SULLIVAN GRAPHICS INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the fiscal year ended March 31, 1997

or

[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from __________ to
__________

Commission file number 33-97090

SULLIVAN COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)

Delaware 62-135968
(State or other jurisdiction of (I.R.S. employer identification number)
incorporation or organization)

225 High Ridge Road
Stamford, Connecticut 06905
(203) 977-8101

(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)

SULLIVAN GRAPHICS, INC.
(Exact name of registrant as specified in its charter)

New York 16-1003976
(State or other jurisdiction of (I.R.S. employer identification number)
incorporation or organization)

100 Winners Circle
Brentwood, Tennessee 37027
(615) 377-0377

(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___

Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants' knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X

Sullivan Communications, Inc. has 123,889 shares outstanding of its Common
Stock, $.01 Par Value, as of May 31, 1997 (all of which are privately owned and
not traded on a public market).

DOCUMENTS INCORPORATED BY REFERENCE
None

INDEX

Page
Referenced
Form 10-K
---------

PART I
ITEM 1. BUSINESS...................................................... 2
ITEM 2. PROPERTIES.................................................... 9
ITEM 3. LEGAL PROCEEDINGS............................................. 9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 9

PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................... 10
ITEM 6. SELECTED FINANCIAL DATA....................................... 10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .......................... 14
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 26
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................... 58

PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.............................. 58
ITEM 11. EXECUTIVE COMPENSATION........................................ 59
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................... 64
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 65

PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K...................................................... 67

SIGNATURES.................................................... 77

PART I

Special Note Regarding Forward Looking Statements

This Annual Report on Form 10-K (the "Report") contains forward-looking
statements within the meaning of Section 21E of the Securities Act of 1934.
Discussions containing such forward-looking statements may be found in Items 1,
3 and 7 hereof, as well as within this Report generally. In addition, when used
in this Report, the words "believes," "anticipates," "expects" and similar
expressions are intended to identify forward-looking statements. Such statements
are subject to a number of risks and uncertainties. Actual results in the future
could differ materially from those described in the forward-looking statements
as a result of many factors outside the control of Sullivan Communications, Inc.
("Communications"), together with its wholly-owned subsidiary, Sullivan
Graphics, Inc. ("Graphics"), collectively (the "Company"), including
fluctuations in the cost of paper and other raw materials used by the Company,
changes in the advertising and printing markets, actions by the Company's
competitors, particularly with respect to pricing, the financial condition of
the Company's customers, the financial condition and liquidity of the Company,
the general condition of the United States economy, demand for the Company's
products and services and the matters set forth in this Report generally.
Consequently, such forward- looking statements should be regarded solely as the
Company's current plans, estimates and beliefs. The Company does not undertake
and specifically declines any obligation to publicly release the results of any
revisions to these forward-looking statements that may be made to reflect any
future events or circumstances after the date of such statements or to reflect
the occurrence of anticipated or unanticipated events.

ITEM 1. BUSINESS

General

The Company is a successor to a business that commenced operations in
1926, and is one of the largest national diversified commercial printers in
North America with ten printing plants in eight states and Canada and fifteen
prepress facilities located throughout the United States. The Company operates
primarily in two business sectors of the commercial printing industry: printing
(which accounted for approximately 86% of total sales during the fiscal year
ended March 31, 1997 ("Fiscal Year 1997")) and digital imaging and prepress
services conducted through its American Color division (which accounted for
approximately 14% of total sales in Fiscal Year 1997). Partnerships affiliated
with Morgan Stanley, Dean Witter, Discover & Co. currently own 66.8% of the
outstanding common stock and 72% of the outstanding preferred stock of
Communications.

On April 8, 1993 (the "Acquisition Date"), pursuant to an Agreement and
Plan of Merger dated March 12, 1993, as amended (the "Merger Agreement"),
between Communications and SGI Acquisition Corp. ("Acquisition Corp."),
Acquisition Corp. was merged with and into Communications (the "1993
Acquisition"). Acquisition Corp. was formed by The Morgan Stanley Leveraged
Equity Fund II, L.P., certain institutional investors and certain members of
management (the "Purchasing Group") for the purpose of acquiring a majority
interest in Communications. Acquisition Corp. acquired a substantial and
controlling majority interest in Communications in exchange for $40 million in
cash. In the 1993 Acquisition, Communications continued as the surviving
corporation and the separate corporate existence of Acquisition Corp. was
terminated.

On August 15, 1995, the Company completed a merger transaction (the
"Shakopee Merger") with Shakopee Valley Printing Inc. ("Shakopee"). Shakopee was
formed to effect the purchase of certain assets and assumption of certain
liabilities of Shakopee Valley Printing, a division of Guy Gannett
Communications. On December 22, 1994, pursuant to an Agreement for the Purchase
of Assets between Guy Gannett Communications (the "Seller") and Shakopee (the
"Buyer"), the Seller agreed to sell (effective at the close of business on
December 22, 1994) certain assets and transfer certain liabilities of Shakopee
Valley Printing to the Buyer for a total purchase price of approximately $42.6
million, primarily financed through the issuance of 35,000 shares of common
stock and bank borrowings. The 35,000 shares were purchased by Morgan Stanley
Capital Partners III, L.P., Morgan Stanley

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Capital Investors, L.P. and MSCP III 892 Investors, L.P. (collectively, the
"MSCP III Entities"), together with First Plaza Group Trust and Leeway & Co. The
general partner of each of the MSCP III Entities is affiliated with Morgan
Stanley, Dean Witter, Discover & Co. In addition, the other stockholders of
Shakopee were also stockholders of the Company.

On March 11, 1996, Graphics sold its 51% interest in National Inserting
Systems, Inc. ("NIS") for approximately $2.5 million in cash and a note for
approximately $0.2 million. The proceeds from the sale were used to repay
indebtedness under the Bank Credit Agreement (as defined below).

On March 12, 1996, Graphics acquired the assets of Gowe, Inc., a
Medina, Ohio regional printer of newspapers, T.V. books and retail advertising
inserts and catalogs ("Gowe") for approximately $6.7 million in cash and
assumption of certain liabilities of Gowe, Inc. (the "Gowe Acquisition").

During March 1996, the Company completed the construction of and
start-up of a plant in Hanover, Pennsylvania ("Flexi-Tech"). Flexi-Tech is
dedicated to the production of commercial flexi books (a form of advertising
inserts) serving various segments of the retail advertising market and the
production of T.V. listing guides serving the newspaper market.

In February of Fiscal Year 1997, the Company made a strategic decision
to shut down the operations of its wholly-owned subsidiary Sullivan Media
Corporation ("SMC"). SMC's shut down has been accounted for as a discontinued
operation, and accordingly, SMC's operations are segregated in the Company's
consolidated financial statements. Sales, costs of sales and selling, general
and administrative expenses attributable to SMC for the fiscal year ended March
31, 1996 ("Fiscal Year 1996") and the fiscal year ended March 31, 1995 ("Fiscal
Year 1995") have been reclassified to discontinued operations. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Discontinued Operations" and note 5 of the Company's consolidated
financial statements.

Market data used throughout this report was obtained from industry
publications and internal Company estimates. While the Company believes such
information is reliable, the accuracy of such information has not been
independently verified and cannot be guaranteed.

Printing

The Company's printing business, which accounted for approximately 86%
of the Company's sales in Fiscal Year 1997, produces retail advertising inserts,
comics (newspaper Sunday comics, comic insert advertising and comic books), and
other publications.

Retail Advertising Inserts (80% of printing sales in Fiscal Year 1997).
The Company believes that it is one of the largest printers of retail
advertising inserts in the United States. Retail advertising inserts are
preprinted advertisements, generally in color, that display products sold by a
particular retailer or manufacturer. Advertising inserts are used extensively by
many retailers and are an important and cost effective means of advertising for
these merchants. Advertising inserts are primarily distributed through insertion
in newspapers but are also distributed by direct mail or in-store by retailers.
They generally advertise for a specific, limited sale period. The Company prints
advertising inserts for approximately 310 retailers.

Comics (14% of printing sales in Fiscal Year 1997). The Company
believes that it is one of the largest printers of comics in the United States.
The Company prints Sunday comics for approximately 330 newspapers in the United
States and Canada and prints the majority of the annual comic book requirements
of Marvel Entertainment Group, Inc. ("Marvel").

Other Publications (6% of printing sales in Fiscal Year 1997). The
Company prints local newspapers, T.V. guide listings and other publications.

3

Printing Production

There are three printing processes that may be used to produce
advertising inserts and newspaper supplements: offset lithography (heatset and
cold), rotogravure and flexography. The Company principally uses heatset offset
and flexographic web printing equipment in its printing business. The Company
owns the majority of its printing equipment, including, at May 31, 1997, 36 web
heatset offset presses, 13 flexographic presses and 5 multi-unit web coldset
offset presses. Most of the Company's advertising inserts and all of its other
publications and comic books are printed using the offset process. Some
advertising inserts and substantially all of the Company's newspaper Sunday
comics and comic insert advertising are printed using the flexographic process.

In the offset process, images are distinguished chemically from
non-image areas of a metal plate and transferred from the plate to a rubber
blanket and then to the paper surface; furthermore, in the heatset offset
process, the printed web goes through an oven which dries the solvents from the
ink, thereby setting the ink on the paper. In the cold offset process, the ink
solvents are absorbed into the paper. Because heatset offset presses can print
on a wide variety of papers and produce sharper reproductions, the heatset
offset process provides a more colorful and attractive product than cold offset
presses.

The flexographic process differs from offset printing in that it
utilizes flexible plates and rapid-drying, water-based (as opposed to
solvent-based) inks. The flexographic image area results from a raised surface
on a polymer plate which is transferred directly to the paper surface.
Flexography is used extensively in printing high quality consumer goods
packaging. The Company's flexographic printing generally provides vibrant color
reproduction at lower cost than heatset offset printing. The strengths of
flexography compared with the rotogravure and offset processes are faster press
set up times, brighter colors, reduced paper waste, reduced energy use and
maintenance costs, and environmental advantages due to the use of water-based
inks. Faster set up times make the process suited to commercial customers with
shorter runs and extensive regional versioning.

