VERTIS INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
ý	Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2002
or
o	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:

Vertis, Inc.
(Exact Names of Registrants as Specified in Their Charters)

Delaware (State of incorporation)		13-3768322 (I.R.S. Employer Identification Nos.)
250 West Pratt Street Baltimore, Maryland (Address of Registrant's Principal Executive Office)		21201 (Zip Code)
(410) 528-9800 (Registrant's telephone number, including area code)

Indicate by check mark whether the Registrants (1) have 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 Registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days Yes o No ý

INDEX

		Page
Part I—Financial Information
Item 1. Financial Statements
	Condensed Consolidated Balance Sheets of Vertis, Inc. and Subsidiaries at September 30, 2002 and December 31, 2001.	2
	Condensed Consolidated Statements of Operations of Vertis, Inc. and Subsidiaries for the Three Months Ended September 30, 2002 and 2001.	3
	Condensed Consolidated Statements of Operations of Vertis, Inc. and Subsidiaries for the Nine Months Ended September 30, 2002 and 2001.	4
	Condensed Consolidated Statements of Cash Flows of Vertis, Inc. and Subsidiaries for the Nine Months Ended September 30, 2002 and 2001.	5
	Notes to Condensed Consolidated Financial Statements of Vertis, Inc. and Subsidiaries.	6
Item 2.
	Management's Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.
	Quantitative and Qualitative Disclosures about Market Risk	29
Item 4.
	Controls and Procedures	30
Part II—Other Information
Item 1.
	Legal Proceedings	31
Item 5.
	Other Information	31
Item 6.
	Exhibits and Reports on Form 8-K	31
Signatures		32
Certifications		33

Part I—FINANCIAL INFORMATION

Item 1: Financial Statements

Vertis, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets

In thousands, except share amounts			September 30, 2002			December 31, 2001
			(Unaudited)
ASSETS
Current Assets:
	Cash and cash equivalents		$	12,651		$	17,533
	Accounts receivable, net			132,746			171,415
	Inventories			40,317			40,182
	Prepaid expenses and other current assets			30,707			26,679
	Deferred income taxes and income tax receivable			5,801			6,002

		Total current assets		222,222			261,811
Property, plant and equipment, net				451,096			495,106
Goodwill, net				339,363			446,529
Investments				72,017			70,824
Deferred financing costs, net				39,107			46,293
Other assets, net				20,521			21,019

		Total Assets	$	1,144,326		$	1,341,582

LIABILITIES AND STOCKHOLDER'S DEFICIT
Current Liabilities:
	Accounts payable		$	117,181		$	143,317
	Compensation and benefits payable			36,147			36,803
	Accrued interest			24,890			22,275
	Accrued income taxes			7,423			7,771
	Current portion of long-term debt			12,877			37,063
	Other current liabilities			32,014			49,480

		Total current liabilities		230,532			296,709
Due to parent				6,239			6,938
Long-term debt, net of current portion				1,111,043			1,125,024
Deferred income taxes				30,689			35,385
Other long-term liabilities				20,261			25,343

		Total liabilities		1,398,764			1,489,399

Stockholder's deficit:
	Common stock—authorized 3,000 shares; $0.01 par value; issued and outstanding 1,000 shares
	Contributed capital			408,959			393,173
	Accumulated deficit			(652,091	)		(526,442	)
	Accumulated other comprehensive loss			(11,306	)		(14,548	)

		Total stockholder's deficit		(254,438	)		(147,817	)

		Total Liabilities and Stockholder's Deficit	$	1,144,326		$	1,341,582

See Notes to Condensed Consolidated Financial Statements.

Vertis, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations

		Three Months Ended September 30,
In thousands		Three Months Ended September 30,
In thousands		2002			2001
		(Unaudited)
Net sales		$	409,583		$	445,344

Operating expenses:
	Costs of production		311,493			346,379
	Selling, general and administrative		47,011			51,755
	Restructuring expense		2,770			7,352
	Depreciation		22,709			22,565
	Amortization of intangibles		108			3,667

			384,091			431,718

Operating income			25,492			13,626

Other expenses (income):
	Interest expense		29,197			29,081
	Amortization of deferred financing costs		2,464			1,845
	Interest income		(63	)		(51	)
	Other, net		1,890			852

			33,488			31,727

Loss before income taxes			(7,996	)		(18,101	)
Income tax benefit			(2,733	)		(27,186	)

Net (loss) income		$	(5,263	)	$	9,085

See Notes to Condensed Consolidated Financial Statements.

Vertis, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations

		Nine Months Ended September 30,
In thousands		Nine Months Ended September 30,
In thousands		2002			2001
		(Unaudited)
Net sales		$	1,220,355		$	1,354,111

Operating expenses:
	Costs of production		921,721			1,061,403
	Selling, general and administrative		139,014			152,689
	Restructuring expense		5,816			29,276
	Depreciation		67,042			66,405
	Amortization of intangibles		231			11,095

			1,133,824			1,320,868

Operating income			86,531			33,243

Other expenses (income):
	Interest expense		84,556			92,202
	Amortization of deferred financing costs		7,747			11,053
	Interest income		(177	)		(467	)
	Other, net		11,219			6,029

			103,345			108,817

Loss before income taxes			(16,814	)		(75,574	)
Income tax benefit			(6,354	)		(26,163	)

Loss before cumulative effect of accounting change			(10,460	)		(49,411	)
Cumulative effect of accounting change			115,201

Net loss		$	(125,661	)	$	(49,411	)

See Notes to Condensed Consolidated Financial Statements.

Vertis, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows

				Nine Months Ended September 30,
In thousands				Nine Months Ended September 30,
In thousands				2002			2001
				(Unaudited)
Cash Flows from Operating Activities:
	Net loss			$	(125,661	)	$	(49,411	)
	Adjustments to reconcile net loss to net cash provided by operating activities:
		Depreciation and amortization			67,273			77,500
		Amortization of deferred financing costs			7,747			11,053
		Restructuring expense			5,816			29,276
		Cumulative effect of accounting change			115,201
		Write-off of deferred financing fees			8,239
		Deferred income taxes			(4,421	)		8,180
		Other			4,464			7,633
		Changes in operating assets and liabilities
			Decrease in accounts receivable		36,072			65,630
			(Increase) decrease in inventories		(135	)		7,188
			Increase in prepaid expenses and other assets		(3,653	)		(2,731	)
			Decrease in accounts payable and other liabilities		(59,809	)		(84,005	)

Net cash provided by operating activities					51,133			70,313

Cash Flows from Investing Activities:
	Capital expenditures				(22,673	)		(54,670	)
	Software development costs capitalized				(1,916	)		(1,164	)
	Proceeds from sale of property, plant and equipment				1,459			1,971
	Other investing activities							578

Net cash used in investing activities					(23,130	)		(53,285	)

Cash Flows from Financing Activities:
	Issuance of long-term debt				247,500
	Net (repayments) borrowings under revolving credit facilities				(27,487	)		73,005
	Repayments of long-term debt				(251,217	)		(15,084	)
	Deferred financing costs				(8,883	)		(14,373	)
	Increase (decrease) in outstanding checks drawn on controlled disbursement accounts				7,512			(51,688	)
	Other financing activities				(679	)		(3,705	)

Net cash used in financing activities					(33,254	)		(11,845	)

Effect of exchange rate changes on cash					369			682

Net (decrease) increase in cash and cash equivalents					(4,882	)		5,865
Cash and cash equivalents at beginning of year					17,533			4,792

Cash and cash equivalents at end of period				$	12,651		$	10,657

Supplemental Cash Flow Information:
	Interest paid			$	80,807		$	91,034

	Income taxes paid			$	1,208		$	2,015

	Detachable warrants issued			$	15,766

See Notes to Condensed Consolidated Financial Statements.

Vertis, Inc. and Subsidiaries

Notes To Condensed Consolidated Financial Statements
(Unaudited)

1. GENERAL

The accompanying condensed consolidated financial statements of Vertis, Inc. and Subsidiaries (collectively, "Vertis" or the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and are unaudited. The financial statements include all normal and recurring adjustments that management of the Company considers necessary for the fair presentation of its financial position and operating results. The Company prepared the condensed consolidated financial statements following the requirements of the Securities and Exchange Commission for interim reporting. As permitted under those rules, the Company condensed or omitted certain footnotes or other financial information that are normally required by GAAP for annual financial statements. As these are condensed financial statements, one should also read the consolidated financial statements and notes for the year ended December 31, 2001.

Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year.

Certain amounts for prior periods have been reclassified to conform to the current period presentation.

