPA business are included in our
consolidated results from and after January 3, 2003, the acquisition closing
date. SPA is now operated as R.H. Donnelley Publishing & Advertising, Inc.
("RHDPA"), an indirect, wholly owned subsidiary of the Company.
Through the DonTech Partnership ("DonTech"), we are also the exclusive sales
agent to sell yellow pages advertising for 129 SBC Communications Inc. ("SBC")
directories in Illinois and northwest Indiana. DonTech was not affected by the
SPA acquisition and continues to act as the exclusive sales agent to SBC.
We have revised our historical segment reporting to reflect the change in the
business that resulted from the SPA acquisition and to reflect the way
management now reviews and analyzes the business. Our reportable operating
segments are Donnelley and DonTech.
Donnelley
Our Donnelley segment includes the revenue from advertising sales in our Sprint
Yellow Pages directories, pre-press publishing services and miscellaneous
revenue from the sale of directories and finance charges on past due accounts as
well as all operating and administrative expenses. The annual billing value of
the advertisements sold in a directory ("publication sales") is deferred when a
directory is published and recognized ratably over the life of a directory,
which is typically twelve months ("deferral and amortization method"). The
amount of directory revenue and corresponding receivables is reduced by an
allowance for sales claims and an allowance for bad debts, respectively. Prior
to the acquisition, we sold yellow pages advertising in certain Sprint Yellow
Pages directories on behalf of SPA and earned a commission based on the contract
value of those sales, subject to an allowance for sales claims and an allowance
for bad debts.
We also earn revenue from SBC for pre-press publishing and billing services for
the yellow pages directories for which DonTech sells advertising and for sales
related computer application services. The fees received for these services are
included in our Donnelley segment, as they relate more to our pre-press
publishing services than DonTech sales activities.
DonTech
DonTech is a 50/50 perpetual partnership in which the Company and an operating
unit of SBC are the partners. DonTech acts as the exclusive sales agent for
yellow pages directories published by SBC in Illinois and northwest Indiana. As
a sales agent for SBC, DonTech earns commission revenue based on the annual
value of sales contracts
22
executed during the period ("calendar sales"). We also earn revenue
participation income based on the level of calendar sales during the period. Our
income associated with DonTech is comprised of our 50% interest in the net
income of DonTech and revenue participation income received directly from SBC.
Although DonTech provides advertising sales of yellow pages and other directory
products similar to Donnelley, the partnership is considered a separate
operating segment since, among other things, it has its own Board of Directors
and the employees of DonTech, including officers and managers, are not employees
of the Company.
DonTech's net income and our revenue participation income are directly
correlated to DonTech's calendar sales and a material decline in their calendar
sales could have an adverse effect on our consolidated results. DonTech manages
the sale of advertising ("sales campaign") on a directory-by-directory basis or
project basis (a project consists of two or more directories in a geographic
area). A typical sales campaign lasts two to five months and ends approximately
two months prior to publication. Accordingly, changes in the beginning and
ending dates of a sales campaign and the actual sales recorded at any point
during the sales campaign can vary from one period to the next. These
variations, or timing factors, can cause income from DonTech to be materially
different from the prior year comparative period.
Critical Accounting Policies
Certain amounts in our financial statements require that management make
assumptions and estimates based on the best available information at that time.
Actual results could vary from these estimates and assumptions. Those accounting
policies that involve assumptions or estimates on our part that could have a
material effect on results of operations or financial condition if the actual
results differ from the assumptions or estimates are presented below. See Note 3
in Item 1 "Financial Statements" for additional information on our accounting
policies.
Principles of Consolidation. The consolidated financial statements include the
accounts of R.H. Donnelley Corporation and its direct and indirect wholly owned
subsidiaries. All intercompany transactions and balances have been eliminated.
We account for DonTech under the equity method. DonTech is a separate legal
entity that provides its services with its own employees and stand-alone
management team. No employees of either RHD or SBC are involved in the
day-to-day operations of DonTech and, because the partners share equally in the
net profits and each has one voting member on the DonTech Board, neither partner
has the unilateral ability to control or influence the operations of DonTech.
Accordingly, DonTech's revenue and expenses are not consolidated in our
financial statements, but our share of its net profits is reported as
partnership income in our consolidated statements of operations.
Revenue Recognition. We earn revenue from the sale of advertising into our
Sprint Yellow Pages directories, pre-press publishing services and miscellaneous
revenue from the sale of directories and finance charges on past due accounts.
Revenue from the sale of advertising is recognized under the deferral and
amortization method. Revenue from the sale of advertising is recorded net of an
allowance for sales claims, estimated based on historical experience on a
directory-by-directory basis. We increase or decrease this estimate from time to
time as information or circumstances indicate that the estimate may no longer
adequately represent the amount of claims we may incur for a directory in the
future. We estimate our allowance for sales claims as a percentage of revenue.
Accordingly, a 1% change in our sales claims allowance rate would impact revenue
by $5 to $6 million annually. We provide pre-press publishing services to SBC
for those directories in the DonTech markets. Revenue from pre-press publishing
services is recognized as services are performed. Miscellaneous revenue is
recognized when earned and comprises less than 2% of our total revenue.
For the 2002 period, we earned sales commission revenue from the sale of
advertising on behalf of SPA and fees for pre-press publishing services. As a
sales agent for SPA, we recognized sales commission revenue, net of an allowance
for sales claims and bad debts, at the time an advertising contract was executed
with a customer.
Deferred Directory Costs. Deferred directory costs include the direct costs for
the selling and production of our directories - sales commissions, printing,
paper and initial distribution, as well as an allowance for sales claims and an
allowance for bad debts. Deferred directory costs are initially deferred when
incurred and recognized ratably over the life of a directory.
Receivables. Advertisers typically enter into a twelve-month contract for their
advertising. Most advertisers are billed a pro rata amount of their contract
value on a monthly basis. Billed receivables represent the amount that has been
billed to advertisers. Unbilled receivables represent amounts for published
directories that have yet to be billed to advertisers in
23
accordance with the terms of their contract. Billed and unbilled receivables are
recorded net of an allowance for bad debts, estimated based on historical
experience on a directory-by-directory basis. We increase or decrease this
estimate from time to time as information or circumstances indicate that the
estimate may no longer adequately represent the amount of bad debts we may incur
for a directory in the future. We estimate our bad debts as a percentage of
revenue. Accordingly, a 1% change in our bad debt rate would impact expenses by
$5 to $6 million annually.
We provide pre-press publishing services to SBC for those directories sold by
DonTech under a separately negotiated contract that expires in 2008. Receivables
for services are billed and collected in accordance with the terms of the
agreement, generally a monthly pro rata amount based on the annual estimated
contract value. An additional amount is billed or reimbursed to SBC early in the
following year based on a reconciliation of actual volumes compared to
contractual volumes.
Concentration of Credit Risk. Approximately 85% of our advertising revenue is
derived from the sale of advertising to local small- and medium-sized
businesses. These advertisers typically enter into twelve-month advertising
sales contracts and typically make monthly payments over the term of the
contract. Some advertisers pre-pay the full amount or a portion of the contract
value. Many new advertisers are subject to a credit review. If the advertisers
qualify, we may extend credit to them for their advertising purchase. Small- and
medium-sized businesses tend to have fewer financial resources and higher
financial failure rates than large businesses. In addition, full collection of
delinquent accounts can take an extended period of time and involve significant
costs. While we do not believe that extending credit to our local advertisers
will have a material adverse effect on our results of operations or financial
condition, no assurances can be given. We do not require collateral from our
advertisers, although we do charge interest to advertisers who do not pay within
specified due dates.
The remaining 15% of our advertising revenue is derived from the sale of
advertising to national or large regional chains, such as rental car companies,
automobile repair shops and pizza delivery businesses. Substantially all of the
revenue derived through national accounts is serviced through Certified
Marketing Representatives ("CMRs"), with which we contract. CMRs are independent
third parties that act as agents for national companies. The CMRs are
responsible for billing the national customers for their advertisement. We
receive payment for the value of advertising placed in our directory, net of the
CMR's commission, directly from the CMR. While we are still exposed to credit
risk, the amount of losses from these accounts have historically been less than
the local accounts as the advertisers, and in some cases, the CMRs tend to be
larger companies with greater financial resources than the local advertisers.
We maintain a significant receivable balance with SBC for revenue participation
and pre-press publishing services fees. The revenue participation receivable is
subject to adjustment, based on collections by SBC from individual advertisers;
however, the adjustment is limited based on contractual provisions. The
receivable is recorded at net realizable value. We do not currently foresee a
material credit risk associated with this receivable, although there can be no
assurance that full payment will be received on a timely basis.
At September 30, we had interest rate swap agreements with major financial
institutions with a notional value of $255 million. We are exposed to credit
risk in the event that one or more of the counterparties to the agreements does
not, or cannot meet their obligation. The notional amount is used to measure
interest to be paid or received and does not represent the amount of exposure to
credit loss. The loss would be limited to the amount that would have been
received, if any, over the remaining life of the swap agreement. The
counterparties to the swap agreements are major financial institutions with
credit ratings of A or higher. While we do not currently foresee a material
credit risk associated with these swap agreements, no assurances can be given.
Identifiable Intangible Assets and Goodwill. Identifiable intangible assets
consist of directory services agreements between Sprint and the Company entered
into as part of the SPA acquisition, established customer relationships and
trade names acquired as part of the SPA acquisition. The estimated fair value
and useful lives of these intangible assets were determined based on an
independent valuation and deemed by management to be reasonable. The fair value
of these intangible assets is being amortized over their estimated useful lives.
Annual amortization expense for the next five years is approximately $50
million. An increase or decrease of one year in the estimated useful lives of
each of these assets would change the annual amortization expense by
approximately $2 million.
The directory services agreements consist of a directory services license
agreement, a trademark license agreement and
24
a non-competition agreement (collectively "Directory Services Agreements"). The
fair value of these agreements was determined based on the present value of
estimated future cash flows and is being amortized under the straight-line
method over 50 years.
The fair value of customer relationships was determined based on the present
value of estimated future cash flows and historical attrition rates and is being
amortized under an accelerated method that recognizes that the value derived
from customer relationships is greater in the earlier years and steadily
declines over time. The weighted average useful life of these relationships is
18 years.
The fair value of the acquired trade names was determined 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. These assets are being amortized under the straight-line method
over 15 years.
Goodwill represents the excess of the purchase price for SPA over the net
tangible and intangible assets acquired. In accordance with SFAS 142 "Goodwill
and Other Intangible Assets," goodwill is not amortized, but is subject to
impairment testing. No impairment losses were recorded during the period.
Derivative Financial Instruments. At September 30, 2003, we had interest rate
swap agreements with a total notional value of $255 million. These agreements
effectively convert $255 million of variable rate debt to fixed rate debt,
mitigating our exposure to changes in interest rates on variable rate debt.
Under the terms of these agreements, we receive variable interest based on
three-month LIBOR and pay a fixed rate of 2.85%. The swaps mature on March 31,
2007.
The interest rate swaps have been designated as cash flow hedges to hedge
three-month LIBOR-based interest payments on $255 million of bank debt. To the
extent the swaps are effective, changes in the fair value of the swaps are
recorded in other comprehensive income, a component of shareholders' equity. Any
ineffectiveness is recorded through earnings. Through September 30, 2003, the
cash flows from the swaps exactly offset the interest payments made during the
quarter on $255 million of bank debt such that no ineffectiveness was charged to
earnings.
