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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 DECEMBER 27, 2003
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
ADVO, INC.
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(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 Targeting Centre, Windsor, CT 06095
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(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 Act).
Yes (X) No ( )
As of January 24, 2004 there were 30,170,011 shares of common stock outstanding.
ADVO, INC.
INDEX TO QUARTERLY REPORT
ON FORM 10-Q
QUARTER ENDED DECEMBER 27, 2003
Page
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Part I - Financial Information
Item 1. Financial Statements (Unaudited).
Consolidated Balance Sheets -
December 27, 2003 and September 27, 2003. 2
Consolidated Statements of Operations -
Three months ended December 27, 2003 and December 28, 2002. 3
Consolidated Statements of Cash Flows -
Three months ended December 27, 2003 and December 28, 2002. 4
Notes to Consolidated Financial Statements. 5
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations. 10
Item 3. Quantitative and Qualitative Disclosures about
Market Risk. 14
Item 4. Controls and Procedures. 15
Part II - Other Information
Item 4. Submission of Matters to a Vote of Security Holders. 16
Item 5. Other Items. 16
Item 6. Exhibits and Reports on Form 8-K. 16
Signatures 18
ADVO, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share data)
December 27, September 27,
2003 2003
------------ -------------
ASSETS
Current assets:
Cash and cash equivalents $ 9,561 $ 17,012
Accounts receivable, net 135,394 122,104
Inventories 2,916 2,491
Prepaid expenses and other current assets 9,894 10,875
Deferred income taxes 12,114 12,496
--------- ---------
Total current assets 169,879 164,978
Property, plant and equipment 328,159 315,314
Less accumulated depreciation and amortization (180,777) (172,289)
--------- ---------
Net property, plant and equipment 147,382 143,025
Investment in deferred compensation plan 13,521 11,917
Goodwill 22,265 22,242
Other assets 11,287 12,130
--------- ---------
TOTAL ASSETS $ 364,334 $ 354,292
========= =========
LIABILITIES
Current liabilities:
Current portion of long-term debt $ 4,000 $ 36,250
Accounts payable 34,457 36,581
Accrued compensation and benefits 26,079 25,286
Other current liabilities 36,556 35,948
--------- ---------
Total current liabilities 101,092 134,065
Long-term debt 124,601 94,000
Deferred income taxes 20,595 19,765
Deferred compensation plan 13,521 11,917
Other liabilities 4,627 4,666
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value
(Authorized 5,000,000 shares, none issued) -- --
Common stock, $.01 par value (Authorized
40,000,000 shares, issued 30,268,057
and 20,042,005 shares, respectively) 303 200
Additional paid-in capital 141,746 137,252
Unamortized deferred compensation (2,216) (1,628)
Accumulated deficit (36,576) (44,384)
--------- ---------
103,257 91,440
Less common stock held in treasury, at cost (3,528) (1,716)
Accumulated other comprehensive income 169 155
--------- ---------
Total stockholders' equity 99,898 89,879
--------- ---------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 364,334 $ 354,292
========= =========
See Accompanying Notes.
-2-
ADVO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Three months ended
----------------------------
December 27, December 28,
2003 2002
------------ ------------
REVENUES $ 302,377 $ 291,178
Costs and expenses:
Cost of sales 221,358 214,354
Selling, general and
administrative 60,662 55,100
Provision for bad debts 599 1,751
--------- ---------
OPERATING INCOME 19,758 19,973
Interest (expense) (1,384) (2,898)
Debt issue costs associated with debt retirement (1,401) --
Equity earnings in joint ventures 682 295
Other (expense) income, net (134) (30)
--------- ---------
Income before income taxes 17,521 17,340
Provision for income taxes 6,308 6,416
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NET INCOME $ 11,213 $ 10,924
========= =========
BASIC EARNINGS PER SHARE $ 0.37 $ 0.37
========= =========
DILUTED EARNINGS PER SHARE $ 0.37 $ 0.36
========= =========
DIVIDENDS DECLARED PER SHARE $ 0.11 $ --
========= =========
Weighted average basic shares 29,939 29,682
Weighted average diluted shares 30,447 29,947
See Accompanying Notes.
