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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 27, 2004
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 Targeting Centre, Windsor, CT 06095
- --------------------------------- ----------
(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 24, 2004 there were 30,335,681 shares of common stock outstanding.
ADVO, INC.
INDEX TO QUARTERLY REPORT
ON FORM 10-Q
QUARTER ENDED MARCH 27, 2004
Page
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Part I - Financial Information
Item 1. Financial Statements (Unaudited).
Consolidated Balance Sheets -
March 27, 2004 and September 27, 2003. 2
Consolidated Statements of Operations -
Six months and three months ended
March 27, 2004 and March 29, 2003. 3
Consolidated Statements of Cash Flows -
Six months ended March 27, 2004
and March 29, 2003. 4
Notes to Consolidated Financial Statements. 5
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations. 11
Item 3. Quantitative and Qualitative Disclosures
about Market Risk. 16
Item 4. Controls and Procedures. 17
Part II - Other Information
Item 1. Legal Proceedings. 17
Item 6. Exhibits and Reports on Form 8-K. 17
Signatures 19
ADVO, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share data)
March 27, September 27,
2004 2003
--------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 13,929 $ 17,012
Accounts receivable, net 134,269 122,104
Inventories 2,289 2,491
Prepaid expenses and other current assets 7,130 10,875
Deferred income taxes 11,509 12,496
--------- -------------
Total current assets 169,126 164,978
Property, plant and equipment 339,970 315,314
Less accumulated depreciation and amortization (188,780) (172,289)
--------- -------------
Net property, plant and equipment 151,190 143,025
Investment in deferred compensation plan 12,743 11,106
Goodwill 22,259 22,242
Other assets 10,932 12,130
--------- -------------
TOTAL ASSETS $ 366,250 $ 353,481
========= =============
LIABILITIES
Current liabilities:
Current portion of long-term debt $ 3,000 $ 36,250
Accounts payable 38,680 36,581
Accrued compensation and benefits 23,888 25,286
Other current liabilities 24,870 35,948
--------- -------------
Total current liabilities 90,438 134,065
Long-term debt 125,491 94,000
Deferred income taxes 20,899 19,765
Deferred compensation plan 13,714 11,917
Other liabilities 5,657 4,666
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value
(Authorized 5,000,000 shares, none issued) -- --
Common stock, $.01 par value (Authorized
80,000,000 shares, issued 30,406,566
and 20,042,005 shares, respectively) 304 200
Additional paid-in capital 145,718 137,252
Unamortized deferred compensation (2,623) (1,628)
Accumulated deficit (28,367) (44,384)
--------- -------------
115,032 91,440
Less common stock held in treasury, at cost (4,770) (2,527)
Accumulated other comprehensive (loss) income (211) 155
--------- -------------
Total stockholders' equity 110,051 89,068
--------- -------------
TOTAL LIABILITIES & STOCKHOLDERS'
EQUITY $ 366,250 $ 353,481
========= =============
See Accompanying Notes.
-2-
ADVO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Six months ended Three months ended
------------------------ ------------------------
March 27, March 29, March 27, March 29,
2004 2003 2004 2003
--------- --------- --------- ---------
REVENUES $ 606,688 $ 578,243 $ 304,311 $ 287,065
Costs and expenses:
Cost of sales 444,817 426,622 223,460 212,268
Selling, general and
administrative 119,961 110,202 59,298 55,101
Provision for bad debts 3,197 2,709 2,598 959
--------- --------- --------- ---------
OPERATING INCOME 38,713 38,710 18,955 18,737
Interest expense (2,623) (4,571) (1,240) (1,673)
Debt issue costs associated with
debt retirement (1,401) --- --- ---
Equity earnings in joint ventures 1,155 501 473 206
Other (expense) income, net (315) 46 (180) 76
--------- --------- --------- ---------
Income before income taxes 35,529 34,686 18,008 17,346
Provision for income taxes 12,790 12,834 6,483 6,418
--------- --------- --------- ---------
NET INCOME $ 22,739 $ 21,852 $ 11,525 $ 10,928
========= ========= ========= =========
BASIC EARNINGS PER SHARE $ 0.76 $ 0.74 $ 0.38 $ 0.37
========= ========= ========= =========
DILUTED EARNINGS PER SHARE $ 0.74 $ 0.73 $ 0.38 $ 0.36
========= ========= ========= =========
DIVIDENDS DECLARED PER SHARE $ 0.22 $ -- $ 0.11 $ --
========= ========= ========= =========
Weighted average basic shares 30,018 29,703 30,097 29,724
Weighted average diluted shares 30,554 29,966 30,660 29,985
See Accompanying Notes.