On October 6, 2003, we executed an additional interest rate swap agreement with
a notional value of $150 million. Under the terms of this agreement, we receive
variable interest based on three-month LIBOR and pay a fixed rate of 1.959%.
This swap has also been designated as a cash flow hedge to hedge three-month
LIBOR-based interest payments on $150 million of bank debt. This swap matures
October 9, 2005.
Pension and Other Postretirement Benefits. Pension and other postretirement
benefits represent estimated amounts to be paid to employees in the future. The
accounting for benefit costs reflects the recognition of these future costs over
the employee's approximate service period based on the terms of the plans and
investment and funding decisions. The determination of the future obligation and
the periodic pension and other postretirement benefit costs requires management
to make assumptions regarding the discount rate, return on retirement plan
assets, increase in future compensation and health care cost trends. Changes in
these assumptions can have a significant impact on the projected benefit
obligation, funding requirement and periodic benefit cost. Our discount rate,
which discounts our future obligation to its present value, is based on rates of
return on Aa corporate bonds. The expected rate of return on plan assets is
based on the mix of assets held by the plan and their historical long-term rates
of return. The anticipated trend of future health care costs is based on
historical experience and external factors.
Effective January 1, 2003, we reduced our rate of return on plan assets from
9.75% to 8.25%. Based on the current investment environment, our outlook for
future returns and the pension plan's asset allocation, we determined that a
long-term rate of return of 8.25% was a more appropriate assumption.
Earnings per Share. Basic earnings per common share (EPS) are generally
calculated by dividing net income available to common shareholders by the
weighted average number of common shares outstanding. However, because the
redeemable convertible cumulative preferred stock ("Preferred Stock") contains
certain participation rights, EITF Topic D-95, "Effect of Participating
Securities on the Computation of Basic Earnings Per Share," ("Topic D-95")
requires that the dilutive effect of those securities be included in the
weighted average number of shares outstanding. Furthermore, Topic D-95 requires
that the dilutive effect to be included in basic EPS may be calculated using
either the
25
if-converted method or the two-class method. However, the dilutive effect of the
Preferred Stock cannot be less than that which would result from the application
of the two-class method. We have elected to use the if-converted method in
calculating basic EPS.
Diluted EPS equals net income divided by the weighted average common shares
outstanding plus common share equivalents. Common share equivalents include
stock options and warrants, the dilutive effect of which is calculated using the
treasury stock method, and Preferred Stock, the potential dilutive effect of
which is calculated using the if-converted method.
RESULTS OF OPERATIONS
Three and nine months ended September 30, 2003 and 2002
Because of the SPA acquisition, related financing and associated accounting,
results for 2003 prepared in accordance with generally accepted accounting
principles ("GAAP") are not comparable to our 2002 GAAP results previously
reported. Also, because purchase accounting rules prevent us from recognizing
deferred revenue and expenses for those directories that published prior to the
acquisition, including all January 2003 published directories, reported 2003
revenue and expenses are not representative of revenue and expenses that would
be reported in subsequent years. Accordingly, in addition to a discussion of the
reported 2003 results compared to the reported 2002 results, we are also
providing a comparison of 2003 adjusted results, which eliminates the effect of
purchase accounting on deferred revenue and expenses, to 2002 pro forma results,
which assumes the acquisition occurred on January 1, 2002. See "- Adjusted and
Pro Forma Results" below for the reconciliation of 2003 and 2002 reported
results to 2003 adjusted and 2002 pro forma results.
REPORTED RESULTS
- ----------------
Net Revenue
Revenue is derived entirely from our Donnelley segment. We earn revenue
primarily from the sale of advertising in our Sprint Yellow Pages directories
and from pre-press publishing services. Net revenue was $89.3 million and $140.4
million for the quarter and nine months ended September 30, 2003, respectively,
compared to $21.4 million and $60.1 million for the quarter and nine months
ended September 30, 2002, respectively. This increase is explained in the
following paragraphs.
Net revenue from the sale of advertising was $84.0 million and $120.7 million
for the three and nine months ended September 30, 2003, respectively, compared
to $13.0 million and $34.9 million for the three and nine months ended September
30, 2002, respectively. The increase in directory revenue is due to the
acquisition. Directory revenue in 2003 includes the amortization of publication
sales for directories published subsequent to the acquisition under the deferral
and amortization method whereas directory revenue for the 2002 periods included
only commission revenue on advertising sales made on behalf of SPA.
Revenue from pre-press publishing services for the three and nine months ended
September 30, 2003 was $4.6 million and $17.6 million, respectively, compared to
$8.4 million and $25.2 million for the three and nine months ended September 30,
2002, respectively. This decline was primarily due to the loss of revenue from
SPA and an independent third-party publisher. As a result of the acquisition,
pre-press publishing services previously provided to SPA are now performed
internally with revenue and expenses eliminated in consolidation. The service
contract with the independent third-party publisher expired December 31, 2002
and all services provided ceased at the end of March 2003 when all data was
transitioned to the publisher.
Expenses
Expenses are derived entirely from our Donnelley segment. Total expenses were
$71.1 million and $192.6 million for the three and nine months ended September
30, 2003, respectively, and $16.2 million and $54.9 million for the three and
nine months ended September 30, 2002, respectively. Operating expenses were
$39.7 million and $106.5 million for the three and nine months ended September
30, 2003, respectively, and $11.5 million and $37.7 million for the three and
nine months ended September 30, 2002, respectively. The increase in operating
expenses in the 2003 periods is primarily due to the acquisition and our new
role as publisher compared to our prior role as a sales agent.
26
Direct sales costs, which includes sales person compensation and lease expense
for sales offices, were $10.4 million and $24.5 million higher than last year's
three and nine months ended September 30, 2002, respectively, due to a greater
number of directories, more sales personnel and more sales offices resulting
from the SPA acquisition. As a publisher, we also incur costs for the printing
(including the cost of paper) and distribution of directories, as well as
marketing and advertising costs, which we did not incur as a sales agent. Total
expenses for these items for the three and nine months ended September 30, 2003
were $9.6 million and $19.4 million, respectively. Publishing and information
technology expenses also increased by $7.5 million and $19.6 million in the
three and nine months ended September 30, 2003, respectively as a result of the
post-acquisition expanded business activities and personnel. Operating expenses
also include $1.0 million and $4.2 million for the three and nine months ended
September 30, 2003, respectively, for the non-cash amortization of a purchase
accounting adjustment that increased the acquired deferred directory costs to
fair value.
As a result of continued improvements in our accounts receivable collection
processes, the estimated amount provided for bad debts for certain directories
exceeded the actual write-offs incurred for those directories. Accordingly, an
adjustment of $6.5 million was recognized in the third quarter of 2003 to more
properly reflect our best estimate of the allowance for bad debts. The estimate
of bad debts for a directory is established at the time of publication based on
historical information available at the time of publication. Due to the annual
billing cycle of a directory, actual bad debts for a directory may not be known
until up to eighteen months after the publication of that directory. Because of
improvements in the accounts receivable collection processes, we were able to
collect more of the receivables from these directories than originally
estimated. Our estimated bad debt rates for current directories have been
properly adjusted to reflect the effect of the improvements in the collection
processes. Operating expenses for the three and nine months ended September 30,
2003 also benefited from a $2.3 million and $3.4 million adjustment,
respectively, for print and paper accruals for certain directories as the
ultimate cost was less than the original estimate.
General and administrative expenses were $14.8 million and $37.0 million for the
quarter and nine months ended September 30, 2003, respectively, and $3.1 million
and $12.5 million for the quarter and nine months ended September 30, 2002,
respectively. The increase is largely attributed to additional general and
administrative expenses related to the acquired SPA business, restructuring
costs for the shutdown of duplicate facilities, the relocation of the corporate
offices to Raleigh, North Carolina and higher insurance costs. General and
administrative expenses related to the acquired SPA business were $3.6 million
and $9.9 million for the quarter and nine months ended September 30, 2003,
respectively. Restructuring costs were $5.0 million in the quarter and $8.1
million for the nine months ended September 30, 2003. The cost of insurance was
$1.0 million and $2.7 million higher for the quarter and nine months ended
September 30, 2003, respectively compared to the prior year periods due to
post-acquisition expanded business activities and an increase in insurance
premiums.
Depreciation and amortization was $16.6 million and $49.1 million for the three
and nine months ended September 30, 2003, respectively, and $1.6 million and
$4.7 million for the three and nine months ended September 30, 2002,
respectively. The increase is primarily due to the amortization of acquired
intangible assets, which was not incurred in 2002. Amortization of intangible
assets was $12.5 million and $37.4 million for the three and nine months ended
September 30, 2003, respectively. Depreciation of fixed assets and amortization
of computer software was $2.5 million higher for the quarter and $7.0 million
higher for the nine-month period due to the acquisition of SPA depreciable
assets.
Partnership Income
Partnership income includes our 50% share of the net income of DonTech and
revenue participation income from SBC. Partnership income in 2002 also included
priority distribution income on our membership interest in CenDon, LLC, which we
no longer recognize as a result of the SPA acquisition.
Partnership income was $32.6 million in the third quarter of 2003 compared to
$40.8 million in the third quarter of 2002, and $91.6 million for the nine
months ended September 30, 2003 compared to $108.8 million for the nine months
ended September 30, 2002. Included in 2002 partnership income was CenDon
priority distribution income of $6.4 million and $15.8 million for the quarter
and nine months ended September 30, 2002, respectively. The remaining decrease
in partnership income for the 2003 quarter and year-to-date periods was due to
lower calendar sales at DonTech resulting from continued weak economic
conditions in the Midwest and intense competition in the Chicago local media
market. DonTech calendar sales were 4.3% lower than last year's third quarter
and 2.0% lower than the
27
nine-month period ended September 30, 2002. Lower partnership expenses are
partially offsetting the impact on partnership income from lower calendar sales.
See "- Advertising Sales" below for a reconciliation of DonTech calendar sales,
a non-GAAP measure, to reported partnership income, the most comparable GAAP
measure.
Operating Income (Loss)
Operating income was $50.8 million and $39.4 million for the quarter and nine
months ended September 30, 2003, respectively, and $46.0 million and $114.0
million for the quarter and nine months ended September 30, 2002, respectively.
Operating income from the Donnelley segment was $18.2 million for the quarter
ended September 30, 2003 and $11.6 million for the quarter ended September 30,
2002. The increase is due to the increases in revenue and expenses resulting
from the acquisition. The Donnelley segment had an operating loss of $52.2
million for the nine months ended September 30, 2003 and operating income of
$21.1 million for the nine months ended September 30, 2002. The significant
decline in year-to-date Donnelley operating income was mainly due to purchase
accounting rules that prevent us from recognizing deferred revenue and expenses
associated with those directories published prior to the acquisition (including
all January 2003 directories) and the increase in expenses incurred as a
publisher.
Operating income from DonTech was $32.6 million in the third quarter of 2003
compared to $34.4 million in the third quarter of 2002, and $91.6 million for
the nine months ended September 30, 2003 compared to $93.0 million for the nine
months ended September 30, 2002. See "- Partnership Income" above for a
discussion of DonTech income.