In addition to advertising insert capacity, certain equipment
parameters are critical to competing in the advertising insert market, including
cut-off length, folding capabilities and in-line finishing. Cut-off length is
one of the determinants of the size of the printed page. Folding capabilities
for advertising inserts must include a wide variety of page sizes, page counts
and special paper folding effects. Finally, many advertising inserts require
gluing or stitching of the product, adding cards, trimming and numbering. These
production activities generally are done in-line with the press to meet the
expedited delivery schedules and pricing required by many customers. The Company
believes that its mix and configuration of presses and press services allows for
efficient tailoring of printing services to customers' product needs.

American Color

The Company's digital imaging and prepress services business is
conducted by its American Color division, which the Company believes is one of
the largest full-service providers of digital imaging, prepress and color
separation services in the United States and a technological leader in its
industry. American Color commenced operations in 1975 and accounted for
approximately 14% of the Company's sales in Fiscal Year 1997. American Color
assists its customers in the capture, manipulation, transmission and
distribution of images. The majority of its work leads to the production of
four-color separations in a format appropriate for use by printers. In recent
years, technological advances have made it possible to replace largely manual
and photography-based production methods with computer-based, electronic means
for producing four-color films faster and at lower costs. American Color makes
page changes, including typesetting, and combines digital page layout
information with electronically scanned and color- corrected four-color images.
From these digital files; proofs, final corrections and, finally, four-color
films or digital output are produced for each advertising or editorial page. The
final four-color films or digital output enable printers to prepare plates for
each color resulting in the appearance of full color in the printed image.

American Color has been a leader in implementing these new
technologies, which has enabled American Color to reduce unit costs and
effectively service the increasingly complex demands of its customers more
quickly than many

4

of its competitors and has also resulted in an expanded customer base. In the
late 1980s, the Company installed a nationwide data communications network. This
was initially accomplished via a satellite system, but has been converted to a
telecommunications based network offering greater flexibility at a reduced cost.
This wide area network links American Color's locations with the Company's
printing operations, as well as to several customer sites. The system reduces
communication time and enables American Color to better serve those customers
with time-sensitive production requirements. This system also allows American
Color to utilize its offices in different locations to service business
generated in other areas, thereby improving customer service and response time
while increasing capacity utilization among its various facilities. In addition,
American Color has been one of the leaders in the integration of electronic page
make-up, microcomputer-based design and layout and digital cameras into prepress
production. The Company has capitalized on these technological changes and has
added additional revenue sources from digital image storage, telecommunications,
design and layout, consulting and training services, facilities management
(operating digital imaging and prepress service facilities at a customer
location), and software and data management.

The digital imaging and prepress services industry is highly
fragmented, primarily consisting of smaller local and regional companies, with
only a few national full-service digital imaging and prepress companies such as
American Color, none of which has a significant nationwide market share. Many
smaller digital imaging and prepress companies have left the industry in recent
years due to their inability to keep pace with technological advances in the
industry.

In April 1995, the Company implemented a plan for its American Color
division designed to improve productivity, increase customer service and
responsiveness, and provide increased growth in this business. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Restructuring Costs and Other Special Charges" and note 18 to the Company's
consolidated financial statements.

Competitive Advantages and Strategy

Competitive Advantages. The Company believes that it has the following
competitive advantages in its printing and digital imaging and prepress services
businesses:

Modern Equipment. The Company believes that its web heatset offset and
flexographic web printing equipment is among the most advanced in the industry
and that the average age of its equipment is significantly less than the
majority of its regional competitors and is comparable to its major national
competitors. The Company is also committed to a comprehensive, long-term
maintenance program which not only enhances the reliability of its production
equipment, but also extends the life of the machines. It also believes that its
digital imaging and prepress equipment is significantly more advanced than many
of its smaller regional competitors, many of whom have not incorporated digital
prepress technologies to the same extent as the Company, nor adopted an open
systems environment which allows greater flexibility and more efficient
maintenance.

Strong Customer Base. The Company provides printing services to a
diverse base of customers, including approximately 310 retailers and
approximately 330 newspapers in the United States and Canada. The customer base
includes a significant number of the major national retailers and larger
newspaper chains as well as numerous smaller regional retailers. The Company's
consistent focus on providing high quality printing products and strong customer
service at competitive prices has resulted in long-term relationships with many
of these customers. American Color's customer base includes large and
medium-sized customers in the retail, publishing and catalog businesses, many of
whom have long-term relationships with the Company. Although the digital imaging
and prepress services business has generally been on a spot bid basis in the
past, the Company has been successful in increasing the proportion of its
business under long-term contracts.

Competitive Cost Structure. The Company has reduced the variable and
fixed costs of production at its printing facilities over the last three years
and believes it is well positioned to maintain its competitive cost structure

5

in the future due to economies of scale. The Company has also reduced both labor
and material costs (the principal variable production costs) in its digital
imaging and prepress services business over the past several years, primarily
through the adoption of new digital prepress production methodologies.

Strong Management Team. Since the 1993 Acquisition, the Company has
strengthened its printing management group by hiring experienced managers with a
clear focus on growth and continued cost reduction, resulting in an improved
cost structure and a well-defined strategy for future expansion. The Company
also has strengthened its management group in its digital imaging and prepress
services business, filling a number of senior, regional and plant management
positions with individuals who the Company believes will manage the digital
imaging and prepress services business for growth and profitability and will
continue to upgrade its capabilities.

National Presence. The Company's nine printing plants in the United
States and one plant in Canada provide the Company with distribution
efficiencies, strong customer service, flexibility and short turnaround times,
all of which are instrumental in the Company's continued success in servicing
its large national and regional retail accounts. The Company's expanded sales
and marketing groups provide greater customer coverage and enable it to more
successfully penetrate regional markets. The Company believes that its fifteen
digital imaging and prepress facilities provide it with contingency
capabilities, increased capacity during peak periods, access to top quality
internal technical personnel throughout the country, short turnaround time and
other customer service advantages.

Strategy. The Company's objective is to increase profitability by
growing its revenues, increasing its market share and reducing costs. The
Company's strategy to achieve this objective is as follows:

Grow Unit Volume. Management believes that the Company's level of
national sales coverage, when coupled with its significant industry experience
and customer-focused sales force, will result in unit growth. In an effort to
stimulate unit volume growth, the Company has strengthened and expanded its
printing sales management group. Unit volume growth is also expected to result
from continued capital expansion and selective printing acquisitions. In
addition, in its digital imaging and prepress services business, the Company has
expanded its sales force, strengthened training, more closely focused its
marketing efforts on new, larger customers and implemented a revised incentive
program.

Continue to Improve Product Mix. The Company intends to increase its
share of the retail advertising insert market. In addition, the Company expects
to continue to adjust the mix of its customers and products within the retail
advertising insert market to those that are more profitable and less seasonable
and to maximize the use of the Company's equipment. The Company is also
continuing expansion of its printing facilities' capabilities for in-plant
prepress and postpress services. The Company's digital imaging and prepress
services business will continue to focus on high value-added new business
opportunities, particularly large-scale projects that will best utilize the
breadth of services and technologies the Company has to offer. Additionally, the
Company will continue to pursue large facilities management opportunities as
well as national and large regional customers that require more sophisticated
levels of service and technologies.

Continue to Reduce Manufacturing Costs and Improve Quality. The Company
intends to further reduce its production costs at its printing facilities
through its Total Quality Management Process, an ongoing cost reduction and
continuous quality improvement process. Additionally, the Company plans to
continue to maximize scale advantages in the purchasing, technology and
engineering areas. The Company also intends to continue to gain variable cost
efficiencies in its digital imaging and prepress services business by using its
technical resources to improve digital prepress workflows at its various
facilities. The Company also believes it will be able to reduce its per unit
technical, sales and management costs as its sales volumes increase in this
business.

Continue to Make Opportunistic Acquisitions. An integral part of the
Company's long-term growth strategy includes a plan to selectively assess and
acquire other printing and digital imaging and prepress services companies that
the Company believes will enhance its leadership position in these industries.

6

Customers and Distribution

Customers. The Company sells its printing products and services to a
large number of customers, primarily retailers and newspapers, and all of the
products are produced in accordance with customer specifications. The Company
performs a portion of its printing work, primarily the printing of Sunday comics
and comic books, under long-term contracts with its customers. The contracts
vary in length and many of the contracts automatically extend for one year
unless there has been notice to the contrary from either of the contracting
parties within a certain number of days before the end of any term. For the
balance of its printing work, the Company obtains varying time commitments from
its customers ranging from job to job to annual allocations. Printing prices are
generally fixed during such commitments; however, the Company's standard terms
of trade call for the pass through of changes in the cost of raw materials,
primarily paper and ink.

American Color's customers consist of retailers, magazine publishers,
newspaper publishers, printers, catalog sales organizations, advertising
agencies and direct mail advertisers. Its customers typically have a need for
high levels of technical expertise, short turnaround times and customer service.
In addition to its historical regional customer base, American Color is
increasingly focused on larger, national accounts that have a need for a broad
range of fully integrated services and communication capabilities requiring
leading edge technology. This includes an increasing amount of contractual
business related to facilities management arrangements with customers, which
contracts typically extend from three to five years in length.

The printing and American Color divisions have historically had certain
common customers and their ability to cross-market is an increasingly valuable
tool as desktop publishing, electronic digital imaging and facilities management
become more important to their customers. This enables the Company to provide
more comprehensive solutions to customers' digital imaging and prepress and
printing needs. New customers of either the printing or American Color divisions
often become customers of both businesses. During Fiscal Year 1997,
approximately 39% of the digital imaging and prepress sector's sales were to
customers of the Company's printing sector.

No single customer accounted for sales in excess of 10% of the
Company's consolidated sales in Fiscal Year 1997. The Company's top ten
customers accounted for approximately 35% of consolidated sales in Fiscal Year
1997.

Distribution. The Company distributes its printing products primarily
by truck to customer designated locations, primarily newspapers. Costs of
distribution are generally paid by the customers, and most shipping is by common
carrier. American Color generally distributes its products by courier or
overnight express, or other methods of personal delivery or electronic
transmission.

