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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
(X) Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended JUNE 29, 2002
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 1-11720
ADVO, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-0885252
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Univac Lane, P.O. Box 755, Windsor, CT 06095-0755
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (860) 285-6100
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 [ ]
As of July 27, 2002 there were 19,978,750 shares of common stock outstanding.
ADVO, INC.
INDEX TO QUARTERLY REPORT
ON FORM 10-Q
QUARTER ENDED JUNE 29, 2002
Page
----
Part I - Financial Information
Item 1. Financial Statements (Unaudited).
Consolidated balance sheets -
June 29, 2002 and September 29, 2001. 2
Consolidated statements of operations -
Nine months and three months ended
June 29, 2002 and June 30, 2001. 3
Consolidated statements of cash flows -
Nine months ended June 29, 2002
and June 30, 2001. 4
Notes to consolidated financial statements. 5
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations. 9
Item 3. Quantitative and Qualitative Disclosures
about Market Risk. 14
Part II - Other Information
Item 5. Other Information. 15
Item 6. Exhibits and Reports on Form 8-K. 15
Signatures 16
ADVO, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share data)
June 29, September 29,
ASSETS 2002 2001
---------- ----------
Current assets:
Cash and cash equivalents $ 19,744 $ 17,728
Accounts receivable, net 107,197 119,388
Inventories 3,068 2,840
Prepaid expenses and other current assets 7,998 7,282
Investment in deferred compensation plan 11,731 11,493
Deferred income taxes 12,716 11,319
---------- ----------
Total current assets 162,454 170,050
Property, plant and equipment 263,019 246,936
Less accumulated depreciation and amortization (142,381) (126,455)
---------- ----------
Net property, plant and equipment 120,638 120,481
Goodwill 22,174 21,525
Other assets 12,523 10,264
---------- ----------
TOTAL ASSETS $ 317,789 $ 322,320
========== ==========
LIABILITIES
Current liabilities:
Current portion of long-term debt $ 20,000 $ 11,250
Notes payable - short term 1,715 2,390
Accounts payable 30,923 37,759
Accrued compensation and benefits 25,928 21,531
Deferred compensation plan 11,731 11,493
Other current liabilities 37,845 44,678
---------- ----------
Total current liabilities 128,142 129,101
Long-term debt 145,000 173,750
Notes payable - long term -- 1,715
Deferred income taxes 10,789 9,852
Other liabilities 5,014 4,949
STOCKHOLDERS' EQUITY
Series A Convertible preferred stock, $.01 par value
(Authorized 5,000,000 shares, none issued) -- --
Common stock, $.01 par value (Authorized
40,000,000 shares, issued 30,549,002
and 30,317,994 shares, respectively) 305 303
Additional paid-in capital 203,043 197,222
Accumulated earnings 49,974 19,321
---------- ----------
253,322 216,846
Less common stock held in treasury, at cost (222,090) (208,620)
Accumulated other comprehensive loss (2,388) (5,273)
---------- ----------
Total stockholders' equity 28,844 2,953
---------- ----------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 317,789 $ 322,320
========== ==========
See Accompanying Notes.
- 2 -
ADVO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Nine months ended Three months ended
----------------- ------------------
June 29, June 30, June 29, June 30,
2002 2001 2002 2001
-------- -------- -------- --------
REVENUES $842,308 $851,083 $280,939 $281,759
Costs and expenses:
Cost of sales 615,892 615,918 206,675 202,572
Selling, general and
administrative 161,436 158,824 53,602 53,660
Provision for bad debts 5,467 4,471 1,355 1,454
-------- -------- -------- --------
OPERATING INCOME 59,513 71,870 19,307 24,073
Interest expense 10,035 13,426 3,170 4,249
Other expense, net 823 406 36 185
-------- -------- -------- --------
Income before income taxes 48,655 58,038 16,101 19,639
Provision for income taxes 18,002 21,474 5,957 7,266
-------- -------- -------- --------
NET INCOME $ 30,653 $ 36,564 $ 10,144 $ 12,373
======== ======== ======== ========
BASIC EARNINGS PER SHARE $ 1.54 $ 1.81 $ .51 $ .61
======== ======== ======== ========
DILUTED EARNINGS PER SHARE $ 1.51 $ 1.77 $ .50 $ .60
======== ======== ======== ========
Weighted average basic shares 19,963 20,151 20,010 20,242
Weighted average diluted shares 20,305 20,629 20,353 20,585
See Accompanying Notes.