The difference between net loss and total comprehensive loss is comprised of foreign currency translation, fair value of interest rate swap and equity investment adjustments, which amounted to $3.2 million of income and $0.6 million of loss for the nine months ended September 30, 2002 and 2001, respectively.

2. RESTRUCTURING

During the nine months ended September 30, 2002, the Company has been involved in two main restructuring efforts. In the first quarter, two facilities were combined and related severance recorded in the Vertis Europe segment. In addition, the Company is involved in an ongoing effort to streamline operations in the Advertising Technology Services segment. As of September 30, 2002, this has involved the termination of employees in certain areas of the business and the planned closing of two facilities. Offsetting these amounts is an adjustment of the estimate of 2001 restructuring made in 2002. In 2001, certain production and sales administration facilities were combined in strategic areas resulting in the closure of 14 facilities, abandonment of assets in those locations and reduction of work force. Approximately 1,000 positions were eliminated. Effective January 1, 2001, the Company transferred 13 management and support personnel employed in our New York City office to Chancery Lane Capital. In exchange for a one time $14.0 million payment by the Company, included in restructuring expense, Chancery Lane Capital assumed all employment and compensation obligations with respect to the transferred employees.

The significant components of the restructuring expense were as follows:

	Severance and Related Costs			Facility Closing Costs			Other Costs			Total
	(In thousands)
Accrued balance at December 31, 2001	$	3,807		$	8,254		$	84		$	12,145
Restructuring in the nine months ended September 2002		4,435			51			1,330			5,816
Amount utilized in the nine months ended September 2002		(6,850	)		(4,073	)		(819	)		(11,742	)

Accrued balance at September 30, 2002	$	1,392		$	4,232		$	595		$	6,219

The Company expects to pay approximately $3.0 million of the remaining balance during the next year, and the remainder by 2007.

3. GOODWILL AND OTHER INTANGIBLES

On January 1, 2002, the Company adopted SFAS No. 142 ("SFAS 142"), "Goodwill and Other Intangibles." Under this statement, goodwill and intangible assets with indefinite lives are no longer amortized. Under the transitional provisions of SFAS 142, the Company's goodwill was tested for impairment as of January 1, 2002. Each of the Company's reporting units was tested for impairment by comparing the fair value of the reporting unit with the carrying value of that unit. Fair value was determined based on a valuation study performed by an independent third party using the discounted cash flow method and the guideline company method. As a result of the Company's impairment test completed in the third quarter of 2002, the Company recorded an impairment loss of $93.4 million at the Vertis Advertising Technology Services segment and $21.8 million at the Vertis Europe segment to reduce the carrying value of goodwill to its implied fair value. Impairment in both cases was due to a combination of factors including operating performance and acquisition price. In accordance with SFAS 142, the impairment charge was reflected as a cumulative effect of accounting change in the accompanying 2002 condensed consolidated statements of operations. The Company will test goodwill for impairment again in 2003 at an annual impairment test date that has yet to be selected by the Company.

In accordance with SFAS 142, the Company stopped amortizing its existing goodwill as of January 1, 2002. A reconciliation of reported net income to net income adjusted to reflect the impact of the discontinuance of the amortization of goodwill for the three months and nine months ended September 30, 2002 and 2001 is as follows:

	Three months ended September 30,					Nine months ended September 30,
	2002			2001		2002			2001
	(In thousands)
Reported net (loss) income	$	(5,263	)	$	9,085	$	(125,661	)	$	(49,411	)
Add: Goodwill amortization					3,313					9,942

Adjusted net (loss) income	$	(5,263	)	$	12,398	$	(125,661	)	$	(39,469	)

4. ACCOUNTS RECEIVABLE

Accounts receivable excludes balances sold in connection with a securitization facility, the proceeds of which serve to reduce long-term borrowings under the Company's revolving credit facility. As of September 30, 2002 and December 31, 2001, interests of $122.6 million and $130.0 million, respectively, had been sold under this program and are reflected as reductions of accounts receivable. This facility was to expire on April 1, 2002. The Company has obtained an amendment to extend this facility until December 1, 2002 and is in the process of securing a new facility which will be in place by that date.

5. SEGMENT INFORMATION

The Company operates in four business segments. Each segment offers different products or services requiring different production and marketing strategies. The four segments are:

•: Vertis Retail and Newspaper Services—includes advertising inserts and circulation-building newspaper products such as Sunday comics, TV listing guides, Sunday magazine sections and special supplements.
•: Vertis Direct Marketing Services—includes highly customized direct mail products and direct marketing services such as fragrance samplers, coatings and chemical production, commercial printing, and specialized digital printing.
•: Vertis Advertising Technology Services—includes outsourced digital premedia and image content management, response management services and newspaper ad development.

•: Vertis Europe—includes direct marketing and advertising technology products and services provided in Europe, principally the United Kingdom.

The following is unaudited information regarding the Company's segments:

		Three Months Ended September 30,						Nine Months Ended September 30,
		2002			2001			2002			2001
		(In thousands)
Net sales	Vertis Retail and Newspaper Services	$	258,922		$	275,036		$	763,266		$	841,093
	Vertis Direct Marketing Services		72,576			80,750			224,744			236,417
	Vertis Advertising Technology Services		48,641			59,717			149,705			187,216
	Vertis Europe		35,286			36,199			99,747			108,644
	Elimination of intersegment sales		(5,842	)		(6,358	)		(17,107	)		(19,259	)

	Consolidated	$	409,583		$	445,344		$	1,220,355		$	1,354,111

EBITDA	Vertis Retail and Newspaper Services	$	36,351		$	24,719		$	113,756		$	86,339
	Vertis Direct Marketing Services		9,257			10,924			31,429			24,567
	Vertis Advertising Technology Services		1,418			475			2,110			6,398
	Vertis Europe		3,075			4,684			9,542			12,866
	General Corporate		(1,792	)		(944	)		(3,033	)		(19,427	)

	Consolidated EBITDA		48,309			39,858			153,804			110,743
	Depreciation		22,709			22,565			67,042			66,405
	Amortization of intangibles		108			3,667			231			11,095

	Consolidated Operating Income	$	25,492		$	13,626		$	86,531		$	33,243

Depreciation	Vertis Retail and Newspaper Services	$	10,867		$	10,422		$	32,080		$	30,926
	Vertis Direct Marketing Services		5,241			4,948			14,814			14,168
	Vertis Advertising Technology Services		4,597			5,276			14,195			15,423
	Vertis Europe		1,845			1,846			5,371			5,632
	General Corporate		159			73			582			256

	Consolidated	$	22,709		$	22,565		$	67,042		$	66,405

Amortization of Intangibles	Vertis Retail and Newspaper Services	$	31		$	1,709		$	94		$	5,213
	Vertis Direct Marketing Services		20			446			60			1,337
	Vertis Advertising Technology Services		57			727			77			2,183
	Vertis Europe					785						2,362

	Consolidated	$	108		$	3,667		$	231		$	11,095

6. NEW ACCOUNTING PRONOUNCEMENTS

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". Among other things, this statement rescinds FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt" which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB Opinion No. 30, "Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", will now be used to classify those gains and losses. The Company has adopted the provisions of this statement related to the rescission of FASB Statement No. 4.

In June 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement requires recording costs associated with exit or disposal activities at their fair value when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management's commitment to an exit plan, which is generally before an actual liability has been incurred. Adoption of this statement is required with the beginning of fiscal year 2003. The Company has not yet completed our evaluation of the impact of adopting this statement.

7. LONG TERM DEBT

Long-term debt consisted of the following:

	September 30, 2002			December 31, 2001
	(In thousands)
Revolving credit facility	$	187,914		$	208,044
Term loan A		144,757			206,180
Term loan B		213,915			294,939
10⁷/8% senior notes		247,595
Senior subordinated credit facility		328,076			450,000
Other notes		1,663			2,924

		1,123,920			1,162,087
Current portion		(12,877	)		(37,063	)

	$	1,111,043		$	1,125,024

The credit facility (the "Credit Facility") consists of three components:

•: A revolving credit facility which allows borrowings of up to $250.0 million, including borrowings in British pounds sterling of up to the equivalent of $160.0 million. The revolving credit facility matures December 7, 2005 with no repayment of principal until maturity. Interest is payable at the Company's option either (a) at a base rate plus a margin of 2.50% or (b) at a Eurodollar-based rate plus a margin of 3.50%. These margins may decline over time in accordance with covenants in the Credit Facility;
•: Term Loan A, which requires periodic principal payments through December 7, 2005, as well as mandatory repayments in the event of specified asset sales and certain other events. A portion of this term loan was repaid in June 2002 in connection with the issuance of the 10⁷/8% notes, hereinafter defined, discussed below. Interest is payable at the Company's option either (a) at a base rate plus a margin of 2.50% or (b) at a Eurodollar-based rate plus a margin of 3.50%. These margins may decline over time in accordance with covenants in the Credit Facility; and
•: Term Loan B, which requires periodic principal payments through December 7, 2008, as well as repayments at the lenders' option in the event of specified asset sales. A portion of this term loan was repaid in June 2002 in connection with the issuance of the 10⁷/8% notes discussed below. Interest is payable at the Company's option either (a) at a base rate plus a margin of 3.25% or (b) at a Eurodollar-based rate plus a margin of 4.25%.