Competition

Commercial printing in the United States is a large, highly fragmented,
capital-intensive industry and the Company competes with numerous national,
regional and local printers. Customer preferences for larger printers with a
greater range of services and more flexibility, capital requirements and
competitive pricing pressures have led to a trend of industry consolidation in
recent years.

The Company believes that competition in the printing business is based
primarily on quality, customer service, price and timeliness of delivery. The
advertising insert business is a large, fragmented industry in which the Company
competes for national accounts with several large national printers, several of
whom are larger and better capitalized than the Company. In addition, the
Company also competes with numerous regional printers for the printing of
advertising inserts. Although the Company faces competition principally from one
other company (Big Flower Press Holdings, Inc.) in the printing of Sunday
newspaper comics in the United States, there are numerous newspapers that print
their own Sunday comics. The Company's other publication business competes with
many large national and regional commercial printers.

7

American Color competes with numerous digital imaging and prepress
service firms on both a national and regional basis. The industry is highly
fragmented, primarily consisting of smaller local and regional companies, with
only a few national full-service digital imaging and prepress companies such as
American Color, none of which has a significant nationwide market share. Many
smaller digital imaging and prepress companies have left the industry in recent
years due to their inability to keep pace with technological advances required
to service increasingly complex customer demands. The Company believes that the
digital imaging and prepress services sector will continue to be subject to high
levels of ongoing technological change and the need for capital expenditures to
keep up with such change.

Raw Materials

The primary raw materials used in the Company's printing business are
paper and ink. The Company purchases substantially all of its ink and related
products under a long-term ink supply contract between the Company and CPS Corp.
Throughout Fiscal Year 1995 and the majority of Fiscal Year 1996, the printing
industry experienced substantial increases in the cost of paper. In late Fiscal
Year 1996 and throughout Fiscal Year 1997, however, the overall cost of paper
declined. Management expects that as a result of the Company's strong
relationship with key suppliers that its material costs will remain competitive
within the industry. In accordance with industry practice, the Company generally
passes through increases in the cost of paper to its customers in the cost of
its printed products while decreases in costs generally result in lower prices
to customers. The primary inputs in prepress services processes are film and
proofing materials.

In both of the Company's business sectors, there is an adequate supply
of the necessary materials available from multiple vendors. The Company is not
dependent on any single supplier and has had no significant problems in the past
obtaining necessary materials.

Backlog

Because the Company's printing, digital imaging and prepress services
products are required to be delivered soon after final customer orders are
received, the Company does not experience any backlog of unfilled customer
orders.

Employees

As of April 30, 1997, the Company had a total of approximately 2,880
employees, of which approximately 200 employees are represented by a collective
bargaining agreement that will expire on December 31, 2001. The Company
considers its relations with its employees to be excellent.

Governmental and Environmental Regulations

The Company is subject to regulation under various federal, state and
local laws relating to employee safety and health, and to the generation,
storage, transportation, disposal and emission into the environment of hazardous
substances. The Company believes that it is in material compliance with such
laws and regulations. Although compliance with such laws and regulations in the
future is likely to entail additional capital expenditures, the Company does not
anticipate that such expenditures will be material. See "Legal Proceedings -
Environmental Matters."

8

ITEM 2. PROPERTIES

The Company operates in 25 locations in 15 states and Canada. The
Company owns seven printing plants in the United States and one in Canada and
leases two printing plants in California and Pennsylvania. The American Color
division of the Company has 15 production locations, 13 of which are leased by
American Color. The American Color division also operates digital imaging and
prepress facilities on the premises of several of its customers ("facilities
management"). In addition, the Company maintains one small executive and two
divisional headquarter facilities, two of which are leased and one which is
owned. The Company believes that its plants and facilities are adequately
equipped and maintained for present and planned operations.

ITEM 3. LEGAL PROCEEDINGS

The Company has been named as a defendant in several legal actions
arising from its normal business activities. In the opinion of management, any
liability that may arise from such actions will not have a material adverse
effect on the financial condition of the Company.

Environmental Matters

Graphics, together with over 300 other persons, has been designated by
the U.S. Environmental Protection Agency as a potentially responsible party (a
"PRP") under the Comprehensive Environmental Response Compensation and Liability
Act ("CERCLA," also known as "Superfund") at one Superfund site. Although
liability under CERCLA may be imposed on a joint and several basis and the
Company's ultimate liability is not precisely determinable, the PRPs have agreed
that Graphics' share of removal costs is approximately 0.46% and therefore
Graphics believes that its share of the anticipated remediation costs at such
site will not be material to its business or financial condition. Based upon an
analysis of Graphics' volumetric share of waste contributed to the site and the
agreement among the PRPs, the Company has a reserve of approximately $0.1
million in connection with this liability on its consolidated balance sheet at
March 31, 1997. The Company believes this amount is adequate to cover such
liability.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders of the
registrant during the fourth quarter of Fiscal Year 1997.

9

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

Market Information

There is no established public market for the common stock of either
Communications or Graphics.

Holders

There are approximately 89 shareholders of Communications' common
stock. Communications is the sole shareholder of Graphics' common stock.

Dividends

There have been no cash dividends declared on any class of common
equity for the two most recent fiscal years.

ITEM 6. SELECTED FINANCIAL DATA

Set forth below is selected financial data for and as of the year ended
December 31, 1992 (pre-1993 Acquisition), for and as of the three months ended
March 31, 1993 (pre-1993 Acquisition) and for and as of the fiscal years ended
March 31, 1994, 1995, 1996 and 1997 (post-1993 Acquisition). The balance sheet
data as of December 31, 1992 and March 31, 1993, 1994, 1995, 1996 and 1997 and
the statement of operations data for the year ended December 31, 1992, the three
months ended March 31, 1993, and the fiscal years ended March 31, 1994, 1995,
1996 and 1997 are derived from the audited consolidated financial statements for
such periods and at such dates. The selected financial data below also reflects
the Company's discontinued coupon free standing insert ("FSI") operation and
it's discontinued wholly-owned subsidiary, SMC. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Discontinued
Operations" and note 5 of the Company's consolidated financial statements. As a
result of the 1993 Acquisition, the Company's consolidated financial statements
for the periods subsequent to March 31, 1993 are presented on the Company's new
basis of accounting, while the consolidated financial statements for March 31,
1993 and December 31, 1992 are presented on the Company's historical cost basis
of accounting. The consolidated results of operations of the Company for the
fiscal years ended March 31, 1994, 1995, 1996 and 1997 are not directly
comparable to the consolidated pre-1993 Acquisition results of operations due to
the effects of the 1993 Acquisition.

In connection with the 1993 Acquisition, the Company elected to change
its fiscal year end from December 31 to March 31 beginning March 31, 1993 in
order to have the Company's fiscal year more closely match the Company's
operating cycle. This change was made on the effective date of the 1993
Acquisition; accordingly, the three-month period ended March 31, 1993
constituted a transition period.

This data should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the Company's
consolidated financial statements appearing elsewhere in this annual report.

10

SELECTED FINANCIAL DATA
SULLIVAN COMMUNICATIONS, INC.

Post-1993 Acquisition (a) Pre-1993 Acquisition (b)
-------------------------------------- ------------------------
Three
Months
Ended Year Ended
Fiscal Year Ended March 31, March 31, December 31,
--------------------------------------
1997 1996 1995(c) 1994 1993(d) 1992
---- ---- ------- ---- ------- ----

Statement of Operations Data: (dollars in thousands)
Sales $524,551 529,523 433,198 414,673 101,601 395,420
Cost of sales 459,880 465,110 370,267 369,520 95,078 357,831
-------- ------- ------- ------- ------- -------
Gross profit 64,671 64,413 62,931 45,153 6,523 37,589
Selling, general and administrative expenses (e) 51,418 44,164 41,792 39,343 10,047 40,661
Restructuring costs and other special charges (f) 2,881 7,533 -- -- -- --
Gain from curtailment and establishment of defined
benefit pension plans, net (g) -- -- (3,311) -- -- --
-------- ------- ------- ------- ------- -------
Operating income (loss) 10,372 12,716 24,450 5,810 (3,524) (3,072)
Interest expense, net 36,132 32,425 25,334 23,737 6,862 27,021
Other expense (income) 245 1,722 985 2,369 204 3,793
Income tax expense (benefit) 2,591 4,874 2,552 2,380 (3,848) (14,601)
-------- ------- ------- ------- ------- -------
Loss from continuing operations before extraordinary
items and cumulative effect of changes in
accounting principles (28,596) (26,305) (4,421) (22,676) (6,742) (19,285)
-------- ------- ------- ------- ------- -------
Discontinued operations: (h)
Loss from operations, net of tax (1,557) (1,364) (912) (23,272) (1,897) (3,689)
Estimated (loss) on shut down and gain on
settlement, net of tax (1,550) 2,868 18,495 (38,412) -- --
Loss on early extinguishment of debt (i) -- (4,526) -- -- -- --
Cumulative effect of changes in accounting principles,
net of tax (j) -- -- -- -- 646 (4,436)
-------- ------- ------- ------- ------- -------
Net (loss) income $(31,703) (29,327) 13,162 (84,360) (7,993) (27,410)
======== ======= ======= ======= ======= =======
Balance Sheet Data (at end of period):
Cash and cash equivalents $ 0 0 4,635 8,839 7,129 2,167
Working capital (deficit) (8,598) 9,612 4,958 6,956 (17,327) (4,138)
Total assets 333,975 351,181 328,368 305,521 274,812 271,219
Long-term debt and capitalized leases, including current
installments (k) 312,309 297,617 258,201 250,439 245,382 247,362
Stockholders' deficit (76,318) (44,396) (14,970) (45,485) (85,194) (77,762)
Other Data:
Net cash provided (used) by operating activities $ 24,313 (4,187) 30,510 (27,329) 11,437 11,831
Net cash used by investing activities (10,997) (24,436) (17,580) (1,332) (4,500) (10,144)
Net cash (used) provided by financing activities (13,312) 23,982 (17,527) 23,113 (1,980) (12,939)
Capital expenditures (including lease obligations entered into) 37,767 28,022 20,415 15,722 4,888 12,029
EBITDA (l) $ 46,972 46,847 51,719 33,068 4,080 34,517

11

NOTES TO SELECTED FINANCIAL DATA

(a) References to "post-1993 Acquisition" refer to the successor company that
resulted from the 1993 Acquisition. The 1993 Acquisition was accounted for
as a purchase. As a result of the 1993 Acquisition, Communications'
consolidated financial statements for the periods subsequent to March 31,
1993 are presented on Communications' new basis of accounting, while the
consolidated financial statements for March 31, 1993 and December 31, 1992
are presented on Communications' historical cost basis of accounting. The
consolidated results of operations of Communications for the post-1993
Acquisition periods are not directly comparable to the consolidated
pre-1993 Acquisition results of operations due to the effects of the 1993
Acquisition and related refinancing.