-3-
ADVO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Three months ended
----------------------------
December 27, December 28,
2003 2002
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 12,884 $ 27,576
Cash flows from investing activities:
Acquisition of property, plant and equipment (13,950) (13,216)
Proceeds from disposals of property, plant and equipment 68 186
Distributions from equity joint ventures 525 329
--------- ---------
NET CASH USED BY INVESTING ACTIVITIES (13,357) (12,701)
Cash flows from financing activities:
Revolving line of credit - net (25,000) (500)
Payments on long-term debt (101,250) (3,750)
Proceeds on private placement notes 125,000 --
Decrease in note payable -- (1,641)
Proceeds from exercise of stock options 1,861 259
Treasury stock transactions (2,159) (341)
Payment of debt issue costs (2,173) --
Cash dividends paid (3,291) --
--------- ---------
NET CASH USED BY FINANCING ACTIVITIES (7,012) (5,973)
--------- ---------
Effect of exchange rate changes on cash and cash equivalents 34 3
Change in cash and cash equivalents (7,451) 8,905
Cash and cash equivalents at beginning of period 17,012 12,281
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 9,561 $ 21,186
========= =========
Noncash activities:
(Increase) decrease in fair value of
interest rate swap liabilities (37) 1,090
Deferred compensation plan
investment gains 1,191 630
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 three-month period ended December 27, 2003 are not
necessarily indicative of the results that may be expected for the fiscal year
ending September 25, 2004. 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 27, 2003.
2. NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," which was revised in December 2003 ("FIN No.
46-R"). This new rule requires that companies consolidate a variable interest
entity if the company is subject to a majority of the risk of loss from the
variable interest entity's activities and/or is entitled to receive a majority
of the entity's residual returns. The provisions of FIN No. 46-R currently are
required to be applied as of the end of the first reporting period after March
15, 2004 for the variable interest entities in which the company holds a
variable interest that it acquired on or before January 31, 2003. The Company is
currently evaluating the effect, if any, that FIN No. 46-R may have on its
financial statements for the second quarter of fiscal 2004.
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:
Three months ended
---------------------------
December 27, December 28,
(In thousands) 2003 2002
------------ ------------
Net income $ 11,213 $ 10,924
Other comprehensive income:
Unrealized (loss) gain on derivative instruments (37) 1,090
Foreign currency translation adjustment 51 5
-------- --------
Total comprehensive income $ 11,227 $ 12,019
======== ========
-5-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
4. FINANCING ARRANGEMENTS
On December 4, 2003, the Company replaced its existing credit facilities. The
new credit facilities totaling $275 million include $125 million private
placement senior secured notes with several institutional investors and a $150
million revolving line of credit ("Revolver") with a syndicate of banks.
The senior secured notes consist of $65 million notes at a fixed interest rate
of 5.71% (Series A Notes) and $60 million notes at a variable interest rate at
LIBOR rate plus 0.92% (Series B Notes). The senior secured notes have a ten-year
life and mature in December 2013. Interest is payable semi-annually on the
Series A Notes and quarterly on the Series B Notes.
The Revolver has a four-year life and remains available until maturity in
December 2007. The Revolver bears interest, at the Company's option, equal to
the LIBOR rate or to the bank's "base rate" plus an "applicable margin" (based
on certain financial ratios). The applicable margin ranges from 0.875% to 1.50%
on the LIBOR rate and 0% to 0.50% on the base rate. Interest is payable
quarterly or upon the maturity of the LIBOR contracts, whichever is shorter.
A summary of debt is set forth in the following table:
(In thousands) December 27, 2003 September 27, 2003
----------------- ------------------
Private Placement Notes
Series A Notes (a) $ 64,601 $ --
Series B Notes 60,000 --
Revolver - base rate of 4.125% at December 27, 2003 4,000 --
Term Loan
Base rate of 4.125% at September 27, 2003 -- 250
LIBOR rate of 2.235% at September 27, 2003 -- 101,000
Revolving Line of Credit
Base rate of 4.125% at September 27, 2003 -- 8,000
LIBOR rate of 2.245% at September 27, 2003 -- 21,000
-------- --------
$128,601 $130,250
Less current portion of long-term debt 4,000 36,250
-------- --------
Total long-term debt $124,601 $ 94,000
======== ========
(a) Includes unrealized losses for fair value hedging arrangement (see note 5
below).