The senior subordinated credit facility expires in 2009. The rate of interest is 13.50%. In connection with the issuance of the 10⁷/8% notes, $107.5 million was repaid on the senior subordinated credit facility.

In June 2002, the Company issued $250.0 million of senior unsecured notes with an interest rate of 10⁷/8% and maturity date of June 15, 2009 (the "10⁷/8% notes"). The notes pay interest semi-annually on June 15 and December 15 of each year. After deducting the initial purchasers discount and transaction expenses, the net proceeds received by the Company was approximately $240 million. The Company used such net proceeds to repay $132.5 million of the Term A and B loans and $107.5 million of the senior subordinated credit facility.

The Credit Facility, the senior subordinated credit facility and the 10⁷/8% notes contain certain covenants including, among other things, restrictions on capital expenditures, dividends, investments and indebtedness and maintenance of specified levels of interest coverage and leverage. All of the Company's assets are pledged as collateral for the Credit Facility debt.

At September 30, 2002, the aggregated maturities of long-term debt were:

For the Twelve Months Ended September 30,	Term Loan A		Term Loan B		Other Debt		Total Long- Term Debt
	(In thousands)
2003	$	9,235	$	2,185	$	1,457	$	12,877
2004		57,915		2,185		206		60,306
2005		61,969		2,185				64,154
2006		15,638		2,185		187,914		205,737
2007				77,283				77,283
Thereafter				127,892		575,671		703,563

	$	144,757	$	213,915	$	765,248	$	1,123,920

8. STOCK REPURCHASE

In 1999 and 2000, certain of the Company's employees were granted the option to purchase shares of Vertis' parent company Vertis Holdings, Inc. ("Vertis Holdings") and to finance this purchase through signing full-recourse loans with Vertis Holdings. These loans (the "Management Loans") had stated interest of 8.5% per year and compounded quarterly, with the principal and interest due in a lump sum on varying dates up to December 7, 2005. The shares purchased with the Management Loans were held as security for the Management Loans.

On September 5, 2002, the Board of Directors of Vertis Holdings adopted a unanimous written consent offering those employees who had an outstanding Management Loan a one-time option to sell the shares securing the Management Loans back to Vertis Holdings in exchange for the cancellation of the Management Loans. These shares had an assumed fair market value of $31.50 as of September 5, 2002. In addition, Vertis Holdings would forgive the interest that had accrued on the Management Loans to any employee who sold their stock back to Vertis Holdings. The tax consequence, if any, of the interest forgiveness is the responsibility of the employee. Employees eligible for Vertis' Executive Incentive Plan were allowed to offset the tax consequences by a partial payment of their 2002 projected bonus. Substantially all employees holding the Management Loans elected this option. As of September 30, 2002, 110,946 shares of Vertis Holdings had been sold to the Company in exchange for cancellation of the Management Loans and $726,000 of interest was forgiven.

On September 5, 2002, the Board of Directors of Vertis Holdings also adopted another unanimous written consent whereby Vertis Holdings authorized issuance of 140,000 options, of which 135,077 were ultimately issued, to certain management employees of the Company. These options will have an exercise price of $31.50, the assumed fair market value of the underlying common stock as of the date of grant, a ten-year term and will vest in installments over three years with accelerated vesting provided certain performance goals are achieved by the Company.

9. GUARANTOR/NON-GUARANTOR CONDENSED CONSOLIDATED FINANCIAL INFORMATION

The Company has senior notes (see Note 7), which are general unsecured obligations of Vertis, Inc., and guaranteed by certain of Vertis, Inc.'s domestic subsidiaries. Accordingly, the following condensed consolidated financial information as of September 30, 2002 and December 31, 2001, the three months ended September 30, 2002 and 2001, and the nine months ended September 30, 2002 and 2001 are included for (a) Vertis, Inc. (the "Parent") on a stand-alone basis; (b) the guarantor subsidiaries; (c) the non-guarantor subsidiaries; and the Company on a consolidated basis.

Investments in subsidiaries are accounted for using the equity method for purposes of the consolidating presentation. The principal elimination entries eliminate investments in subsidiaries, intercompany balances and intercompany transactions. Separate financial statements and other disclosures with respect to the subsidiary guarantors have not been made because the subsidiaries are wholly-owned and the guarantees are full and unconditional and joint and several.

Condensed Consolidating Balance Sheet at September 30, 2002

In thousands			Parent			Guarantor Companies			Non-Guarantor Companies			Eliminations			Consolidated
ASSETS
Current Assets:
	Cash and cash equivalents		$	(3,396	)	$	13,476		$	2,571					$	12,651
	Accounts receivable, net			17,332			28,872			86,542						132,746
	Inventories			26,713			11,682			1,922						40,317
	Prepaid expenses and other current assets			20,330			5,253			5,124						30,707
	Deferred income taxes and income tax receivable			5,671			509			(379	)					5,801

		Total current assets		66,650			59,792			95,780						222,222
Intercompany Receivable				177,794								$	(177,794	)
Investments in subsidiaries				98,428			18,240						(116,668	)
Property, plant and equipment, net				307,256			122,086			21,754						451,096
Goodwill, net				197,202			48,625			93,536						339,363
Investments										72,017						72,017
Deferred financing costs, net				38,970						137						39,107
Other assets, net				18,978			1,512			31						20,521

		Total Assets	$	905,278		$	250,255		$	283,255		$	(294,462	)	$	1,144,326

LIABILITIES AND STOCKHOLDER'S (DEFICIT) EQUITY
Current Liabilities:
	Accounts payable		$	71,644		$	28,192		$	17,345					$	117,181
	Compensation and benefits payable			26,368			9,096			683						36,147
	Accrued interest			22,773						2,117						24,890
	Accrued income taxes			13,381			(1,658	)		(4,300	)					7,423
	Current portion of long-term debt			12,606			163			108						12,877
	Other current liabilities			68,151			(45,943	)		9,806						32,014

		Total current liabilities		214,923			(10,150	)		25,759						230,532
Due to parent							94,722			42,511		$	(130,994	)		6,239
Long-term debt, net of current portion				1,003,144						107,899						1,111,043
Deferred income taxes				31,272			(1,433	)		850						30,689
Other long-term liabilities				(6,183	)		72,313			931			(46,800	)		20,261

		Total liabilities		1,243,156			155,452			177,950			(177,794	)		1,398,764
Stockholder's (deficit) equity				(337,878	)		94,803			105,305			(116,668	)		(254,438	)

		Total Liabilities and Stockholder's (Deficit) Equity	$	905,278		$	250,255		$	283,255		$	(294,462	)	$	1,144,326

Condensed Consolidating Balance Sheet at December 31, 2001

In thousands			Parent			Guarantor Companies			Non-Guarantor Companies			Eliminations			Consolidated
ASSETS
Current Assets:
	Cash and cash equivalents		$	14,618		$	(358	)	$	3,273					$	17,533
	Accounts receivable, net			33,100			31,752			106,563						171,415
	Inventories			25,744			13,098			1,340						40,182
	Prepaid expenses and other current assets			17,772			5,493			3,414						26,679
	Deferred income taxes and income tax receivable			(1,205	)		7,385			(178	)					6,002

		Total current assets		90,029			57,370			114,412						261,811
Intercompany Receivable				254,958								$	(254,958	)
Investments in subsidiaries				98,428			18,240						(116,668	)
Property, plant and equipment, net				332,209			139,079			23,818						495,106
Goodwill, net				268,041			71,286			107,202						446,529
Investments										70,824						70,824
Deferred financing costs, net				46,072						221						46,293
Other assets, net				19,102			1,888			29						21,019