(b) References to "pre-1993 Acquisition" refer to the predecessor company that
existed before the 1993 Acquisition.

(c) On August 15, 1995, Shakopee was merged with and into Graphics. The merger
has been accounted for as a combination of entities under common control
(similar to a pooling-of-interests), and accordingly, the consolidated
financial statements give retroactive effect to the Shakopee Merger and
include the combined operations of Communications and Shakopee subsequent
to December 22, 1994 (the date on which Shakopee became under common
control with the Company). Shakopee's financial results are not reflected
in periods prior to December 22, 1994 as these periods were prior to
common control ownership.

(d) In connection with the 1993 Acquisition, the Company elected to change its
fiscal year end from December 31 to March 31 beginning March 31, 1993 in
order to have the Company's fiscal year more closely match the Company's
operating cycle. This change was made on the effective date of the 1993
Acquisition; accordingly, the three-month period ended March 31,1993
constituted a transition period.

(e) Fiscal Year 1997 selling, general and administrative expenses include $2.5
million of non-recurring employee termination expenses (including $1.9
million related to the resignation of the Company's Chief Executive
Officer--see note 20 to the Company's consolidated financial statements).

(f) In April 1995, the Company implemented a restructuring plan for its
American Color division which was designed to improve productivity,
increase customer service and responsiveness, and provide increased growth
in the business. The Company recognized $0.9 million and $4.1 million of
costs under such plan in Fiscal Year 1997 and Fiscal Year 1996,
respectively. In addition, the Company recorded $1.9 million and $3.4
million of other special charges related to asset write-offs and
write-downs in its Print and American Color divisions in Fiscal Year 1997
and Fiscal Year 1996, respectively (see note 18 to the Company's
consolidated financial statements).

(g) In October 1994, the Company amended its defined benefit pension plans,
which resulted in the freezing of additional defined benefits for future
services under the plans effective January 1, 1995. The Company recognized
a curtailment gain of $3.7 million as a result of freezing such benefits.
Also in October 1994, the Board of Directors approved a new Supplemental
Executive Retirement Plan ("SERP"), which is a defined benefit plan, for
certain key executives. The Company recognized a $0.4 million expense
associated with the establishment of the SERP.

(h) In February of Fiscal Year 1997, the Company made a strategic decision to
shut down the operation of its wholly-owned subsidiary SMC. SMC's shut
down has been accounted for as a discontinued operation, and accordingly,
SMC's operations are segregated in the Company's consolidated financial
statements. Sales, costs of sales and selling, general and administrative
expenses attributable to SMC for Fiscal Years 1997, 1996 and 1995 have
been reclassified to discontinued operations. See "Management's Discussion
and Analysis of Financial Condition and Results of
Operations--Discontinued Operations" and note 5 of the Company's
consolidated financial statements.

12

On February 16, 1994, the Company assigned the coupon FSI contracts of its
subsidiary, Sullivan Marketing, Inc. ("SMI"), to News America FSI, Inc.
("News America"). In June 1994, the Company recorded income from the
settlement of a lawsuit entitled Sullivan Marketing, Inc. and Sullivan
Graphics, Inc. v. Valassis Communications, Inc., News America FSI Inc. and
David Brandon (the "SMI Settlement") of $18.5 million, net of taxes, and
when coupled with settlement expenses which had previously been accrued,
the net cash proceeds resulting from this settlement were approximately
$16.7 million.

In Fiscal Year 1996, the Company recognized settlement of a complaint
naming SMI, News America and two packaged goods companies as defendants of
(the "EPI lawsuit") and reversed certain accruals related to the estimated
loss on shut down of SMI. The resulting effect reflected in the Fiscal
Year 1996 consolidated statement of operations was $2.9 million income in
discontinued operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Discontinued Operations"
and note 5 of the Company's consolidated financial statements.

(i) As part of the Shakopee Merger and the refinancing transactions (the
"Refinancing"), collectively (the "Transactions"), the Company recorded an
extraordinary loss related to early extinguishment of debt of $4.5
million, net of zero taxes. This extraordinary loss primarily consisted of
the early redemption premium on Graphics' 15% Senior Subordinated Notes
due 2000 (the "15% Notes") and the write-off of deferred financing costs
related to refinanced indebtedness partially offset by the write-off of a
bond premium associated with the 15% Notes.

(j) Effective January 1, 1993, the Company changed its method of accounting
for income taxes to Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" ("SFAS 109"). The cumulative effect of
adopting SFAS 109, as of January 1, 1993 was a decrease in net loss by
$0.6 million. In 1992, the Company elected to adopt the provisions of
Statement of Financial Accounting Standards No. 106, "Employers Accounting
for Postretirement Benefits Other Than Pensions." This resulted in a
charge to earnings net of related tax benefits of $4.4 million.

(k) The balance of long-term debt outstanding at March 31, 1995 and 1994
includes an additional $9.7 million and $11.3 million, respectively,
relating to a purchase accounting adjustment to the 15% Notes resulting
from the 1993 Acquisition. The principal amount payable at maturity of the
15% Notes remained at $100 million. The 15% Notes were redeemed in
connection with the Refinancing.

(l) EBITDA is included in the Selected Financial Data because management
believes that investors regard EBITDA as a key measure of a leveraged
company's performance and ability to meet its future debt service
requirements. EBITDA is defined as earnings before net interest expense,
income tax expense (benefit), depreciation, amortization, other special
charges related to asset write-offs and write-downs, other income
(expense), the cumulative effect of changes in accounting principles,
discontinued operations and extraordinary items. EBITDA is not a measure
of financial performance under generally accepted accounting principles
and should not be considered an alternative to net income (or any other
measure of performance under generally accepted accounting principles) as
a measure of performance or to cash flows from operating, investing or
financing activities as an indicator of cash flows or as a measure of
liquidity. Certain covenants in the Indenture dated as of August 15, 1995
(the "Indenture") and the Company's Credit Agreement with BT Commercial
Corporation (the "Bank Credit Agreement") are based on EBITDA, subject to
certain adjustments.

EBITDA includes non-recurring employee termination expenses of $2.5
million in Fiscal Year 1997 (including $1.9 million related to the
resignation of the Company's Chief Executive Officer - see note 20 to the
Company's consolidated financial statements).

13

EBITDA includes $0.9 million and $4.1 million of restructuring costs
related to its American Color division in Fiscal Year 1997 and Fiscal Year
1996, respectively (see note 18 to the Company's consolidated financial
statements).

EBITDA in Fiscal Year 1995 includes a $3.3 million net gain related to a
change in the Company's defined benefit pension plans (see note 11 to the
Company's consolidated financial statements).

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Overview

On August 15, 1995, Shakopee was merged with and into Graphics. The
merger has been accounted for as a combination of entities under common control
(similar to a pooling-of-interests), and accordingly, the consolidated financial
statements give retroactive effect to the Shakopee Merger and include the
combined operations of Communications and Shakopee subsequent to December 22,
1994 (the date on which Shakopee became under common control with the Company).
Shakopee's financial results are not reflected in periods prior to December 22,
1994 as these periods were prior to common control ownership. This affects the
comparability of the financial results after the date of common control with the
financial results prior to common control.

On March 11, 1996, the Company sold its 51% interest in NIS for
approximately $2.5 million in cash and a note for approximately $0.2 million.
This transaction resulted in a net gain on disposal of approximately $1.3
million, which is classified as other, net in the consolidated statement of
operations. The proceeds of the sale were used to repay indebtedness under the
Bank Credit Agreement.

On March 12, 1996, Graphics acquired the assets of Gowe, Inc., a
Medina, Ohio based regional printer of newspapers, T.V. books and retail
advertising inserts and catalogs for approximately $6.7 million in cash and
assumption of certain liabilities of Gowe, Inc. The Gowe Acquisition was
accounted for under the purchase method of accounting applying the provisions of
Accounting Principles Board Opinion No. 16 ("APB 16"). Pursuant to the
requirements of APB 16, the purchase price was allocated to the tangible assets
and identifiable intangible assets and liabilities assumed based upon their
respective fair values. Gowe's results of operations are included in the
Company's consolidated financial statements subsequent to March 11, 1996.

During March 1996, the Company completed the construction and start-up
of Flexi-Tech, a new plant in Hanover, Pennsylvania. Flexi-Tech is dedicated to
the production of commercial flexi books (a form of advertising inserts) serving
various segments of the retail advertising market and the production of T.V.
listing guides serving the newspaper market.

In Fiscal Year 1997, the Company began to present certain costs of its
American Color production facilities within cost of sales rather than as
selling, general and administrative expenses. This new presentation is
consistent with the Company's presentation of the printing sector's financial
information, and the Company believes that this is a more accurate measure of
the gross margin of the business. The financial information for Fiscal Year 1996
and Fiscal Year 1995 has been reclassified to conform with this presentation.

In February of Fiscal Year 1997, the Company made a strategic decision
to shut down the operations of its wholly-owned subsidiary SMC. SMC's shut down
has been accounted for as a discontinued operation, and accordingly, SMC's
operations are segregated in the Company's consolidated financial statements.
Sales, cost of sales and selling, general and administrative expenses
attributable to SMC for Fiscal Year 1996 and Fiscal Year 1995 have been
reclassified to discontinued operations.

