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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

1


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.

2


Vertis, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations

 
   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.

3


Vertis, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations

 
   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.

4


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

 
   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.

5


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.

6

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:

7

        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  
   </