- 3 -
ADVO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine months ended
-----------------
June 29, June 30,
2002 2001
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 58,138 $ 42,901
Cash flows from investing activities:
Acquisition of property, plant and equipment (21,932) (22,958)
Proceeds from disposals of property, plant and equipment 331 118
Distributions from equity affiliates 71 --
Acquisitions/joint ventures, net of cash acquired (1,429) (14,303)
-------- --------
NET CASH USED BY INVESTING ACTIVITIES (22,959) (37,143)
Cash flows from financing activities:
Revolving line of credit - net (12,500) 1,000
Payments on long-term debt (7,500) --
(Decrease) increase in note payable - net (2,391) 4,105
Proceeds from exercise of stock options 2,692 4,733
Purchase of common stock for treasury (13,469) (4,954)
-------- --------
NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES (33,168) 4,884
-------- --------
Effect of exchange rate changes on cash and cash equivalents 5 --
-------- --------
Increase in cash and cash equivalents 2,016 10,642
Cash and cash equivalents at beginning of period 17,728 6,003
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 19,744 $ 16,645
======== ========
Noncash activities:
Change in fair value of 2,876 (2,849)
interest rate swap liabilities
Change in noncash portion of deferred
compensation plan 341 (1,184)
Note receivable in sale of business -- 415
See Accompanying Notes.
- 4 -
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included.
Operating results for the nine month period ended June 29, 2002 are not
necessarily indicative of the results that may be expected for the fiscal year
ending September 28, 2002. For further information, refer to the consolidated
financial statements and footnotes thereto included in ADVO's annual report on
Form 10-K for the fiscal year ended September 29, 2001. Certain
reclassifications have been made in the fiscal 2001 financial statements to
conform with the fiscal 2002 presentation.
2. SUMMARY OF ACCOUNTING POLICIES
Long-lived assets
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("Statement") No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
for the disposal of a segment of a business. The Company expects to adopt
Statement No. 144 in fiscal 2003 and does not expect such adoption to have a
material effect on the Company's financial position or results of operations.
Foreign Currency Translation
The functional currency for the Company's Canadian operation is the Canadian
dollar. As such, assets and liabilities are translated into United States
dollars at month-end exchange rates. Income and expenses are translated into
United States dollars at average rates of exchange for the reporting period. The
resulting translation adjustments, as well as, gains and losses from certain
intercompany transactions are reported in a separate component of stockholders'
equity.
3. ACQUISITIONS
During the third quarter of the current fiscal year, the Company acquired two
businesses for a total of $0.9 million, all paid in cash. On June 5, 2002, the
Company acquired FACC Corporation ("FACC") based in Toronto, Canada which
includes both FACC and Breezeway Communications, Inc. FACC, which has been
renamed ADVO Canada, Inc., is an innovator in both targeting and distribution of
in-home print advertising in Canada. On May 29, 2002, the Company acquired a
franchise operation directly from the franchisee of the Company's MailCoups
subsidiary.
The purchase price for both companies was allocated to the fair value of assets
acquired totaling $1.5 million and liabilities assumed of $1.2 million and
resulted in goodwill of $0.6 million which is expected to be deductible for tax
purposes. Under the terms of the purchase agreement with FACC, the Company may
be required to pay certain contingencies if certain future earnings objectives
are achieved.
The results of operations for the acquired companies have been included in the
consolidated statement of operations from the acquisition dates. The acquired
assets have been recorded at their estimated fair values. The acquisitions did
not have a material pro-forma effect on operations for the periods prior to the
acquisition.
- 5 -
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective October 1, 2001, the Company adopted Statement No. 142, "Goodwill and
Other Intangible Assets". Under Statement No. 142, goodwill and intangible
assets that have indefinite useful lives are no longer subject to amortization.
Accordingly, the Company ceased amortization of all goodwill upon adoption.
Intangible assets that have a finite life continue to be amortized over their
useful lives.
Statement No. 142 also requires that goodwill be tested for impairment at least
annually. Impairment exists when the carrying amount of goodwill exceeds its
fair market value. The Company performed the impairment tests upon the adoption
of Statement No. 142 on October 1, 2001. Fair value was determined using the
discounted cash flow methodology. The Company has determined that no impairment
of goodwill exists.