-3-
ADVO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Six months ended
------------------------
March 27, March 29,
2004 2003
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 31,888 $ 43,158
Cash flows from investing activities:
Acquisition of property, plant and equipment (27,231) (28,007)
Proceeds from disposals of property, plant and equipment 81 395
Distributions from equity affiliates 1,106 363
Acquisitions/joint ventures, net of cash acquired --- 146
--------- ---------
NET CASH USED BY INVESTING ACTIVITIES (26,044) (27,103)
Cash flows from financing activities:
Revolving line of credit - net (26,000) (5,500)
Payments on long-term debt (101,250) (10,000)
Proceeds on private placement notes 125,000 ---
Decrease in note payable --- (1,641)
Proceeds from exercise of stock options 4,512 467
Treasury stock transactions (2,430) (435)
Payment of debt issue costs (2,189) ---
Cash dividends paid (6,592) ---
--------- ---------
NET CASH USED BY FINANCING ACTIVITIES (8,949) (17,109)
--------- ---------
Effect of exchange rate changes on cash and cash equivalents 22 46
--------- ---------
Decrease in cash and cash equivalents (3,083) (1,008)
Cash and cash equivalents at beginning of period 17,012 12,281
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 13,929 $ 11,273
========= =========
Noncash activities:
(Increase) decrease in fair value of
interest rate swap liabilities (401) 1,090
Deferred compensation plan
investment gains 1,494 101
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 27, 2004 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.
Certain reclassifications have been made in the fiscal 2003 financial statements
to conform with the fiscal 2004 presentation.
2. NEW ACCOUNTING POLICIES
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 adoption
of FIN No. 46-R did not have any impact to the financial position or results of
operations of the Company.
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 27, March 29, March 27, March 29,
(In thousands) 2004 2003 2004 2003
--------- --------- --------- ---------
Net income $ 22,739 $ 21,852 $ 11,525 $ 10,928
Other comprehensive income:
Unrealized loss on derivative
instruments (401) -- (363) --
Reclassification adjustment on
derivative instruments -- 1,090 -- --
Foreign currency translation adjustment 35 91 (16) 87
--------- --------- --------- ---------
Total comprehensive income $ 22,373 $ 23,033 $ 11,146 $ 11,015
========= ========= ========= =========
-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 of
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) March 27, 2004 September 27, 2003
-------------- ------------------
Private Placement Notes
Series A Notes (a) $ 65,491 $ --
Series B Notes 60,000 --
Revolver - base rate of 4.125% at March 27, 2004 3,000 --
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
-------------- ------------------
$ 128,491 $ 130,250
Less current portion of long-term debt 3,000 36,250
-------------- ------------------
Total long-term debt $ 125,491 $ 94,000
============== ==================
(a) Includes unrealized gains 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 March 27, 2004,
there was $137.4 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 $3.0 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 the four-year
life of the Revolver, whichever is applicable.
-6-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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
during the first quarter of fiscal 2004. 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 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 March 27, 2004 and September 27,
2003, unamortized costs totaled $2.6 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
receivable of $0.5 million at March 27, 2004, increased the carrying amount of
debt and decreased 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 $0.7 million and was
recorded net of taxes, a loss of $0.4 million, in accumulated other
comprehensive income (loss) at March 27, 2004.
-7-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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.
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 and $6.6 million, respectively, for the
three and six months ended March 27, 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 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 27, March 29, March 27, March 29,
2004 2003 2004 2003
--------- --------- --------- ---------
(In thousands, except per share data)
Net income $ 22,739 $ 21,852 $ 11,525 $ 10,928
Weighted average basic shares 30,018 29,703 30,097 29,724
Effect of dilutive securities:
Stock options 487 231 515 231
Restricted stock 49 32 48 30
--------- --------- --------- ---------
Dilutive potential common shares 536 263 563 261
Weighted average diluted shares 30,554 29,966 30,660 29,985
========= ========= ========= =========
Basic earnings per share $ 0.76 $ 0.74 $ 0.38 $ 0.37
========= ========= ========= =========
Diluted earnings per share $ 0.74 $ 0.73 $ 0.38 $ 0.36
========= ========= ========= =========
-8-
ADVO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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.