Interest Expense
Net interest expense was $45.5 million and $137.5 million for the quarter and
nine months ended September 30, 2003, respectively, and $5.2 million and $17.4
million for the quarter and nine months ended September 30, 2002, respectively.
Interest expense in 2003 is significantly higher than interest expense in 2002
due to the substantial amount of debt issued in connection with the SPA
acquisition (see "- Liquidity and Capital Resources").
Other Income
Other income of $1.5 million in the nine month period ended September 30, 2003
represents a gain on hedging activities. At December 31, 2002, a $75 million
notional value interest rate swap did not qualify for hedge accounting treatment
due to the then-pending repayment of existing variable rate debt in connection
with the SPA acquisition. In December 2002, a charge of $1.5 million was
recorded to reclassify the cumulative change in the fair value of the swap that
was previously recognized in accumulated other comprehensive loss on the balance
sheet to earnings. Due to the loss of hedge accounting treatment, a gain of $1.5
million was recognized in earnings in 2003. The swap matured in June 2003.
Net Income (Loss), Net Income (Loss) Available to Common Shareholders and
Earnings (Loss) Per Share
Net income for the third quarter 2003 was $3.9 million and a loss of $56.2
million for the nine months ended September 30, 2003 compared to net income of
$25.1 million and $59.4 million for the three and nine months ended September
30, 2002, respectively. The results for 2003 have been effected by purchase
accounting rules that prevented us from recognizing deferred revenue and
expenses associated with those directories published prior to the acquisition,
higher expenses as a publisher and significantly higher interest expense due to
acquisition financing. The Preferred Stock dividend was $5.1 million for the
three months ended September 30, 2003 and $53.2 million for the nine months
ended September 30, 2003. The three and nine month Preferred Stock dividend
amounts include a "deemed dividend" of $0.9 million and $41.0 million,
respectively related to a beneficial conversion feature. The resulting net loss
available to common shareholders was $1.2 million and $109.4 million for the
three and nine months ended September 30, 2003.
Basic and diluted earnings per share were a loss of $0.04 and $3.58 for the
quarter and nine months ended September 30, 2003, respectively. Because there
was a net loss available to common shareholders for the three and nine months
ended September 30, 2003, diluted earnings per share were anti-dilutive compared
to basic earnings per share. Diluted earnings per share cannot be greater (or
less of a loss) than basic earnings per share; therefore, basic and diluted
earnings per share reported for the three and nine months ended September 30,
2003 were the same. Basic and diluted earnings per share for the three months
ended September 30, 2002 were $0.84 and $0.83, respectively and basic and
diluted earnings per share for the nine months ended September 30, 2002 were
$2.01 and $1.96, respectively.
28
ADJUSTED AND PRO FORMA RESULTS
- ------------------------------
As a result of the SPA acquisition, our 2003 results are not comparable to our
previously reported 2002 results. Additionally, due to purchase accounting rules
that prevent us from recognizing deferred revenue and expenses associated with
directories that published prior to the acquisition, our reported 2003 results
are not indicative of our underlying operations and financial performance.
Accordingly, management is presenting adjusted results for 2003 that eliminate
the purchase accounting impacts on revenue and expenses and pro forma results
for 2002 that assume the acquisition and related financing occurred January 1,
2002. Management believes that the presentation of these adjusted and pro forma
results will help investors better and more easily compare 2003 underlying
operating results versus what the combined company performance would likely have
been in the comparable 2002 periods. However, while management believes that the
2002 pro forma amounts reasonably represent results as if the two businesses had
been combined as of January 1, 2002, because of differences in the application
of accounting policies between SPA and RHD, management does not believe the pro
forma 2002 amounts are strictly comparable to adjusted 2003 results on a
quarterly basis, particularly with respect to expenses.
amounts in millions Three months ended September 30,
---------------------------------------------------------
Reported Adjustments Adjusted
----------------- ----------------- ---- ----------------
2003
Net revenue................................. $ 89.3 $ 53.2 (1) $ 142.5
Operating expenses.......................... 39.7 12.7 (1) 52.4
General and administrative expenses......... 14.8 -- 14.8
Depreciation and amortization............... 16.6 -- 16.6
Partnership income.......................... 32.6 -- 32.6
----------------- ----------------- ---- ----------------
Operating income............................ $ 50.8 $ 40.5 $ 91.3
----------------- ----------------- ---- ----------------
Reported Adjustments Pro forma
----------------- ----------------- ---- ----------------
2002
Net revenue................................. $ 21.4 $ 120.9 (2) $ 142.3
Operating expenses.......................... 11.5 45.7 (3) 57.2
General and administrative expenses......... 3.1 6.8 (4) 9.9
Depreciation and amortization............... 1.6 14.6 (5) 16.2
Partnership income.......................... 40.8 (6.4) (6) 34.4
----------------- ----------------- ---- ----------------
Operating income............................ $ 46.0 $ 47.4 $ 93.4
----------------- ----------------- ---- ----------------
amounts in millions Nine months ended September 30,
---------------------------------------------------------
Reported Adjustments Adjusted
------------------ ---------------- ---- ----------------
2003
Net revenue................................. $ 140.4 $ 289.2 (1) $ 429.6
Operating expenses.......................... 106.5 58.7 (1) 165.2
General and administrative expenses......... 37.0 -- 37.0
Depreciation and amortization............... 49.1 -- 49.1
Partnership income.......................... 91.6 -- 91.6
------------------ ---------------- ---- ----------------
Operating (loss) income..................... $ 39.4 $ 230.5 $ 269.9
------------------ ---------------- ---- ----------------
Reported Adjustments Pro forma
------------------ ---------------- ---- ----------------
2002
Net revenue................................. $ 60.1 $ 369.3 (2) $ 429.4
Operating expenses.......................... 37.7 150.7 (3) 188.4
General and administrative expenses......... 12.5 16.5 (4) 29.0
Depreciation and amortization............... 4.7 43.9 (5) 48.6
Partnership income.......................... 108.8 (15.8) (6) 93.0
------------------ ---------------- ---- ----------------
Operating income............................ $ 114.0 $ 142.4 $ 256.4
------------------ ---------------- ---- ----------------
29
(1) Represents the net revenue and direct costs for directories published
prior to the acquisition that would have been recognized during the
period had it not been for purchase accounting adjustments required
under GAAP in accordance with RHD's accounting policies.
(2) Represents revenue recognized by SPA during the period less RHD
commission revenue and pre-press publishing revenue from SPA included
in the reported amounts. The RHD commission revenue and pre-press
publishing revenue would have been eliminated as intercompany revenue
had the acquisition occurred on January 1, 2002. Revenue recognized by
SPA for the quarter and nine months ended September 30, 2002 was $135.5
million and $409.3 million, respectively, and RHD commission revenue
and pre-press publishing revenue from SPA for the quarter and nine
months ended September 30, 2002 was $14.6 million and $40.0 million,
respectively.
(3) Represents operating expenses recognized by SPA during the period, net
of commission and pre-press publishing expenses for services provided
by RHD, plus an expense related to the amortization of a purchase
accounting adjustment recorded to increase acquired deferred directory
costs to fair value. The SPA commission and pre-press publishing
expenses for services provided by RHD would have been eliminated as
intercompany expenses had the acquisition occurred on January 1, 2002.
SPA expenses for the quarter and nine months ended September 30, 2002,
net of commission and pre-press publishing expenses for services
provided by RHD were $45.0 million and $142.5 million, respectively,
and the additional expense related to a required purchase accounting
adjustment for the quarter and nine months ended September 30, 2002 was
$0.7 million and $8.2 million, respectively.
(4) Represents general and administrative expenses recognized by SPA during
the period.
(5) Represents depreciation and amortization expense recognized by SPA for
the quarter and nine months ended September 30, 2002 of $2.2 million
and $6.5 million, respectively plus amortization expense for intangible
assets acquired in the acquisition assuming it occurred on January 1,
2002 of $12.4 million and $37.4 million for the quarter and nine months
ended September 30, 2002, respectively.
(6) Represents income from CenDon, LLC recognized by RHD and included in
reported amounts, which would have been eliminated as intercompany
income had the acquisition occurred on January 1, 2002.
Adjusted net revenue in the third quarter 2003 was $142.5 million, consistent
with pro forma revenue of $142.3 million in the third quarter of 2002. Adjusted
and pro forma net revenue for the nine months ended September 30, 2003 and 2002
were also consistent at $429.6 million and $429.4 million, respectively. The
flat revenue from the prior year periods is primarily due to the loss of
pre-press publishing revenue from the independent third-party publisher and the
deferred effect of publication cycle sales growth on revenue. Under the deferral
and amortization method of revenue recognition, revenue from directory
advertising sales are recognized ratably over the life of the directory, which
is typically twelve months. Accordingly, the slight increase in advertising
sales during 2003 is not immediately recognized in revenue.
Adjusted operating expenses in the third quarter 2003 were $52.4 million
compared to pro forma operating expenses of $57.2 million for the same period
last year. Adjusted operating expenses for the nine months ended September 30,
2003 were $165.2 million compared to pro forma operating expenses of $188.4
million for the nine months ended September 30, 2002. These decreases were
primarily attributable to lower bad debt expense for the three and nine months
ended September 30, 2003 of approximately $7 million and $14 million,
respectively, and lower print and paper costs for the three and nine months
ended September 30, 2003 of approximately $2 million and $8 million,
respectively. The reduction in bad debt expense is due to improvements in the
collection processes resulting in lower reserve rates on recently published
directories and a favorable adjustment in the third quarter of $6.5 million to
more properly reflect our best estimate of the allowance for bad debts. As a
result of continued improvements in our accounts receivable collection
processes, the estimated amount provided for bad debts for certain directories
exceeded the actual write-offs incurred for those directories. The reduction in
print and paper costs is due to lower paper prices and fewer pages in 2003
directories. Print and paper costs also benefited from a favorable adjustment of
$2.3 million in the third quarter 2003 and $3.4 million in the nine months ended
September 30, 2003 for certain directories as the ultimate cost was less than
the original estimated liability.
Adjusted general and administrative expenses in the third quarter 2003 were
$14.8 million compared to pro forma general and administrative expenses of $9.8
million in the third quarter 2002. Adjusted general and administrative expenses
for the nine months ended September 30, 2003 were $37.0 million compared to pro
forma general and administrative expenses of $29.0 million for the nine months
ended September 30, 2002. The increase in the 2003
30
periods was primarily due to restructuring costs of $5.0 million in the quarter
and $8.1 million through September 30, 2003 for the shutdown of one of our
pre-press publishing facilities in Tennessee and the relocation of corporate
headquarters to Raleigh, North Carolina.
Advertising Sales
Management utilizes publication sales as its primary sales performance measure.
Management believes that a comparison of publication sales for the same
directories from one period to another gives a better indication of underlying
sales trends, economic conditions and business confidence than a comparison of
directory revenue on a GAAP basis due to the deferral and amortization method.
Because directory revenue is recognized ratably over the life of a directory
under the deferral and amortization method, the amount of revenue recognized
during a period is not directly related to the sales trends, economic conditions
and business confidence during that period. Publication sales are comparable to
a "same-store" sales measure and are utilized and disclosed by many directory
publishers, thus facilitating comparison of sales performance between
publishers.
For the third quarter 2003, publication sales for the Donnelley segment were
$160.3 million, up 2.2% from publication sales of $156.8 million last year.