The increase in the carrying amount of goodwill from the beginning of the fiscal
year to June 29, 2002 is the result of the Company's acquisitions during the
third quarter of fiscal 2002.
The following table reflects actual results of operations for the nine-month and
three-month periods ended June 29, 2002 and pro-forma results of operations for
the nine-month and three-month periods ended June 30, 2001 had the Company
applied the non-amortization provisions of Statement No. 142 in those periods:
Nine months ended Three months ended
----------------- ------------------
June 29, June 30, June 29, June 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
(In thousands, except per share data)
Reported net income $ 30,653 $ 36,564 $ 10,144 $ 12,373
Add: Goodwill amortization, net of tax -- 724 -- 285
---------- ---------- ---------- ----------
Adjusted net income $ 30,653 $ 37,288 $ 10,144 $ 12,658
========== ========== ========== ==========
Reported basic earnings per share $ 1.54 $ 1.81 $ .51 $ .61
Add: Goodwill amortization, net of tax -- .04 -- .01
---------- ---------- ---------- ----------
Adjusted basic earnings per share $ 1.54 $ 1.85 $ .51 $ .62
========== ========== ========== ==========
Reported diluted earnings per share $ 1.51 $ 1.77 $ .50 $ .60
Add: Goodwill amortization, net of tax -- .04 -- .01
---------- ---------- ---------- ----------
Adjusted diluted earnings per share $ 1.51 $ 1.81 $ .50 $ .61
========== ========== ========== ==========
Intangible assets that continue to be subject to amortization are included in
other assets and consist primarily of customer based intangibles with a gross
carrying value of $4.0 million and accumulated amortization of $3.5 million at
June 29, 2002.
Amortization expense for the quarter and nine months ended June 29, 2002 was
$0.1 million and $0.3 million, respectively. Amortization expense is estimated
to be $0.1 million for the remainder of fiscal 2002 and $0.4 million for fiscal
2003. Subsequent to fiscal 2003, all intangible assets are expected to be fully
amortized.
-6-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5. COMPREHENSIVE INCOME
Comprehensive income for a period encompasses net income and all other changes
in a company's equity other than from transactions with the company's owners.
The Company's comprehensive income was as follows:
Nine months ended Three months ended
----------------- ------------------
June 29, June 30, June 29, June 30,
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
Net income $ 30,653 $ 36,564 $ 10,144 $ 12,373
Other comprehensive income (loss):
Unrealized gain (loss) on derivative
instruments 2,876 (2,849) 848 280
Foreign currency translation adjustments 9 -- 9 --
-------- -------- -------- --------
Total comprehensive income $ 33,538 $ 33,715 $ 11,001 $ 12,653
======== ======== ======== ========
6. EARNINGS PER SHARE
Basic earnings per share excludes the effect of common stock equivalents, such
as stock options, and is computed by dividing net income by the weighted average
number of common shares outstanding for the period. Diluted earnings per share
reflect the potential dilution that could occur if common stock equivalents,
such as stock options, were exercised.
Nine months ended Three months ended
----------------- ------------------
June 29, June 30, June 29, June 30,
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands, except per share data)
Net income $ 30,653 $ 36,564 $ 10,144 $ 12,373
Weighted average basic shares 19,963 20,151 20,010 20,242
Effect of dilutive securities:
Stock options 315 443 324 310
Restricted stock 27 35 19 33
-------- -------- -------- --------
Dilutive potential common shares 342 478 343 343
Weighted average diluted shares 20,305 20,629 20,353 20,585
======== ======== ======== ========
Basic earnings per share $ 1.54 $ 1.81 $ .51 $ .61
======== ======== ======== ========
Diluted earnings per share $ 1.51 $ 1.77 $ .50 $ .60
======== ======== ======== ========
-7-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
7. NON-RECURRING CHARGES
In the third quarter of the current fiscal year, the Company recorded a pre-tax
charge of approximately $4.2 million, or $0.13 per share, in selling, general
and administrative costs for structural changes to the organization. The changes
resulting from this charge will strengthen the focus of the Company's sales and
marketing efforts.
During the third quarter of fiscal 2001, the Company recorded a pre-tax charge
of approximately $1.9 million, or $0.06 per share, in selling, general and
administrative costs as a result of a pre-existing contractual agreement upon
the resignation of the former President and Chief Operating Officer.
-8-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section should be read in conjunction with the consolidated financial
statements of the Company and the notes thereto.