The Company pays fees on the unused commitments at a rate ranging from 0.20% to
0.40% depending on the Company's debt ratio, as defined. At December 27, 2003,
there was $136.4 million available for future borrowings, $9.6 million utilized
by letters of credit under separate agreements related to the Company's workers'
compensation program and $4.0 million outstanding.
In the first quarter of fiscal 2004, the Company capitalized $2.2 million of
debt issue costs directly associated with the issuance of the new credit
facilities. These costs are included in other assets and are being amortized
either over the ten-year life of the senior secured notes or over four-year life
of the Revolver, whichever is applicable.
As a result of the debt refinancing the Company wrote off $1.4 million of
unamortized debt issue costs associated with the previous credit facilities. The
Company concluded that the replacement of the term loan with private placement
notes met the criteria of an extinguishment of debt per EITF 96-19 "Debtor's
Accounting for a Modification or Exchange of Debt Instruments." Consequently,
all unamortized debt issue costs associated with the term loan were written off.
In addition, the Company followed the guidance per EITF 98-14, "Debtor's
-6-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Accounting for Changes in the Line-of-Credit or Revolving-Debt Arrangements," to
calculate the amount of unamortized debt issue costs associated with the
replacement of the revolving line of credit and wrote off a portion of those
costs. In accordance with EITF 98-14, the remaining unamortized debt issue costs
of $0.6 million will be amortized over the life of the new Revolver. At December
27, 2003 and September 27, 2003, unamortized costs totaled $2.7 million and $2.1
million, respectively.
Under the terms of the senior secured notes and Revolver, the Company is
required to maintain certain financial ratios. In addition, the credit
facilities also place restrictions on disposals of assets, mergers and
acquisitions, dividend payments, investments and additional debt.
5. DERIVATIVES AND HEDGING ACTIVITIES
During the first quarter of fiscal year 2004, the Company entered into various
interest rate swap agreements to allow the Company to take advantage of low,
near term interest rates and to mitigate risk from exposure to forward upward
movements in interest rates. The Company does not enter into derivative
financial instruments for trading or speculative purposes. The Company
documented all relationships between hedging instruments and hedged items, as
well as its risk management objective and strategy for undertaking various hedge
transactions in accordance with Statement of Financial Accounting Standards
("Statement") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The Company has determined that the current interest rate swap
agreements qualify for treatment under the short-cut method of assessing
effectiveness and are considered highly effective, as defined by Statement No.
133 since all of the terms of the derivative instruments match those of the
hedged item.
The following table presents the notional amount of interest rate swaps by
class:
(In thousands)
FINANCIAL INSTRUMENT HEDGE TYPE NOTIONAL AMOUNT START DATE MATURITY DATE
- -------------------- ---------- --------------- ---------- -------------
Fixed to floating Fair Value $25,000 12/23/03 12/04/13
Floating to fixed Cash Flow 8,000 12/04/04 12/04/08
Floating to fixed Cash Flow 8,000 12/04/05 12/04/09
Floating to fixed Cash Flow 9,000 12/04/06 12/04/10
Statement No. 133 requires companies to recognize all derivatives on the balance
sheet at fair value. Changes in the fair value of the interest rate swap
agreements that are designated as fair value hedges are recognized in earnings
as an offset to the changes in the fair value of the exposures being hedged. As
a result, the fair value of the interest rate swap (fixed to floating), a
liability of $0.4 million at December 27, 2003, decreased the carrying amount of
debt and increased the interest rate swap liability.
The changes in the fair value of the interest rate swap agreements that are
designated as cash flow hedges are deferred in accumulated other comprehensive
income (loss) and are recognized in earnings as the hedged transactions occur.
The fair value of the cash flow hedges was a liability of $61,000, and recorded
net of taxes, a loss of $37,000 in accumulated other comprehensive income (loss)
at December 27, 2003.
6. STOCKHOLDERS' EQUITY
On October 16, 2003, the Company announced a three-for-two stock split of its
common stock effected in the form of a stock dividend. As a result of the split,
stockholders received one additional share of common stock for every two shares
held. The stock dividend was paid on November 7, 2003 to common shareholders of
record as of October 24, 2003. The stock split was recorded by increasing common
stock by $0.1 million and decreasing accumulated earnings by $0.1 million on the
Consolidated Balance Sheets (issuance of 10 million shares at $0.01 par value).
There was no effect to the Company's overall equity position as a result of the
stock split. All share and per share data have been restated to give retroactive
effect to the split.