Through September 30, 2003, publication sales were $438.3 million, up 1.4% from
publication sales of $432.4 through September 30, 2002. The 2.2% increase in
publication sales in the quarter resulted from favorable sales performance in
two of our major markets, Las Vegas and southwest Florida. The year-to-date
increase was held down by weaker performance in several military markets due to
troop deployment in connection with the Iraqi conflict. Publication sales are a
non-GAAP measure and the most comparable GAAP measure related to the Donnelley
segment is net revenue. A reconciliation of publication sales to net revenue for
the Donnelley segment is presented below.
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------------- -------------------------------
amounts in millions 2003 2002 2003 2002
--------------- --------------- ---------------- --------------
Publication sales in the period.................. $ 160.3 $ 156.8 $ 438.3 $ 432.4
Less publication sales for January 2003 directories
not recognized as revenue due to purchase
accounting.................................... (102.4)
Less publication sales not recognized as revenue in
current period................................ (121.8) (271.1)
Less publication sales for SPA directories not sold
by RHD........................................ (106.4) (306.9)
Plus revenue recognized from prior period
publication sales............................. 45.5 55.9
--------------- --------------- ---------------- --------------
Publication sales reported by RHD in 2002........ 50.4 125.5
Less the value of executed sales contracts reported
as calendar sales in prior periods............ (49.7) (95.7)
Plus the value of sales contracts executed during
the period to be reported as publication sales in
future periods................................ 56.0 122.5
--------------- --------------
Calendar sales reported by RHD in 2002........... $ 56.7 $ 152.3
--------------- --------------
Net directory advertising revenue................ 84.0 120.7
Net commission revenue on 2002 calendar sales.... $ 13.0 $ 34.9
Pre-press publishing revenue..................... 4.6 8.4 17.6 25.2
Other revenue.................................... 0.7 -- 2.1 --
--------------- --------------- ---------------- --------------
Net revenue...................................... $ 89.3 $ 21.4 $ 140.4 $ 60.1
--------------- --------------- ---------------- --------------
Management also utilizes publication sales to evaluate the sales performance of
DonTech. Although partnership income from DonTech is not directly correlated to
DonTech publication sales, management believes that this measure provides a
better indication of underlying sales trends, economic conditions and business
confidence in the DonTech
31
markets than calendar sales or partnership income. Publication sales at DonTech
represent the annual billing value of the SBC directories published during the
period for which DonTech sells advertising. For the third quarter, publication
sales were $64.2 million, 3.7% lower than publication sales of $66.7 million in
the same period of 2002. For the nine month period ended September 30, 2003,
publication sales were $243.6 million, 3.1% lower than publication sales of
$251.4 million for the nine-month period ended September 30, 2002. These
declines reflect the weak economic conditions and business confidence in the
Midwest, as well as the impact of local media competition in the Chicago market.
Publication sales for DonTech are a non-GAAP measure and the most comparable
GAAP measure is partnership income. A reconciliation of DonTech publication
sales to calendar sales to partnership income is provided below.
Three months ended Nine months ended
September 30, September 30,
------------------------------ -------------------------------
amounts in million 2003 2002 2003 2002
-------------- --------------- --------------- ---------------
DonTech publication sales in the period.......... $ 64.2 $ 66.7 $ 243.6 $ 251.4
Less the value of executed sales contracts reported
as calendar sales in prior periods............ (62.6) (63.6) (235.7) (240.9)
Plus the value of sales contracts executed during the
period to be reported as publication sales in
future periods................................ 108.6 112.0 307.6 311.6
-------------- --------------- --------------- ---------------
DonTech calendar sales in the period............. $ 110.2 $ 115.1 $ 315.5 $ 322.1
-------------- --------------- --------------- ---------------
Commission revenue from above calendar sales..... $ 27.8 $ 29.1 $ 79.7 $ 81.3
Partnership net expenses......................... (15.7) (15.8) (47.6) (49.5)
-------------- --------------- --------------- ---------------
Partnership profit............................... $ 12.1 $ 13.3 $ 32.1 $ 31.8
-------------- --------------- --------------- ---------------
Company's 50% share of partnership profits....... $ 6.1 $ 6.6 $ 16.1 $ 15.9
Revenue participation income from SBC sales...... 26.5 27.8 75.5 77.1
-------------- --------------- --------------- ---------------
Total income from DonTech........................ 32.6 34.4 91.6 93.0
Priority distribution income from CenDon, LLC.... -- 6.4 -- 15.8
-------------- --------------- --------------- ---------------
Partnership income............................... $ 32.6 $ 40.8 $ 91.6 $ 108.8
-------------- --------------- --------------- ---------------
LIQUIDITY AND CAPITAL RESOURCES
In connection with the SPA acquisition, we entered into a $1,525 million Credit
Facility ("Credit Facility"), consisting of a $500 million Term Loan A, a $900
million Term Loan B and a $125 million Revolving Credit Facility (the
"Revolver") and issued $325 million 8 7/8% Senior Notes due 2010 ("Senior
Notes") and $600 million 10 7/8% Senior Subordinated Notes due 2012
("Subordinated Notes," and collectively with the Senior Notes, the "Notes").
These funds were used to acquire SPA, refinance existing debt and pay
transactions costs. Amounts outstanding prior to the acquisition under our
former senior secured term facilities of $114.2 million were refinanced and in
connection with a tender offer and exit consent solicitation, we repurchased
$128.8 million of the 9 1/8% Senior Subordinated Notes due 2008
("Pre-acquisition Notes").
Our primary source of liquidity is cash flows from operations as well as
available borrowing capacity under the Revolver. At September 30, 2003, there
were no outstanding borrowings under the Revolver. Our primary liquidity
requirements are to fund operating expenses and service our debt. Our primary
sources of cash flow consist mainly of cash receipts from the sale of
advertising in our Sprint Yellow Pages directories, revenue participation
payments from SBC and cash distributions from DonTech. These sources are
directly dependent on the value of yellow pages advertising sold and can be
impacted by, among other factors, general economic conditions, competition from
other yellow pages directory publishers and other alternative products, consumer
confidence and the level of demand for yellow pages advertising. We believe that
cash flow from operations, along with borrowing capacity under the Revolver,
will be adequate to fund our operations and meet our debt service requirements
for at least the next 12 to 24 months. However, we make no assurances that our
business will generate sufficient cash flow from operations or that
32
sufficient borrowing will be available under the Revolver to enable us to fund
our operations and meet all debt service requirements.
Cash flow from operations was $226.1 million for the nine months ended September
30, 2003 and $56.5 million for the same period in 2002. When we purchased SPA,
we acquired the rights to collect of over $250 million of accounts receivables
under advertising contracts executed prior to the SPA acquisition, but we did
not acquire the associated deferred revenue liability. As a result, the increase
in deferred revenue resulted in a source of cash of $217.4 million. Deferred
revenue represents the value of published directories that will be recognized as
revenue over the remaining life of the directories. Because we did not acquire
the pre-acquisition deferred revenue liability of SPA, we are not amortizing the
revenue associated with those directories that were published prior to the
acquisition (including all January 2003 directories). However, we continue to
bill and collect from advertisers the amounts due for directories published
prior to the acquisition in accordance with terms of the advertising contract.
The increase in other current assets resulted in a use of cash of $37.0 million
primarily due to payments made to sales persons and vendors for directories that
will publish at a later date. These payments are deferred until the directory is
published. Through September 30, 2003, we also made interest payments of $105.8
million for borrowings under our Credit Facility, the Notes and Pre-acquisition
Notes. In December 2003, we will make the required semi-annual interest payments
of approximately $48.0 on the Notes and Pre-acquisition Notes.
Cash used in investing activities was $373.2 million through September 30, 2003
and $2.5 million through September 30, 2002. In 2003, we paid $2,259.6 million
to acquire SPA and fund transaction costs, of which $1,825.0 million raised
prior to year-end 2002 was released from escrow in January 2003. Also prior to
year-end 2002, we issued $70 million of Preferred Stock to investment
partnerships affiliated with The Goldman Sachs Group, Inc. (collectively, the
"GS Funds"). The net proceeds of $69.3 million were reported as restricted cash
at year-end 2002. The remaining funds were obtained from additional borrowings
under the Credit Facility and the issuance of Preferred Stock at the closing
(see cash flow from financing activities below).
Cash provided by financing activities was $145.2 million through September 30,
2003 compared to cash used in financing activities of $58.8 million through
September 30, 2002. On January 3, 2003, we borrowed $500 million under the
Credit Facility and received net proceeds after issuance costs of $461.3
million. We also issued $130 million of Preferred Stock and received net
proceeds after issuance costs of $125.7 million. With the proceeds raised from
the issuance of debt and Preferred Stock, we refinanced pre-acquisition debt of
$243.0 million, which consisted of $114.2 million of variable rate bank debt and
$128.8 million of the Pre-acquisition Notes. Through September 30, 2003, we also
repaid $219.6 million of acquisition-related debt, net of $37.6 million of
borrowings under the Revolver and received $20.8 million from stock option
exercises. Cash used by financing activities through September 30, 2002
consisted of debt repayments of $62.5 million and $3.6 million received from
stock option exercises.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
---------------------------------------------------------
Risk Management
The Credit Facility bears interest at variable rates. Accordingly, our earnings
and cash flow are affected by changes in interest rates. To mitigate our
exposure to changes in interest rates, at September 30, 2003, we had interest
rate swap agreements with a total notional value of $255 million. These interest
rate swaps effectively convert $255 million of variable rate debt to fixed rate
debt. Under the terms of these swap agreements, we receive variable interest
based on three-month LIBOR and pay a fixed rate of 2.85%. The swaps mature on
March 31, 2007. The terms of the Credit Facility require that we maintain a
fixed interest rate or interest rate protection on at least 50% of our total
outstanding debt. At September 30, 2003, after the effect of the swaps, total
fixed rate debt comprised 57% of our total debt portfolio.
In October 2003, we executed an additional interest rate swap agreement with a
notional value of $150 million. Under the terms of this agreement, we receive
variable interest based on three-month LIBOR and pay a fixed rate of 1.959%.
This swap agreement matures October 9, 2005.
The outstanding interest rate swaps expose us to credit risk in the event that
the counterparties to the agreements do not or cannot meet their obligations.
The notional amount is used to measure interest to be paid or received and does
not represent the amount of exposure to credit loss. The loss would be limited
to the amount that would have been
33
received, if any, over the remaining life of the swap agreements. The
counterparties to the swaps are major financial institutions with a credit
rating of A or higher and we expect the counterparties to be able to perform
their obligations under the swaps. We use derivative financial instruments for
hedging purposes only and not for trading or speculative purposes.
Market Risk Sensitive Instruments
The swaps have been designated as cash flow hedges to hedge three-month
LIBOR-based interest payments on $255 million of bank debt. To the extent the
swaps provide an effective hedge, changes in the fair value of the swaps are
recorded in other comprehensive income, a component of shareholders' equity. Any
ineffectiveness is recorded through earnings. The fair value of the swaps was
determined based on quoted market prices. At September 30, 2003, the unrealized
fair value of the swaps, which represents the difference between what the
Company would pay to terminate the swaps, and the book value of the swaps, was a
loss of $2.6 million (a loss of $1.5 million after tax). The unrealized
after-tax fair value of the swaps was recognized in other comprehensive loss as
the cash flows from the swaps exactly offset the interest payments made on $255
million of bank debt.
