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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 MARCH 29, 2003
or
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from________ to ________
Commission file number 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 ( )
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act). Yes (X) No ( )
As of April 26, 2003 there were 19,922,205 shares of common stock outstanding.
ADVO, INC.
INDEX TO QUARTERLY REPORT
ON FORM 10-Q
QUARTER ENDED MARCH 29, 2003
Page
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Part I - Financial Information
Item 1. Financial Statements (Unaudited).
Consolidated balance sheets -
March 29, 2003 and September 28, 2002. 2
Consolidated statements of operations -
Six months and three months ended
March 29, 2003 and March 30, 2002. 3
Consolidated statements of cash flows -
Six months ended March 29, 2003
and March 30, 2002. 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. 13
Item 4. Controls and Procedures 14
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K. 15
Signatures 16
Certification 17
ADVO, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share data)
March 29, September 28,
2003 2002
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 11,273 $ 12,281
Accounts receivable, net 119,989 120,600
Inventories 2,583 2,415
Prepaid expenses and other current assets 7,262 7,140
Deferred income taxes 12,771 13,189
--------- ---------
Total current assets 153,878 155,625
Property, plant and equipment 299,804 276,301
Less accumulated depreciation and amortization (159,351) (147,913)
--------- ---------
Net property, plant and equipment 140,453 128,388
Investment in deferred compensation plan 10,158 10,311
Goodwill 22,062 22,124
Other assets 14,325 13,661
--------- ---------
TOTAL ASSETS $ 340,876 $ 330,109
========= =========
LIABILITIES
Current liabilities:
Current portion of long-term debt $ 28,750 $ 22,500
Notes payable - short term 74 1,715
Accounts payable 30,846 32,923
Accrued compensation and benefits 27,217 24,798
Other current liabilities 38,427 37,127
--------- ---------
Total current liabilities 125,314 119,063
Long-term debt 125,000 146,750
Deferred income taxes 15,431 12,770
Deferred compensation plan 10,158 10,311
Other liabilities 4,803 4,885
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 30,672,169
and 30,594,410 shares, respectively) 307 306
Additional paid-in capital 207,445 205,164
Unamortized deferred compensation (1,913) (873)
Accumulated earnings 83,182 61,329
--------- ---------
289,021 265,926
Less common stock held in treasury, at cost (228,909) (228,473)
Accumulated other comprehensive income (loss) 58 (1,123)
--------- ---------
Total stockholders' equity 60,170 36,330
--------- ---------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 340,876 $ 330,109
========= =========
See Accompanying Notes.
-2-
ADVO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Six months ended Three months ended
------------------------ ------------------------
March 29, March 30, March 29, March 30,
2003 2002 2003 2002
--------- --------- --------- ---------
REVENUES $ 578,243 $ 561,369 $ 287,065 $ 274,433
Costs and expenses:
Cost of sales 426,622 409,321 212,268 201,855
Selling, general and
administrative 110,202 107,731 55,101 53,376
Provision for bad debts 2,709 4,112 959 1,987
--------- --------- --------- ---------
OPERATING INCOME 38,710 40,205 18,737 17,215
Interest expense 4,571 6,864 1,673 3,349
Other (income) expense, net (547) 787 (282) 493
--------- --------- --------- ---------
Income before income taxes 34,686 32,554 17,346 13,373
Provision for income taxes 12,834 12,045 6,418 4,948
--------- --------- --------- ---------
NET INCOME $ 21,852 $ 20,509 $ 10,928 $ 8,425
========= ========= ========= =========
BASIC EARNINGS PER SHARE $ 1.10 $ 1.03 $ .55 $ .42
========= ========= ========= =========
DILUTED EARNINGS PER SHARE $ 1.09 $ 1.01 $ .55 $ .42
========= ========= ========= =========
Weighted average basic shares 19,802 19,939 19,816 19,950
Weighted average diluted shares 19,977 20,281 19,990 20,276
See Accompanying Notes.