		Total Assets	$	1,108,839		$	287,863		$	316,506		$	(371,626	)	$	1,341,582

LIABILITIES AND STOCKHOLDER'S (DEFICIT) EQUITY
Current Liabilities:
	Accounts payable		$	99,373		$	29,048		$	14,896					$	143,317
	Compensation and benefits payable			23,882			12,232			689						36,803
	Accrued interest			20,735						1,540						22,275
	Accrued income taxes			17,249			(6,314	)		(3,164	)					7,771
	Current portion of long-term debt			36,546			378			139						37,063
	Other current liabilities			83,814			(44,049	)		9,715						49,480

		Total current liabilities		281,599			(8,705	)		23,815						296,709
Due to parent							209,657			61,512		$	(264,231	)		6,938
Long-term debt, net of current portion				1,025,431			24			99,569						1,125,024
Deferred income taxes				33,121			1,300			964						35,385
Other long-term liabilities				12,845			249			2,976			9,273			25,343

		Total liabilities		1,352,996			202,525			188,836			(254,958	)		1,489,399
Stockholder's (deficit) equity				(244,157	)		85,338			127,670			(116,668	)		(147,817	)

		Total Liabilities and Stockholder's (Deficit) Equity	$	1,108,839		$	287,863		$	316,506		$	(371,626	)	$	1,341,582

Condensed Consolidating Statement of Operations
Three months ended September 30, 2002

In thousands		Parent			Guarantor Companies			Non-Guarantor Companies			Eliminations			Consolidated
Net sales		$	282,203		$	97,003		$	36,223		$	(5,846	)	$	409,583

Operating expenses:
	Costs of production		220,204			71,394			25,741			(5,846	)		311,493
	Selling, general and administrative		29,691			10,364			6,956						47,011
	Restructuring expense		1,852			717			201						2,770
	Depreciation		14,669			6,162			1,878						22,709
	Amortization of intangibles		84			20			4						108

			266,500			88,657			34,780			(5,846	)		384,091

Operating income			15,703			8,346			1,443						25,492

Other expenses (income):
	Interest expense		27,086			4			2,107						29,197
	Amortization of deferred financing costs		2,464												2,464
	Interest income		(44	)		(15	)		(4	)					(63	)
	Other, net		(81	)		1,278			693						1,890

			29,425			1,267			2,796						33,488

Equity in net income (loss) of subsidiaries			13,710									(13,710	)
(Loss) income before income taxes			(12	)		7,079			(1,353	)		(13,710	)		(7,996	)
Income tax expense (benefit)			5,251			(7,828	)		(156	)					(2,733	)

Net (loss) income		$	(5,263	)	$	14,907		$	(1,197	)	$	(13,710	)	$	(5,263	)

Condensed Consolidating Statement of Operations
Three months ended September 30, 2001

In thousands		Parent			Guarantor Companies			Non-Guarantor Companies			Eliminations			Consolidated
Net sales		$	303,526		$	110,846		$	37,331		$	(6,359	)	$	445,344

Operating expenses:
	Costs of production		247,750			79,089			25,899			(6,359	)		346,379
	Selling, general and administrative		31,385			13,867			6,503						51,755
	Restructuring expense		4,693			2,586			73						7,352
	Depreciation		14,517			6,144			1,904						22,565
	Amortization of intangibles		2,312			566			789						3,667

			300,657			102,252			35,168			(6,359	)		431,718

Operating income			2,869			8,594			2,163						13,626

Other expenses (income):
	Interest expense		27,083			(38	)		2,036						29,081
	Amortization of deferred financing costs		1,845												1,845
	Interest income		(23	)		(20	)		(8	)					(51	)
	Other, net		(171	)		(291	)		1,314						852

			28,734			(349	)		3,342						31,727

Equity in net income (loss) of subsidiaries			27,656									(27,656	)
Income (loss) before income taxes			1,791			8,943			(1,179	)		(27,656	)		(18,101	)
Income tax (benefit) expense			(7,294	)		(20,296	)		404						(27,186	)

Net income (loss)		$	9,085		$	29,239		$	(1,583	)	$	(27,656	)	$	9,085

Condensed Consolidating Statement of Operations
Nine months ended September 30, 2002

In thousands		Parent			Guarantor Companies			Non-Guarantor Companies			Eliminations			Consolidated
Net sales		$	834,508		$	301,008		$	101,946		$	(17,107	)	$	1,220,355

Operating expenses:
	Costs of production		648,736			219,503			70,589			(17,107	)		921,721
	Selling, general and administrative		85,936			33,692			19,386						139,014
	Restructuring expense		2,191			1,502			2,123						5,816
	Depreciation		43,937			17,620			5,485						67,042
	Amortization of intangibles		157			61			13						231

			780,957			272,378			97,596			(17,107	)		1,133,824

Operating income			53,551			28,630			4,350						86,531

Other expenses (income):
	Interest expense		78,674			(60	)		5,942						84,556
	Amortization of deferred financing costs		7,747												7,747
	Interest income		(121	)		(41	)		(15	)					(177	)
	Other, net		7,870			1,153			2,196						11,219

			94,170			1,052			8,123						103,345

Equity in net income (loss) of subsidiaries			(15,521	)								15,521
(Loss) income before income taxes			(56,140	)		27,578			(3,773	)		15,521			(16,814	)
Income tax (benefit) expense			(1,254	)		(4,517	)		(583	)					(6,354	)

(Loss) income before cumulative effect of accounting change			(54,886	)		32,095			(3,190	)		15,521			(10,460	)
Cumulative effect of accounting change			70,775			22,661			21,765						115,201

Net (loss) income		$	(125,661	)	$	9,434		$	(24,955	)	$	15,521		$	(125,661	)

Condensed Consolidating Statement of Operations
Nine months ended September 30, 2001

In thousands		Parent			Guarantor Companies			Non-Guarantor Companies			Eliminations			Consolidated
Net sales		$	932,267		$	330,781		$	111,244		$	(20,181	)	$	1,354,111

Operating expenses:
	Costs of production		762,488			241,687			77,409			(20,181	)		1,061,403
	Selling, general and administrative		87,122			45,153			20,414						152,689
	Restructuring expense		23,647			5,241			388						29,276
	Depreciation		42,932			17,664			5,809						66,405
	Amortization of intangibles		7,023			1,698			2,374						11,095

			923,212			311,443			106,394			(20,181	)		1,320,868

Operating income			9,055			19,338			4,850						33,243

Other expenses (income):
	Interest expense		85,886			(106	)		6,422						92,202
	Amortization of deferred financing costs		11,053												11,053
	Interest income		(393	)		(52	)		(22	)					(467	)
	Other, net		(211	)		1,336			4,904						6,029

			96,335			1,178			11,304						108,817

Equity in net income (loss) of subsidiaries			1,492									(1,492	)
(Loss) income before income taxes			(85,788	)		18,160			(6,454	)		(1,492	)		(75,574	)
Income tax (benefit) expense			(36,377	)		12,045			(1,831	)					(26,163	)

Net (loss) income		$	(49,411	)	$	6,115		$	(4,623	)	$	(1,492	)	$	(49,411	)

Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2002

In thousands		Parent			Guarantor Companies			Non- Guarantor Companies			Consolidated
Cash Flows from Operating Activities		$	(95,403	)	$	128,574		$	17,962		$	51,133

Cash Flows from Investing Activities:
	Capital expenditures		(18,394	)		(2,202	)		(2,077	)		(22,673	)
	Software development costs capitalized		(1,916	)								(1,916	)
	Proceeds from sale of property, plant and equipment and divested assets		1,088			312			59			1,459

Net cash used in investing activities			(19,222	)		(1,890	)		(2,018	)		(23,130	)

Cash Flows from Financing Activities:
	Issuance of long-term debt		247,500									247,500
	Net (repayments) borrowings under revolving credit facilities		(28,461	)					974			(27,487	)
	Repayments of long-term debt		(250,938	)		(240	)		(39	)		(251,217	)
	Deferred financing costs		(8,883	)								(8,883	)
	Increase in outstanding checks drawn on controlled disbursement accounts		4,136			2,325			1,051			7,512
	Other financing activities		(679	)								(679	)
	Change in intercompany balances		133,936			(114,935	)		(19,001	)

Net cash provided by (used in) by financing activities			96,611			(112,850	)		(17,015	)		(33,254	)

Effect of exchange rate changes on cash									369			369

Net (decrease) increase in cash and cash equivalents			(18,014	)		13,834			(702	)		(4,882	)
Cash and cash equivalents at beginning of year			14,618			(358	)		3,273			17,533

Cash and cash equivalents at end of period		$	(3,396	)	$	13,476		$	2,571		$	12,651

Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2001

In thousands		Parent			Guarantor Companies			Non-Guarantor Companies			Consolidated
Cash Flows from Operating Activities		$	(81,713	)	$	113,646		$	38,380		$	70,313

