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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 28, 2003
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or
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission file number 1-11720
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ADVO, INC.
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(Exact name of registrant as specified in its charter)
Delaware 06-0885252
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(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
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (860) 285-6100
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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
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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
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As of July 26, 2003 there were 19,955,565 shares of common stock outstanding.
ADVO, INC.
INDEX TO QUARTERLY REPORT
ON FORM 10-Q
QUARTER ENDED JUNE 28, 2003
Part I - Financial Information Page
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Item 1. Financial Statements (Unaudited).
Consolidated balance sheets -
June 28, 2003 and September 28, 2002. 2
Consolidated statements of operations -
Nine months and three months ended
June 28, 2003 and June 29, 2002. 3
Consolidated statements of cash flows -
Nine months ended June 28, 2003
and June 29, 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
ADVO, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share data)
June 28, September 28,
ASSETS 2003 2002
--------- ---------
Current assets:
Cash and cash equivalents $ 19,284 $ 12,281
Accounts receivable, net 112,534 120,600
Inventories 2,871 2,415
Prepaid expenses and other current assets 8,754 7,140
Deferred income taxes 11,886 13,189
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Total current assets 155,329 155,625
Property, plant and equipment 307,896 276,301
Less accumulated depreciation and amortization (165,841) (147,913)
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Net property, plant and equipment 142,055 128,388
Investment in deferred compensation plan 11,481 10,311
Goodwill 22,246 22,124
Other assets 13,068 13,661
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TOTAL ASSETS $ 344,179 $ 330,109
========= =========
LIABILITIES
Current liabilities:
Current portion of long-term debt $ 32,500 $ 22,500
Notes payable - short term -- 1,715
Accounts payable 29,523 32,923
Accrued compensation and benefits 26,599 24,798
Other current liabilities 35,304 37,127
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Total current liabilities 123,926 119,063
Long-term debt 113,000 146,750
Deferred income taxes 16,069 12,770
Deferred compensation plan 11,481 10,311
Other liabilities 4,763 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 30,725,135
and 30,594,410 shares, respectively) 307 306
Additional paid-in capital 208,940 205,164
Unamortized deferred compensation (1,971) (873)
Accumulated earnings 96,788 61,329
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304,064 265,926
Less common stock held in treasury, at cost (229,310) (228,473)
Accumulated other comprehensive income (loss) 186 (1,123)
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Total stockholders' equity 74,940 36,330
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TOTAL LIABILITIES & STOCKHOLDERS'
EQUITY $ 344,179 $ 330,109
========= =========
See Accompanying Notes.
- 2 -
ADVO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Nine months ended Three months ended
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June 28, June 29, June 28, June 29,
2003 2002 2003 2002
--------- --------- --------- ---------
REVENUES $ 867,929 $ 842,308 $ 289,686 $ 280,939
Costs and expenses:
Cost of sales 640,432 616,130 213,810 206,809
Selling, general and
administrative 163,940 161,198 53,739 53,468
Provision for bad debts 3,222 5,467 512 1,355
--------- --------- --------- ---------
OPERATING INCOME 60,335 59,513 21,625 19,307
Interest expense 6,070 10,035 1,499 3,170
Other (income) expense, net (864) 823 (317) 36
--------- --------- --------- ---------
Income before income taxes 55,129 48,655 20,443 16,101
Provision for income taxes 19,671 18,002 6,837 5,957
--------- --------- --------- ---------
NET INCOME $ 35,458 $ 30,653 $ 13,606 $ 10,144
========= ========= ========= =========
BASIC EARNINGS PER SHARE $ 1.79 $ 1.54 $ .69 $ .51
========= ========= ========= =========
DILUTED EARNINGS PER SHARE $ 1.77 $ 1.51 $ .68 $ .50
========= ========= ========= =========
Weighted average basic shares 19,818 19,963 19,849 20,010
Weighted average diluted shares 20,027 20,305 20,126 20,353
See Accompanying Notes.
- 3 -
ADVO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine months ended
-------------------------
June 28, June 29,
2003 2002
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NET CASH PROVIDED BY OPERATING ACTIVITIES $ 69,536 $ 58,138
Cash flows from investing activities:
Acquisition of property, plant and equipment (38,858) (21,932)
Proceeds from disposals of property, plant and equipment 549 331
Distributions from equity affiliates 815 71
Acquisitions/joint ventures, net of cash acquired 19 (1,429)
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NET CASH USED BY INVESTING ACTIVITIES (37,475) (22,959)
Cash flows from financing activities:
Revolving line of credit - net (7,500) (12,500)
Payments on long-term debt (16,250) (7,500)
Decrease in note payable - net (1,715) (2,391)
Proceeds from exercise of stock options 1,102 2,692
Purchase of common stock for treasury (820) (13,469)
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NET CASH USED BY FINANCING ACTIVITIES (25,183) (33,168)
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Effect of exchange rate changes on cash and cash equivalents 125 5
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Increase in cash and cash equivalents 7,003 2,016
Cash and cash equivalents at beginning of period 12,281 17,728
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CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 19,284 $ 19,744
======== ========
Noncash activities:
Change in fair value of 1,090 2,876
interest rate swap liabilities
Change in noncash portion of deferred
compensation plan 1,370 341
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 28, 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 to 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.