-3-
ADVO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Six months ended
----------------------
March 29, March 30,
2003 2002
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 43,158 $ 28,633
Cash flows from investing activities:
Acquisition of property, plant and equipment (28,007) (13,370)
Proceeds from disposals of property, plant and equipment 395 301
Distributions from equity affiliates 363 44
Acquisitions/joint ventures, net of cash acquired 146 (450)
-------- --------
NET CASH USED BY INVESTING ACTIVITIES (27,103) (13,475)
Cash flows from financing activities:
Revolving line of credit - net (5,500) (9,000)
Payments on long-term debt (10,000) (3,750)
Decrease in note payable - net (1,641) (2,391)
Proceeds from exercise of stock options 467 1,522
Purchase of common stock for treasury (435) (8,674)
-------- --------
NET CASH USED BY FINANCING ACTIVITIES (17,109) (22,293)
-------- --------
Effect of exchange rate changes on cash and cash equivalents 46 --
Decrease in cash and cash equivalents (1,008) (7,135)
Cash and cash equivalents at beginning of period 12,281 17,728
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 11,273 $ 10,593
======== ========
Noncash activities:
Decrease in fair value of 1,090 2,028
interest rate swap liabilities
Change in noncash portion of deferred
compensation plan 101 1,967
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 six-month period ended March 29, 2003 are not
necessarily indicative of the results that may be expected for the fiscal year
ending September 27, 2003. 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 28, 2002.
Certain reclassifications have been made in the fiscal 2002 financial statements
to conform with the fiscal 2003 presentation.
2. SUMMARY OF ACCOUNTING POLICIES
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("Statement") No. 143, "Accounting for Asset
Retirement Obligations". Statement No. 143 establishes accounting standards for
the recognition and measurement of legal obligations associated with the
retirement of tangible long-lived assets and requires the recognition of a
liability for an asset retirement obligation in the period in which it is
incurred. The Company adopted Statement No. 143 at the beginning of fiscal 2003
and such adoption had no effect on the Company's financial position and results
of operations.
In August 2001, the FASB issued 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 adopted Statement No.
144 at the beginning of fiscal 2003 and such adoption had no effect on the
Company's financial position and results of operations.
In July 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" which supercedes Emerging Issues
Task Force Issue ("EITF") No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (Including Certain
Costs Associated with a Restructuring)". Statement No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred as opposed to when management is committed to an
exit plan. Such liabilities should be recorded based on their fair value, as
defined. This statement is effective for exit or disposal activities initiated
after December 31, 2002. The Company recorded a severance charge in the first
quarter of fiscal 2003 and recognized the liability in accordance with Statement
No. 146.
In November 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, including Guarantees of
Indebtedness of Others" which requires companies to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. FIN No. 45 provides specific guidance for identifying the
characteristics of contracts that are subject to its guidance in its entirety
from those only subject to the initial recognition and measurement provisions.
The recognition and measurement provisions of FIN No. 45 are effective on a
prospective basis for guarantees issued or modified after December 31, 2002.
-5-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The disclosure requirements of FIN No. 45 are effective for interim and annual
period financial statements ending after December 15, 2002. The Company's
contingent consideration related to the acquisition of ADVO Canada in June 2002
is subject to the disclosure requirements of FIN No. 45. If certain earning
targets are met by ADVO Canada, the Company will be required to pay an
additional payment of up to a maximum of $0.7 million over the next three years.
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. Statement No. 148 also amends the
disclosure requirements of Statement No. 123, "Accounting for Stock-Based
Compensation", to require more prominent and additional disclosure in both
annual and interim financial statements on the method of accounting for
stock-based compensation. The interim disclosure provisions are effective for
financial reports for interim periods beginning after December 15, 2002. The
Company adopted the disclosure provisions of Statement No. 148 in the second
quarter of fiscal 2003. See Note 5 of the "Notes to Consolidated Financial
Statements".
3. 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:
Six months ended Three months ended
--------------------- ---------------------
March 29, March 30, March 29, March 30,
2003 2002 2003 2002
------- ------- ------- -------
(In thousands)
Net income $21,852 $20,509 $10,928 $ 8,425
Other comprehensive income:
Unrealized gain on derivative instruments 1,090 2,028 -- 1,362
Foreign currency translation adjustment 91 -- 87 --
------- ------- ------- -------
Total comprehensive income $23,033 $22,537 $11,015 $ 9,787
======= ======= ======= =======
-6-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4. 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.