Cash Flows from Investing Activities:
	Capital expenditures		(43,184	)		(8,181	)		(3,305	)		(54,670	)
	Software development costs capitalized		(1,164	)								(1,164	)
	Proceeds from sale of property, plant and equipment and divested assets		292			994			685			1,971
	Other investing activities					578						578

Net cash used in investing activities			(44,056	)		(6,609	)		(2,620	)		(53,285	)

Cash Flows from Financing Activities:
	Net borrowings under revolving credit facilities		70,021						2,984			73,005
	Repayments of long-term debt		(14,722	)		(329	)		(33	)		(15,084	)
	Deferred financing costs		(14,373	)								(14,373	)
	(Decrease) increase in outstanding checks drawn on controlled disbursement accounts		(52,231	)		(64	)		607			(51,688	)
	Other financing activities		(3,127	)		(578	)					(3,705	)
	Change in intercompany balances		123,905			(85,226	)		(38,679	)

Net cash provided by (used in) by financing activities			109,473			(86,197	)		(35,121	)		(11,845	)

Effect of exchange rate changes on cash									682			682

Net (decrease) increase in cash and cash equivalents			(16,296	)		20,840			1,321			5,865
Cash and cash equivalents at beginning of year			1,388			1,514			1,890			4,792

Cash and cash equivalents at end of period		$	(14,908	)	$	22,354		$	3,211		$	10,657

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Introduction

Vertis is a leading provider of integrated advertising products and marketing services. We deliver a comprehensive range of solutions that simplify, improve and maximize the effectiveness of multiple phases of our customers' marketing campaigns from the inception of an advertising concept, through design, production, targeted distribution, and ultimately to providing advertising effectiveness measurement.

We operate through four principal business segments. Vertis Retail and Newspaper Services, Vertis Direct Marketing Services and Vertis Advertising Technology Services provide advertising solutions to clients on a functional basis in the U.S., while Vertis Europe provides both production and direct marketing services to clients overseas, predominantly in the U.K.

When we use the terms "Vertis", the "Company" "we" and "our", we mean Vertis, Inc., a Delaware corporation, and its consolidated subsidiaries. The words "Vertis Holdings" refer to Vertis Holdings, Inc., the parent company of Vertis and its sole stockholder.

Corporate Consolidation

In the first quarter of 2000, we began a multi-phase consolidation and restructuring plan intended to streamline operations, improve sales and reduce the cost of operating our business in order to better serve our customers while at the same time also improving our operating and financial performance. Our consolidation plan had three principal components:

•: eliminating our two-tier holding company structure and centralizing our domestic and European operations under one management team that has successfully managed our largest business segment since 1994, while integrating advertising and marketing production services;
•: reorganizing our sales force to correspond more directly to our clients' evolving needs for broad-based, integrated marketing solutions; and
•: consolidating back office operations and eliminating duplicative overhead.

As part of this plan, we also consolidated our sales organization to create an integrated product offering and sales effort. We have established national and retail sales groups to target large accounts that can employ multiple service lines to augment sales units focused on selling the products and services of each business unit. We believe that this structure, which we call Vertis Integrated Selling, will maximize multi-solution sales opportunities while continuing to drive the sales of our products and services through our individual business units. Finally, this consolidation has allowed us to realize substantial cost savings through the elimination of duplicative positions as well as much of the corporate overhead previously incurred by our parent, Vertis Holdings.

In order to further reduce duplicative overhead, on January 1, 2001, we transferred 13 management and support personnel employed at our parent, Vertis Holdings, to Chancery Lane Capital ("CLC") in exchange for a $14.0 million one-time payment by us to CLC. Concurrently, Thomas H. Lee Partners acquired an additional $40 million of our equity from an affiliate of CLC in exchange for $40 million of Vertis Holdings' mezzanine debt.

During 2001, we continued the restructuring program initiated in 2000. Certain production and sales administration facilities were combined in strategic areas resulting in the closure of 14 facilities, abandonment of assets in those locations and reduction in work force. Approximately 1,000 positions were eliminated in 2001 as a result of these closures.

In 2002 we have been involved in two main restructuring efforts. In the first quarter, two facilities were combined and related severance recorded in the Vertis Europe segment. In addition, we are

involved in an ongoing effort to streamline operations in the Advertising Technology Services segment. This has involved the termination of employees in certain areas of the business and the planned closing of two facilities. Offsetting these amounts is an adjustment of the estimate of 2001 restructuring made in 2002. To date, the total of all planned actions has eliminated approximately 1,200 positions and closed 18 facilities with an annual cost of approximately $79 million, including $8.1 million relating to the transfer of management and support personnel to CLC as described above.

In connection with these actions, we recorded $6.8 million and $31.4 million of restructuring expense and restructuring-related expenses in the nine months ended September 30, 2002 and 2001, respectively.

In the nine months ended September 30, 2002 and 2001, the Company incurred incremental expenses related to the restructuring plan of $1.0 million and $2.1 million, respectively. The "restructuring-related" expenses include costs such as those to publicize the corporate identity as a brand name, consulting fees, retention compensation and professional fees. While related to the consolidation and restructuring plan, these charges do not meet the definition of "exit costs" in accordance with accounting principles generally accepted in the United States ("GAAP") and, therefore, are recorded in selling, general and administrative expenses.

Restructuring costs incurred but not paid are $6.2 million at September 30, 2002. We expect to pay approximately $3.0 million of the accrued restructuring balance in the next year and the remainder by 2007.

Results of Continuing Operations

The following table presents major components from the Consolidated Statements of Operations and Cash Flows.

	Three months ended September 30,						Nine months ended September 30,
	2002			2001			2002			2001
	(percentages of net sales)
Net sales		100.0	%		100.0	%		100.0	%		100.0	%

Costs of production		76.1			77.8			75.5			78.4
Selling, general and administrative		11.5			11.6			11.4			11.3
Restructuring expense		0.7			1.7			0.5			2.2
Depreciation		5.5			5.1			5.5			4.9
Amortization of intangibles					0.8						0.8

Total operating costs		93.8			97.0			92.9			97.6

Operating income		6.2	%		3.0	%		7.1	%		2.4	%

Other data:
(in thousands)
Cash flows provided by operating activities	$	40,222		$	28,526		$	51,133		$	70,313
Cash flows used in investing activities		9,632			13,243			23,130			53,285
Cash flows used in financing activities		23,363			12,209			33,254			11,845
EBITDA	$	48,309		$	39,858		$	153,804		$	110,743

EBITDA as a percentage of net sales		11.8	%		8.9	%		12.6	%		8.2	%

"EBITDA" represents the sum of operating income, depreciation and amortization of intangibles. We present EBITDA here to provide additional information regarding our ability to meet our future debt service, capital expenditures and working capital requirements and because it is the measure by which we gauge the profitability of our segments. EBITDA is not a measure of financial performance in accordance with GAAP. You should not consider it an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. Our calculation of EBITDA may be different than the calculation used by other companies and therefore comparability may be limited.

General

Several factors can affect the comparability of our results from one period to another. Primary among these factors are acquisitions, the cost of paper, changes in business mix, the timing of restructuring expense and the realization of the associated benefits.

The cost of paper is a principal factor in our pricing to certain customers in the Retail and Newspaper Services segment since a substantial portion of sales includes the pass-through cost of paper. Therefore, the cost of paper significantly affects our net sales in that business segment, as does the proportion of paper provided by customers. We are generally able to pass on increases in the cost of paper to our customers, while decreases in paper costs generally result in lower prices to customers. For these reasons, when discussing results for the Retail and Newspaper Services segment, we analyze both net sales and "value-added revenue". We define "value-added revenue" as net sales less the cost of paper and ink. See also the discussion of paper costs in the subheadings captioned "Operating Costs (Before Depreciation and Amortization)".

Variances in expense category ratios, as percentages of net sales, may reflect business mix. As our business mix changes, the nature of products sold in a period can lead to offsetting increases and decreases in different expense categories.

You should consider all of these factors in reviewing the discussion of our operating results.

Consolidated Results

	Three months Ended September 30,							Nine months Ended September 30,
(In thousands)	Three months Ended September 30,					% Change		Nine months Ended September 30,						% Change
(In thousands)	2002			2001		% Change		2002			2001			% Change
Net sales	$	409,583		$	445,344	-8.0	%	$	1,220,355		$	1,354,111		-9.9	%
Operating income		25,492			13,626	87.1	%		86,531			33,243		160.3	%
Net (loss) income		(5,263	)		9,085				(125,661	)		(49,411	)
EBITDA		48,309			39,858	21.2	%		153,804			110,743		38.9	%

Net Sales

The decline in net sales for the three and nine months ended September 30, 2002 is largely the result of the downward impact on revenue of declines in the cost of paper. The impact of the decline in the cost of paper represented $26.7 million, 74.6%, and $96.9 million, 72.5%, of the decline in net sales for the three and nine months ended September 30, 2002, respectively. It is estimated that the overall average cost per ton of paper in the U.S. increased 4.6% in the third quarter, however, through the first nine months of 2002 costs have decreased 16.4%. For further discussion of net sales, see "—Results by Segment".

