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EXHIBIT 18
May 27, 1998
Mr. Xxx Xxxxx
Xxxxxxxxx Enterprise Solutions Inc.
000 X. Xxxxx Xxxxxx
00xx Xxxxx
Xxxxxxx, XX 00000
Dear Xxx:
Reference is made to the Tax Allocation and Indemnification Agreement
(the "Agreement") dated as of October 25, 1996, between X.X. Xxxxxxxxx & Sons
Company, a Delaware corporation ("RRD"), and Donnelley Enterprise Solutions
Incorporated, a Delaware corporation (the "Company"). This letter is intended to
document the procedures employed by RRD and the Company in settling certain tax
benefits and liabilities under the Agreement. Except as otherwise indicated, all
capitalized terms used herein have the same meaning as set forth in the
Agreement.
This letter deals solely with the tax deduction for earn-out payments
made in October, 1996 under the terms of the Merger Agreement (the "Merger
Agreement") between Lan Systems, Inc., Donnelley DBS, Inc. and RRD dated as of
May 29, 1995. Earn-out payments of $8.7 million due under the Merger Agreement
were deducted by the Company on its U.S. Corporate Income Tax return for the
period ending October 31, 1996, which deduction resulted in a tax benefit to RRD
in RRD's consolidated U.S. Corporate Income Tax return for calendar 1996.
Approximately 26.2% of the $8.7 million earn-out payment (or $2,282,500) was
made to employee non-shareholders of Lan Systems; the remaining payments were
made to employee shareholders. All employees, whether or not they were
shareholders, were issued Form 1099-MISC reporting these payments as "other
income". The Company deducted the payment of $8.7 million on its tax return, and
RRD received the benefit of this deduction. The Company treated the entire
deduction of $8.7 million as a "Schedule M" adjustment under which taxable
income was different than book income for the year of payment. RRD has estimated
that the deduction for the 26.2% of the earn-out payment made to employee
non-shareholders has a high probability of being successfully defended on audit
by the IRS. RRD has estimated a lower probability of success for the balance of
the deduction of the earn-out payment.
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Mr. Xxx Xxxxx
May 27, 1998
Page
RRD's traditional practice for allocating tax benefits and liabilities
among its consolidated subsidiaries would have provided a payment to the Company
for the losses it contributed to the RRD consolidated tax return. RRD and the
Company agreed to utilize this traditional practice in determining the amounts
owed from one party to another under the Agreement. As an interim settlement of
the 1996 tax return, RRD and the Company agreed in December, 1997 that RRD would
pay the Company for 26.2% of the benefit generated by the earn-out deduction at
a 41.5% tax rate ($947,237.50). No cash payment was made from RRD to the
Company; instead, the Company received the benefit of a credit of $947,237.50 in
settling intercompany liabilities between RRD and the Company. The balance of
the benefit of the deduction has been retained by RRD pending conclusion of the
IRS audit of the 1996 consolidated tax return. When the tax treatment of this
issue has been concluded with the IRS, a final allocation settlement with the
Company will be made. If the IRS allows a deduction for the earn-out payment in
excess of the 26.2% previously paid to the Company, then RRD will pay the
Company the tax benefit associated with the deduction less the benefits
previously paid. If the IRS allows an earn-out deduction less than the 26.2%
previously paid to DESI, then the Company will refund to RRD the proportionate
tax benefit previously paid to DESI and subsequently disallowed. Each of these
payments and refunds will be computed under the terms of the Agreement.
Signed
/s/ Xxxxxx X. Xxxxx /s/ Xxxxxx X. Xxxxxxx
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DESI RRD
Vice President & CFO Executive Vice President & CFO