Six months ended Three months ended
-------------------- --------------------
March 29, March 30, March 29, March 30,
2003 2002 2003 2002
-------- -------- -------- --------
(In thousands, except per share data)
Net income $ 21,852 $ 20,509 $ 10,928 $ 8,425
Weighted average basic shares 19,802 19,939 19,816 19,950
Effect of dilutive securities:
Stock options 154 310 154 305
Restricted stock 21 32 20 21
-------- -------- -------- --------
Dilutive potential common shares 175 342 174 326
Weighted average diluted shares 19,977 20,281 19,990 20,276
======== ======== ======== ========
Basic earnings per share $ 1.10 $ 1.03 $ .55 $ .42
======== ======== ======== ========
Diluted earnings per share $ 1.09 $ 1.01 $ .55 $ .42
======== ======== ======== ========
5. STOCK - BASED COMPENSATION
The Company maintains several stock-based compensation plans relating to stock
options. The Company accounts for those plans under the recognition and
measurement principles of Accounting Principles Board Opinion No. 25 ("APB
Opinion No. 25") "Accounting for Stock Issued to Employees", and related
Interpretations. Aside from the amortization of restricted stock awards, no
stock-based employee compensation cost is reflected in net income, as all
options granted under those plans have an exercise price equal to the market
value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
as if the Company had applied the Black-Scholes fair value method which is
described in Statement No. 123, to stock-based employee compensation plans.
-7-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Six months ended Three months ended
-------------------------- -------------------------
March 29, March 30, March 29, March 30,
2003 2002 2003 2002
---------- ---------- ---------- ---------
(In thousands, except per share data)
Net income, as reported $ 21,852 $ 20,509 $ 10,928 $ 8,425
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related
tax effects (1,850) (2,324) (808) (1,173)
---------- ---------- ---------- ---------
Pro forma net income $ 20,002 $ 18,185 $ 10,120 $ 7,252
========== ========== ========== =========
Earnings per share:
Basic - as reported $ 1.10 $ 1.03 $ .55 $ .42
Basic - pro forma $ 1.01 $ .91 $ .51 $ .36
Diluted - as reported $ 1.09 $ 1.01 $ .55 $ .42
Diluted - pro forma $ 1.00 $ .91 $ .51 $ .36
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the stock options' vesting period, ranging
from one to four years. The pro forma effect on net income and related earnings
per share may not be representative of the future years' impact since the terms
and conditions of new grants may vary from the current terms.
-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 The Company reported revenues of $287.1 million for the second quarter
of fiscal 2003 representing a 4.6%, or $12.6 million, increase from $274.4
million in the second quarter of fiscal 2002. This growth was primarily related
to increased volumes in the Company's core shared mail products demonstrated by
a 5.4% increase in shared mail pieces distributed and a 4.8% increase in average
pieces per package, when comparing the current quarter to the prior year
quarter. Also contributing to the revenue growth for the second quarter of
fiscal 2003 were revenues of $1.8 million from ADVO Canada acquired in June
2002. Offsetting the second quarter revenue increases were shifts in product mix
and weights, from heavier to lighter weight products, which contributed to the
1.5% decrease in shared mail revenue per piece to $37.96 for the three months
ended March 29, 2003 when compared to the three months ended March 30, 2002.
Driven by the volume growth that occurred in the second quarter of fiscal 2003
which is detailed above, revenues for the year-to-date period ended March 29,
2003 increased $16.9 million, or 3.0%, to $578.2 million. Also contributing to
the year-to-date revenue growth were ADVO Canada revenues of $3.9 million. Key
statistics for the first six months of fiscal 2003 included a 2.2% increase over
the first half of fiscal 2002 in shared mail pieces delivered. Shared mail
packages delivered also increased 2.2% for the year-to-date period ended March
29, 2003, driven mainly by the 3.8% shared mail package growth in the first
quarter of fiscal 2003. Average pieces per package increased 0.1% for the first
half of fiscal 2003 due to the blending of the 4.8% increase in the second
quarter and a 4.6% decrease in the first quarter of fiscal 2003.
OPERATING EXPENSES Cost of sales as a percentage of revenue remained
comparatively flat at 73.9% for the second quarter of fiscal 2003 compared to
73.6% for the second quarter of fiscal 2002. Cost of sales for the six months
ended March 29, 2003 increased 0.9 percentage points to 73.8% of revenues when
compared to the same period of the prior year.