Operating Costs (Before Depreciation and Amortization)

Costs of Production

Costs of production decreased $34.9 million, 10.1%, from $346.4 million in the third quarter 2001 to $311.5 million in the third quarter of 2002. Through September 30, 2002, costs of production amounted to $921.7 million, a decline of $139.7 million, or 13.2%, versus the nine months ended September 30, 2001. As a percentage of net sales, cost of production decreased 1.7 percentage points and 2.9 percentage points versus the third quarter and first nine months of 2001, respectively. The cost of paper and ink consumed represented $30.2 million and $110.1 million of the decline in costs of production in the three and nine months ended September 30, 2002, respectively. The balance of the decline in costs of production was the result of cost management of variable and fixed costs and the ongoing efforts to improve operating efficiencies.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased $4.7 million versus the third quarter of 2001 and $13.7 million versus the nine months ended September 30, 2001. The decline reflects benefits realized from our restructuring programs and other cost control measures. Selling, general and administrative expenses were essentially flat as a percentage of net sales.

Restructuring Expense

Results for the three months and nine months ended September 30, 2002 include $2.8 million and $5.8 million, respectively of restructuring expense compared to $7.4 million and $29.3 million, respectively for the three months and nine months ended September 31, 2001, all of which are related to the consolidation of operations throughout our business.

Depreciation and Amortization

On January 1, 2002, we adopted Statement of Financial Accounting Standards ("SFAS") No. 142. Under this standard, goodwill and intangibles assets with indefinite useful lives are no longer amortized. Accordingly, we stopped amortizing our existing goodwill at that date. For further discussion, see "New Accounting Pronouncements."

Operating Income and EBITDA

Operating income and EBITDA increased for three and nine months ended September 30, 2002, respectively. Compared to the comparable periods in 2001, operating income increased 87.1% and 160.3%, respectively, and EBITDA increased 21.2% and 38.9%, respectively. These increases primarily reflect the year-over-year growth in our Retail and Newspaper Services segment, reduction in the level of restructuring expense in 2002 in both the three month and nine month periods and the effect of cost management initiatives. Operating income was also favorably impacted by the reduction in amortization expense due to the adoption of SFAS No. 142.

For further discussion of operating income, see—"Results by Segment".

Other Expenses (Income)

Other expenses and income included the following:

	Three months Ended September 30,								Nine months Ended September 30,
(In thousands)	Three months Ended September 30,						% Change		Nine months Ended September 30,						% Change
(In thousands)	2002			2001			% Change		2002			2001			% Change
Interest expense	$	29,197		$	29,081		0.4	%	$	84,556		$	92,202		-8.3	%
Amortization of deferred financing costs		2,464			1,845		33.6	%		7,747			11,053		-29.9	%
Interest income		(63	)		(51	)	23.5	%		(177	)		(467	)	-62.1	%
Other, net		1,890			852		121.8	%		11,219			6,029		86.1	%

	$	33,488		$	31,727				$	103,345		$	108,817

Interest Expense

Interest expense in the nine months ended September 30, 2002 decreased from 2001 due to a decrease in interest rates driven by decreases in LIBOR and prime interest rates in 2002.

Amortization of Deferred Financing Costs

The increase in amortization expense for the quarter ended September 30, 2002 is attributable to the amortization of the senior unsecured notes which were issued in June 2002 (see "—Debt Offering"). The decrease in amortization expense in the nine month period was primarily a result of the full amortization of extension fees related to our senior subordinated credit facility financing, which were amortized over the six-month extension period from January 2001 to June 2001.

Other, Net

Included in other, net is an $8.2 million write off of deferred financing fees in connection with our recent debt offering and related debt pay down in June 2002. Also, included in the 2001 results is a $2.0 million loss on the sale of a remaining portion of an equity investment. In addition, other, net includes costs associated with our accounts receivable securitization facility and other miscellaneous expenses such as foreign exchange transaction losses.

The costs of our accounts receivable securitization facility amounted to $0.6 million in the third quarter of 2002 and $2.1 million in the first nine months of 2002, as compared to $1.3 million in the third quarter of 2001 and $4.9 million in the first nine months of 2001. The cost associated with the accounts receivable securitization facility varies based on the level of receivables sold during each period and fees, which are based on LIBOR rates.

Both years also include income earned on investments that we account for as leveraged leases in accordance with Statement of Financial Accounting Standards No. 13, "Accounting for Leases". The amount of investment income totaled $0.4 million in the third quarter of 2002 and $1.2 million in the nine months ended September 30, 2002, as compared to $0.6 million in the third quarter of 2001 and $2.1 million in the nine months ended September 30, 2001.

Income Taxes

Our effective tax rate in the three months and nine months ended September 30, 2002 was slightly higher than our statutory rate due to non-deductible expenses. The effective tax rate decrease from the same periods in the prior year was primarily a result of the change in accounting for goodwill.

Results by Segment

Retail and Newspaper Services

	Three months Ended September 30,						Nine months Ended September 30,
(In thousands)	Three months Ended September 30,				% Change		Nine months Ended September 30,				% Change
(In thousands)	2002		2001		% Change		2002		2001		% Change
Net sales	$	258,922	$	275,036	-5.9	%	$	763,266	$	841,093	-9.3	%
Operating income		25,453		12,588	102.2	%		81,582		50,200	62.5	%
EBITDA		36,351		24,719	47.1	%		113,756		86,339	31.8	%

Net Sales

Net sales at our Retail and Newspaper Services segment include the impact of the decline in the cost of paper; $25.3 million for the three months ended September 30, 2002 and $93.0 million for the nine months ended September 30, 2002. Eliminating the impact of the decline in the cost of paper, the Retail and Newspaper Services segment net sales increased $9.2 million, or 3.3% in the third quarter and $15.1 million, or 1.8% through the first nine months of 2002. Illustrating the negative impact that paper had on net sales, value-added revenue increased in both the three and nine month periods ended September 30, 2002 by 7.1% and 4.9%, respectively. The increase in value-added revenue reflects increased volume and pricing.

Operating Income and EBITDA

The increases in operating income and EBITDA in the table above reflect the positive impact of the volume increase and pricing gains mentioned in the discussion of net sales, which provided $5.4 million of the improvement in the third quarter and $14.9 million of the improvement through September 30, 2002. The remainder of the period-over-period increase reflects lower costs, including restructuring expense, which are less than 2001 by $3.5 million and $5.3 million, for the three and nine months ended September 30, 2002, respectively. In addition, operating income was impacted by the decrease in depreciation and amortization expense, primarily as a result of the adoption of SFAS No. 142, of $1.2 million for the three month period and $4.0 million for the nine month period.

Direct Marketing Services

	Three months Ended September 30,						Nine months Ended September 30,
(In thousands)	Three months Ended September 30,				% Change		Nine months Ended September 30,				% Change
(In thousands)	2002		2001		% Change		2002		2001		% Change
Net sales	$	72,576	$	80,750	-10.1	%	$	224,744	$	236,417	-4.9	%
Operating income		3,996		5,530	-27.7	%		16,555		9,062	82.7	%
EBITDA		9,257		10,924	-15.3	%		31,429		24,567	27.9	%

Net Sales

The $11.7 million decline in net sales in the nine month period includes $3.9 million due to the decline in the cost of paper. Excluding the impact of the cost of paper, net sales decreased $7.7 million, or 3.3% during the nine months ended September 30, 2002. During the third quarter and nine months ended September 31, 2002, our Direct Marketing Services segment has seen double-digit growth in impressions (volume) that has been offset by lower pricing due to a shift by our customers to less complex products. Additionally, revenue in this segment was negatively affected by the impact of the postal rate increase at the beginning of the third quarter and market-driven delays in traditional direct mail campaigns by clients in certain sectors.