14

Printing. In recent years, the Company has taken a number of steps
which have resulted in improved printing sector performance including the hiring
of several key managers in the manufacturing, purchasing, quality, technical
services, production planning and customer service departments (see "EBITDA" at
page 24). Comprehensive quality improvement and cost reduction programs have
also been implemented for all the Company's printing processes. As a result of
these measures, the Company has been successful in lowering its manufacturing
costs within the printing sector, while improving product quality.

Additionally, in order to grow sales and improve gross margins, the
Company increased the size, and geographic and industry scope of its sales force
and shifted the mix of its business toward retail customers and away from the
printing of certain lower margin publications. The Shakopee Merger, Gowe
Acquisition and Flexi-Tech operations (see "Business - Printing") are consistent
with the Company's overall strategy to continue to increase profitability by
growing its revenues, increasing its market share and reducing costs.

Commercial Printing in the United States is highly competitive. The
significant capital required to keep pace with changing technology and
competitive pricing trends has led to a trend of industry consolidation in
recent years. In addition, customers' preference for larger printers, such as
the Company, with a wider variety of services, greater distribution capabilities
and more flexibility have also contributed to consolidation within the industry.
The industry is expected to remain competitive in the near future and the
Company's sales will continue to be subject to changes in retailers' demands for
printed products.

The cost of paper is a principal factor in the Company's overall
pricing to its customers. The level of paper costs also has a significant impact
on the Company's reported sales. Beginning in Fiscal Year 1994 and throughout
Fiscal Year 1995 and the majority of Fiscal Year 1996, the paper industry
experienced increased demand and high capacity utilization in various grades of
paper. This led to a global tightening of the paper supply, and as a result, the
printing industry experienced substantial increases in the cost of paper. In
late Fiscal Year 1996 and throughout Fiscal Year 1997, the overall cost of paper
declined. In accordance with industry practice, the Company generally passes
through increases to its customers in the cost of its printed products while
decreases in costs generally result in lower prices to customers. Although the
Company has been successful in passing through paper price increases to its
customers in the past, significant increases in paper prices and continuing
price competition resulted in pressure by certain customers to reduce selling
prices and to reduce sizes/pages in order to mitigate the effect of increased
paper costs during these periods. In addition, there can be no assurances that
the Company will be able to pass through future paper price increases.

American Color. The digital imaging and prepress services industry has
experienced significant technological advances as electronic digital prepress
systems have replaced the largely manual and photography-based methods utilized
in the past. This shift in technology (which improved process efficiencies and
decreased processing costs) produced increased unit growth for American Color as
the demand for color pages increased. However, American Color's selling price
levels per page have declined because of greater efficiencies resulting from
increased use of technology. American Color's revenue from traditional services
are now supplemented by new revenue sources from electronic digital imaging and
prepress services such as digital image storage, facilities management,
telecommunications, design and layout, consulting and training services.

In April 1995, the Company implemented a plan for its American Color
division which was designed to improve productivity, increase customer service
and responsiveness, and provide increased growth in this business. The cost of
this plan was accounted for in accordance with the guidelines set forth in
Emerging Issues Task Force Issue 94-3 "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)" ("EITF 94-3") (see "Restructuring
Costs and Other Special Charges" below).

15

The following table summarizes the Company's historical results of
continuing operations for Fiscal Year 1997, 1996 and 1995.

Fiscal Year Ended March 31,
----------------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
Sales:
Printing $ 449,924 $ 453,381 $ 353,123
American Color 74,627 72,461 76,070
Other (a) -- 3,681 4,005
--------- --------- ---------
Total $ 524,551 $ 529,523 $ 433,198
========= ========= =========

Gross Profit:
Printing $ 49,469 $ 49,015 $ 43,212
American Color 15,133 13,687 17,936
Other (a) 69 1,711 1,783
--------- --------- ---------
Total $ 64,671 $ 64,413 $ 62,931
========= ========= =========

Gross Margin:
Printing 11.0% 10.8% 12.2%
American Color 20.3% 18.9% 23.6%
Total 12.3% 12.2% 14.5%

Operating Income (Loss):
Printing (b) $ 25,858 $ 28,239 $ 24,683
American Color (b) (c) (1,576) (3,975) 7,855
Other (a) (d) (13,910)(f) (11,548) (8,088)(e)
--------- --------- ---------
Total $ 10,372 $ 12,716 $ 24,450
========= ========= =========

- ----------
(a) Other operations in Fiscal Year 1996 and Fiscal Year 1995 include
revenues and expenses associated with the Company's 51% owned
subsidiary, NIS (sold on March 11, 1996, see note 4 to the Company's
consolidated financial statements).
(b) Printing operating income includes the impact of $0.4 million and $2
million in Fiscal Year 1997 and 1996, respectively, of other special
charges related to fixed asset write-offs and write-downs. American
Color's operating loss includes the impact of $1.5 million and $1.4
million in Fiscal Year 1997 and 1996, respectively, of other special
charges related to fixed asset write-offs and write-downs (see note 18
to the Company's consolidated financial statements).
(c) Includes the impact of restructuring costs of $0.9 million in Fiscal
Year 1997 and $4.1 million in Fiscal Year 1996 (see note 18 to the
Company's consolidated financial statements).
(d) Also includes corporate selling, general and administrative expenses,
and amortization expense.
(e) Includes the net gain of $3.3 million in Fiscal Year 1995 from the
curtailment and establishment of defined benefit pension plans (see
discussion below).
(f) Also reflects non-recurring employee termination expenses of $2.5
million in Fiscal Year 1997 (including $1.9 million related to the
resignation of the Company's Chief Executive Officer-see note 20 to the
Company's consolidated financial statements).

16

Historical Results of Operations

Fiscal Year 1997 vs. Fiscal Year 1996

The Company's sales decreased 0.9% to $524.6 million in Fiscal Year
1997 from $529.5 million in Fiscal Year 1996. This decrease includes a decrease
in printing sales of $3.5 million, or 0.8%, an increase in American Color sales
of $2.2 million, or 3%, and a $3.7 million decrease in other sales. The
Company's gross profit increased to $64.7 million or 12.3% of sales in Fiscal
Year 1997 from $64.4 million or 12.2% of sales in Fiscal Year 1996. The
Company's operating income decreased to $10.4 million or 2% of sales in Fiscal
Year 1997 from $12.7 million or 2.4% of sales in Fiscal Year 1996. See the
discussion of these changes by sector below.

Printing

Sales. Printing sales decreased to $449.9 million in Fiscal Year 1997
from $453.4 million in Fiscal Year 1996. This decrease includes a decrease in
paper prices and the effect of an increase in customer supplied paper. These
decreases were partially offset by $46.2 million of incremental sales from Gowe
and Flexi-Tech and an increase in production volume of approximately 3%
(excluding Gowe and Flexi-Tech).

Gross Profit. Printing gross profit increased $0.5 million, or 0.9%, to
$49.5 million in Fiscal Year 1997 from $49 million in Fiscal Year 1996. Printing
gross margin increased to 11% in Fiscal Year 1997 from 10.8% in Fiscal Year
1996. The increase in gross profit primarily reflects incremental gross profit
from Gowe and an increase in production volume. In addition, the gross profit
improvement includes reduced variable production and certain other manufacturing
costs due to continued cost containment programs at the printing plants. These
gains were partially offset by an increase in depreciation expense, a reduction
in the price of scrap paper and incremental costs related to the start-up of
Flexi-Tech. The increase in gross margin as a percentage of sales is due
primarily to the impact of the above described items and the impact of lower
paper prices on sales in Fiscal Year 1997.

Selling, General and Administrative Expenses. Printing selling, general
and administrative expenses increased 23.2% to $23.1 million, or 5.1% of
printing sales, in Fiscal Year 1997 from $18.8 million, or 4.1% of printing
sales, in Fiscal Year 1996. The increase in Fiscal Year 1997 was primarily the
result of increased sales and marketing expenses and incremental selling,
general and administrative costs at Gowe and Flexi-Tech.

Operating Income. As a result of the above factors and the incurrence
of other special charges related to fixed asset write-offs and write-downs of
$0.4 million and $2 million in Fiscal Year 1997 and 1996, respectively (see
"Restructuring Costs and Other Special Charges" below), operating income from
the printing business decreased to $25.9 million in Fiscal Year 1997 from $28.2
million in Fiscal Year 1996.

American Color

Sales. American Color's sales increased 3% to $74.6 million in Fiscal
Year 1997 from $72.5 million in Fiscal Year 1996. The increase in Fiscal Year
1997 was primarily the result of higher digital imaging and prepress production
volume due to American Color's implementation of various digital prepress
technologies, including facilities management and software and image management
services and increases in digital visual effects work partially offset by lower
equipment sales.

Gross Profit. American Color's gross profit increased $1.4 million to
$15.1 million in Fiscal Year 1997 from $13.7 million in Fiscal Year 1996.
American Color's gross margin was 20.3% in Fiscal Year 1997, up from 18.9% in
Fiscal Year 1996. These increases were primarily the result of increased volume
and material cost savings offset in part by increased facilities management
costs.

17

Selling, General and Administrative Expenses. American Color's selling,
general and administrative expenses increased 18% to $14.3 million or 19.2% of
American Color sales in Fiscal Year 1997 from $12.1 million or 16.7% of American
Color sales in Fiscal Year 1996, primarily as a result of the addition of sales
and marketing and administrative support personnel and related expenses,
including expenses related to its digital visual effects group.

Operating Loss. As a result of the above factors and the restructuring
costs associated with the American Color restructuring plan of $0.9 million in
Fiscal Year 1997 and $4.1 million in Fiscal Year 1996 and the incurrence of
other special charges related to fixed asset write-offs and write-downs of $1.5
million and $1.4 million in Fiscal Year 1997 and 1996, respectively (see
"Restructuring Costs and Other Special Charges" below), operating loss at
American Color decreased to $1.6 million in Fiscal Year 1997 from $4 million in
Fiscal Year 1996.

Fiscal Year 1996 vs. Fiscal Year 1995

The Company's sales increased $96.3 million to $529.5 million in Fiscal
Year 1996 from $433.2 million in Fiscal Year 1995, reflecting a $100.3 million
increase in printing sales, a $3.6 million decrease in American Color sales and
a $0.3 million decrease in other sales. The Company's gross profit increased to
$64.4 million or 12.2% of sales in Fiscal Year 1996 from $62.9 million or 14.5%
of sales in Fiscal Year 1995. The Company's operating income decreased to $12.7
million or 2.4% of sales in Fiscal Year 1996 from $24.5 million or 5.6% of sales
in Fiscal Year 1995. See the discussion of these changes by sector below.