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:
Six months ended Three months ended
------------------------- -------------------------
March 27, March 29, March 27, March 29,
2004 2003 2004 2003
---------- ---------- ---------- ----------
(In thousands, except per share data)
Net income, as reported $ 22,739 $ 21,852 $ 11,525 $ 10,928
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related
tax effects 1,877 1,850 894 808
---------- ---------- ---------- ----------
Pro forma net income $ 20,862 $ 20,002 $ 10,631 $ 10,120
========== ========== ========== ==========
Earnings per share:
Basic - as reported $ 0.76 $ 0.74 $ 0.38 $ 0.37
Basic - pro forma $ 0.69 $ 0.67 $ 0.35 $ 0.34
Diluted - as reported $ 0.74 $ 0.73 $ 0.38 $ 0.36
Diluted - pro forma $ 0.69 $ 0.67 $ 0.35 $ 0.34
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.
During the first quarter of fiscal 2004, 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.
-9-
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 for the three and six months ended March 27, 2004 since
achievement of the performance criteria is not considered probable. For each
subsequent quarter, the Company will re-evaluate the probability of achieving
the performance criteria and record compensation expense accordingly.
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 to be completed during the
fourth quarter of fiscal 2004. The lease agreement included the right to
purchase the property, which the Company exercised in 2003. The Company
subsequently decided to terminate the lease agreement in its entirety and is
constructing the new facility and will record the construction costs to
construction in progress ("CIP") included in property, plant and equipment. As
of March 27, 2004, CIP related to the construction of the facility was $8.7
million. In addition, the Company capitalized $1.6 million of land acquisition
costs. Total construction costs are estimated to be approximately $27.0 million.
10. COMMITMENTS AND CONTINGENCIES
State Audit
The Company has received a state sales and use tax assessment for $4.7 million
covering the period of January 1995 through October 1998. The Company appealed
the assessment and the decision of the administrative law judge is pending. The
Company believes that the assessment and the state's underlying position are
neither supportable by the law nor consistent with previously provided
interpretative guidance from the Comptroller's office. The Company believes the
assessment will be overturned based on the applicable laws and regulations. The
Company is also concurrently pursuing a refund of the tax assessment that would
effectively eliminate the liability. In the event the assessment stands and the
refund is denied, the Company will pursue its rights in court. The Company has
no provision for this tax exposure because the Company has concluded it is not
probable or reasonably estimable at this time. Although the final results of the
audits for the subsequent periods and the outcome of resulting legal action
cannot be reasonably estimated, this tax dispute applies to all open years up to
and including the current period. If the decision of the administrative law
judge is upheld, the potential exposure for open years may be significantly
higher than the aforementioned assessment.
Kmart Corporation
In January 2002, Kmart Corporation filed for Chapter 11 bankruptcy protection
and requested the Bankruptcy Court (the "Court") designate the Company and
several other companies to be classified under critical vendor status. The Court
approved this designation and the Company received $1.1 million due from Kmart.
In February 2004, the U.S. Court of Appeals for the 7th Circuit affirmed an U.S.
District Court ruling that Kmart incorrectly paid critical vendors, including
the Company. As a result of the ruling, Kmart has filed lawsuits against each
critical vendor seeking reimbursement of these payments. The Company believes
that it has meritorious defenses to the lawsuit. The range of the potential
liability is $0 to $1.1 million with no amount within this range representing a
better estimate than any other amount at this time. The Company has not provided
any amount for the exposure because the Company does not believe it is probable
and reasonably estimable at this time.
-10-
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 Revenues for the three months ended March 27, 2004 were $304.3 million,
increasing $17.2 million or 6.0%, from revenues of $287.1 million for the three
months ended March 29, 2003. For the six months ended March 27, 2004, revenues
were $606.7 million, increasing $28.4 million or 4.9%, from revenues of $578.2
million for the six months ended March 29, 2003. The revenue growth for both the
three and six-month periods was mainly attributable to the increased volume of
the Company's shared mail products. These volume gains were illustrated in the
growth of shared mail packages and pieces for both the three and six-month
periods ended March 27, 2004. For the three months ended March 27, 2004, shared
mail packages increased 2.9% and shared mail pieces distributed grew 8.1%. For
the six-month period ended March 27, 2004, shared mail packages increased 3.3%
and shared mail pieces distributed grew 9.1%. In addition, average pieces per
package were 8.40 for the three months ended March 27, 2004 and 8.29 for the six
months ended March 27, 2004 growing 5.1% and 5.6% over the same three and
six-month periods of fiscal 2003.
The revenue growth detailed above was somewhat offset by lower priced products
which contributed to the 1.8% decrease in revenue per thousand pieces for the
second quarter of fiscal 2004. For the first six months of fiscal 2004, revenue
per thousand pieces decreased 3.5% due to shifts in product mix to lower priced
and lighter weight products. The grocery strike in Southern California, which
ended in March, negatively impacted the three and six-month periods. The Company
estimates a revenue loss of approximately $3.0 million for the three months and
$7.9 million for six months ended March 27, 2004 due to the grocery strike.