Upon completion of the first year, ADVO Canada met its earning targets and the
previous shareholders received $0.2 million during the third quarter of fiscal
2003.
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".
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" which addresses when a company should include in its
financial statements the assets and liabilities of unconsolidated variable
interest entities ("VIEs"). It defines VIEs as those entities in which equity
investors do not have the characteristics of a controlling financial interest or
in which equity investors do not bear the residual economic risks. FIN No. 46 is
effective for fiscal years or interim periods beginning after June 15, 2003. The
Company is currently evaluating the effect, if any, that FIN No. 46 may have on
its financial statements in the fourth quarter of fiscal 2003.
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:
Nine months ended Three months ended
---------------------- ----------------------
June 28, June 29, June 28, June 29,
2003 2002 2003 2002
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(In thousands)
Net income $35,458 $30,653 $13,606 $10,144
Other comprehensive income:
Reclassification of unrealized gain on
derivative instruments 1,090 2,876 -- 848
Foreign currency translation adjustments 219 9 128 9
------- ------- ------- -------
Total comprehensive income $36,767 $33,538 $13,734 $11,001
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- 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.
Nine months ended Three months ended
---------------------- ----------------------
June 28, June 29, June 28, June 29,
2003 2002 2003 2002
------- ------- ------- -------
(In thousands, except per share data)
Net income $35,458 $30,653 $13,606 $10,144
Weighted average basic shares 19,818 19,963 19,849 20,010
Effect of dilutive securities:
Stock options 186 315 250 324
Restricted stock 23 27 27 19
------- ------- ------- -------
Dilutive potential basic shares 209 342 277 343
Weighted average diluted shares 20,027 20,305 20,126 20,353
======= ======= ======= =======
Basic earnings per share $ 1.79 $ 1.54 $ .69 $ .51
======= ======= ======= =======
Diluted earnings per share $ 1.77 $ 1.51 $ .68 $ .50
======= ======= ======= =======
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)
Nine months ended Three months ended
--------------------------- ---------------------------
June 28, June 29, June 28, June 29,
2003 2002 2003 2002
-------- -------- -------- --------
(In thousands, except per share data)
Net income, as reported $ 35,458 $ 30,653 $ 13,606 $ 10,144
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related
tax effects (3,026) (3,500) (1,176) (1,176)
-------- -------- -------- --------
Pro forma net income $ 32,432 $ 27,153 $ 12,430 $ 8,968
======== ======== ======== ========
Earnings per share:
Basic - as reported $ 1.79 $ 1.54 $ .69 $ .51
Basic - pro forma $ 1.64 $ 1.36 $ 63 $ .45
Diluted - as reported $ 1.77 $ 1.51 $ .68 $ .50
Diluted - pro forma $ 1.62 $ 1.35 $ 62 $ .44
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.
6. NON-RECURRING CHARGES
In the third quarter of fiscal 2002, 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 sales and marketing
organization.
-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 third quarter revenues of $289.7 million,
increasing $8.7 million, or 3.1%, over prior year's third quarter. For the first
nine months of fiscal 2003, revenues were $867.9 million, increasing $25.6
million, or 3.0%, over the comparable prior year period. The revenue gains for
both the three and nine-month periods were primarily attributable to the volume
growth in the Company's core shared mail products as demonstrated by the
Company's key statistics and to a lesser degree pricing gains. Total shared mail
pieces distributed increased 4.1% for the third quarter and 2.9% for the
year-to-date period of fiscal 2003 over the comparable prior year periods of
fiscal 2002. Total shared mail packages increased 0.1% and 1.5% for the three
and nine months ended June 28, 2003 versus the same periods in the prior year.
In addition, average pieces per package were 7.85 for both the third quarter and
nine months ended June 28, 2003 growing 4.0% and 1.4%, respectively, over the
prior quarter and year-to-date periods.
The third quarter and nine-month periods of fiscal 2003 included revenues of
$1.1 million and $5.0 million, respectively, associated with the acquisition of
ADVO Canada in June 2002. The revenue growth detailed above was offset in part
by shifts in product mix and weights which contributed to the 1.4% and 0.5%
decrease in revenue per thousand pieces for the third quarter and nine-months
ended June 28, 2003, respectively.