The interest rate swap executed in October 2003 has also been designated as a
cash flow hedge to hedge three-month LIBOR-based interest payments on $150
million of bank debt. To the extent the swap provides an effective hedge,
changes in the fair value of the swap will be recorded in other comprehensive
income. Any ineffectiveness will be recorded through earnings.
Item 4. Controls and Procedures
-----------------------
(a) Evaluation of Disclosure Controls and Procedures. Based on their
evaluation, as of the end of the period covered by this Quarterly Report on
Form 10-Q, of the effectiveness of the Company's disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended), the principal executive
officer and principal financial officer of the Company have each concluded
that such disclosure controls and procedures are effective and sufficient
to ensure that information required to be disclosed by the Company in
reports that it files or submits under the Securities Exchange Act of 1934
is recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission's rules and forms.
(b) Changes in internal controls over financial reporting. There have not been
any changes in the Company's internal controls over financial reporting
identified in connection with the evaluation described in (a) above that
have materially affected, or are reasonably likely to materially affect the
Company's internal controls over financial reporting.
PART II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings
-----------------
We are involved in various legal proceedings arising in the ordinary course of
our business, as well as certain extraordinary litigation and tax matters
described below. We periodically assess our liabilities and contingencies in
connection with these matters based upon the latest information available to us.
For those matters where it is probable that we have incurred a loss and the loss
or range of loss can be reasonably estimated, we record reserves in our
consolidated financial statements. In other instances, we are unable to make a
reasonable estimate of any liability because of the uncertainties related to
both the probable outcome and amount or range of loss. As additional information
becomes available, we adjust our assessment and estimates of such liabilities
accordingly.
Based on our review of the latest information available, we believe our ultimate
liability in connection with pending legal proceedings, including the
extraordinary litigation and tax matters described below, will not have a
material adverse effect on our results of operations, cash flows or financial
position, as described further below.
34
In order to understand our potential exposure under the extraordinary litigation
and tax matters described below under the captions "Information Resources, Inc."
and "Tax Matters," one needs to understand the relationship between us and The
Dun & Bradstreet Corporation, and certain of its predecessors and affiliates
that, through various corporate reorganizations and contractual commitments,
have assumed varying degrees of responsibility with respect to such matters.
In November 1996, the company then known as The Dun & Bradstreet Corporation
("D&B1") separated (the "1996 Distribution") through a spin-off into three
separate public companies: D&B1, ACNielsen Corporation ("ACNielsen") and
Cognizant Corporation ("Cognizant"). In June 1998, D&B1 separated (the "1998
Distribution") through a spin-off into two separate public companies: D&B1,
which changed its name to R.H. Donnelley Corporation ("Donnelley"), and a new
company named The Dun & Bradstreet Corporation ("D&B2"). Later in 1998,
Cognizant separated (the "Cognizant Distribution") through a spin-off into two
separate public companies: IMS Health Incorporated ("IMS") and Nielsen Media
Research, Inc. ("NMR"). In September 2000, D&B2 separated (the "2000
Distribution") through a spin-off into two separate public companies: D&B2,
which changed its name to Moody's Corporation ("Moody's"), and a new company
named The Dun & Bradstreet Corporation ("D&B3," and together with D&B1 and D&B2,
also referred to elsewhere in this Quarterly Report on Form 10-Q as "D&B"). As a
result of the form of our separation from D&B, we are the corporate successor
of, and technically the defendant and taxpayer referred to below as D&B.
Rockland Yellow Pages
In 1999, Sandy Goldberg, Dellwood Publishing, Inc. and Rockland Yellow Pages
initiated a lawsuit against the Company and Bell Atlantic Corporation in the
United States District Court for the Southern District of New York. The Rockland
Yellow Pages is a proprietary directory that competes against a Bell Atlantic
directory in the same region, for which we served as Bell Atlantic's advertising
sales agent through June 30, 2000. The complaint alleged that the defendants
disseminated false information concerning the Rockland Yellow Pages, which
resulted in damages to the Rockland Yellow Pages. In May 2001, the District
Court dismissed substantially all of plaintiffs' claims, and in August 2001, the
remaining claims were either withdrawn by the plaintiffs or dismissed by the
District Court. The plaintiffs then filed a complaint against the same
defendants in New York State Supreme Court, in Rockland County, alleging
virtually the same state law tort claim previously dismissed by the District
Court and seeking unspecified damages. In October 2001, defendants filed a
motion to dismiss this complaint. In May 2002, the Court granted defendants'
motion to dismiss the complaint. Plaintiffs filed an appeal of this dismissal.
In April 2003, the Appellate Division dismissed all but one count of the
complaint, which count alleges immaterial compensatory damages with respect to
only one advertiser. Accordingly, we presently do not believe that the final
outcome of this matter will have a material adverse effect on our results of
operations or financial condition.
Information Resources, Inc.
In 1996, Information Resources, Inc. ("IRI"), filed a complaint in the United
States District Court for the Southern District of New York, naming as
defendants the Company, as successor of D&B, ACNielsen Company and IMS
International Inc., at the time of the filing, all wholly owned subsidiaries of
D&B. IRI alleges, among other things, various violations of the antitrust laws,
including alleged violations of Sections 1 and 2 of the Sherman Act. The
complaint also alleges a claim of tortious interference with a contract and a
claim of tortious interference with a prospective business relationship. These
claims relate to the acquisition by defendants of Survey Research Group Limited
("SRG"). IRI alleges SRG violated an alleged agreement with IRI when it agreed
to be acquired by the defendants and that the defendants induced SRG to breach
that agreement. IRI is seeking damages in excess of $350 million, which amount
IRI seeks to treble under antitrust laws. IRI is also seeking punitive damages
of an unspecified amount. No trial date has been set, and discovery is ongoing.
Under the agreements relating to the 1996 Distribution, Cognizant, AC Nielsen
and D&B agreed to conduct a joint defense and allocated liabilities amongst
themselves. Under the agreements relating to the 1998 Distribution, D&B assumed
the defense and agreed to indemnify us against any payments that we may be
required to make, including related legal fees. As required by those agreements,
Moody's Corporation, which subsequently separated from D&B in the 2000
Distribution, has agreed to be jointly and severally liable with D&B for the
indemnity obligation to us. At this stage in the proceedings, we are unable to
predict the outcome of this matter. While we cannot assure you as to any
outcome, management presently believes that D&B and Moody's have sufficient
financial resources, borrowing capacity and indemnity rights against IMS and NMR
(who succeeded to Cognizant's indemnity obligations under the Cognizant
Distribution) to reimburse us for any payments we may be required to make and
related costs we may incur in connection with this matter.
35
Tax Matters
D&B entered into global tax planning initiatives in the normal course of its
business, principally through tax-free restructurings of both their foreign and
domestic operations. The status of Internal Revenue Service ("IRS") reviews of
these initiatives is summarized below.
Pursuant to a series of agreements relating to the 1996, 1998, Cognizant and
2000 Distributions, IMS and NMR are jointly and severally liable for, and must
pay one-half, and D&B and Moody's are jointly and severally liable for, and must
pay the other half, of any payments over $137 million for taxes, accrued
interest and other amounts resulting from unfavorable IRS rulings on the tax
matters summarized below (other than the matter summarized below as
"Amortization Expense Deductions - 1997 - 2002," for which D&B and Moody's,
jointly and severally, are solely responsible). D&B, on our behalf, was
contractually obligated to pay, and did pay, the first $137 million of tax
liability in connection with the matter summarized below as "Utilization of
Capital Losses - 1989 - 1990." Under the agreements relating to the 1998
Distribution, D&B agreed to assume the defense and to indemnify us for any tax
liability that may be assessed against us and any related costs and expenses
that we may incur in connection with any of these tax matters. Also, as required
by those agreements, Moody's has agreed to be jointly and severally liable with
D&B for the indemnity obligation to us. Under the agreements relating to the
2000 Distribution, D&B and Moody's have, between each other, agreed to each be
financially responsible for 50% of any potential liabilities that may arise to
the extent such potential liabilities are not directly attributable to each
party's respective business operations.
While we cannot assure you as to any outcome in these matters, management
presently believes that D&B and Moody's have sufficient financial resources,
borrowing capacity and indemnity rights against IMS and NMR (who succeeded to
Cognizant's indemnity obligations under the Cognizant Distribution) to reimburse
us for any payments we may be required to make and related costs we may incur in
connection with these tax matters. We understand that D&B has reserved $100
million in its financial statements with respect to these matters.
Utilization of Capital Losses - 1989 - 1990
- -------------------------------------------
In 2000, D&B filed an amended tax return with respect to the utilization of
capital losses in 1989 and 1990 in response to a formal IRS assessment. The
amended tax return reflected an additional $561.6 million of tax and interest
due. In 2000, D&B paid the IRS $349.3 million while IMS (on behalf of itself and
NMR) paid $212.3 million to the IRS. We understand that these payments were made
under dispute in order to stop additional interest from accruing, that D&B is
contesting the IRS's formal assessment and would also contest the assessment of
amounts, if any, in excess of the amounts paid, and that D&B has filed a
petition for a refund in the United States District Court. This case is expected
to go to trial in 2004.
Subsequent to making its payment to the IRS in 2000, IMS sought to obtain
partial reimbursement from NMR under the terms of the agreements relating to the
Cognizant Distribution. NMR paid IMS less than IMS sought. Accordingly, in 2001,
IMS filed an arbitration proceeding against NMR claiming that NMR underpaid to
IMS its proper allocation of the above tax payments as provided by the
agreements relating to the Cognizant Distribution. Neither D&B nor we were party
to the Cognizant Distribution. IMS nonetheless sought to include us in this
arbitration, arguing that if NMR should prevail in its interpretation against
IMS, then IMS could seek to enforce the same interpretation against us (as
successor to D&B) under the agreements relating to the 1996 Distribution. The
arbitration panel ruled that we were a proper party to this arbitration
proceeding. In April 2003, the arbitration panel dismissed all claims against us
and found for IMS. If, on appeal of that ruling, NMR should prevail against IMS
and, in turn, IMS should prevail against us, then we believe that our additional
liability would be approximately $15 million, net of tax benefits. As noted
above, D&B and Moody's would be jointly and severally obligated to indemnify us
against any such additional liability and related costs.
We believe the fact that D&B and IMS have already paid the IRS a substantial
amount of additional taxes with respect to the contested tax planning strategies
significantly mitigates our risk. While no assurances can be given, we currently
believe that D&B and Moody's have sufficient financial resources, borrowing
capacity and indemnity rights against IMS and NMR to reimburse us for any
payments we may be required to make and related costs we may incur with respect
to this matter.
Royalty Expense Deductions - 1994 - 1996
- ----------------------------------------
During the second quarter of 2003, D&B received on our behalf an IRS agent's
examination report with respect to a
36
partnership transaction entered into by D&B in 1993. Specifically, the IRS is
disallowing certain royalty expense deductions claimed by D&B on its 1993
through 1996 tax returns. D&B estimates that the disallowance of the 1995 and
1996 royalty expense deductions would require payment of up to $43 million (tax,
interest and penalties, net of associated tax benefits).