In absolute terms, cost of sales increased $10.4 million and $17.3 million,
respectively, for the three and six months ended March 29, 2003 when compared to
the same periods ended March 30, 2002. This increase was primarily caused by a
6.1% (quarter) and 5.2% (year-to-date) increase in distribution costs, which
consist mostly of postage costs, resulting from the shared mail package and
piece growth and the postal rate increase. Although the Company processed an
increased number of pieces and packages in our facilities, the Company's
variable operation costs remained flat for the quarter and increased slightly
for the year-to-date period. The Company's cost per thousand pieces manufactured
decreased 6.7% and 4.6%, respectively, for the current quarter and year-to-date
periods, demonstrating continued efficiencies at the facilities. Also
contributing to the increase for the quarter and year-to-date period were higher
facilities overhead costs, such as utilities and increased rent associated with
the modernization of certain facilities.
-9-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the quarter and year-to-date periods ended March 29, 2003, selling, general
and administrative ("SG&A") costs, including the provision for bad debts,
increased $0.7 million and $1.1 million, respectively, when compared to the same
periods in the prior year. As a percentage of revenues, SG&A costs decreased 0.7
and 0.4 percentage points for the three and six months ended March 29, 2003
versus the comparable periods in fiscal 2002. SG&A costs for the second quarter
and year-to-date periods included higher incentive compensation costs offset to
a degree by lower bad debt expense. Both the quarter and year-to-date periods
included $1.4 million and $3.5 million, respectively, for a project focused on
developing programs to accelerate the achievement of the Company's revenue
growth potential. Also impacting the year-to-date SG&A costs was $0.8 million of
severance expense related to the departure of the Company's former Chief
Financial Officer. These additional costs were partially offset by strict cost
controls.
OPERATING INCOME For the second quarter ended March 29, 2003, the Company
reported operating income of $18.7 million compared to $17.2 million for the
quarter ended March 30, 2002, representing an 8.8% increase. For the first half
of fiscal 2003, operating income was $38.7 million versus $40.2 million for the
same period in the prior year, representing a 3.7% decrease.
INTEREST EXPENSE Interest expense decreased $1.7 million and $2.3 million for
the three and six month periods ended March 29, 2003, respectively. The
decreases were due to lower market rates of interest, a decrease in the average
outstanding debt balance and the elimination of the Company's interest swap
agreements at the beginning of December 2002.
OTHER INCOME/EXPENSE For the three and six months ended March 29, 2003, other
income of $0.3 million and $0.5 million, respectively, was primarily the result
of equity earnings from a newspaper partnership which the Company accounts for
under the equity method. In the prior year's second quarter and year-to-date
periods, other expense of $0.5 million and $0.8 million, respectively, included
equity losses of $0.3 million and $0.4 million associated with the start up of
the newspaper partnership.
INCOME TAXES The effective income tax rate for both the three and six months
ended March 29, 2003 and March 30, 2002 was 37%.
EARNINGS PER SHARE As a result of the Company's improved earnings, diluted
earnings per share increased 31.0% to $0.55 for the second quarter of fiscal
2003 from $0.42 for the same period of the prior year. On a year-to-date basis,
diluted earnings per share were $1.09 for the first six months of fiscal 2003
versus $1.01 in the comparable prior year period, representing a 7.9% increase.
FINANCIAL CONDITION
Working capital at March 29, 2003 was $28.6 million reflecting an $8.0 million
decrease from the September 28, 2002 working capital of $36.6 million. The
decrease was comprised of a $1.7 million decrease in current assets and a $6.3
million increase in current liabilities.
A lower cash balance at the end of March versus the end of September and a
decrease in accounts receivable due to the continued focus on collection efforts
account primarily for the change in current assets.
The overall increase in current liabilities was the result of the following: a
$2.4 million increase in accrued compensation and benefits for higher incentive
wages, increases in other current liabilities relating to the timing of customer
advance payments of $3.7 million and a $6.3 million increase in the current
portion of long-term debt due to scheduled debt repayments. Offsetting these
increases was a $2.1 million decrease in accounts payable due to the timing of
vendor payments and a decrease in other current liabilities due to the
expiration of the Company's interest rate swap agreements of $1.1 million.