OPERATING EXPENSES Cost of sales, as a percentage of revenue, was 73.8% for both
the three and nine-month periods ended June 28, 2003, reflecting an increase
over the prior year of 0.2 percentage points for the quarter and 0.7 percentage
points for the nine-month year-to-date period. Cost of sales, in absolute terms,
increased $7.0 million for the third quarter and $24.3 million for the first
nine months of fiscal 2003 over the comparable periods of the prior year.
Distribution costs, primarily consisting of postage costs, increased 5.1% for
the third quarter and 5.2% for the current year-to-date period due to the shared
mail package and piece growth in fiscal 2003 and the postal rate increase in the
prior year. Also contributing to the cost of sales increase for the quarter and
year-to-date periods of fiscal 2003 were higher facilities and overhead costs,
which included such items as utilities, insurance and increased rent associated
with the modernization of certain facilities. Offsetting these increased costs
were efficiencies at the Company's branches. The Company's cost per thousand
pieces manufactured decreased 6.6% and 5.6% for the current quarter and
year-to-date period, respectively, as compared to the prior year periods even as
the Company processed an increased number of pieces and packages.
As a percentage of revenues, selling, general and administrative ("SG&A") costs,
including the provision for bad debts, decreased 0.8 percentage points to 18.7%
for the third quarter of fiscal 2003 and 0.5 percentage points to 19.3% for the
nine-month period ended June 28, 2003 reflecting the Company's commitment of
strictly monitoring fixed costs. In absolute terms SG&A costs, including the
provision for bad debts, decreased $0.6 million for the third quarter and
increased $0.5 million for the nine-month year-to-date period when compared to
the same periods in the prior year. SG&A costs included higher incentive
compensation for the three and nine months ended June 28, 2003 but were offset
to a degree by lower bad debt expense. SG&A costs for the current nine-month
period included an $0.8 million severance charge pursuant to the departure of
the Company's former Chief Financial Officer. The third quarter and nine-month
year-to-date SG&A expenses of fiscal 2003 included $3.3 million and $6.7
million, respectively, of costs for a project focused on developing programs to
accelerate the achievement of the Company's revenue growth potential. These
costs included incremental consulting expenses, additional compensation and
other re-deployed costs associated with the formation of this project group. In
the prior year's quarter and year-to-date periods, SG&A costs included a $4.2
million charge relating to structural changes to strengthen the Company's sales
and marketing organization.
-9-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OPERATING INCOME Operating income for the third quarter of fiscal 2003 was $21.6
million, increasing $2.3 million, or 12.0%, over the same period of the prior
year. For the first nine months of fiscal 2003, operating income was $60.3
million, versus $59.5 million for the same period of fiscal 2002, increasing
$0.8 million.
INTEREST EXPENSE For the third quarter and nine months of fiscal 2003, interest
expense decreased $1.7 million and $4.0 million, respectively, compared to the
same periods of the prior year. Contributing to this decrease were 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 nine months ended June 28, 2003, other
income of $0.3 million and $0.9 million, respectively, resulted primarily from
the equity earnings of a newspaper partnership with the Company which was
accounted for under the equity method. In the prior year's third quarter and
year-to-date periods, other expense of $0.1 million and $0.8 million,
respectively, included equity earnings of $0.1 million and equity losses of $0.3
million associated with the start up of the newspaper partnership.
INCOME TAXES The effective income tax rate for the three and nine months ended
June 28, 2003 was approximately 33.4% and 35.7%, respectively versus 37% for the
comparable periods in the prior year. The decrease in the tax rate was due to
federal and state tax credits expected to be received by the end of the current
fiscal year.
EARNINGS PER SHARE As a result of the Company's improved earnings, lower
interest expense and higher other income, diluted earnings per share increased
36.0% to $0.68 for the third quarter of fiscal 2003 from $0.50 for the same
period of the prior year. On a year-to-date basis, diluted earnings per share
were $1.77 for the first nine months of fiscal 2003 versus $1.51 in the
comparable prior year period, representing a 17.2% increase.
FINANCIAL CONDITION
Working capital decreased $5.2 million from $36.6 million at September 28, 2002
to $31.4 million at June 28, 2003. The decrease in working capital from the end
of the prior year is attributable to a $0.3 million decrease in current assets
and a $4.9 million increase in current liabilities. The components of current
assets included: a $8.1 million decrease in accounts receivable attesting to the
Company's focused collection efforts, offset by increases of $7.0 million in
cash and cash equivalents and $1.6 million in prepaid and current assets due in
part to higher insurance premiums.
The increase in current liabilities included: a $10.0 million increase in the
current portion of long-term debt due to scheduled debt repayments and a $1.8
million increase in accrued compensation and benefits for higher incentive
wages. These increases were offset by decreases of $3.4 million in accounts
payable due the timing of vendor payments and $1.8 million in other current
liabilities due to the timing of customer advances and the expiration of the
Company's interest rate swap agreements.