Also in the second quarter of 2003, D&B received on behalf of the partnership
associated with the above transaction an IRS agent's examination report
challenging the tax treatment of certain royalty payments received by the
partnership in which D&B was a partner. The IRS is seeking to reallocate certain
partnership income to D&B. D&B's share of this income would require an
additional payment of $20 million (tax, interest and penalties, net of
associated tax benefits). We understand that D&B believes that this position is
inconsistent with the IRS' position with respect to the same royalty expense
deductions described above.
Again, under the agreements relating to the 1998 and 2000 Distributions, D&B and
Moody's have agreed to jointly and severally defend and indemnify us against any
such liabilities and related costs.
We understand that D&B has filed protests relating to these proposed adjustments
with the IRS Office of Appeals. If the IRS were to prevail in its position, D&B
would share responsibility for the matter with Moody's, IMS and NMR, as
disclosed above. If D&B were to challenge the assessment in U.S. District Court
rather than in U.S. Tax Court, the disputed amounts would need to be paid in
advance.
Amortization Expense Deductions - 1997 - 2002
- ---------------------------------------------
We understand that the IRS has sought certain documentation from D&B with
respect to a transaction entered into in 1997 that produces amortization expense
deductions for D&B. While we understand that D&B believes the deductions are
appropriate, the IRS could ultimately challenge them and issue an assessment. If
the IRS were to prevail or the assessment were to be challenged by us in U.S.
District Court, we understand that D&B estimates that its cash payment to the
IRS with respect to deductions claimed to date and including any potential
assessment of penalties could be up to $50 million , net of associated tax
benefits. This transaction is scheduled to expire in 2012 and, unless earlier
terminated by D&B, the cash exposure, based on current interest rates and tax
rates, would increase at a rate of approximately $2.1 million per quarter
(including potential penalties) as future amortization expenses are deducted.
Again, under the agreements relating to the 1998 and 2000 Distributions, D&B and
Moody's are required to jointly and severally indemnify us against any such
liability and related costs.
Conclusion
- ----------
As a result of our assessment of our exposure in these matters, especially in
light of our indemnity arrangements with D&B and Moody's, and their financial
resources, borrowing capacity and indemnity rights against IMS and NMR, no
material amounts have been accrued for in our consolidated financial statements
for any of these D&B-related litigation and tax matters.
Coastal Termite and Pest Control
In 2001, Marnan Group, Inc., doing business as Coastal Termite and Pest Control
("Coastal"), filed a complaint in the United States District Court for the
Middle District of Florida against SPA. The complaint, as amended, alleged that
SPA breached certain directory advertising contracts between 1996 and 1999,
fraudulently induced Coastal to enter into another directory advertising
contract and tortiously interfered with Coastal's business relationships with
its customers. Coastal is seeking damages for lost contract benefits, lost
profits and diminution of business value in an unspecified amount, including
pre-judgment interest. In January 2002, SPA filed a motion to dismiss certain of
Coastal's claims. In September 2002, the court denied SPA's motion to dismiss.
In October 2003, the parties settled this dispute and the matter has been
dismissed. The settlement would require the Company to pay an amount that will
not exceed the amount reserved in the Company's financial statements with
respect to this matter.
Other matters
We are also involved in other legal proceedings, claims and litigation arising
in the ordinary conduct of our business. Although we cannot assure you of any
outcome, management presently believes that the outcome of such legal
proceedings will not have a material adverse effect on our results of operations
or financial condition.
37
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit Document
No.
3.1 Certificate of Incorporation of the Company (incorporated by reference
to Exhibit 3.1 to the Quarterly Report on Form 10-Q for the three
months ended March 31, 1999, Commission File No. 001-07155)
3.2 By-laws of the Company (incorporated by reference to Exhibit 3.2 to
the Quarterly Report on Form 10-Q for the three months ended March 31,
1999, Commission File No. 001-07155)
3.3 Certificate of Incorporation of R.H. Donnelley Inc. (incorporated by
reference to Exhibit 3.3 to Amendment No. 1 to the Registration
Statement on Form S-4, filed with the Securities and Exchange
Commission on August 7, 1998, Registration No. 333-59287)
3.4 By-laws of R.H. Donnelley Inc. (incorporated by reference to Exhibit
3.4 to the Registration Statement on Form S-4, filed with the
Securities and Exchange Commission on July 17, 1998, Registration No.
333-59287)
3.5 Certificate of Designations of Convertible Cumulative Preferred Stock
of R.H. Donnelley Corporation (incorporated by reference to Exhibit
3.2 to the Current Report on Form 8-K, filed with the Securities and
Exchange Commission on January 17, 2003, Commission File No.
001-07155)
3.6 Certificate of Designations of Series B-1 Convertible Cumulative
Preferred Stock of R.H. Donnelley Corporation (incorporated by
reference to Exhibit 3.1 to the Current Report Form 8-K, filed with
the Securities and Exchange Commission on December 3, 2002, Commission
File No. 001-07155)
4.1 Indenture dated as of September 5, 1998 between R.H. Donnelley Inc.,
as Issuer, the Company, as Guarantor, and the Bank of New York, as
Trustee, with respect to the 9 1/8% Senior Subordinated Notes due 2008
(incorporated by reference to Exhibit 4.1 to the Registration
Statement on Form S-4, filed with the Securities and Exchange
Commission on July 17, 1998, Registration No. 333-59287)
4.2 Form of the 91/8% Senior Subordinated Notes due 2008 (included in
Exhibit 4.1)
4.3 Company Guarantee (included in Exhibit 4.1)
4.4 First Supplemental Indenture, dated as of November 25, 2002, among
R.H. Donnelley Inc., as Issuer, and R.H. Donnelley Corporation, R.H.
Donnelley Acquisitions, Inc., R.H. Donnelley APIL, Inc., R.H.
Donnelley CD, Inc. and Get Digital Smart.com, Inc., as Guarantors, and
the Bank of New York, as Trustee, with respect to the 9 1/8% Senior
Subordinated Notes due 2008 (incorporated by reference to Exhibit 4.1
to the Current Report on Form 8-K, filed with the Securities and
Exchange Commission on November 25, 2002, Commission File No.
001-07155)
38
Exhibit Document
No.
4.5 Second Supplemental Indenture, dated as of December 20, 2002, among
R.H. Donnelley Inc., as Issuer, and R.H. Donnelley Corporation, R.H.
Donnelley Acquisitions, Inc., R.H. Donnelley Acquisitions II, Inc.,
R.H. Donnelley APIL, Inc., R.H. Donnelley CD, Inc. and Get Digital
Smart.com, Inc., as Guarantors, and the Bank of New York, as Trustee,
with respect to the 9 1/8% Senior Subordinated Notes due 2008
(incorporated by reference to Exhibit 4.1 to the Current Report on
Form 8-K, filed with the Securities and Exchange Commission on
December 20, 2002, Commission File No. 001-07155)
4.6 Third Supplemental Indenture, dated as of December 20, 2002 (operative
as of January 3, 2003), among R.H. Donnelley Inc., as Issuer, and R.H.
Donnelley Corporation, R.H. Donnelley Acquisitions, Inc., R.H.
Donnelley Acquisitions II, Inc., R.H. Donnelley APIL, Inc., R.H.
Donnelley CD, Inc. and Get Digital Smart.com, Inc., as Guarantors, and
the Bank of New York, as Trustee, with respect to the 9 1/8% Senior
Subordinated Notes due 2008 (incorporated by reference to Exhibit 4.1
to the Current Report on Form 8-K, filed with the Securities and
Exchange Commission on January 6, 2003, Commission File No. 001-07155)
4.7 Indenture dated as of December 3, 2002 between R.H. Donnelley Inc. (as
successor to R.H. Donnelley Finance Corporation I), as Issuer, and the
Bank of New York, as Trustee, with respect to the 8 7/8% Senior Notes
due 2010 (incorporated by reference to Exhibit 4.13 to the Annual
Report on Form 10-K filed with the Securities and Exchange Commission
on March 20, 2003, Commission File No. 001-07155)
4.8 Supplemental Indenture dated as of January 3, 2003 among R.H.
Donnelley Inc., as Issuer, the Company and the other guarantors
signatory thereto, as Guarantors, and the Bank of New York, as
Trustee, with respect to the 8 7/8% Senior Notes due 2010
(incorporated by reference to Exhibit 4.14 to the Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March
20, 2003)
4.9 Form of 8 7/8% Senior Notes due 2010 (included in Exhibit 4.7)
4.10 Guarantees relating to the 8 7/8% Senior Notes due 2010 (incorporated
by reference to Exhibit 4.16 to the Annual Report on Form 10-K filed
with the Securities and Exchange Commission on March 20, 2003,
Commission File No. 001-07155)
4.11 Indenture dated as of December 3, 2002 between R.H. Donnelley Inc. (as
successor to R.H. Donnelley Finance Corporation I), as Issuer, and the
Bank of New York, as Trustee, with respect to the 10 7/8% Senior
Subordinated Notes due 2012 (incorporated by reference to Exhibit 4.17
to the Annual Report on Form 10-K filed with the Securities and
Exchange Commission on March 20, 2003, Commission File No. 001-07155)
4.12 Supplemental Indenture dated as of January 3, 2003 among R.H.
Donnelley Inc., as Issuer, the Company and the other guarantors
signatory thereto, as Guarantors, and the Bank of New York, as
Trustee, with respect to the 10 7/8% Senior Subordinated Notes due
2012 (incorporated by reference to Exhibit 4.18 to the Annual Report
on Form 10-K filed with the Securities and Exchange Commission on
March 20, 2003, Commission File No. 001-07155)
4.13 Form of 10 7/8% Senior Subordinated Notes due 2012 (included in
Exhibit 4.11)
4.14 Guarantees relating to the 10 7/8% Senior Subordinated Notes due 2012
(incorporated by reference to Exhibit 4.20 to the Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March
20, 2003, Commission File No. 001-07155)
39
Exhibit Document
No.