-10-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Stockholders' equity increased $23.8 million to $60.2 million at March 29, 2003
from $36.3 million at September 28, 2002. Year-to-date net income of $21.9
million significantly contributed to the increase in stockholders' equity. Also
contributing to the increase was $1.2 million of restricted stock amortization
and employee stock plan activity and related tax benefits and a positive change
of $1.1 million in the fair value of derivative instruments. These increases
were offset by treasury stock purchases of $0.4 million consisting of $0.2
million made on the open market during the first fiscal quarter associated with
the Company's buyback program and $0.2 million pursuant to elections by
employees to satisfy withholding requirements under the Company's restricted
stock and stock option plans.
PROPERTY, PLANT AND EQUIPMENT
Investments in property, plant and equipment for the six-month period ended
March 29, 2003 totaled $28.0 million. The primary focus continues to be on
software development for the Company's order fulfillment and service delivery
redesign project. Additional capital investments were directed toward the
deployment of computer hardware, Alphaliner computerized mail sorters and
renovations to certain of the Company's facilities. The Company expects its
capital expenditures for the entire year to be approximately $45.0 million.
LIQUIDITY
The Company's main source of liquidity continues to be funds generated from
operating activities. The Company also has available unused credit commitments
of $115.2 million which may be used to fund working capital requirements.
Cash and cash equivalents decreased $1.0 million to $11.3 million at March 29,
2003. Factoring into the decrease was cash used for investing and financing
activities of $27.1 million and $17.1 million, respectively, offset by cash
provided by operating activities of $43.2 million.
Net cash provided by operating activities for the six months ended March 29,
2003 was $43.2 million versus $28.6 million for the six months ended March 30,
2002. The year over year increase, the first half of fiscal 2003 compared to the
first half of fiscal 2002, was due to the following: a decrease in the cash
outlay for accounts payable, the timing of customer advances which increased for
the first half of fiscal 2003 and decreased for the comparable fiscal 2002
period, both offset by a decrease in cash collected from accounts receivable.
Capital investments in property, plant and equipment for the six-month period
ended March 29, 2003, as detailed above, were the primary use of cash by
investing activities. Investing activities of $13.5 million for the first six
months of the prior year were also mainly comprised of capital expenditures.
Net cash used for financing activities for the year-to-date period ended March
29, 2003 and March 30, 2002 was $17.1 million and $22.3 million, respectively.
In the current period, financing activities consisted of $15.5 million of net
payments on the revolver and scheduled principal payments on the term loan and
the final payment of a $1.6 million note resulting from the acquisition of Mail
Marketing Systems Inc. ("MMSI"). Financing activities for the prior period
included net revolver/term loan payments of $12.8 million, $2.4 million repaid
to MMSI, and $8.7 million of treasury stock purchases offset by $1.5 million of
proceeds from stock option exercises.
-11-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Contractual and commercial commitments
The Company's contractual obligations are as follows:
(In millions) Long term debt Operating leases
-------------- ----------------
Less than one year $ 28.8 $ 16.1
One to three years 125.0 28.4
Four to five years -- 11.2
After five years -- 17.9
-------- -------
Total $ 153.8 $ 73.6
======== =======
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 portion of these contracts has lapsed, and the
Company has the right to cancel these contracts subject to termination charges
ranging from $12.7 million in fiscal 2003 to $0.2 million in fiscal 2008
depending on the year in which the cancellation becomes effective.
The Company has agreements with various paper suppliers to assure the continuity
of supply as well as supply of proper paper grades. Approximately 70% of the
Company's expected paper requirements are covered by these agreements. The
Company has negotiated prices that are tied to a published paper price index.
These arrangements expire at various dates through October 31, 2005.
The Company has outstanding letters of credit of approximately $9.8 million
under separate agreements primarily relating to its worker's compensation
program, expiring in April 2004.
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.
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 March 29, 2003, there was $153.8 million of
debt outstanding, with $28.8 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 April 2003, the
Company borrowed an additional $20.0 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
The FASB has issued several Statements of Financial Accounting Standards that
the Company adopted at the beginning of the fiscal year. For further discussion
of these Statements see Note 2 of the "Notes to Consolidated Financial
Statements".
-12-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 of operations and which
require complex or subjective judgments or estimates. The preparation of
financial statements in conformity with generally 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 has determined
its critical accounting polices to include the allowance for doubtful accounts
and the valuation of goodwill and intangible assets.