RESULTS OF OPERATIONS
REVENUES For the third quarter and nine months ended June 29, 2002 revenues were
$280.9 million and $842.3 million, respectively, decreasing 0.3% and 1.0% from
the comparable periods in fiscal 2001. The decline in revenues was attributable
to decreases in volumes and shifts in product mix and weights, offset by pricing
gains due in part to the postal rate increases in the prior year. Revenue
results included decreases in shared mail products and declines in revenues
associated with the Company's MailCoups subsidiary. These decreases were offset
by increases in the Company's A.N.N.E. (ADVO National Network Extension)
brokered distribution program and revenues associated with the Company's second
in-home date mailings, as well as, revenue associated with the acquisition of
ADVO Canada. In June 2002, the Company acquired FACC Corporation based in
Toronto, Canada, which has been renamed ADVO Canada. In addition, offsetting the
year-to-date revenue decline were incremental revenues associated with the
Company's acquisition of the New Jersey Shoppers Guide in the third quarter of
fiscal 2001 of approximately $4.0 million.
Revenue per thousand pieces for the three months ended June 29, 2002 was $39.81,
representing a 0.5% decrease over the comparable period in the prior year.
Revenue per thousand pieces remained relatively constant for the nine months
ended June 29, 2002 at $39.59 versus $39.54 for the same period in fiscal 2001.
Average pieces per package were 7.55 for the third quarter and 7.74 for the nine
months ended June 29, 2002, decreasing 5.6% and 5.0%, respectively, from the
prior year due to the dilutive effect of the second in-home date mailings.
Conversely, these additional mailings contributed to the increase in shared mail
packages delivered to 853.6 million packages and 2,509.5 million packages for
the three and nine months ended June 29, 2002, representing a 6.4% and 4.5%
increase, respectively, over the prior year period. Also, total shared mail
pieces distributed increased 0.4% and decreased 0.7% for the third quarter and
nine months of fiscal 2002, respectively, compared to the same periods in fiscal
2001.
OPERATING EXPENSES Cost of sales as a percentage of revenue increased 1.7 and
0.7 percentage points, respectively, for the three and nine months ended June
29, 2002 when compared to the same periods last year. The increase for both
periods primarily resulted from underweight postage costs incurred as a result
of the decline in average pieces per package due to the expected dilutive effect
of the second in-home date initiatives, as well as fewer pieces in the Company's
core packages. This increase was offset to a degree by continued improvements
and efficiencies in the branch operations of the Company and favorable print and
paper costs.
In absolute terms, cost of sales increased $4.1 million to $206.7 million for
the third quarter of fiscal 2002 and remained essentially flat at $615.9 million
for the nine months ended June 29, 2002 when compared to the same periods in the
prior year. The increase was due to higher distribution and security costs,
offset to a degree by lower print and paper costs and branch operational
efficiencies. Distribution costs, consisting primarily of postage costs,
increased for the three months ended June 29, 2002 due to higher postage costs
resulting from the 6.4% increase in shared mail packages delivered in the
current quarter. Security costs related to operations increased quarter over
quarter as the Company continues to strengthen its security and safety, as
announced at the beginning of the fiscal year. Print costs decreased for the
third quarter due to volume declines and lower paper prices. Cost of sales for
the nine months ended June 29, 2002 was affected by the same factors detailed
above in the analysis for the quarter, however, higher distribution and security
costs were offset entirely by lower print and paper costs and branch operating
efficiencies.
-9-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Subsequent to the end of the third quarter, on June 30, 2002, new postage rates
became effective. The new rates represent approximately a 3.0% increase to the
Company's shared mail clients. The Company expects its preplanning activities in
the past months will result in a full pass-through of the new postal rate
increase.
Selling, general and administrative costs ("SG&A costs"), including the
provision for bad debt, decreased $0.2 million and increased $3.6 million,
respectively, for the three and nine months ended June 29, 2002 when compared to
the same periods in the prior year. As a percentage of revenues, SG&A costs
remained flat at 19.6% for the third quarter of fiscal 2002 and increased 0.6
percentage points for the nine months ended June 29, 2002 versus the comparable
periods in fiscal 2001.