-7-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Also on October 16, 2003, the Company established a regular quarterly cash
dividend. The initial quarterly dividend was aligned with the stock split and
was paid at a rate of $0.11 per share, on a post-split basis. The Company paid
quarterly cash dividends of $3.3 million for the first quarter of fiscal 2004.
At the Company's Annual Meeting held on January 23, 2004, the Company's
stockholders' approved the amendment of the Company's Certificate of
Incorporation to increase the number of authorized shares of common stock, $0.01
par value per share, from 40 million to 80 million shares.
7. EARNINGS PER SHARE
Basic earnings per share excludes common stock equivalents, such as stock
options, and is computed by dividing earnings 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.
Three months ended
---------------------------
December 27, December 28,
(In thousands, except per share data) 2003 2002
------------ ------------
Net income $11,213 $10,924
======= =======
Weighted average basic shares 29,939 29,682
Effect of dilutive securities:
Stock options 458 230
Restricted stock 50 35
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Dilutive potential basic shares 508 265
------- -------
Weighted average diluted shares 30,447 29,947
======= =======
Basic earnings per share $ 0.37 $ 0.37
======= =======
Diluted earnings per share $ 0.37 $ 0.36
======= =======
8. 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.
On December 11, 2003, the Company granted 26,000 performance based restricted
stock units to its Chief Executive Officer. The units vest in installments of
one-third each year from the date of grant subject to the Company achieving
certain performance criteria. The performance criteria is based on
pre-established thresholds. The units vest cumulatively, in that, if the
threshold is not met in a given year, but is achieved in the subsequent fiscal
year, the cumulative units will be awarded in that subsequent year in which the
threshold is met.
-8-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Since on the grant date neither the fair market value on the day the units vest
nor the number of units that could ultimately be earned are known, the
restricted stock units have been deemed to be a variable award. In accordance
with variable stock compensation accounting, the estimated compensation expense,
as measured quarterly, may fluctuate based on the fair market value of the stock
price and the probability of achieving the performance criteria. No compensation
expense was recorded in the first quarter of fiscal 2004. For each subsequent
quarter, the Company will re-evaluate the probability of achieving the
performance criteria and record compensation expense accordingly.
As required under Statement No. 123, "Accounting for Stock-Based Compensation,"
and Statement No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure," the pro forma effects of stock-based compensation on net income and
net earnings per share have been estimated at the date of grant using the
Black-Scholes option-pricing model, as follows:
Three months ended
------------------------------
December 27, December 28,
(In thousands, except per share data) 2003 2002
------------ ------------
Net income, as reported $ 11,213 $ 10,924
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related
tax effects (983) (1,103)
---------- ----------
Pro forma net income $ 10,230 $ 9,821
========== ==========
Earnings per share:
Basic - as reported $ 0.37 $ 0.37
Basic - pro forma $ 0.34 $ 0.33
Diluted - as reported $ 0.37 $ 0.36
Diluted - pro forma $ 0.34 $ 0.33
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the stock options' vesting periods, 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.
9. NEW PRODUCTION FACILITY
During fiscal 2003, the Company entered into a lease agreement for a new
Hartford, Connecticut area production facility with lease payments to begin
after the construction of the facility, expected in June 2004. The lease
agreement included the right to purchase the property, which the Company
exercised in December 2003. The purchase price, which was dependent upon
construction costs and was limited to a negotiated maximum amount, was estimated
to be approximately $20.0 million. The Company subsequently decided to terminate
the lease agreement in its entirety and will construct the new facility and
record the construction costs to construction in progress ("CIP"). As of
December 27, 2003, CIP related to the construction of the facility was $4.4
million, of which $1.6 million is attributable to land acquisition costs.
-9-
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 first quarter ended December 27, 2003, the Company reported
revenues of $302.4 million, representing an $11.2 million, or 3.8%, increase
over the first quarter of the prior year. The revenue gain was driven by volume
growth in the Company's shared mail products, illustrated by the 10.1% increase
in total shared mail pieces delivered to 7.0 billion pieces for the first
quarter of fiscal 2004. Other key performance indicators include a 3.8% increase
in total shared mail packages delivered from 829.9 million packages in the first
quarter of fiscal 2003 to 861.1 million for the current quarter of fiscal 2004.