OPERATING EXPENSES Cost of sales as a percentage of revenue was 73.4% and 73.3%,
respectively, for the three and six months periods ended March 27, 2004
reflecting a decrease of 0.5 percentage points for both periods. Cost of sales
increased $11.2 million for the second quarter and $18.2 million for the first
six months of fiscal 2004 over the comparable periods of the prior year. The
increase for both the second quarter and first half of fiscal 2004 was
attributable to higher distribution costs, which were driven by the increase in
shared mail packages and pieces delivered. Distribution costs, primarily
consisting of postage costs, increased 3.7% for both the second quarter and
first half of fiscal 2004. Print expense also contributed to the increase in
cost of sales, increasing 14.2% and 12.8%, respectively, for the second quarter
and first half of fiscal 2004 due to print costs associated with the growth of
certain shared mail products.
As a percentage of revenues, selling, general and administrative expenses
(including the provision for bad debts) ("SG&A" costs) increased 0.8 percentage
points to 20.3% for both the second quarter and first half of fiscal 2004. SG&A
costs were $61.9 million for the second quarter of fiscal 2004 increasing $5.8
million. For the first half of fiscal 2004, SG&A costs were $123.2 million
increasing $10.2 million. These increases were primarily the result of the
following: higher commission expense and related benefits of $2.6 million for
the second quarter and $4.3 million for the first half of fiscal 2004 as a
result of the revenue growth; increases of $1.6 million for the second quarter
and $0.5 million for the first half of fiscal 2004 in bad debts expense
primarily due to specific receivables; $1.1 million of severance related to the
departure of two senior executives during the second quarter and higher
depreciation expense resulting from certain phases of the service delivery
redesign project being placed into service.
-11-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OPERATING INCOME For the second quarter of fiscal 2004, the Company reported
operating income of $19.0 million versus $18.7 million for the second quarter of
fiscal 2003, representing an increase of $0.2 million. For the six months ended
March 27, 2004, operating income was $38.7 million remaining relatively
unchanged from operating income for the six months ended March 29, 2003.
INTEREST EXPENSE Interest expense decreased $0.4 million and $1.9 million,
respectively, for the three months and six months ended March 27, 2004. The
decrease was the result of lower market rates of interest and a decrease in the
average outstanding debt balance.
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 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 joint ventures performed well
for the second quarter and first half of fiscal 2004 increasing equity earnings
by $0.3 million and $0.7 million, respectively.
INCOME TAXES The effective income tax rate was 36% for the three and six months
ended March 27, 2004 and 37% for the same periods of fiscal 2003 which reflects
a reduction in the Company's tax liability of approximately 1.0%.
EARNINGS PER SHARE Diluted earnings per share was $0.38 for the second quarter
of fiscal 2004 increasing 5.6% from prior year's second quarter. For the first
half of fiscal 2004, diluted earnings per share was $0.74 versus $0.73 for the
first half of fiscal 2003.
FINANCIAL CONDITION
Working capital was $78.7 million at March 27, 2004 increasing $47.8 million
from the September 27, 2003 working capital of $30.9 million. The working
capital change consisted of an increase in current assets of $4.1 million and a
decrease of $43.6 million in current liabilities. The change in current assets
was comprised of an increase in accounts receivable due to the 14.7% revenue
growth in the month of March offset in part by a lower cash and cash equivalents
balance at the end of March versus the end of September and a decrease in other
current assets due to the timing of insurance payments. The principal cause of
the decrease in total current liabilities was the Company's debt refinancing
which resulted in a $33.3 million decrease in the current portion of long-term
debt as a consequence of the type of debt instruments under the new agreements.
Another mitigating factor was the decrease in other current liabilities due in
part to tax benefits resulting from employee option exercises and the timing of
tax payments.
Stockholders' equity increased $21.0 million to $110.1 million at March 27, 2004
from $89.1 million at September 27, 2003. This increase was primarily
attributable to year-to-date net income of $22.7 million. Other increases
included employee stock plan activity and related tax benefits of $7.2 million
and restricted stock
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ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
amortization of $0.6 million. The increases to stockholders' equity were offset
in part by the Company's quarterly cash dividend payments totaling $6.6 million,
treasury stock transactions of $2.4 million pursuant to elections by employees
to satisfy tax withholding requirements under the Company's stock option plans
and a $0.4 million unrealized loss in the fair value of derivative instruments.
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
$137.4 million at March 27, 2004, which may be used to fund working capital
requirements.
Cash and cash equivalents decreased $3.1 million for the six-month period ended
March 27, 2004. The components of the decrease were: net cash provided by
operating activities of $31.9 million offset by net investing activities and net
financing activities of $26.0 million and $8.9 million, respectively.