4.15 Registration Rights Agreement, dated as of December 3, 2002, by and
among R.H. Donnelley Inc. and Salomon Smith Barney, Bear, Stearns &
Co., Inc. and Deutsche Bank Securities Inc., as representatives of the
initial purchasers (incorporated by reference to Exhibit 4.15 to the
Registration Statement on Form S-3 filed with the SEC on July 31,
2003, Registration No. 333-104964)
4.16 Rights Agreement, dated as of October 27, 1998 between R.H. Donnelley
Corporation and First Chicago Trust Company (incorporated by reference
to Exhibit 4 to the Registration Statement on Form 8-A, filed with the
Securities and Exchange Commission on November 5, 1998, Registration
No. 001-07155)
4.17 Amendment No. 1 to Rights Agreement dated as of February 26, 2001 by
and among R.H. Donnelley Corporation, First Chicago Trust Company of
New York (as initial Rights Agent) and The Bank of New York (as
successor Rights Agent) (incorporated by reference to Exhibit 4.5 to
the Annual Report on Form 10-K for the year ended December 31, 2000,
Commission File No. 001-07155)
4.18 Amendment No. 2 to Rights Agreement, dated as of September 21, 2002,
between the Company and The Bank of New York, as successor Rights
Agent (incorporated by reference to Exhibit 4.1 to the Current Report
on Form 8-K, filed with the Securities and Exchange Commission on
October 1, 2002, Commission File No. 001-07155)
4.19 Form of Warrant Agreement, dated as of November 25, 2002, between the
Company and investment partnerships affiliated with The Goldman Sachs
Group, Inc. (incorporated by reference to Exhibit 4.1 to the Current
Report on Form 8-K, filed with the Securities and Exchange Commission
on January 17, 2003, Commission File No. 001-07155)
10.1 Form of Distribution Agreement between the Company (f/k/a The Dun &
Bradstreet Corporation) and The New Dun & Bradstreet Corporation
(incorporated by reference to Exhibit 99.2 to the Form 8-K of the
Company (f/k/a The Dun & Bradstreet Corporation), filed on September
30, 1998, Commission File No. 001-07155)
10.2 Form of Tax Allocation Agreement between the Company (f/k/a The Dun &
Bradstreet Corporation) and The New Dun & Bradstreet Corporation
(incorporated by reference to Exhibit 99.3 to the Form 8-K of the
Company (f/k/a The Dun & Bradstreet Corporation), filed on September
30, 1998, Commission File No. 001-07155)
10.3 Form of Employee Benefits Agreement between the Company (f/k/a The Dun
& Bradstreet Corporation) and The New Dun & Bradstreet Corporation
(incorporated by reference to Exhibit 99.4 to the Form 8-K of the
Company (f/k/a The Dun & Bradstreet Corporation), filed on September
30, 1998, Commission File No. 001-07155)
10.4 Form of Intellectual Property Agreement between the Company (f/k/a The
Dun & Bradstreet Corporation) and The New Dun & Bradstreet Corporation
(incorporated by reference to Exhibit 99.5 to the Form 8-K of the
Company (f/k/a The Dun & Bradstreet Corporation), filed on September
30, 1998, Commission File No. 001-07155)
10.5 Form of Amended and Restated Transition Services Agreement between the
Company (f/k/a The Dun & Bradstreet Corporation), The New Dun &
Bradstreet Corporation, Cognizant Corporation, IMS Health
Incorporated, ACNielsen Corporation and Gartner Group, Inc.
(incorporated by reference to Exhibit 99.9 to the Form 8-K of the
Company (f/k/a The Dun & Bradstreet Corporation), filed on September
30, 1998, Commission File No. 001-07155)
40
Exhibit Document
No.
10.6 Credit Agreement among the Company, R.H. Donnelley Inc., The Chase
Manhattan Bank, as Administrative Agent and the Lenders party thereto
(incorporated by reference to Exhibit 10.9 to the Registration
Statement on Form S-4, filed with the Securities and Exchange
Commission on July 17, 1998, Registration No. 333-59287)
10.7 First Amendment to Credit Agreement, dated as of March 4, 1999, among
the Company, R.H. Donnelley Inc., The Chase Manhattan Bank, as
Administrative Agent, and the Lenders party thereto (incorporated by
reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the
three months ended March 31, 1999, Commission File No. 001-07155)
10.8 DonTech II Partnership Agreement, effective August 19, 1997, by and
between R.H. Donnelley Inc. (f/k/a The Reuben H. Donnelley
Corporation) and Ameritech Publishing of Illinois, Inc. (incorporated
by reference to Exhibit 10.10 to Amendment No. 1 to the Registration
Statement on Form S-4, filed with the Securities and Exchange
Commission on August 7, 1998, Registration No. 333-59287)
10.9 Revenue Participation Agreement, dated as of August 19, 1997, by and
between APIL Partners Partnership and R.H. Donnelley Inc. (f/k/a The
Reuben H. Donnelley Corporation) (incorporated by reference to Exhibit
10.11 to Amendment No. 1 to the Registration Statement on Form S-4,
filed with the Securities and Exchange Commission on August 7, 1998,
Registration No. 333-59287)
10.10 Master Agreement, executed August 19, 1997, by and among R.H.
Donnelley Inc. (f/k/a The Reuben H. Donnelley Corporation), the
Company (f/k/a The Dun & Bradstreet Corporation), The Am-Don
Partnership a/k/a DonTech, DonTech II, Ameritech Publishing, Inc.,
Ameritech Publishing of Illinois, Inc., Ameritech Corporation, DonTech
I Publishing Company LLC and the APIL Partners Partnership
(incorporated by reference to Exhibit 10.12 to Amendment No. 1 to the
Registration Statement on Form S-4, filed with the Securities and
Exchange Commission on August 7, 1998, Registration No. 333-59287)
10.11 Exclusive Sales Agency Agreement, effective August 19, 1997, between
APIL Partners Partnership and DonTech II (incorporated by reference to
Exhibit 10.13 to Amendment No. 1 to the Registration Statement on Form
S-4, filed with the Securities and Exchange Commission on August 7,
1998, Registration No. 333-59287)
10.12 Second Amended and Restated Partnership Agreement, effective as of
August 19, 1997, by and between R.H. Donnelley Inc. (f/k/a The Reuben
H. Donnelley Corporation) and Ameritech Publishing of Illinois
(incorporated by reference to Exhibit 10.14 to Amendment No. 1 to the
Registration Statement on Form S-4, filed with the Securities and
Exchange Commission on August 7, 1998, Registration No. 333-59287)
10.13 Agreement for Publishing Services, dated as of January 1, 2002
between Ameritech Publishing Inc. and R.H. Donnelley Inc. (certain
portions of this exhibit have been omitted and filed separately with
the Securities and Exchange Commission pursuant to an Application for
an Order Granting Confidential Treatment) (incorporated by reference
to Exhibit 10.13 to the Company's Quarterly Report on Form 10-Q for
the three months ended March 31, 2002, Commission File No. 001-07155)
41
Exhibit Document
No.
10.14 Limited Liability Company Agreement of CenDon, L.L.C. dated April 27,
2000 between R.H. Donnelley Inc. and Centel Directory Company (certain
portions of this exhibit have been omitted and filed separately with
the Securities and Exchange Commission pursuant to an Application for
an Order Granting Confidential Treatment) (incorporated by reference
to Exhibit 10.14 to the Company's Quarterly Report on Form 10-Q for
the three months ended September 30, 2002, Commission File No.
001-07155)
10.15 Sales Agency Agreement dated April 27, 2000 among R.H. Donnelley
Inc., Centel Directory Company and CenDon, L.L.C. (incorporated by
reference to Exhibit 10.15 to the Company's Quarterly Report on Form
10-Q for the three months ended September 30, 2002, Commission File
No. 001-07155)
10.16 Agreement for Publishing Services dated April 27, 2000 between R.H.
Donnelley and CenDon, L.L.C. (certain portions of this exhibit have
been omitted and filed separately with the Securities and Exchange
Commission pursuant to an Application for an Order Granting
Confidential Treatment) (incorporated by reference to Exhibit 10.16 to
the Company's Quarterly Report on Form 10-Q for the three months ended
September 30, 2002, Commission File No. 001-07155)
10.17^ Key Employees' Performance Unit Plan, as amended and restated
(incorporated by reference to Exhibit 10.15 to Amendment No. 3 to the
Registration Statement on Form S-4, filed with the Securities and
Exchange Commission on September 28, 1998, Registration No. 333-59287)
10.18^ 1991 Key Employees' Stock Option Plan, as amended and restated
through April 25, 2000 (incorporated by reference to Exhibit 10.17 to
the Company's Quarterly Report on Form 10-Q for the three months ended
March 31, 2000, Commission File No. 001-07155)
10.19^ Amended and Restated 1998 Directors' Stock Plan (incorporated by
reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1999, Commission File No. 001-07155)
10.20^ Pension Benefit Equalization Plan (incorporated by reference to
Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2001, Commission File No. 001-07155)
10.21^ 2001 Stock Award and Incentive Plan (incorporated by reference to
Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2001, Commission File No. 001-07155)
10.22^ 2001 Partner Share Plan (incorporated by reference to Exhibit 99.1
to Registration Statement on Form S-8, filed with the Securities and
Exchange Commission on April 30, 2001, Registration No. 333-59790)
10.23^ Form of Non-Qualified Stock Option Agreement (incorporated by
reference to Exhibit 99.02 to Registration Statement on Form S-8,
filed with the Securities and Exchange Commission on July, 25, 2001,
Registration No. 333-65822)
10.24^ Form of Annual Incentive Program Award (incorporated by reference to
Exhibit 99.03 to Registration Statement on Form S-8, filed with the
Securities and Exchange Commission on July, 25, 2001, Registration No.
333-65822)
42
Exhibit Document
No.
10.25^ Form of Performance Unit Program Award (incorporated by reference to
Exhibit 99.04 to Registration Statement on Form S-8, filed with the
Securities and Exchange Commission on July, 25, 2001, Registration No.
333-65822)
10.26^ Deferred Compensation Plan (incorporated by reference to Exhibit
4.01 to the Company's Registration Statement on Form S-8, filed with
the Securities and Exchange Commission on November 24, 1999,
Registration No. 333-91613)
10.27^ Amended and Restated Employment Agreement dated as of December 27,
2001 between the Company and Frank R. Noonan (incorporated by
reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2001, Commission File No. 001-07155)
10.28^ Amended and Restated Employment Agreement dated as of December 27,
2001 between the Company and Philip C. Danford (incorporated by
reference to Exhibit 10.24 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2001, Commission File No. 001-07155)
10.29^ Employment Agreement effective as of May 1, 2002 between the Company
and David C. Swanson (incorporated by reference to Exhibit 10.29 to
the Company's Quarterly Report on Form 10-Q for the three months ended
September 30, 2002, Commission File No. 001-07155)
10.30^ Employment Agreement effective September 21, 2002 between the
Company and Peter J. McDonald (incorporated by reference to Exhibit
10.30 to the Company's Quarterly Report on Form 10-Q for the three
months ended September 30, 2002, Commission File No. 001-07155)
10.31^ Employment Agreement effective March 1, 2002 between the Company and
Steven M. Blondy (incorporated by reference to Exhibit 10.30 to the
Company's Quarterly Report on Form 10-Q for the three months ended
September 30, 2002, Commission File No. 001-07155)
10.32^ Employment Agreement dated as of September 28, 1998 between the
Company and Frank M. Colarusso (incorporated by reference to Exhibit
10.32 to the Annual Report on Form 10-K for the year ended December
31, 2000, Commission File No. 001-07155)
10.33^ Amendment No. 1 to Employment Agreement dated as of July 27, 2000
between the Company and Frank M. Colarusso (incorporated by reference
to Exhibit 10.33 to the Annual Report on Form 10-K for the year ended
December 31, 2000, Commission File No. 001-07155)
10.34^ Amendment No. 2 to Employment Agreement dated as of February 27,
2001 between the Company and Frank M. Colarusso (incorporated by
reference to Exhibit 10.34 to the Annual Report on Form 10-K for the
year ended December 31, 2000, Commission File No. 001-07155)
10.35^ Employment Agreement dated as of September 26, 2000 between the
Company and William C. Drexler (incorporated by reference to Exhibit
10.35 to the Annual Report on Form 10-K for the year ended December
31, 2000, Commission File No. 001-07155)
43
Exhibit Document
No.