For the third quarter and nine months ended June 29, 2002, SG&A costs included a
$4.2 million charge, recorded in the current quarter, relating to structural
changes in the Company. The changes resulting from this charge will strengthen
the focus of the Company's sales and marketing efforts. Third quarter costs also
included incremental security costs related to the Company's newly established
Office of Safety and Security. These increases were offset by lower incentive
wages and lower commission expense in the current period versus the prior
period, and reductions in spending due to strict fixed cost controls implemented
throughout the organization. In the third quarter of fiscal 2001, SG&A costs
included a $1.9 million charge as a result of a pre-existing contractual
agreement with the Company's former President and Chief Operating Officer
("COO"). In addition, SG&A costs for the nine months ended June 29, 2002, also
included organizational realignment costs incurred during the first quarter of
fiscal 2002.
OPERATING INCOME For the third quarter of fiscal 2002, the Company reported
operating income of $19.3 million compared to $24.1 million for the third
quarter of fiscal 2001. Operating income was $59.5 million for the year to date
period ended June 29, 2002 versus $71.9 million for the same period in the prior
year.
Excluding the $4.2 million structural charge in the third quarter of fiscal 2002
and the $1.9 million charge related to the former COO in the third quarter of
fiscal 2001, operating income would have been $23.5 million and $26.0 million,
respectively, for the current and prior year third quarter.
INTEREST EXPENSE Interest expense decreased $1.1 million and $3.4 million for
the three and nine month periods ended June 29, 2002, respectively. The
decreases were due to lower market rates of interest and a decrease in the
average outstanding debt balance.
INCOME TAXES The effective income tax rate was 37% for both the three and nine
months ended June 29, 2002 and June 30, 2001.
EARNINGS PER SHARE For the three months ended June 29, 2002, the Company
reported diluted earnings per share of $0.50 versus $0.60 for the same period of
the prior year. Excluding the $4.2 million structural charge, diluted earnings
per share would have increased $0.13 per share in the third quarter of fiscal
2002. Excluding the $1.9 million charge related to the former COO, diluted
earnings per share would have increased $0.06 per share in the third quarter of
fiscal 2001. Diluted earnings per share was $1.51 for the nine months ended June
29, 2002 and $1.77 in the comparable prior year period.
-10-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
Working capital was $34.3 million at June 29, 2002, decreasing $6.6 million from
September 29, 2001. The decrease in working capital from the end of the prior
fiscal year was primarily related to the $7.6 million decrease in current assets
offset by $1.0 million decrease in current liabilities. The decrease in current
assets was primarily attributed to a decrease in accounts receivable due to
improved and focused collection efforts and lower revenues in fiscal 2002 versus
fiscal 2001. This decrease was offset by an increase in cash and cash
equivalents and deferred income taxes. The overall decrease in current
liabilities was the result of the following: decreases in accounts payable due
to the timing of vendor payments, decreases in other current liabilities
relating to the timing of customer advance payments and the change in the fair
value of interest rate swap liabilities. Offsetting these decreases were
increases in accrued compensation and benefits due to the third quarter
structural charge and an increase in the current portion of long-term debt due
to scheduled debt payments.
Stockholders' equity increased $25.9 million to $28.8 million at June 29, 2002.
The increase in stockholders' equity was primarily the result of the Company's
net income of $30.7 million. Also contributing to the increase was $5.8 million
of stock/option related transactions by associates and a positive $2.9 million
change in the fair value of derivative instruments since the beginning of the
fiscal year. These increases were offset by treasury stock purchases of $13.5
million, which consisted of $11.2 million made on the open market associated
with the Company's buyback program and $2.3 million pursuant to elections by
employees to satisfy withholding requirements under the Company's restricted
stock and stock option plans.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment investments were $21.9 million for the nine-month
period ended June 29, 2002. These capital investments consisted mainly of
software development for several new systems being developed, as well as,
upgrades to the human resource/payroll systems, deployment of computer hardware
and renovations at certain of the Company's facilities. The Company expects its
capital expenditures for the entire year to be between $35.0 million and $37.0
million.
LIQUIDITY
The Company's main source of liquidity continues to be funds generated from
operating activities. In addition, the Company has available unused credit
commitments of $120.0 million that may be used to fund operating activities.
The Company experienced a $15.2 million increase in net cash provided by
operating activities for the nine months ended June 29, 2002. The year over year
increase resulted primarily from the change in accounts receivable due to
improved collections and the change in accrued compensation and benefits as a
result of two items: the fiscal 2000 incentive payment which was made in fiscal
2001 for which no comparable payment was made in fiscal year 2002 and the
structural charge in the current quarter. The favorable change in accounts
payable year over year also contributed to the increase in cash provided by
operating activities.
