SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x                              Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2005

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: 333-97721

Vertis, Inc.

(Exact Names of Registrants as Specified in Their Charters)

 

(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 x No o

Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

Yes o No x

INDEX

		Page
Part I—Financial Information
Item 1. Financial Statements
	Condensed Consolidated Balance Sheets at March 31, 2005 and December 31, 2004		3
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2005 and 2004		4
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004		5
	Notes to Condensed Consolidated Financial Statements		6
Item 2.
	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3.
	Quantitative and Qualitative Disclosures about Market Risk		31
Item 4.
	Controls and Procedures		32
Part II—Other Information
Item 1.
	Legal Proceedings		33
Item 5.
	Other Information		33
Item 6.
	Exhibits		34
Signatures			35

 

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PART 1—FINANCIAL INFORMATION

Item 1.                        FINANCIAL STATEMENTS

Vertis, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
In thousands, except per share amounts

		March 31,			December 31,
		2005			2004
		(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents		$	4,958			$	2,638
Accounts receivable, net		158,685				178,650
Inventories, net		45,214				44,601
Maintenance parts, net		20,921				21,017
Prepaid expenses and other current assets		19,007				12,206
Total current assets		248,785				259,112
Property, plant and equipment, net		366,127				379,438
Goodwill		263,283				359,865
Deferred financing costs, net		25,045				26,815
Other assets, net		23,950				24,565
Total assets		$	927,190			$	1,049,795
LIABILITIES AND STOCKHOLDER’S DEFICIT
Current Liabilities:
Accounts payable		$	191,500			$	243,905
Compensation and benefits payable		38,952				36,975
Accrued interest		42,154				13,550
Accrued income taxes		10,577				10,294
Current portion of long-term debt		6				6
Other current liabilities		28,251				27,120
Total current liabilities		311,440				331,850
Due to parent		5,041				7,410
Long-term debt, net of current portion		1,054,798				1,024,042
Other long-term liabilities		34,394				35,053
Total liabilities		1,405,673				1,398,355
Stockholder’s deficit:
Common stock—authorized 3,000 shares; $0.01 par value; issued and outstanding 1,000 shares
Contributed capital		409,051				409,059
Accumulated deficit		(883,589		)		(753,661		)
Accumulated other comprehensive loss		(3,945		)		(3,958		)
Total stockholder’s deficit		(478,483		)		(348,560		)
Total liabilities and stockholder’s deficit		$	927,190			$	1,049,795

 

See Notes to Condensed Consolidated Financial Statements.

3

Vertis, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
In thousands

Three Months Ended March 31,				2005			2004
				(Unaudited)
Net sales				$	385,826		$	390,618
Operating expenses:
Costs of production				308,818			301,588
Selling, general and administrative				47,325			46,910
Restructuring charges				10,008			862
Goodwill impairment loss				97,790
Depreciation and amortization of intangibles				17,303			19,069
				481,244			368,429
Operating (loss) income				(95,418		)	22,189
Other expenses (income):
Interest expense, net				32,287			32,717
Other, net				1,965			502
				34,252			33,219
Loss before income tax expense				(129,670		)	(11,030		)
Income tax expense				258			223
Net loss				$	(129,928	)	$	(11,253	)

 

See Notes to Condensed Consolidated Financial Statements.

4

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

Three Months Ended March 31,				2005			2004
				(Unaudited)
Cash Flows from Operating Activities:
Net loss				$	(129,928	)	$	(11,253	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization				17,303			19,069
Amortization of deferred financing costs				1,838			1,964
Restructuring and asset impairment charges				10,008			862
Goodwill impairment loss				97,790
Deferred income taxes							128
Other non-cash income and expense, net				4,348			988
Changes in operating assets and liabilities (excluding effect of acquisitions):
Decrease in accounts receivable				18,202			11,910
Increase in inventories				(613		)	(251		)
(Increase) decrease in prepaid expenses and other assets				(5,888		)	7,229
Decrease in accounts payable and other liabilities				(13,246		)	(12,170		)
Net cash (used in) provided by operating activities				(186		)	18,476
Cash Flows from Investing Activities:
Capital expenditures				(4,319		)	(8,675		)
Software development costs capitalized				(440		)	(482		)
Acquisition of business, net of cash acquired				(3,208		)
Proceeds from sale of property, plant and equipment				78			78
Net cash used in investing activities				(7,889		)	(9,079		)
Cash Flows from Financing Activities:
Net borrowings under revolving credit facilities				30,965			7,016
Repayments of long-term debt				(6		)	(51		)
Deferred financing costs				(67		)	(9		)
Decrease in outstanding checks drawn on controlled disbursement accounts				(18,825		)	(10,089		)
Other financing activities				(2,369		)	(63		)
Net cash provided by (used in) financing activities				9,698			(3,196		)
Effect of exchange rate changes on cash				697			353
Net increase in cash and cash equivalents				2,320			6,554
Cash and cash equivalents at beginning of year				2,638			2,083
Cash and cash equivalents at end of period				$	4,958		$	8,637
Supplemental Cash Flow Information:
Interest paid				$	1,259		$	4,642
Income taxes paid				$	156		$	547

 

See Notes to Condensed Consolidated Financial Statements.

5

Vertis, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)

1.   GENERAL

The accompanying unaudited 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 (“generally accepted accounting principles”). 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 the generally accepted accounting principles for annual financial statements. As these are condensed consolidated financial statements, one should also read the consolidated financial statements and notes in the Company’s annual report on Form 10-K for the year ended December 31, 2004.

The Company is a wholly-owned subsidiary of Vertis Holdings, Inc. (“Vertis Holdings”).