10.36^ Amendment No. 1 to Employment Agreement dated as of February 27,
2001 between the Company and William C. Drexler (incorporated by
reference to Exhibit 10.36 to the Annual Report on Form 10-K for the
year ended December 31, 2000, Commission File No. 001-07155)
10.37^ Employment Agreement dated as of January 1, 2001 between the Company
and Robert J. Bush (incorporated by reference to Exhibit 10.37 to the
Annual Report on Form 10-K for the year ended December 31, 2000,
Commission File No. 001-07155)
10.38^ Amendment No. 1 to Employment Agreement dated as of February 27,
2001 between the Company and Robert J. Bush (incorporated by reference
to Exhibit 10.38 to the Annual Report on Form 10-K for the year ended
December 31, 2000, Commission File No. 001-07155)
10.39^ Separation Agreement and Release dated as of July 25, 2003 between
the Company and Frank M. Colarusso (incorporated by reference to
Exhibit 10.39 to the Company's Quarterly Report on Form 10-Q for the
three months ended June 30, 2003, Commission File No. 001-07155)
10.40 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
Current Report on Form 8-K dated October 1, 2002, Commission File No.
001-07155)
10.41 Preferred Stock and Warrant Purchase Agreement, dated as of September
21, 2002, among R.H. Donnelley Corporation and investment partnerships
affiliated with The Goldman Sachs Group, Inc. (incorporated by
reference to Exhibit 2.2 to the Current Report on Form 8-K dated
October 1, 2002, Commission File No. 001-07155)
10.42 Letter Agreement, dated as of November 25, 2002, among the Company,
R.H. Donnelley Inc. and investment partnerships affiliated with The
Goldman Sachs Group, Inc. (incorporated by reference to Exhibit 10.1
to Current Report on Form 8-K, filed with the Securities and Exchange
Commission on December 3, 2002, Commission File No. 001-0715)
10.43 Registration Rights Agreement, dated as of November 25, 2002, among
the Company and investment partnerships affiliated with The Goldman
Sachs Group, Inc. (incorporated by reference to Exhibit 10.2 to
Current Report on Form 8-K, filed with the Securities and Exchange
Commission on December 3, 2002, Commission File No. 001-07155)
10.44 Letter Agreement dated as of January 3, 2003 among the Company, R.H.
Donnelley Inc. and investment partnerships affiliated with The Goldman
Sachs Group, Inc. (incorporated by reference to Exhibit 10.8 to the
Current Report on Form 8-K, filed with the Securities and Exchange
Commission on January 17, 2003, Commission File No. 001-07155)
10.45 Letter Agreement, dated as of July 22, 2003, among the Company and
investment partnerships affiliated with The Goldman Sachs Group, Inc.
(incorporated by reference to Exhibit 10.39 to the Company's Quarterly
Report on Form 10-Q for the three months ended June 30, 2003,
Commission File No. 001-07155)
44
Exhibit Document
No.
10.46 Directory Services License Agreement, dated as of January 3, 2003, by
and among R.H. Donnelley Publishing & Advertising, Inc. (f/k/a Sprint
Publishing & Advertising, Inc.), CenDon L.L.C., R.H. Donnelley
Directory Company (f/k/a Centel Directory Company), Sprint
Corporation, Sprint Directory Trademark Company, LLC and the Sprint
Local Telecommunications Division (incorporated by reference to
Exhibit 10.1 to the Current Report on Form 8-K, filed with the
Securities and Exchange Commission on January 17, 2003, Commission
File No. 001-07155)
10.47 Trademark License Agreement, dated as of January 3, 2003, by and
among Sprint Directory Trademark Company, LLC, R.H. Donnelley
Publishing & Advertising, Inc. (f/k/a Sprint Publishing & Advertising,
Inc.), CenDon L.L.C. and R.H. Donnelley Directory Company (f/k/a
Centel Directory Company) (incorporated by reference to Exhibit 10.2
to the Current Report on Form 8-K, filed with the Securities and
Exchange Commission on January 17, 2003, Commission File No.
001-07155)
10.48 Publisher Trademark License Agreement, dated as of January 3, 2003,
by and among R.H. Donnelley Publishing & Advertising, Inc. (f/k/a
Sprint Publishing & Advertising, Inc.), R.H. Donnelley Directory
Company (f/k/a Centel Directory Company) and Sprint Corporation
(incorporated by reference to Exhibit 10.3 to the Current Report on
Form 8-K, filed with the Securities and Exchange Commission on January
17, 2003, Commission File No. 001-07155)
10.49 Non-Competition Agreement, dated as of January 3, 2003, by and among
the Company, R.H. Donnelley Publishing & Advertising, Inc. (f/k/a
Sprint Publishing & Advertising, Inc.), CenDon L.L.C., R.H. Donnelley
Directory Company (f/k/a Centel Directory Company), Sprint Corporation
and the Sprint Local Telecommunications Division (incorporated by
reference to Exhibit 10.4 to the Current Report on Form 8-K, filed
with the Securities and Exchange Commission on January 17, 2003,
Commission File No. 001-07155)
10.50 Subscriber Listings Agreement, dated as of January 3, 2003, by and
among R.H. Donnelley Publishing & Advertising, Inc. (f/k/a Sprint
Publishing & Advertising, Inc.), CenDon L.L.C., R.H. Donnelley
Directory Company (f/k/a Centel Directory Company), Sprint Corporation
and the Sprint Local Telecommunications Division (incorporated by
reference to Exhibit 10.5 to the Current Report on Form 8-K, filed
with the Securities and Exchange Commission on January 17, 2003,
Commission File No. 001-07155)
10.51 Credit Agreement, dated as of December 6, 2002, among the Company,
R.H. Donnelley Inc., R.H. Donnelley Finance Corporation II
(subsequently merged with and into R.H. Donnelley Inc.), the several
lenders from time to time party thereto, Bear Stearns Corporate
Lending Inc. and Citicorp North America, Inc., as joint syndication
agents, BNP Paribas and Fleet National Bank, as joint documentation
agents, Deutsche Bank Trust Company Americas, as administrative agent,
and Deutsche Bank Securities Inc., Salomon Smith Barney Inc. and Bear,
Stearns & Co. Inc., as joint lead arrangers and joint bookrunners
(incorporated by reference to Exhibit 10.10 to the Current Report on
Form 8-K, filed with the Securities and Exchange Commission on January
17, 2003, Commission File No. 001-07155)
21 Subsidiaries of the Company (incorporated by reference to Exhibit 21
to the Annual Report on Form 10-K for the year ended December 31,
2002, Commission File No. 001-07155)
45
Exhibit Document
No.
31.1* Certification of Quarterly Report on Form 10-Q for the period ended
September 30, 2003 under Section 302 of Sarbanes-Oxley Act by David C.
Swanson, Chief Executive Officer for R.H. Donnelley Corporation
31.2* Certification of Quarterly Report on Form 10-Q for the period ended
September 30, 2003 under Section 302 of Sarbanes-Oxley Act by Steven
M. Blondy, Senior Vice President and Chief Financial Officer for R.H.
Donnelley Corporation
31.3* Certification of Quarterly Report on Form 10-Q for the period ended
September 30, 2003 under Section 302 of Sarbanes-Oxley Act by David C.
Swanson, Chief Executive Officer for R.H. Donnelley Inc.
31.4* Certification of Quarterly Report on Form 10-Q for the period ended
September 30, 2003 under Section 302 of Sarbanes-Oxley Act by Steven
M. Blondy, Senior Vice President and Chief Financial Officer for R.H.
Donnelley Inc.
32.1* Certification of Quarterly Report on Form 10-Q for the period ended
September 30, 2003 under Section 906 of the Sarbanes-Oxley Act by
David C. Swanson, Chief Executive Officer and Steven M. Blondy, Senior
Vice President and Chief Financial Officer for R.H. Donnelley
Corporation
32.2* Certification of Quarterly Report on Form 10-Q for the period ended
September 30, 2003 under Section 906 of the Sarbanes-Oxley Act by
David C. Swanson, Chief Executive Officer and Steven M. Blondy, Senior
Vice President and Chief Financial Officer for R.H. Donnelley Inc.
* Filed herewith
^ Management contract or compensatory plan
(b) Reports on Form 8-K:
On October 29, 2003, the Company furnished a Current Report on Form 8-K
disclosing under Item 12 certain financial results of the Company for the three
and nine months ended September 30, 2003, and attached a copy of its related
press release as Exhibit 99.1.
On September 8, 2003, the Company furnished a Current Report on Form 8-K
disclosing under Item 9 that on September 9, 2003, certain members of senior
management of the Company were scheduled to make a presentation at a media
industry conference sponsored by Morgan Stanley. The Company attached a copy of
the slide presentation made at the conference as Exhibit 99.1.
On July 23, 2003, the Company furnished a Current Report on Form 8-K disclosing
under Item 9 (nominally, but substantively under Item 12) certain quarterly
publication cycle advertising sales and adjusted pro forma financial results for
each of the quarters ended March 31, 2002, June 30, 2002, September 30, 2002 and
December 31, 2002 that gave effect to the Company's acquisition of Sprint
Publishing & Advertising, assuming the acquisition occurred on January 1, 2002.
On July 23, 2003, the Company furnished a Current Report on Form 8-K disclosing
under Items 7 and 9 (nominally, but substantively under Item 12) certain
financial results of the Company for the three and six months ended June 30,
2003, and attached a copy of its related press release as Exhibit 99.1.
46
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
R.H. DONNELLEY CORPORATION
Date: November 13, 2003 By: /s/ Steven M. Blondy
--------------------
Steven M. Blondy
Senior Vice President and Chief
Financial Officer
Date: November 13, 2003 By: /s/ William C. Drexler
----------------------
William C. Drexler
Vice President and Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
R.H. DONNELLEY INC.
Date: November 13, 2003 By: /s/ Steven M. Blondy
--------------------
Steven M. Blondy
Senior Vice President and Chief
Financial Officer
Date: November 13, 2003 By: /s/ William C. Drexler
----------------------
William C. Drexler
Vice President and Controller
47
EXHIBIT INDEX
Exhibit
Number Document
- ------- --------
31.1* Certification of Quarterly Report on Form 10-Q for the period ended September 30, 2003 under
Section 302 of Sarbanes-Oxley Act by David C. Swanson, Chief Executive Officer for R.H. Donnelley
Corporation
31.2* Certification of Quarterly Report on Form 10-Q for the period ended September 30, 2003 under
Section 302 of Sarbanes-Oxley Act by Steven M. Blondy, Senior Vice President and Chief Financial
Officer for R.H. Donnelley Corporation
31.3* Certification of Quarterly Report on Form 10-Q for the period ended September 30, 2003 under
Section 302 of Sarbanes-Oxley Act by David C. Swanson, Chief Executive Officer for R.H. Donnelley Inc.
31.4* Certification of Quarterly Report on Form 10-Q for the period ended September 30, 2003 under
Section 302 of Sarbanes-Oxley Act by Steven M. Blondy, Senior Vice President and Chief Financial
Officer for R.H. Donnelley Inc.
32.1* Certification of Quarterly Report on Form 10-Q for the period ended September 30, 2003 by David C.
Swanson, Chief Executive Officer and Steven M. Blondy, Senior Vice President and Chief Financial
Officer for R.H. Donnelley Corporation
32.2* Certification of Quarterly Report on Form 10-Q for the period ended September 30, 2003 by David C.
Swanson, Chief Executive Officer and Steven M. Blondy, Senior Vice President and Chief Financial
Officer for R.H. Donnelley Inc.