In addition, average shared mail pieces per package were 8.17 increasing 6.1%
over the prior year's first quarter.
The revenue growth detailed above was slightly offset by shifts in product mix
to lower priced products and lighter weight products, resulting in a 5.1%
decrease in shared mail revenue per thousand pieces for this current quarter
compared to prior year's quarter. The grocery strike in Southern California also
affected the revenues for the first quarter. The Company estimates a loss of
approximately $4.9 million of revenues for the quarter due to the grocery
strike.
OPERATING EXPENSES Cost of sales as a percentage of revenue decreased 0.4
percentage points to 73.2% for the first quarter of the current year when
compared to the same quarter of the prior year. For the three months ended
December 27, 2003, cost of sales was $221.4 million, increasing $7.0 million
from the comparable period of the prior year. This increase was primarily
attributable to the 3.7% increase in distribution costs, comprised mainly of
higher postage costs resulting from the volume growth in shared mail pieces and
packages. Additionally, print costs associated with the revenue growth in
certain printed shared mail products increased 11.4% contributing to the overall
increase in cost of sales.
Selling, general and administrative costs, including the provision for bad debts
("SG&A costs") as a percentage of revenue was 20.3% for the first quarter of
fiscal 2004 versus 19.5% for the same quarter of fiscal 2003. SG&A costs
increased $4.4 million for the current quarter over prior year's quarter. This
increase was related to the 8.8% increase in commission expense and related
benefits associated with the revenue growth, the increase in costs associated
with a project that is focused on accelerating the Company's growth potential
which includes additional compensation, relocation and consulting costs and
increased depreciation expense as a result of certain software projects being
placed into service. Offsetting these increases was a decrease of $1.2 million
in bad debts expense due to improved credit and collection efforts. In the prior
year, SG&A costs included $0.8 million of severance expense related to the
departure of the Company's former Chief Financial Officer.
OPERATING INCOME For the first quarter of fiscal 2004, the Company reported
operating income of $19.8 million versus $20.0 million for the first quarter of
fiscal 2003.
INTEREST EXPENSE For the first quarter of fiscal 2004, interest expense was $1.4
million, decreasing $1.5 million from the same period in the prior year. The
decrease was the result of lower interest rates, a lower average outstanding
debt balance and the expiration of the Company's interest swap agreements during
the first quarter of fiscal 2003.
On December 4, 2003, the Company replaced its existing credit facilities, term
loan and revolving line of credit, with private placement notes and a new bank
revolver. The Company concluded that the replacement of the term loan with
private placement notes met the criteria of an extinguishment of debt per EITF
96-19, "Debtor's
-10-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Accounting for a Modification or Exchange of Debt Instruments." Consequently,
all unamortized debt issue costs associated with the term loan were written off.
In addition, the Company followed the guidance per EITF 98-14, "Debtor's
Accounting for Changes in the Line-of-Credit or Revolving-Debt Arrangements," to
calculate the amount of unamortized debt issue costs associated with the
replacement of the revolving line of credit. In total, the Company wrote off
$1.4 million of unamortized debt issue costs associated with the previous credit
facilities.
EQUITY EARNINGS IN JOINT VENTURES The Company's equity earnings in their joint
ventures increased to $0.7 million for the first three months of fiscal 2004
from $0.3 million for the same prior year period due to improved performance.
INCOME TAXES The Company's effective tax rate for the first quarter of fiscal
2004 was 36% versus 37% in the prior year quarter, which reflects a reduction in
the Company's tax liability of approximately 1.0%.
FINANCIAL CONDITION
Working capital increased $37.9 million to $68.8 million at December 27, 2003
from September 27, 2003. The working capital change consisted of an increase in
current assets of $4.9 million and a $33.0 million decrease in current
liabilities. The increase in current assets correlates with a higher accounts
receivable balance due to improved revenue results and the timing of customer
receipts during the last week of December. Offsetting this increase was a $7.5
million decrease in cash and cash equivalents. The decrease in current
liabilities was primarily due to the Company's debt refinancing which resulted
in a $32.3 million decrease in the current portion of long-term debt as a
consequence of the type of debt instruments under the new agreements.
Stockholders' equity of $99.9 million at December 27, 2003 represents an
increase of $10.0 million from the September 27, 2003 balance of $89.9 million.