Printing

Sales. Printing sales increased $100.3 million to $453.4 million in
Fiscal Year 1996 from $353.1 million in Fiscal Year 1995. This increase includes
$53.8 million of increased sales by Shakopee. In addition, the increase in sales
includes the impact of increased paper prices and a slight increase in overall
production volume (excluding Shakopee). These increases were partially offset by
an increase in sales to customers that supply their own paper and the impact of
continued competitive pricing pressure. Production volume is primarily dependent
on economic activity in general and the level of advertising by retailers in
particular. In the last quarter of Fiscal Year 1996, the Company experienced
lower than expected production volume and a higher level of price competition
than anticipated as a result of a weak retail environment in the last quarter of
calendar year 1995.

Gross Profit. Printing gross profit increased $5.8 million to $49
million in Fiscal Year 1996 from $43.2 million in Fiscal Year 1995. Printing
gross margin decreased to 10.8% in Fiscal Year 1996 from 12.2% in Fiscal Year
1995. The increase in gross profit primarily reflects incremental gross profit
from Shakopee. In addition, the gross profit improvement includes reduced
variable production and certain other manufacturing costs due to continued cost
containment programs at the printing plants. These gains were partially offset
by continued competitive pricing pressure. The decrease in gross margin as a
percentage of sales is due primarily to the impact of increased paper prices.

Selling, General and Administrative Expenses. Printing selling, general
and administrative expenses increased to $18.8 million or 4.1% of printing sales
in Fiscal Year 1996 from $18.5 million or 5.2% of printing sales in Fiscal Year
1995. This increase includes incremental Shakopee expenses and additional
administrative support expenses offset in part by a reduction in certain
employee related costs.

Operating Income. As a result of these factors, and the incurrence of
other special charges related to fixed asset write-offs and write-downs of $2
million in Fiscal Year 1996 (see "Restructuring Costs and Other Special Charges"
below), operating income from the printing business increased to $28.2 million
in Fiscal Year 1996 from $24.7 million in Fiscal Year 1995.

18

American Color

Sales. American Color's sales decreased $3.6 million to $72.5 million
in Fiscal Year 1996 from $76.1 million in Fiscal Year 1995. The decrease is
primarily the result of decreased selling prices and lower prepress production
volume due in part to American Color's restructuring efforts during Fiscal Year
1996 (see note 18 to the Company's consolidated financial statements).

Gross Profit. American Color's gross profit decreased $4.2 million to
$13.7 million in Fiscal Year 1996 from $17.9 million in Fiscal Year 1995.
American Color's gross margin decreased to 18.9% in Fiscal Year 1996 from 23.6%
in Fiscal Year 1995. These decreases in Fiscal Year 1996 are primarily the
result of decreases in both prepress production volume and selling prices, as
well as increased depreciation expense.

Selling, General and Administrative Expenses. American Color's selling,
general and administrative expenses increased to $12.1 million or 16.7% of
American Color's sales in Fiscal Year 1996 from $10.1 million or 13.3% of
American Color's sales in Fiscal Year 1995. These increases are a result of
increased sales and marketing expenses and additional administrative support
personnel.

Operating Income (Loss). As a result of these factors and the
incurrence of $4.1 million of restructuring costs related primarily to employee
termination and other expenses associated with the American Color restructuring
plan and other special charges related to fixed asset write-downs of $1.4
million (see "Restructuring Costs and Other Special Charges" below), operating
income at American Color decreased to a loss of $4 million in Fiscal Year 1996
from income of $7.9 million in Fiscal Year 1995.

Other Operations (Fiscal Year 1997 vs. Fiscal Year 1996 and Fiscal Year 1996
vs. Fiscal Year 1995)

Other operations consist primarily of revenues and expenses associated
with the Company's 51% owned subsidiary, NIS (sold on March 11, 1996), corporate
selling, general and administrative expenses, other expenses and amortization
expense. Amortization expenses for other operations, including goodwill
amortization (see below), were $8.4 million, $8.7 million and $8.4 million in
Fiscal Year 1997, 1996 and 1995, respectively.

Operating losses from other operations increased $2.4 million to a loss
of $13.9 million in Fiscal Year 1997 from a loss of $11.5 million in Fiscal Year
1996. This increase primarily reflects non-recurring employee termination
expenses of $2.5 million in Fiscal Year 1997 (including $1.9 million related to
the resignation of the Company's Chief Executive Officer - see note 20 to the
Company's consolidated financial statements).

Operating losses from other operations increased $3.4 million to a loss
of $11.5 million in Fiscal Year 1996 from a loss of $8.1 million in Fiscal Year
1995. The primary reasons for this change include the recognition of a net gain
of $3.3 million recorded in Fiscal Year 1995 resulting from a change in the
Company's defined benefit pension plans (see discussion below), and increased
amortization expenses.

Goodwill Amortization

Amortization expense associated with goodwill was $8.3 million, $8.6
million and $8.4 million for Fiscal Year 1997, 1996 and 1995, respectively.

Restructuring Costs and Other Special Charges

In April 1995, the Company implemented a plan for its American Color
division which was designed to improve productivity, increase customer service
and responsiveness, and provide increased growth in the digital imaging and
prepress services business. The cost of this plan was accounted for in
accordance with the guidance set forth in EITF 94-3. The pretax costs of $5
million which were incurred as a part of this plan represent employee
termination, goodwill write-down and other related costs that were incurred as a
direct result of the plan. Approximately $0.9 million of restructuring costs
primarily related to relocation expenses were recognized in Fiscal Year 1997. In
Fiscal Year 1996 the Company recognized $4.1 million of such restructuring
charges, which included $0.9 million of goodwill write-down, and $3.2 million
primarily for severance and other personnel related costs. The goodwill written
down was the portion related to certain facilities that were either shut down or
relocated in conjunction with the American Color restructuring.

19

During Fiscal Year 1997 and Fiscal Year 1996, the Company recorded
special charges totaling $1.9 million and $3.4 million, respectively, for
impaired long-lived assets and to adjust the carrying values of idle, disposed
and under performing assets to estimated fair values. The provisions were based
on a review of long-lived assets in connection with the adoption of Financial
Accounting Standards Board Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("FASB 121"). Of
the Fiscal Year 1997 total of long-lived assets that were adjusted based on
being idle, disposed of or under performing, approximately $0.4 million and $1.5
million related to the print and American Color sectors, respectively. Fair
value was based on the Company's estimate of held and used and idle assets based
on current market conditions using the best information available. Approximately
$2 million of the Fiscal Year 1996 total related to the print sectors long-lived
assets that were adjusted based on being idle, disposed of or under performing.
The remaining $1.4 million of the Fiscal Year 1996 total related to the American
Color sector. The estimated undiscounted future cash flows attributable to
certain American Color division identifiable long-lived assets held and used was
less than their carrying value principally as a result of high levels of ongoing
technological change. The methodology used to assess the recoverability of the
American Color sector long-lived assets involved projecting aggregate cash
flows. Based on this evaluation, the Company determined in Fiscal Year 1996 that
long-lived assets with a carrying amount of $2.2 million were impaired and wrote
them down by $1.4 million to their fair value. Fair value was based on Company
estimates and appraisals. Such special charges are classified as restructuring
costs and other special charges in the consolidated statement of operations.

Changes in Defined Benefit Pension Plans, Net

In October 1994, the Board of Directors approved an amendment to the
Company's defined benefit pension plans which resulted in the freezing of
additional defined benefits for future services under the plans effective
January 1, 1995. The Company recognized a curtailment gain of $3.7 million as a
result of freezing such benefits.

Also in October 1994, the Board of Directors approved a new SERP, which
is a defined benefit plan, for certain key executives. The Company recognized a
$0.4 million expense associated with the establishment of the SERP.

The net effect of the above, a $3.3 million gain, is reflected in the
Company's consolidated statement of operations for Fiscal Year 1995.

Interest Expense

Interest expense increased 11% to $36.3 million in Fiscal Year 1997
from $32.7 million in Fiscal Year 1996. This increase includes the impact of
increased average indebtedness levels including indebtedness related to the
Transactions and obligations under capital leases. Interest expense increased
26.9% to $32.7 million in Fiscal Year 1996 from $25.8 million in Fiscal Year
1995. This increase includes the impact of increased indebtedness levels and
increases in prevailing market interest rates associated with the Company's
floating rate debt. The increased indebtedness includes the additional
indebtedness related to the Shakopee Merger and indebtedness incurred to fund
the fees and expenses associated with the Refinancing (see notes 2 and 9 to the
Company's consolidated financial statements).

Nonrecurring Charges Related to Terminated Merger

The Company recognized $1.5 million of expenses related to a terminated
merger in Fiscal Year 1996.

20

Other Expense (Income) and Taxes

Other expense, net, remained relatively unchanged at $0.2 million in
both Fiscal Year 1997 and Fiscal Year 1996. Other expense, net, decreased to
$0.2 million in Fiscal Year 1996 from $1 million in Fiscal Year 1995. This
decrease includes a $1.3 million net gain realized on the disposal of the
Company's 51% interest in NIS in Fiscal Year 1996 (see note 4 to the Company's
consolidated financial statements), offset in part by incremental expenses
associated with an employee benefit program also recorded in Fiscal Year 1996.

Income tax expense decreased to $2.6 million in Fiscal Year 1997 from
$4.9 million in Fiscal Year 1996. This change is primarily due to smaller
amounts of taxable income in foreign jurisdictions, the Shakopee Merger and the
sale of NIS, partially offset by an increase in the deferred tax valuation
allowance. During Fiscal Year 1997, the Company increased its valuation
allowance by $8.9 million to $30.1 million. The increase in the valuation
allowance during Fiscal Year 1997 resulted primarily from the loss incurred
during this period for which a tax benefit will not be recorded.