Operating Income and EBITDA

The decrease in operating income and EBITDA for the third quarter is attributable to the noted net sales decline and the negative impact of the postal rate increase, which were only partially offset by the positive impact of expense management. For the nine month period, an increase in operating income and EBITDA was the result of expense management, which more than offset the decline in net sales. In addition, restructuring costs, as compared to 2001, were $1.2 million less in the third quarter and $4.3 million less for the nine months ended September 30, 2002. Operating income was favorably impacted by the adoption of SFAS No. 142, which resulted in a decrease in amortization expense of $0.4 million in the three month period and $1.3 million in the nine month period. This decrease in amortization expense was offset by the increase in depreciation expense of $0.3 million in the three month period and $0.6 million in the nine month period.

Advertising Technology Services

	Three months Ended September 30,								Nine months Ended September 30,
(In thousands)	Three months Ended September 30,						% Change		Nine months Ended September 30,						% Change
(In thousands)	2002			2001			% Change		2002			2001			% Change
Net sales	$	48,641		$	59,717		-18.5	%	$	149,705		$	187,216		-20.0	%
Operating loss		(3,236	)		(5,528	)	41.5	%		(12,162	)		(11,208	)	-8.5	%
EBITDA		1,418			475		198.5	%		2,110			6,398		-67.0	%

Net Sales

Net sales in our Advertising Technology Services segment have been negatively impacted by the soft advertising environment, especially the advertising agency business. Indicative of the weak advertising agency business, net sales to this sector have declined 35.1% versus the nine months ended September 30, 2001, and comprised $27.6 million of the total decline in net sales of $37.5 million. The balance of the decline is indicative of the overall soft advertising environment.

Operating Income and EBITDA

The third quarter decrease in operating loss and increase in EBITDA resulted from the restructuring initiatives and cost management activities, which offset the decline in net sales. Although strict cost management has been in place, it only offset a portion of the decline in net sales in the nine months ended September 31, 2002, which caused the decrease in operating income and EBITDA. Additionally, commensurate with the right-sizing initiatives, there was an increase in restructuring expense of $0.6 million for the nine month period. Operating income was favorably impacted by the adoption of SFAS No. 142 which caused a decrease in amortization expense of $0.7 million in the three month period and $2.1 million in the nine month period. In addition depreciation expense decreased $0.7 million in the three month period and $1.2 million in the nine month period, as a result of the restructuring actions which have reduced the number of locations and related fixed assets.

Vertis Europe

	Three months Ended September 30,						Nine months Ended September 30,
(In thousands)	Three months Ended September 30,				% Change		Nine months Ended September 30,				% Change
(In thousands)	2002		2001		% Change		2002		2001		% Change
Net sales	$	35,286	$	36,199	-2.5	%	$	99,747	$	108,644	-8.2	%
Operating Income		1,230		2,053	-40.1	%		4,171		4,872	-14.4	%
EBITDA		3,075		4,684	-34.4	%		9,542		12,866	-25.8	%

Net Sales

Our Vertis Europe segment continues to experience pressure on net sales resulting from a weak demand for long-run direct mail products coupled with a decline in our agency business similar to that experienced in the U.S. In addition, the decrease in net sales reflects the sale of Iceberg Marketing Limited, effective May 2001, which generated sales of $1.5 million in the nine month period ended September 31, 2001. The change in the exchange rate of the British pound sterling to the U.S. dollar resulted in a $1.9 million increase in net sales in the third quarter and a $3.2 million increase in net sales in the first nine months as compared to the comparable 2001 periods.

Operating Income and EBITDA

For the three and nine months ended September 30, 2002, the negative impact of the pressure on the top line more than offset the benefits of expense management resulting in a year-over-year decline in operating income and EBITDA. In addition, operating income and EBITDA were influenced by restructuring expense which increased by $0.1 million and $1.5 million for the three and nine month periods, respectively, as we sought to streamline certain portions of our European business. Operating income was favorably impacted by the adoption of SFAS No. 142 which caused a decrease in amortization expense of $0.7 million in the three month period and $2.4 million in the nine month period.

Liquidity and Capital Resources

Sources of Funds

We fund our operations, acquisitions and investments with internally generated funds, revolving credit facility borrowings, sales of accounts receivable, and issuances of debt.

We believe that the facilities in place, as well as our cash flows, will be sufficient to meet operational needs (including capital expenditures and restructuring costs) for the next twelve months. At September 30, 2002, we had approximately $64.1 million available to borrow under our revolving credit facility.

We also believe that the facilities in place, as well as our cash flows, will be sufficient to meet operating needs (including capital expenditures and restructuring costs) for several years. There can be no assurance, however, that our operations will generate sufficient cash flows or that we will always be able to refinance our current debt or obtain additional financing to refinance debt we assume in acquisition transactions. In the event we are unable to obtain sufficient financing, we would pursue other sources of funding such as debt offerings by Vertis Holdings, equity offerings by us and/or Vertis Holdings or asset sales.

Items that could impact liquidity are described below.

Contractual Obligations

The following table discloses aggregate information about our contractual obligations as of December 31, 2001 and the periods in which payments are due:

Contractual Obligations	Total		Less than 1 year		1-3 years		4-5 years		After 5 years
(In thousands)
Long-term debt	$	1,162,087	$	37,063	$	118,459	$	276,571	$	729,994
Operating leases		103,886		22,385		35,561		22,701		23,239

Total contractual cash obligations	$	1,265,973	$	59,448	$	154,020	$	299,272	$	753,233

Foreign Currency

Fluctuation in foreign currency would affect approximately $108.0 million of the British pound sterling based debt as of September 30, 2002.

Off-Balance Sheet Arrangements

In 1996, we entered into a six-year accounts receivable securitization facility (as amended, the "Existing A/R Facility") to sell, on a revolving basis, certain accounts receivable. A maximum of $130.0 million can be sold under the Existing A/R Facility and the amount outstanding at any time depends upon the level of the eligible receivables. The interest rate associated with the Existing A/R Facility is LIBOR plus 34 basis points. On April 1, 2002, a refinancing occurred, with the expiration date of the Existing A/R Facility extended to December 1, 2002. We are currently negotiating and expect to obtain a new accounts receivable facility to replace the Existing A/R Facility when it expires on December 1, 2002. The successful execution of the new facility, however, could have an interest rate cost structure higher than the existing facility. To the extent that there are not adequate receivables to support the off-balance sheet facility, funds would have to be borrowed under our revolving credit facility to fund the off-balance sheet structure.

We have no other off-balance sheet arrangements that may have a material current or future effect on financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses.

Debt Offering

In June 2002, we issued $250.0 million of 10⁷/8% senior unsecured notes with a maturity date of June 15, 2009. After deducting the initial purchasers' discounts and transaction expenses, the net proceeds received by us from the sale of such notes was approximately $240 million. We used such net proceeds to repay $132.5 million of the term loans outstanding under our senior credit facility and $107.5 million of debt outstanding under our senior subordinated credit facility. The net proceeds applied to the term loans were paid as such that there would be substantially no principal repayment required until the third quarter of 2003.

Working Capital

Our current liabilities exceeded current assets by $8.3 million at September 30, 2002 and by $34.9 million at December 31, 2001. This represents an increase in working capital of $26.6 million for the nine months ended September 30, 2002. The working capital amounts exclude accounts receivable sold under a securitization, the proceeds of which serve to reduce long-term borrowings under our revolving credit facility. Excluding the effect of the securitization (i.e., adding back receivables and reflecting the offsetting increase in long-term debt as if the securitization facility was not in place), working capital at September 30, 2002 and December 31, 2001 would have been $114.3 million and

$95.1 million, respectively. The ratio of current assets to current liabilities as of September 30, 2002 was 0.96 to 1 (1.50 to 1, excluding the securitization effect) compared to 0.88 to 1 as of December 31, 2001 (1.32 to 1, excluding the securitization effect).

The increase in working capital was due primarily to a decrease in the current portion of long-term debt in addition to fluctuations in operating assets and liabilities.

Summary of Cash Flows

Net cash provided by operating activities in the first nine months of 2002 decreased by $19.2 million from the first nine months of 2001. This is primarily a result of the timing of payments and collection of receivables offset by the improved results of operations before the cumulative effect of accounting change and the decrease in restructuring expense in 2002.

Net cash used for investing activities in the first nine months of 2002 declined from the 2001 level due to a $32.0 million decrease in capital expenditures. We currently expect to spend approximately $43.4 million in 2002 for capital additions and software development.

The amounts of cash used in financing activities in each period reflect the relative levels of capital expenditures and investments in those years. In June 2002, we issued $250.0 million of senior unsecured notes which, after debt discount and fees, netted proceeds of approximately $240 million. The proceeds of this issuance were used to repay existing debt and this transaction is reflected in cash flows from financing activities. There were no dividends to our parent, Vertis Holdings, in the first nine months of 2002. From August 2001 to June 24, 2002, the entire 12% interest on Vertis Holdings' mezzanine debt was payable in kind. Previously, 10% of that interest was payable in cash. Effective June 25, 2002 the interest rate was changed to 13% payable in kind through December 31, 2005.