The following factors contributed to the increase; net income of $11.2 million,
$3.9 million associated with employee stock plan activity and related tax
benefits and $0.3 million of amortization of deferred compensation. The increase
was offset in part by $3.3 million for the Company's initial quarterly cash
dividend payment and $2.2 million pursuant to elections by employees to satisfy
tax withholding requirements under the Company's stock option plans.
On October 16, 2003, the Company announced a three-for-two stock split of its
common stock effected in the form of a stock dividend. As a result of the split,
stockholders received one additional share of common stock for every two shares
held. The stock dividend was paid on November 7, 2003 to common shareholders of
record as of October 24, 2003. The stock split was recorded by increasing common
stock by $0.1 million and decreasing accumulated earnings by $0.1 million on the
Consolidated Balance Sheets (issuance of 10 million shares at $0.01 par value).
There was no effect to the Company's overall equity position as a result of the
stock split. All share and per share data have been restated to give retroactive
effect to the split.
LIQUIDITY
The Company's main source of liquidity continues to be funds generated from
operating activities. The Company has available unused credit commitments of
$136.4 million at December 27, 2003, which may be used to fund working capital
requirements.
Overall cash and cash equivalents decreased $7.5 million for the quarter ended
December 27, 2003 and were comprised of net cash provided by operating
activities of $12.9 million offset by net investing activities of $13.4 million
and net financing activities of $7.0 million.
-11-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The net cash provided by operating activities for the three months ended
December 27, 2003 was $12.9 million versus $27.6 million for the same period of
the prior year. The year over year change was the result of an increase in
accounts receivable as detailed in the "Financial Condition" section and the
change in income taxes payable and accounts payable due to timing of federal tax
payments and vendor payments, respectively.
Investing activities for the three months ended December 27, 2003 were
predominately related to capital expenditures. Investments in property, plant
and equipment totaled $14.0 million for the current quarter versus $13.2 million
in the prior year's quarter. The Company's capital expenditure focus is on the
development of software for its order fulfillment and service delivery redesign
project scheduled to be implemented in phases during fiscal 2004 and at the
beginning of fiscal 2005. The Company purchased land and incurred construction
costs for the relocation of the Company's existing Hartford, Connecticut
production facility. In addition, the Company has deployed Alphaliners, which
are computerized mail sorting machines and various other machinery. The Company
expects its capital expenditures for the entire year to be approximately $67.0
million, which includes $20.0 million for the Hartford facility relocation.
Net cash used by financing activities for the three months ended December 27,
2003 reflected the following debt activity; the reclassification between the
term loan and private placement notes as a result of the Company's refinancing
during the first quarter, net repayments on the revolving line of credit taking
into account the refinancing activity and the payment of $2.2 million of debt
issue costs associated with the debt refinancing. Other financing activity for
the first quarter of fiscal 2004 included, $3.3 million for the quarterly cash
dividend that was announced and paid by the Company during the quarter, $2.2
million of treasury stock pursuant to elections by employee to satisfy tax
withholding requirements and $1.9 million of proceeds both from the exercise of
stock options.
CONTRACTUAL AND COMMERCIAL COMMITMENTS
As a result of the debt refinancing, the Company's contractual obligations as of
December 27, 2003 are as follows; $4.0 million of the revolving line of credit,
which the Company has classified as current and $125.0 million of senior secured
notes due in ten years.
During fiscal 2003, the Company entered into a lease agreement for a new
Hartford, Connecticut production facility with lease payments to begin after the
construction of the facility, expected in June 2004. The lease agreement
included the right to purchase the property, which the Company exercised in
December 2003. The purchase price, which was dependent upon construction costs
and was limited to a negotiated maximum amount, was estimated to be
approximately $20.0 million. The Company subsequently decided to terminate the
lease agreement in its entirety and now intends to construct the new facility
and record the construction costs to construction in progress ("CIP"). As of
December 27, 2003, CIP related to the construction of the facility was $4.4
million, of which $1.6 million is attributable to land acquisition costs.
FINANCING ARRANGEMENTS
On December 4, 2003, the Company replaced its existing credit facilities. The
new credit agreements totaling $275 million include $125 million private
placement senior secured notes with several institutional investors and a $150
million revolving line of credit ("Revolver") with a syndicate of banks.