Income tax expense increased to $4.9 million in Fiscal Year 1996 from
$2.6 million in Fiscal Year 1995. This change is primarily due to larger amounts
of taxable income in foreign jurisdictions and the inclusion of Shakopee in
Fiscal Year 1996. During Fiscal Year 1996, the Company increased its valuation
allowance by $7.4 million to $21.2 million. The increase in the valuation
allowance during Fiscal Year 1996 resulted primarily from the loss incurred
during this period for which a tax benefit will not be recorded.

Discontinued Operations

Sullivan Media Corporation

The Company's net loss in Fiscal Year 1997, Fiscal Year 1996 and Fiscal
Year 1995 includes the loss from operations of its discontinued wholly-owned
subsidiary SMC of approximately $1.6 million, $1.4 million and $0.9 million,
respectively. The Company's Fiscal Year 1997 net loss also includes the
estimated net loss on shut down of approximately $1.5 million. See note 5 to the
Company's consolidated financial statements.

SMI Settlement

On June 29, 1994, Graphics and SMI settled the lawsuit they initiated
in federal court against Valassis Communications, Inc., News America and David
Brandon. The Company recorded income from the SMI Settlement of $18.5 million
net of taxes in Fiscal Year 1995 and when coupled with settlement expenses which
had previously been accrued, the net cash proceeds resulting from this
settlement were approximately $16.7 million. Proceeds received were primarily
used in July 1994 to reduce borrowings under the Company's old bank credit
agreement which primarily related to SMI losses prior to the shut down.

In Fiscal Year 1996, the Company recognized settlement of the EPI
lawsuit and reversed certain accruals related to the estimated loss on shut down
of SMI. The resulting effect reflected in the Fiscal Year 1996 consolidated
statement of operations was $2.9 million income in discontinued operations.

Loss on Early Extinguishment of Debt, Net of Tax

As part of the Shakopee Merger and the Refinancing in Fiscal Year 1996
(see notes 2 and 9 to the Company's consolidated financial statements), the
Company recorded an extraordinary loss related to early extinguishment of debt
of $4.5 million, net of zero taxes. This extraordinary loss primarily consisted
of the early redemption premium on the 15% Notes and the write-off of deferred
financing costs related to refinanced indebtedness partially offset by the
write-off of a bond premium associated with the 15% Notes.

21

Net Income (Loss)

As a result of the factors discussed above, the Company's net loss
increased to a loss of $31.7 million in Fiscal Year 1997 from a loss of $29.3
million in Fiscal Year 1996. As discussed above, Fiscal Year 1997 includes $0.9
million of expense related to the American Color restructuring, $1.9 million of
other special charges related to fixed asset write-offs and write-downs, $2.5
million of non-recurring employee termination expenses and approximately a $3.1
million loss from discontinued operations related to SMC. The Company's net loss
was $29.3 million in Fiscal Year 1996 and its net income was $13.2 million in
Fiscal Year 1995. As discussed above, Fiscal Year 1996 includes $4.1 million of
expense related to the American Color restructuring, $3.4 million of other
special charges related to fixed asset write-offs and write-downs, a $1.5
million non-recurring expense associated with a terminated merger, a $4.5
million extraordinary loss on early extinguishment of debt and approximately
$2.9 million of income and a $1.4 million loss from discontinued operations
related to SMI and SMC, respectively. The Company's net income for Fiscal Year
1995 includes a $3.3 million gain from the curtailment and establishment of
defined benefit pension plans, net and approximately $18.5 million of income and
a $0.9 million loss from discontinued operations of SMI and SMC, respectively.

Liquidity and Capital Resources

In August 1995, the Company refinanced substantially all of its
existing indebtedness (see note 9 to the Company's consolidated financial
statements). The primary objectives of the Refinancing were to gain greater
financial and operating flexibility, to facilitate the merger with Shakopee, to
refinance near-term debt service requirements and to provide further opportunity
for internal growth and growth through acquisitions.

As part of the Refinancing, the Company received gross proceeds of $185
million from the sale of 12 3/4% Senior Subordinated Notes Due 2005 (the
"Notes"). The gross proceeds of the offering of the Notes, together with $85.6
million in borrowings under the Bank Credit Agreement, and existing cash
balances were used (i) to redeem all $100 million principal amount of the 15%
Notes at a redemption price of $105.6 million (plus $1.8 million of accrued
interest to September 15, 1995, the redemption date), (ii) to repay all $126.5
million of indebtedness outstanding under Graphics' old bank credit agreement
(plus $2.3 million of accrued interest at the repayment date), (iii) to repay
all $24.6 million of indebtedness assumed in the Shakopee Merger (plus $0.1
million of accrued interest at the repayment date) and (iv) to fund
approximately $11.8 million of fees and expenses incurred in connection with the
Transactions.

The Bank Credit Agreement includes a revolving credit facility which
matures on September 30, 2000 (the "Revolving Credit Facility") providing for a
maximum of $75 million of borrowing availability, subject to a borrowing base
requirement. As of May 31, 1997, the Company had borrowings of $38.2 million
outstanding under the Revolving Credit Facility and $12.3 million of additional
borrowing availability. On June 30, 1997, the Company entered into a $25 million
term loan facility which matures on March 31, 2001 (the "Term Loan Facility")
(see note 9 to the Company's consolidated financial statements). Net proceeds
received under this facility of $23 million were used to reduce outstanding
borrowings under the Revolving Credit Facility. Based upon activity through June
27, 1997 and after giving pro forma effect to receipt and application of the
above $23 million Term Loan Facility net proceeds, the Company had additional
borrowing availability under the Revolving Credit Facility of approximately
$25.8 million at June 27, 1997.

The Bank Credit Agreement also provides for a $60 million amortizing
term loan with a final maturity on September 30, 2000 (the "Term Loan"). At May
31, 1997, $47.1 million of the Term Loan was outstanding. Scheduled Term Loan
payments due over the upcoming fiscal year ending March 31, 1998 ("Fiscal Year
1998") approximate $10.6 million. Capital lease obligation repayments will be
approximately $6.4 million in Fiscal Year 1998.

In Fiscal Year 1997, net cash from operating activities and net
borrowings under the Revolving Credit Facility (see the consolidated statements
of cash flows) were used to pay $13.6 million in scheduled principal payments on
indebtedness (including capital lease obligations). Additionally, these cash
sources were used to fund the Company's Fiscal Year 1997 cash capital
expenditures of $10.8 million and meet additional investing and financing needs
of $1.1 million. The Company plans to continue its program of upgrading its
printing and prepress equipment and expanding production capacity and currently
anticipates that Fiscal Year 1998 cash capital expenditures will approximate
$11.1 million and equipment acquired under capital leases will approximate $14.6
million during Fiscal Year 1998. The Company had zero cash on hand at March 31,
1997 due to a requirement under the Bank Credit Agreement that the Company's
daily available funds be used to reduce borrowings under the Revolving Credit
Facility.

22

At March 31, 1997, the Company had total indebtedness outstanding of
$312.3 million, including capital lease obligations. Of the total debt
outstanding at March 31, 1997, $87.8 million was outstanding under the Bank
Credit Agreement at a weighted average interest rate of 8.45%. Indebtedness
under the Bank Credit Agreement bears interest at floating rates, causing the
Company to be sensitive to prevailing interest rates. At March 31, 1997, the
Company had indebtedness other than obligations under the Bank Credit Agreement
of $224.5 million (including $185 million of the Notes). In connection with the
Term Loan Facility, the Company obtained amendments with respect to certain
financial covenants and an amendment that decreased the Borrowing Base through
March 31, 1998, in the Bank Credit Agreement and after giving effect to such
amendments, the Company is currently in compliance with all financial covenants
set forth in the Bank Credit Agreement, as amended. See note 9 to the Company's
consolidated financial statements.

23

EBITDA
Fiscal Year Ended March 31,
-------------------------------------
1997 1996 1995
---- ---- ----
EBITDA: (dollars in thousands)

Printing $ 46,755 $ 46,597 $ 38,357
American Color(a) 5,770 2,907 12,662
Other (b) (c) (5,553)(e) (2,657) 700(d)
-------- -------- --------
Total $ 46,972 $ 46,847 $ 51,719
======== ======== ========

EBITDA Margin:
Printing 10.4% 10.3% 10.9%
American Color 7.7% 4.0% 16.6%
Total 9.0% 8.8% 11.9%

- ----------
(a) American Color EBITDA for Fiscal Year 1997 and 1996 includes the impact
of restructuring costs of $0.9 million and $4.1 million, respectively
(see note 18 to the Company's consolidated financial statements and
discussion above).
(b) Other operations in Fiscal Year 1996 and Fiscal Year 1995 include
revenues and expenses associated with the Company's 51% owned
subsidiary, NIS (sold on March 11, 1996; see note 4 to the Company's
consolidated financial statements).
(c) Also includes corporate selling, general and administrative expenses.
(d) Includes a net gain of $3.3 million in Fiscal Year 1995 from the
curtailment and establishment of defined benefit pension plans (see
discussion above).
(e) Also reflects non-recurring employee termination expenses of $2.5
million in Fiscal Year 1997 (including $1.9 million related to the
resignation of the Company's Chief Executive Officer - see note 20 to
the Company's consolidated financial statements).

EBITDA is presented and discussed because management believes that
investors regard EBITDA as a key measure of a leveraged company's performance
and ability to meet its future debt service requirements. EBITDA is defined as
earnings before net interest expense, income tax expense (benefit),
depreciation, amortization, other special charges related to asset write-offs
and write-downs, other income (expense), discontinued operations and
extraordinary items. "EBITDA Margin" is defined as EBITDA as a percentage of net
sales. EBITDA is not a measure of financial performance under generally accepted
accounting principles and should not be considered an alternative to net income
(or any other measure of performance under generally accepted accounting
principles) as a measure of performance or to cash flows from operating,
investing or financing activities as an indicator of cash flows or as a measure
of liquidity. Certain covenants in the Indenture and the Bank Credit Agreement
are based on EBITDA, subject to certain adjustments.