For the period ended March 27, 2004, net cash provided by operating activities
was $31.9 million, versus $43.2 million for the same period of the prior year.
Contributing to the year over year decrease was the change in accounts
receivable and other current assets both previously discussed in the "Financial
Condition" section, along with the change in income taxes payable due to the
timing of federal tax payments and accounts payable due to timing of vendor
payments.
The Company's investing activities are principally investments in property,
plant and equipment. For the six months ended March 27, 2004 and March 29, 2003,
capital expenditures were $27.2 million and $28.0 million, respectively. The
Company continues to focus on the development of software for its order
fulfillment and service delivery redesign project, which is scheduled to be
implemented in phases during fiscal 2004 and through the beginning of fiscal
2005. The Company is relocating its existing Hartford, Connecticut production
facility to another Hartford area location and purchased land and incurred
construction costs for its new facility. Additional capital dollars were
directed toward the deployment of Alphaliner computerized mail sorters, computer
software and hardware and increased security measures. The Company expects its
capital expenditures for the entire year to be approximately $74.0 million,
which includes $27.0 million for the new production facility.
Debt related transactions primarily accounted for the net cash used by financing
activities for the six-month period ended March 27, 2004. The debt activity
included 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. Also factoring into net cash used by financing activities were
quarterly cash dividends totaling $6.6.million that were paid in the first and
second quarters, proceeds of $4.5 million related to stock option exercise
activities and $2.4 million of treasury stock transactions pursuant to elections
by employees to satisfy tax withholding requirements.
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ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As detailed in Note 10 to the Consolidated Financial Statements, the Company has
received a state sales and use tax assessment for $4.7 million. The Company
believes the assessment will be overturned based on applicable laws and
regulations. The Company is also concurrently pursuing a refund of the tax
assessment that would effectively eliminate the liability. In the event the
assessment stands and the refund is denied, the Company will pursue its rights
in court. In order to pursue these remedies, the Company may be required to pay
the tax assessment. The Company will fund the payment from cash generated from
operating activities or from its available unused credit commitments and does
not expect this funding to have an adverse impact to the Company's liquidity.
CONTRACTUAL AND COMMERCIAL COMMITMENTS
As a result of the debt refinancing, the Company's contractual obligations as of
March 27, 2004 are $3.0 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 to be completed in the fourth quarter of
fiscal 2004. The lease agreement included the right to purchase the property,
which the Company exercised in 2003. The Company subsequently decided to
terminate the lease agreement in its entirety and is constructing the new
facility and will record the construction costs to construction in progress
("CIP") included in property, plant and equipment. As of March 27, 2004, CIP
related to the construction of the facility was $8.7 million. In addition, the
Company capitalized $1.6 million of land acquisition costs. Total construction
costs are estimated to be approximately $27.0 million.
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 of
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.
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 March 27,
2004, there was $128.0 million of debt outstanding, of which $3.0 million was
classified as current. The Company anticipates it will be able to meet its debt
obligations through funds generated from operations. During April 2004, the
Company had net borrowings of $10.0 million under the revolving line of credit.
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ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 March 27, 2004,
there was $137.4 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 $3.0 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 policies 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, historical trends and specific accounts. 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 2004 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.
-15-
ADVO, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 adoption
of FIN No. 46-R did not have any impact on the financial position or results of
operations of the Company.
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 March 27, 2004, interest expense
would increase/decrease by approximately $1.5 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.
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 27A
of the Securities Exchange Act of 1933 and 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.
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, Corporate Governance
Committee, Compensation and Nomination Committee and the Company's Corporate
Governance Guidelines, are posted on
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our website, www.advo.com. 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.
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.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 10 to the Consolidated Financial Statements within Part I, Item 1.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit No. Exhibits Included Within:
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31(a) Certification of the Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
31(b) Certification of the Acting Chief Financial Officer pursuant
to Rule 13a-14(a) of the Securities Exchange Act.
32 Certifications of the Chief Executive Officer and Acting Chief
Financial Officer pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
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(b) Reports on Form 8-K
The Company filed a current report on Form 8-K dated March 25, 2004,
and reported under Item 5 thereof, that James Dahmus, Executive Vice
President and Chief Financial Officer, left the Company to pursue
another business interest.
The Company furnished a current report on Form 8-K dated April 15,
2004 which reported the Company's earnings press release for the
second quarter ended March 27, 2004.
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: May 10, 2004 By: /s/ JOHN D. SPERIDAKOS
----------------------------------
John D. Speridakos
Vice President and Controller
(Principal Accounting Officer)
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