Stockholders' equity increased $38.6 million to $74.9 million at June 28, 2003.
The increase in stockholders' equity was primarily the result of the Company's
$35.5 million year-to-date net income. Other increases were $2.8 million of
stock and option related transactions by associates, a positive change of $1.1
million in the fair value of derivative instruments and cumulative foreign
currency translation adjustments of $0.2 million. Offsetting these increases
were treasury stock purchases of $0.9 million, which consisted of $0.7 million
pursuant to elections by employees to satisfy tax withholding requirements under
the Company's restricted stock and stock option plans and $0.2 million made on
the open market during the first fiscal quarter associated with the Company's
buyback program.
-10-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PROPERTY, PLANT AND EQUIPMENT
Capital expenditures for property, plant and equipment were $38.9 million for
the nine-month period ending June 28, 2003. The Company is concentrating its
capital investments on the development of software for its order fulfillment and
service delivery redesign project. There were also capital outlays for
Alphaliner computerized mail sorters, assorted computer hardware and renovations
to certain of the Company's facilities. Capital expenditures for the entire year
are expected to be in the high $40 million range.
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 $127.0 million, of which $117.4 million may be used to fund working capital
requirements.
Cash and cash equivalents increased $7.0 million for the nine-month period ended
June 28, 2003. The increase was derived from net cash provided by operating
activities of $69.5 million offset by net investing activities of $37.5 million
and net financing activities of $25.2 million.
Net cash provided by operating activities was $69.5 million for the period ended
June 28, 2003. Principal contributing factors were the Company's net earnings
and a decrease in accounts receivable due to stringent collection efforts
counterbalanced by the timing of both vendor payments and customer advances. Net
cash provided by operating activities increased $11.4 million over the prior
year.
Investing activities for the nine-month period ended June 28, 2003 mainly
related to capital expenditures for property, plant and equipment as previously
discussed. For the prior period ended June 29, 2002 investing activities
consisted of $21.9 million for capital expenditures and $1.4 million for the
acquisition of ADVO Canada and a MailCoups franchisee.
Net cash used for financing activities for the periods ended June 28, 2003 and
June 29, 2002 was $25.2 million and $33.2 million, respectively. In the current
year debt payments of $23.8 million included net payments on the revolver and
scheduled principal payments on the term loan. In addition, cash used for
financing activities included the final payment of a $1.7 million note resulting
from the acquisition of Mail Marketing Systems, Inc. ("MMSI"). These uses of
cash were offset by proceeds of $1.1 million pursuant to stock option exercises.
Financing activities in the prior year included debt payments of $20.0 million,
payment of a $2.4 million note associated with the acquisition of MMSI and $13.5
million of treasury stock purchases offset by cash of $2.7 million generated
from the exercise of options.
Contractual and commercial commitments
The Company's contractual obligations are as follows:
(In millions) Long-term debt Operating leases
-------------- ----------------
Less than one year $ 32.5 $ 15.4
One to three years 113.0 28.0
Four to five years -- 12.1
After five years -- 16.8
-------- -------
Total $ 145.5 $ 72.3
======== =======
-11-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 $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 $9.6 million
under separate agreements expiring in April 2004, 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.
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. The $300 million credit facility has been
reduced by scheduled term loan principal payments to date. At June 28, 2003,
there was $145.5 million of debt outstanding, with $32.5 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 2003, the Company borrowed an additional $5.0 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".
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ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
Critical accounting policies 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 judgments 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 policies 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 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 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 third 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 June 28, 2003, 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 $0.7 million.
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ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and Results of
Operations includes 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 that 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
As of the end of the period covered by 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), were, as of
the end of the period covered by this Quarterly Report on Form 10-Q, 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 change to the Company's internal control over financial
reporting occurred during the period covered by this Quarterly Report that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit No. Exhibits
- ----------- --------
10 Executive Severance Agreement between
James M. Dahmus and ADVO, Inc. dated
April 17, 2003.
31.1 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 - Gary M. Mulloy.
31.2 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 - James M. Dahmus.
32.1 Certification of Periodic Report Pursuant
to Section 906 of the Sarbanes-Oxley Act
of 2002 - Gary M. Mulloy.
32.2 Certification of Periodic Report Pursuant
to Section 906 of the Sarbanes-Oxley Act
of 2002 - James M. Dahmus.
(b) Reports on Form 8-K
The Company furnished a current report on Form 8-K dated July 17,
2003 which reported the Company's earnings press release for the
third quarter ended June 28, 2003.
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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 11, 2003 By: /s/ JOHN D. SPERIDAKOS
--------------- -------------------------------
John D. Speridakos
Vice President and Controller
(Principal Accounting Officer)
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