The senior secured notes consist of $65 million notes at a fixed interest rate
of 5.71% (Series A Notes) and $60 million notes at a variable interest rate at
LIBOR rate plus 0.92% (Series B Notes). The senior secured notes have a ten-year
life and mature in December 2013. Interest is payable semi-annually on the
Series A and quarterly on the Series B Notes.
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ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Revolver has a four-year life and remains available until maturity in
December 2007. The Revolver bears interest, at the Company's option, equal to
the LIBOR rate or to the bank's base rate plus an applicable margin (based on
certain financial ratios). The applicable margin ranges from 0.875% to 1.50% on
the LIBOR rate and 0% to 0.50% on the base rate. Interest is payable quarterly
or upon the maturity of the LIBOR contracts, whichever is shorter.
At December 27, 2003 there was $128.6 million of debt outstanding, of which $4.0
million was classified as current. The Company anticipates it will be able to
meet its debt obligations through funds generated from operations. During
January 2004, the Company had net borrowings of $20.0 million under the
revolving line of credit.
The Company pays fees on the unused commitments at a rate ranging from 0.20% to
0.40% depending on the Company's debt ratio, as defined. At December 27, 2003,
there was $136.4 million available for future borrowings, $9.6 million utilized
by letters of credit under separate agreements related to the Company's workers'
compensation program and $4.0 million outstanding.
In the first quarter of fiscal 2004, the Company capitalized $2.2 million of
debt issue costs directly associated with the issuance of the new debt. These
costs are included in other assets and are being amortized either over the
ten-year life of the senior secured notes or over the four-year life of the
Revolver, whichever is applicable.
Under the terms of the senior secured notes and Revolver, the Company is
required to maintain certain financial ratios. In addition, the credit
facilities also place restrictions on disposals of assets, mergers and
acquisitions, dividend payments, investments and additional debt.
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 judgements or estimates. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States, 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, which
has been discussed with the Company's audit committee.
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. The Company reviews potential problems,
such as past due accounts, a bankruptcy filing or deterioration in the
customer's financial condition, to ensure the Company is adequately accrued for
potential loss. Amounts are considered past due based on when payment was
originally due. 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. The
Company will write off accounts receivable at the time they are either deemed
uncollectible or submitted to an outside agency for additional collection
efforts.
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ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Valuation of goodwill and intangible assets
Goodwill represents the excess of the purchase price over the fair value of net
assets acquired in 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 the reporting entity. 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 used to determine
the fair value, are less favorable than expected, the Company may be required to
record an impairment charge.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," which was revised in December 2003 ("FIN No.
46-R"). This new rule requires that companies consolidate a variable interest
entity if the company is subject to a majority of the risk of loss from the
variable interest entity's activities and/or is entitled to receive a majority
of the entity's residual returns. The provisions of FIN No. 46-R currently are
required to be applied as of the end of the first reporting period after March
15, 2004 for the variable interest entities in which the company holds a
variable interest that it acquired on or before January 31, 2003. The Company is
currently evaluating the effect, if any, that FIN No. 46-R may have on its
financial statements for the second quarter of fiscal 2004.
ITEM 3. 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 maintains
interest rate swap agreements on notional amounts totaling $50 million.
If interest rates should change by 2 percentage points for the remainder of the
2004 fiscal year from those rates in effect at December 27, 2003, interest
expense would increase/decrease by approximately $1.3 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.
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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. In addition, 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 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.
WEBSITE ACCESS TO COMPANY REPORTS AND OTHER INFORMATION
We make available free of charge through our website, www.advo.com, our Annual
Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form
8-K as soon as reasonably practicable after such material is electronically
filed with the Securities and Exchange Commission. Our Internet website and the
information contained therein or incorporated therein are not intended to be
incorporated into this Quarterly Report on Form 10-Q.
We have adopted a Code of Business Ethics and Conduct that applies to all
employees as well as our Board of Directors. The Code of Business Ethics and
Conduct, as well as the Charters for the committees of our Board of Directors,
the Audit Committee, Qualified Legal Compliance Committee, Compensation and
Nomination Committee and the Company's Corporate Governance Guidelines, are
posted on our website, www.advo.com. The Charter of our newly formed Corporate
Governance Committee will be posted on our website shortly. Copies of these
documents will be provided free of charge upon written request directed to
Corporate Secretary, ADVO, Inc., One Targeting Centre, Windsor, CT, 06095-2639.