-11-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cash and cash equivalents for the first nine months of fiscal 2002 increased
$2.0 million to $19.7 million. The increase was comprised of net cash outlays
for investing activities of $23.0 million and financing activities of $33.2
million partially offset by net cash provided by operating activities of $58.1
million.
Investing activities of $23.0 million during the first nine months of fiscal
2002 primarily consisted of $21.9 million for the capital expenditures detailed
previously, and acquisitions and joint ventures totaling $1.4 million, primarily
related to the acquisition of ADVO Canada and a MailCoups franchisee in the
current quarter. Investing activities for the first nine months of the prior
fiscal year included $23.0 million of capital expenditures and $14.3 million for
acquisitions and joint ventures, most notably for the $8.3 million acquisition
of MMSI, net of cash acquired and the New Jersey Shoppers Guide for $4.9
million.
Net cash used for financing activities was $33.2 million for the nine months
ended June 29, 2002 versus net cash provided by financing activities of $4.9
million in the same prior year period. In the current year, financing activities
consisted of debt payments of $20.0 million which included net payments on the
revolver and scheduled principal payments on the term loan, payment of a $2.4
million note resulting from the acquisition of MMSI in the prior year, and $13.5
million of treasury stock purchases. These uses of cash were offset by $2.7
million of proceeds from option exercises under the Company's stock option
plans. In the prior year, financing activities included net borrowings of $1.0
million, a $4.1 million note payable related to the acquisition of MMSI and
proceeds of $4.7 million relating to stock option exercises offset by treasury
stock purchases of $5.0 million.
Contractual and commercial commitments
The Company's contractual obligations are as follows:
(In millions) Long-term debt Operating leases
-------------- ----------------
Less than one year $ 20.0 $ 13.2
One to three years 145.0 23.4
Four to five years -- 11.1
After five years -- 16.2
------ ------
Total $165.0 $ 63.9
====== ======
The Company's long-term debt obligations are discussed below in the "Financing
Arrangements" section. The Company leases property in its normal business
operations under noncancellable operating leases. Certain of these leases
contain renewal options and certain leases also provide for cost escalation
payments.
The Company has various agreements with International Business Machines
Corporation ("IBM") Global Services to provide systems development, technical
support, a customer support center and server farm management services to the
Company. The noncancellable portions of these contracts have lapsed, allowing
the Company the option to cancel these contracts subject to termination charges
ranging from $9.6 million in fiscal 2002 to $1.7 million in fiscal 2006
depending on the year in which the cancellation becomes effective.
The Company has outstanding letters of credit of approximately $7.5 million
under separate agreements expiring in April 2003, primarily relating to its
worker's compensation program.
The Company anticipates it will be able to meet its commitments detailed above
through funds generated from operations or from unused credit under its
revolving line of credit.
- 12 -
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCING ARRANGEMENTS
The Company maintains a credit agreement which provides for total credit
facilities of $300 million, consisting of a $135 million term loan and a $165
million revolving line of credit. At June 29, 2002, there was $165.0 million of
debt outstanding, with $20.0 million classified as current due to scheduled
principal payments. The Company anticipates it will be able to meet its debt
obligations through funds generated from operations. During July 2002, the
Company borrowed an additional $10.0 million under the revolving line of credit.
Under the terms of the credit agreement, the Company is required to maintain
certain financial ratios. In addition, the credit agreement also places
restrictions on disposals of assets, mergers and acquisitions, dividend
payments, investments and additional debt.
NEW ACCOUNTING PRONOUNCEMENTS
Effective October 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("Statement") No. 142, "Goodwill and Other Intangible Assets". Under
Statement No. 142, goodwill and intangible assets that have indefinite useful
lives are no longer subject to amortization. Accordingly, the Company ceased
amortization of all goodwill upon adoption. Additionally, intangible assets that
have a finite life continue to be amortized over their useful lives. Operating
income was $19.3 million and $24.1 million for the third quarter of fiscal 2002
and 2001, respectively, and $59.5 million and $71.9 million for the first nine
months of fiscal 2002 and 2001, respectively. Had the Company applied the
non-amortization provisions of Statement No. 142 in fiscal 2001, operating
income would have been $24.5 million and $73.0 million for the three and nine
months ended June 30, 2001. See the discussion in Note 3 of the "Notes to
Consolidated Financial Statements" of this report for a further discussion of
the impact of Statement No. 142 to the Company.