Printing. As a result of the reasons previously described under
"--Printing" (excluding the increase in depreciation expense), printing EBITDA
increased to $46.8 million in Fiscal Year 1997 from $46.6 million in Fiscal Year
1996, representing an increase of $0.2 million. The Company's printing sector
EBITDA increased to $46.6 million in Fiscal Year 1996 from $38.4 million in
Fiscal Year 1995, representing an increase of $8.2 million. Printing EBITDA
Margin increased to 10.4% in Fiscal Year 1997 from 10.3% in Fiscal Year 1996 and
decreased to 10.3% in Fiscal Year 1996 from 10.9% in Fiscal Year 1995.

American Color. As a result of the reasons previously described under
"--American Color," American Color's EBITDA increased to $5.8 million in Fiscal
Year 1997 from $2.9 million in Fiscal Year 1996, representing an increase of
$2.9 million. EBITDA Margin increased to 7.7% in Fiscal Year 1997 from 4% in
Fiscal Year 1996. American Color EBITDA decreased to $2.9 million in Fiscal Year
1996 from $12.7 million in Fiscal Year 1995, representing a reduction of $9.8
million. EBITDA Margin decreased to 4% in Fiscal Year 1996 from 16.6% in Fiscal
Year 1995. Included in the Fiscal Year 1996 EBITDA and EBITDA Margin is $4.1
million of restructuring costs related to the American Color restructuring plan
(see discussion above).

24

Other Operations. As a result of the reasons previously described under
"--Other Operations," excluding changes in amortization expense, other
operations negative EBITDA increased to negative EBITDA of $5.6 million in
Fiscal Year 1997 from negative EBITDA of $2.7 million in Fiscal Year 1996.
EBITDA from other operations decreased to a negative EBITDA of $2.7 million in
Fiscal Year 1996 from EBITDA of $0.7 million in Fiscal Year 1995. Negative
EBITDA for Fiscal Year 1997 includes the impact of non-recurring employee
termination expenses of $2.5 million (including $1.9 million related to the
resignation of the Company's Chief Executive Officer - see note 20 to the
Company's consolidated financial statements). EBITDA in Fiscal Year 1995
includes the net gain of $3.3 million relating to a change in the Company's
defined benefit plans (see discussion above).

Amortization of Goodwill

The goodwill is amortized on a straight-line basis by business sector.
Goodwill amortization expense will be approximately $8.4 million for Fiscal Year
1998 and approximately $2.3 million annually thereafter.

Impact of Inflation

Generally, the Company believes it has been able to pass along
increases in its costs to its customers (primarily paper and ink) through
increased prices of its printed products. Throughout the majority of Fiscal Year
1996, the printing industry experienced substantial increases in the cost of
paper. In late Fiscal Year 1996, however, the overall cost of paper began to
decline and that decline continued throughout Fiscal Year 1997. Management
expects that as a result of the Company's strong relationship with key suppliers
that its material costs will remain competitive within the industry.

Seasonality

Some of the Company's printing and digital imaging and prepress
services business is seasonal in nature, particularly those revenues derived
from advertising inserts. Generally, the Company's sales from advertising
inserts are highest during periods prior to the following advertising periods:
Spring advertising season (March 15 -- May 15); Back-to- School (July 15 --
August 15); and Thanksgiving/Christmas (October 15 -- December 15). One of the
reasons the Company chose to enter the comic book printing market is that it is
not subject to significant seasonal fluctuations. Sales of Sunday comics and
magazine products are also not subject to significant seasonal fluctuations. The
Company's strategy has been and will continue to be to try to mitigate the
seasonality of its printing business by increasing its sales to food and drug
companies whose own sales are less seasonal.

Environmental

Environmental expenditures that relate to current operations are
expensed or capitalized as appropriate. Expenditures that relate to an existing
condition caused by past operations and which do not contribute to current or
future period revenue generation are expensed. Environmental liabilities are
recorded when assessments and/or remedial efforts are probable and the related
costs can be reasonably estimated.

The Company believes that environmental liabilities, currently and in
the prior periods discussed herein, are not material. The Company has recorded
an environmental reserve of approximately $0.1 million in connection with a
Superfund site in its consolidated statement of financial position at March 31,
1997 which the Company believes to be adequate. See "Legal Proceedings -
Environmental Matters." The Company does not anticipate receiving insurance
proceeds related to this potential settlement. Management does not expect that
any identified matters, individually or in the aggregate, will have a material
adverse effect on the consolidated financial position or results of operations
of the Company.

Accounting

There are no pending accounting pronouncements that, when adopted, are
expected to have a material effect in the Company's results of operations or its
financial position.

25

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Page No.
--------

The following consolidated financial statements of Sullivan Communications, Inc.
are included in this report:

Report of Independent Auditors........................................................................... 27
Consolidated balance sheets - March 31, 1997 and 1996................................................... 28
For the Years Ended March 31, 1997, 1996 and 1995:
Consolidated statements of operations........................................................... 30
Consolidated statements of stockholders' deficit................................................ 31
Consolidated statements of cash flows........................................................... 32
Notes to Consolidated Financial Statements............................................................... 34

The following consolidated financial statement schedules of Sullivan
Communications, Inc. are included in Part IV, Item 14:

I. Condensed Financial Information of Registrant
Condensed Consolidated Financial Statements
(parent company only) for the years ended March 31, 1997, 1996,
and 1995, and as of March 31, 1997 and 1996

II. Valuation and qualifying accounts

All other schedules specified under Regulation S-X for Sullivan
Communications, Inc. have been omitted because they are either not applicable,
not required, or because the information required is included in the financial
statements or notes thereto.

26

Report of Independent Auditors

The Board of Directors
Sullivan Communications, Inc.

We have audited the accompanying consolidated balance sheets of Sullivan
Communications, Inc. as of March 31, 1997 and 1996, and the related consolidated
statements of operations, stockholders' deficit, and cash flows for each of the
three fiscal years in the period ended March 31, 1997. Our audits also included
the financial statement schedules listed in the Index at Item 14(a). These
financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Sullivan Communications, Inc. at March 31, 1997 and 1996, and the consolidated
results of their operations and their cash flows for each of the three fiscal
years in the period ended March 31, 1997, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedules, when considered in relation to the basic financial statements taken
as a whole, present fairly in all material respects the information set forth
therein.

As discussed in Note 18 to the consolidated financial statements, in fiscal year
1996 the Company adopted the provisions of the Financial Accounting Standards
Board's Statement of Financial Accounting Standards No. 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."

Ernst & Young LLP

Nashville, Tennessee
May 23, 1997, except as to Note 9,
as to which the date is
June 30, 1997

27

SULLIVAN COMMUNICATIONS, INC.
Consolidated Balance Sheets
(Dollars in thousands, except par values)

March 31,
---------
1997 1996
---- ----
Assets
Current assets:
Cash $ 0 0
Receivables:
Trade accounts, less allowance for doubtful
accounts of $5,879 and $4,830 at
March 31, 1997 and 1996, respectively 53,510 64,465
Other 3,252 3,588
--------- ---------
Total receivables 56,762 68,053

Inventories 9,711 13,181
Prepaid expenses and other current assets 3,604 4,285
--------- ---------
Total current assets 70,077 85,519

Property, plant and equipment:
Land and improvements 3,278 3,259
Buildings and improvements 17,837 16,346
Machinery and equipment 175,196 169,375
Furniture and fixtures 3,625 3,212
Leased assets under capital leases 35,113 8,606
Equipment installations in process 3,118 6,466
--------- ---------
238,167 207,264
Less accumulated depreciation (71,270) (51,103)
--------- ---------
Net property, plant and equipment 166,897 156,161

Excess of cost over net assets acquired,
less accumulated amortization of
$33,523 and $25,269 at March 31, 1997
and 1996, respectively 81,964 89,324
Other assets 15,037 20,177
--------- ---------
Total assets $ 333,975 351,181
========= =========

See accompanying notes to consolidated financial statements.

28

SULLIVAN COMMUNICATIONS, INC.
Consolidated Balance Sheets
(Dollars in thousands, except par values)

March 31,
---------
1997 1996
---- ----

Liabilities and Stockholders' Deficit
Current liabilities:
Current installments of long-term debt and capitalized leases $ 18,252 11,490
Trade accounts payable 29,364 35,931
Accrued expenses 30,037 27,271
Income taxes 1,022 1,215
--------- ---------
Total current liabilities 78,675 75,907

Long-term debt and capitalized leases, excluding
current installments 294,057 286,127
Deferred income taxes 8,713 7,801
Other liabilities 28,848 25,742
--------- ---------
Total liabilities 410,293 395,577

Stockholders' deficit:
Common stock, voting, $.01 par value, 5,852,223 shares
authorized, 123,889 shares issued and outstanding 1 1

Series A convertible preferred stock, $.01 par value,
4,000 shares authorized, issued and outstanding,
$40,000,000 liquidation preference -- --

Series B convertible preferred stock, $.01 par value,
1,750 shares authorized, issued and outstanding,
$17,500,000 liquidation preference -- --

Additional paid-in capital 57,499 57,499
Accumulated deficit (132,228) (100,525)
Cumulative translation adjustment (1,590) (1,371)
--------- ---------
Total stockholders' deficit (76,318) (44,396)
--------- ---------
Commitments and contingencies
Total liabilities and stockholders' deficit $ 333,975 351,181
========= =========

See accompanying notes to consolidated financial statements.

29

SULLIVAN COMMUNICATIONS, INC.
Consolidated Statements of Operations
(In thousands)

Year ended March 31,
--------------------
1997 1996 1995
---- ---- ----

Sales $ 524,551 529,523 433,198
Cost of sales 459,880 465,110 370,267
--------- --------- ---------
Gross profit 64,671 64,413 62,931

Selling, general and administrative expenses 43,164 35,533 33,406
Amortization of goodwill 8,254 8,631 8,386
Restructuring costs and other special charges 2,881 7,533 --
Gain from curtailment and establishment of
defined benefit pension plans, net -- -- (3,311)
--------- --------- ---------
Operating income 10,372 12,716 24,450
--------- --------- ---------
Other expense (income):
Interest expense 36,289 32,688 25,752
Interest income (157) (263) (418)
Nonrecurring charge related to terminated
merger -- 1,534 --
Other, net 245 188 985
--------- --------- ---------
Total other expense 36,377 34,147 26,319
--------