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 categories 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 the fair value of net assets
acquired in connection with purchase business combinations. The Company is
required to test goodwill annually for impairment. Impairment exists when the
carrying amount of goodwill exceeds its fair market value. 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 performed the annual impairment testing
during the first quarter of fiscal 2003 and 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 used to determine
the fair value, are 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 had historically
maintained interest rate swap agreements on notional amounts totaling $100
million. However, the interest rate swap agreements expired on December 9, 2002.
If interest rates should change by 2 percentage points for the remainder of the
2003 fiscal year from those rates in effect at March 29, 2003, interest expense
would increase or decrease by approximately $1.6 million. These amounts are
determined by considering the hypothetical interest rates on the Company's
borrowing cost. The sensitivity analysis also assumes no changes in the
Company's financial structure.
-13-
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. The Company's business
is promotional in nature, and ADVO serves its clients on a "just in time" basis.
As a result, fluctuations in the amount, timing, pages and weight, and kinds of
advertising pieces can vary significantly from week to week, depending on its
customers' promotional needs, inventories, and other factors. In any particular
quarter these transactional fluctuations are difficult to predict, and can
materially affect the Company's revenue and profit results. The Company's
business contains additional risks and uncertainties which include but are not
limited to: general 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, the number of shares the Company will purchase in the future under its
buyback program, fluctuations in interest rates related to the outstanding debt
and other general economic factors.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the filing of this Quarterly Report on Form 10-Q, the
Company evaluated, under the supervision and with the participation of
management, the principal executive officer and principal financial officer, the
design and operation of its disclosure controls and procedures to determine
whether they are effective in ensuring that the disclosure of required
information is made timely in accordance with the Securities Exchange Act and
the rules and forms of the Securities and Exchange Commission.
The principal executive officer and principal financial officer have concluded,
based on their review, that the Company's disclosure controls and procedures, as
defined in Securities Exchange Act Rules 13a-14(c) and 15d-14(c), are effective
to ensure that information required to be disclosed by the Company in reports it
files under the Exchange Act are recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission
rules and forms. No significant changes were made to the Company's internal
controls or other factors that could significantly affect these controls
subsequent to the date of their evaluation.
-14-
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit No. Exhibits
- ----------- --------
10 Trust Agreement between ADVO, Inc. and
Fidelity Management Trust Company for the
ADVO, Inc. Executive Deferred
Compensation Plan Trust dated January 2,
2003 *
99(a) Certification of Periodic Report Pursuant
to Section 906 of the Sarbanes-Oxley Act
of 2002 - Gary M. Mulloy.
99(b) Certification of Periodic Report Pursuant
to Section 906 of the Sarbanes-Oxley Act
of 2002 - Donald E. McCombs.
* Management contract or compensatory plan required to be filed as an exhibit.
(b) Reports on Form 8-K
The Company furnished a current report on Form 8-K dated April 18,
2003 which reported the Company's earnings press release for the
second quarter ended March 29, 2003.
- --------------------------------------------------------------------------------
Omitted from this Part II are items which are inapplicable or to which the
answer is negative for the period covered.
-15-
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: May 12, 2003 By: /s/ JOHN D. SPERIDAKOS
------------ -------------------------------
John D. Speridakos
Vice President and Controller
(Principal Accounting Officer)
-16-
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Gary M. Mulloy, Chairman and Chief Executive Officer of ADVO, Inc., certify
that:
1) I have reviewed this quarterly report on Form 10-Q of ADVO, Inc (the
"registrant");
2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3) Based on my knowledge, the financial statements and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of this registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
/s/ GARY M. MULLOY
------------------
Gary M. Mulloy
Chairman and Chief Executive Officer
Date: May 12, 2003
-17-
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Donald E. McCombs, Executive Vice President - President, Operations Group and
Acting Chief Financial Officer, certify that:
1) I have reviewed this quarterly report on Form 10-Q of ADVO, Inc (the
"registrant");
2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of this registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
/s/ DONALD E. MCCOMBS
---------------------
Donald E. McCombs
Executive Vice President - President, Operations
Group and Acting Chief Financial Officer
Date: May 12, 2003
-18-