Seasonality and Other Factors

While our advertising insert business is generally seasonal in nature, the expansion of other product lines and the expansion of advertising insert business to year-round customers has reduced the overall seasonality of our revenues. Of our full year 2001 net sales, 24.7% were generated in the first quarter, 24.4% in the second, 24.1% in the third and 26.8% in the fourth. Profitability, however, continues to follow a more seasonal pattern due to the higher margins and efficiencies gained from running at full capacity during the year-end holiday production season. On the other hand, lower margins in the first quarter do not fully leverage fixed depreciation, amortization and interest costs that are incurred evenly throughout the year. Based on our historical experience and projected operations, we expect our operating results in the near future to be strongest in the fourth quarter and softest in the first.

We have approximately $210.0 million of federal net operating losses available to carry forward as of December 31, 2001. We expect that these carryforwards will be used to offset taxable income in future years, thereby lowering our cash tax obligations for several years.

New Accounting Pronouncements

On January 1, 2002, we adopted SFAS No. 142 ("SFAS 142"), "Goodwill and Other Intangibles." Under this statement, goodwill and intangible assets with indefinite lives are no longer amortized. Under the transitional provisions of SFAS 142, our goodwill was tested for impairment as of January 1, 2002. Each of our reporting units was tested for impairment by comparing the fair value of the reporting unit with the carrying value of that unit. Fair value was determined based on a valuation study performed by an independent third party using the discounted cash flow method and the guideline company method. As a result of our impairment test completed in the third quarter of 2002, we recorded an impairment loss of $93.4 million at our Vertis Advertising Technology Services segment

and $21.8 million at our Vertis Europe segment to reduce the carrying value of goodwill to its implied fair value. Impairment in both cases was due to a combination of factors including operating performance and acquisition price. In accordance with SFAS 142, the impairment charge was reflected as a cumulative effect of accounting change in the accompanying 2002 consolidated statements of operations. We will test goodwill for impairment again in 2003 at an annual impairment test date that has yet to be selected.

In accordance with SFAS 142, we stopped amortizing our existing goodwill on January 1, 2002. A reconciliation of reported net income to net income adjusted to reflect the impact of the discontinuance of the amortization of goodwill for the three months ended and nine months ended September 30, 2002 and 2001 is as follows:

	Three months ended September 30,					Nine months ended September 30,
(In thousands)	Three months ended September 30,					Nine months ended September 30,
(In thousands)	2002			2001		2002			2001
Reported net (loss) income	$	(5,263	)	$	9,083	$	(125,661	)	$	(49,411	)
Add: Goodwill amortization					3,313					9,942

Adjusted net (loss) income	$	(5,263	)	$	12,396	$	(125,661	)	$	(39,469	)

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". Among other things, this statement rescinds FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt" which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB Opinion No. 30, "Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", will now be used to classify those gains and losses. We have adopted the provisions of this statement related to the rescission of FASB Statement No. 4.

In June 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement requires recording costs associated with exit or disposal activities at their fair value when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management's commitment to an exit plan, which is generally before an actual liability has been incurred. Adoption of this statement is required with the beginning of fiscal year 2003. We have not yet completed our evaluation of the impact of adopting this statement.

Item 3. Qualitative and Quantitative Disclosures about Market Risk

Qualitative Information

Our primary exposure to market risks relates to interest rate fluctuations on variable rate debt. Generally, our exposure to foreign currency exchange rate fluctuations is immaterial as foreign operations are a small proportion of the total company and foreign currency borrowings act as a natural hedge against fluctuations in net asset values.

The objective of our risk management program is to seek a reduction in the potential negative earnings effects from changes in interest and foreign exchange rates. To meet this objective, consistent with past practices, we intend to vary the proportions of fixed-rate and variable-rate debt based on our perception of interest rate trends and the marketplace for various debt instruments. Except for those used to meet hedging requirements in our credit facility, we generally do not use derivative financial instruments in our risk management program. This practice may change in the future as market conditions change. We do not use any derivatives for trading purposes.

Quantitative Information

At September 30, 2002, 46.9% of our long-term debt held a variable interest rate (including off-balance sheet debt related to the accounts receivable securitization facility, the fees on which are variable).

If interest rates increased 10%, the expected effect related to variable-rate debt would be to increase net loss for the twelve months ended September 30, 2002 by approximately $2.8 million.

For the purpose of sensitivity analysis, we assumed the same percentage change for all variable-rate debt and held all factors constant. The sensitivity analysis is limited in that it is based on balances outstanding at September 30, 2002 and does not provide for changes in borrowings that may occur in the future.

Item 4. Controls and Procedures

Within the 90-day period prior to the filing of this report, an evaluation was carried out under the supervision and with the participation of Vertis' management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective. No significant changes were made in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

We are involved in a number of legal proceedings concerning matters arising in the ordinary course of business. We do not expect that any of these matters, individually or in the aggregate, will have a material impact on our results of operations or financial condition.

Item 5. Other Information

Forward Looking Statements

We have included in this Form 10-Q filing, and from time to time our management may make, statements which may constitute "forward-looking statements" within the meaning of the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts but instead represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside of our control. It is possible that our actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Important factors that could cause actual results to differ from those in our specific forward-looking statements include, but are not limited to those discussed in our Form S-4 filing dated September 6, 2002, under "Risk Factors—Risks Related to Our Business" as well as:

•: fluctuations in the cost of raw materials we use;
•: changes in the advertising, marketing and information services markets;
•: the financial condition of our customers;
•: execution of key strategies;
•: the general economic and business condition of the United States and other countries;
•: the effects of supplier price fluctuations on our operations;
•: downgrades in our credit ratings;
•: changes in interest and foreign currency exchange rates; and
•: matters discussed in this document generally.

Consequently, you should consider these forward-looking statements only as our current plans, estimates and beliefs. We do not undertake and specifically decline any obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect future events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. We undertake no obligation to update or revise any forward-looking statement in this memorandum to reflect any new events or any change in conditions or circumstances. All of the forward-looking statements in this offering memorandum are expressly qualified by these cautionary statements. Even if these plans, estimates or beliefs change because of future events or circumstances after the date of these statements, or because anticipated or unanticipated events occur, we decline, and cannot be required to accept, an obligation to publicly release the results of revisions to these forward-looking statements.

Item 6. Exhibits and Reports on Form 8-K

(a): Exhibits

None

(b): Reports on Form 8-K

None

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.

		VERTIS, INC.
			/s/ DONALD E. ROLAND Donald E. Roland Chairman, President and Chief Executive Officer
			/s/ DEAN D. DURBIN Dean D. Durbin Chief Financial Officer

Date: November 13, 2002

Certification

I, Donald E. Roland, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Vertis, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors:

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

By:

/s/ DONALD E. ROLAND

Name: Donald E. Roland
Title: Chairman, President and
Chief Executive Officer

Date: November 13, 2002

Certification

I, Dean D. Durbin, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Vertis, Inc.;

b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors:

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

By:

/s/ DEAN D. DURBIN

Name: Dean D. Durbin
Title: Chief Financial Officer

Date: November 13, 2002

QuickLinks

INDEX
Part I—FINANCIAL INFORMATION

Item 1: Financial Statements

Vertis, Inc. and Subsidiaries Condensed Consolidated Balance Sheets
Vertis, Inc. and Subsidiaries Condensed Consolidated Statements of Operations
Vertis, Inc. and Subsidiaries Condensed Consolidated Statements of Operations
Vertis, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows
Vertis, Inc. and Subsidiaries Notes To Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidating Balance Sheet at September 30, 2002
Condensed Consolidating Balance Sheet at December 31, 2001
Condensed Consolidating Statement of Operations Three months ended September 30, 2002
Condensed Consolidating Statement of Operations Three months ended September 30, 2001
Condensed Consolidating Statement of Operations Nine months ended September 30, 2002
Condensed Consolidating Statement of Operations Nine months ended September 30, 2001
Condensed Consolidating Statement of Cash Flows Nine Months Ended September 30, 2002
Condensed Consolidating Statement of Cash Flows Nine Months Ended September 30, 2001

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Qualitative and Quantitative Disclosures about Market Risk

Item 4. Controls and Procedures

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

Item 5. Other Information

Forward Looking Statements

Item 6. Exhibits and Reports on Form 8-K

Signatures
Certification
Certification