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 is 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the 2004 Annual Meeting of Stockholders of ADVO, Inc., held on January 23,
2004, the following matters were submitted to a vote of the stockholders:
1. The election of seven directors to serve until the Annual Meeting of
Stockholders in 2005;
2. The authorization of an amendment to the Company's Certificate of
Incorporation to increase the number of authorized shares of Common Stock,
$.01 par value per share, from 40,000,000 to 80,000,000 shares; and
3. The ratification of the appointment of Ernst & Young LLP as the Company's
independent auditors for the fiscal year ending September 25, 2004.
Each of the three proposals was approved by the stockholders in its entirety.
For a list of the directors elected and the votes cast for and against each of
the proposals, reference is made to Exhibit No. 22, Report of Inspectors of
Election for ADVO, Inc.'s Annual Meeting, attached hereto.
ITEM 5. OTHER ITEMS
Nominating Committee Functions
Recent SEC rules require companies to disclose information regarding a company's
process for nominating directors. The Compensation and Nomination Committee
("Committee') considers candidates for Board membership suggested by its members
and other Board members, as well as management and stockholders. The Company has
also retained a third-party executive search firm to identify candidates upon
request of the Committee from time to time. A stockholder who wishes to
recommend a candidate for the Board should notify the Committee in writing in
care of the Company's Corporate Secretary, providing whatever supporting
documentation the stockholder wishes. The stockholder must include with the
notice a statement by the nominee that he or she is willing to be named in the
Company's proxy and to serve if elected. The Company's by-laws also provide a
process for stockholders to nominate candidates for Board membership. The
Committee will also evaluate any person nominated by a stockholder under these
provisions. The Committee evaluates candidates recommended by stockholders
according to the same criteria (such as independence, experience relevant to the
needs of the Company, leadership qualities, diversity and ability to represent
the stockholders) that it uses for candidates identified by third-party
executive search firms and nominations by its own members, other Board members
or management.
Subsequent Event
Subsequent to the end of the first quarter of fiscal 2004, two senior officers
left the Company. The Company will record costs of approximately $1.1 million
during the second quarter of fiscal 2004 as a result of their departures.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit No. Exhibits Included Within:
- ----------- -------------------------
3(a) Certificate of Amendment of Restated
Certificate of Incorporation of ADVO,
Inc.
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Exhibit No. Exhibits Included Within:
- ----------- -------------------------
10(a) Agreement dated January 8, 2004 between
ADVO, Inc. and A. Brian Sanders. *
10(b) Agreement dated January 29, 2004 between
ADVO, Inc. and B. Kabe Woods. *
22 Report of Inspectors of Election for
ADVO, Inc.'s Annual Meeting.
31(a) Certification of Periodic Report Pursuant
to Section 302 of the Sarbanes-Oxley Act
of 2002 - Gary M. Mulloy.
31(b) Certification of Periodic Report Pursuant
to Section 302 of the Sarbanes-Oxley Act
of 2002 - James M. Dahmus
32 Certification of Periodic Report Pursuant
to Section 906 of the Sarbanes-Oxley Act
of 2002 - Gary M. Mulloy and James M.
Dahmus.
* Management contract or compensatory plan required to be filed as an exhibit
pursuant to item 14(c) of this report.
(b) Reports on Form 8-K
1) A report on Form 8-K dated October 16, 2003 was filed by the Company during
the quarter ended December 27, 2003 and reported under Item 5 thereof, the
following:
- A three-for-two split of its common stock, to be effected by way of a
one-for-two stock dividend.
- The establishment of a regular quarterly cash dividend.
- An increase in its stock repurchase authorization to 1.5 million
post-split shares.
The stock dividend and quarterly cash dividend were distributed on November
7, 2003 to stockholders of record on October 24, 2003.
2) A report on Form 8-K dated November 6, 2003 was filed by the Company during
the quarter ended December 27, 2003 and reported under Item 5 thereof, the
election of Karen Kaplan to the Company's Board of Directors.
3) A report on Form 8-K dated January 23, 2004 was filed by the Company, which
furnished the Company's earnings press release for the first quarter ended
December 27, 2003.
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: February 10, 2004 By: /s/ JOHN D. SPERIDAKOS
----------------------
John D. Speridakos
Vice President and Controller
Principal Accounting Officer
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