Statement No. 142 also requires that goodwill be tested for impairment at least
annually. Impairment exists when the carrying amount of goodwill exceeds its
fair market value. The Company performed the impairment tests upon the adoption
of Statement No. 142 on October 1, 2001. Fair value was determined using the
discounted cash flow methodology. The Company has determined that no impairment
of goodwill exists. Additional evaluations of goodwill may be performed in
future periods should any circumstances arise that would indicate that the
carrying value of goodwill might be impaired. Impairment adjustments recognized
after adoption, if any, are required to be recognized as operating expenses.
CRITICAL ACCOUNTING POLICIES
Critical accounting polices are defined as those that are most important to the
portrayal of a company's financial condition and results and which require
complex or subjective judgements or estimates. The preparation of financial
statements in conformity with general accepted accounting principles requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements. Actual results could differ from those estimates under
different assumptions and conditions. The Company had determined its critical
accounting polices to include the allowance for doubtful accounts and the
valuation of goodwill and intangible assets.
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ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Allowance for doubtful accounts
The Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. The
Company reviews the collectibility of its receivables on an ongoing basis taking
into account a combination of factors. On a monthly basis, the Company conducts
meetings to identify and review potential problems, such as a bankruptcy filing
or deterioration in the customer's financial condition, to ensure the Company is
adequately accrued for potential loss. The Company also calculates a trended
write-off of bad debts over a rolling twelve-month period and takes into account
aging category and historical trends. If a customer's situation changes, such as
bankruptcy or creditworthiness, or there is a change in the current economic
climate, the Company may modify its estimate of the allowance for doubtful
accounts.
Valuation of goodwill and intangible assets
Goodwill represents the excess purchase price over fair value of net assets
acquired in connection with purchase business combinations. With the adoption of
Statement No. 142, the Company ceased amortization of goodwill, but is now
subject to an annual impairment test as discussed under "New Accounting
Pronouncements". The Company's goodwill impairment test was performed by
comparing the net present value of projected cash flows to the carrying value of
goodwill. The Company utilized discount rates determined by management to be
similar with the level of risk in the current business model. The Company has
determined that no impairment of goodwill exists. If the assumptions the Company
made regarding estimated cash flows, such as future operating performance and
other factors to determine the fair value, is less favorable than expected, the
Company may be required to record an impairment charge.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's interest expense is sensitive to changes in interest rates. In
this regard, changes in interest rates affect the interest paid on its debt. To
mitigate the impact of interest rate fluctuations, the Company has historically
maintained interest rate swap agreements on notional amounts totaling $100
million which is currently over 50% of its outstanding debt balance.
The Company believes that the interest rate swap agreements limit substantial
risk if interest rates should fluctuate. If interest rates should change by 2
percentage points for the remainder of the 2002 fiscal year from those rates in
effect at June 29, 2002, assuming no change in the outstanding debt balance and
considering the effects of the Company's interest rate swap agreements, interest
expense would increase/decrease by approximately $0.3 million.
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ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
Except for the historical information stated herein, the matters discussed in
this Management's Discussion and Analysis of Financial Condition and Results of
Operations contain forward looking statements within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended. Such forward looking
statements are based on current information and expectations and are subject to
risks and uncertainties which could cause the Company's actual results to differ
materially from those in the forward looking statements. Such risks and
uncertainties include but are not limited to: changes in customer demand and
pricing; the possibility of consolidation throughout the retail sector; the
impact of economic and political conditions on retail advertising spending and
our distribution system; postal and paper prices; possible governmental
regulation or legislation affecting aspects of the Company's business; the
efficiencies achieved with technology upgrades and other general economic
factors.
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION
Beginning in July 2002, the Company's internal audit function will be performed
by PricewaterhouseCoopers.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit No. Exhibits
----------- --------
99a Certification of Periodic Report - CEO.
99b Certification of Periodic Report - CFO.
(b) Reports on Form 8-K
No report on Form 8-K was filed by the Company with respect to the
quarter ended June 29, 2002.
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Omitted from this Part II are items which are inapplicable or to which the
answer is negative for the period covered.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVO, Inc.
Date: August 13, 2002 By: /s/ JOHN SPERIDAKOS
--------------------------
John Speridakos
Vice President and Controller
(Principal Accounting Officer)
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