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 gains which amounted to $13 thousand and $2.7 million for the three months ended March 31, 2005 and 2004, respectively. The total comprehensive loss for the three months ended March 31, 2005 and 2004 is $129.9 million and $8.5 million, respectively.

2.   RESTRUCTURING CHARGES

The Company began the first phase of a restructuring program in the first quarter of 2005 (the  “2005 Program”) aimed at regionalizing and streamlining operations to capitalize on operating efficiencies and improve productivity and consistency, and reducing the Company’s overall cost base. The execution of the first phase of the 2005 Program is substantially complete as of March 31, 2005 and should be final by the end of the second quarter of 2005. This program includes reductions in work force of approximately 220 employees; the closure of three premedia facilities and one direct mail warehouse in the U.K., some of which are associated with the consolidation of operations; and the transfer of certain positions. The Company expects the costs associated with the first phase of the 2005 Program to be an estimated $9.5 million (net of estimated sublease income of $1.6 million), $9.3 million of which were recorded in the first quarter of 2005. Liabilities for severance costs related to future restructurings are not accrued as the amounts cannot be reasonably estimated. The Company is continuously evaluating the need to implement restructuring programs to rationalize its costs and improve operating efficiency. It is likely that the Company will incur additional restructuring costs in 2005 in an on-going effort to achieve these objectives. The Company expects these costs to be incurred in each of the operating segments and also to impact corporate overhead costs.

In the three months ended March 31, 2005, under the 2005 Program, Vertis North America recorded $6.6 million in severance and related costs associated with the elimination of approximately 160 positions and $1.7 million in facility closure costs associated with the closure of two facilities. Under the 2005 Program, Vertis Europe recorded $0.5 million in severance costs due to headcount reductions of

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approximately 60 employees. Under the Company’s General Corporate segment (See Note 7), $0.5 million in severance costs were recorded under the 2005 Program due to a staffing reduction of one employee at the Company’s corporate office. Additionally, $0.7 million in costs were recorded in the first quarter of 2005 under the General Corporate segment related to the amendment of an executive level employment agreement announced in 2004, as discussed below.

In the first quarter of 2004, Vertis North America recorded $0.7 million in severance costs due to headcount reductions of approximately 50 employees, and $0.2 million in facility closure costs. These costs were associated with a restructuring plan begun in 2003 which included the closure of facilities, some of which were associated with the consolidation of operations; transfer of certain positions to the corporate office; reductions in work force of approximately 260 employees; and the abandonment of assets associated with vacating these premises.

Vertis Europe began a restructuring program in the second quarter of 2004 (the “2004 Program”) that included planned staffing reductions totaling approximately 184 employees. The 2004 Program was substantially complete as of December 31, 2004. Additionally, in 2004 the Company announced an amendment of an executive level employment agreement at the Vertis corporate office resulting in an estimated cost of $1.2 million.

The significant components of restructuring charges were as follows:

		Severance					Facility
		and Related					Closing			Other
		Costs					Costs			Costs			Total
		(in thousands)
Accrued balance at December 31, 2004			$	1,176			$	7,312		$	575		$	9,063
Restructuring charges in the three months ended March 2005			8,348				1,660						10,008
Restructuring payments and usage in the three months ended March 2005			(2,463		)		(343		)				(2,806		)
Accrued balance at March 31, 2005			$	7,061			$	8,629		$	575		$	16,265

 

The Company expects to pay approximately $11.3 million of the accrued restructuring costs during the next year, and the remainder, approximately $5.0 million, by 2011. The portion of this accrual attributable to facility closing costs is recorded net of anticipated sublease income. Actual future cash requirements may differ from the accrual, particularly if actual sublease income differs from current estimates.

3.   GOODWILL

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangibles”, the Company has elected to perform its annual impairment test as of January 1.  Each of the Company’s reporting units is tested for impairment by comparing the fair value of the reporting unit with the carrying value of that unit. Fair value is determined based on a valuation study performed by the Company using the discounted cash flow method and the estimated market values of the reporting units. As a result of the Company’s impairment test completed in the first quarter of 2005, the Company recorded an impairment loss of $97.8 million at the Vertis Europe segment to reduce the carrying value of goodwill to its implied fair value. This impairment charge reflects the current assessment of the value of the Vertis Europe goodwill, including the impact of the poor near term outlook for the entire direct mail industry in Europe, and reduces the carrying value of goodwill remaining on Vertis Europe’s balance sheet to $13.8 million.

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4.   ACQUISITION

On January 20, 2005, the Company acquired Elite Mailing and Fulfillment Services, Inc. (“Elite”) for $3.1 million. Elite is a full-service lettershop and mail presorting facility based in Bellmawr, New Jersey. Elite has been a strategic partner of Vertis since 1996, providing lettershop and fulfillment services.

Goodwill arising in connection with this acquisition was approximately $2.6 million, calculated as the excess of the liabilities assumed over the fair value of the net assets acquired. The financial results of Elite are included in the Company’s consolidated financial statements from the date of acquisition. Allocation of purchase price has been done on a preliminary basis and is subject to change as the Company continues to gather information on intangible assets.

Elite sales for the three months ended March 31, 2005 and 2004 were $1.4 million and $3.2 million, respectively, of which sales to other Vertis subsidiaries accounted for 99.2% and 97.1% of Elite sales,  respectively. Vertis pro forma net loss, adjusted to include Elite as though the acquisition had occurred at the beginning of 2004, is $129.9 million and $11.0 million for the three months ended March 31, 2005 and 2004, respectively.

5.   ACCOUNTS RECEIVABLE

In December 2002, the Company entered into a three-year agreement (the “A/R Facility”), terminating November 30, 2005, to sell substantially all trade accounts receivable generated by subsidiaries in the U.S. through the issuance of $130.0 million of variable rate trade receivable backed certificates.

The A/R Facility allows for a maximum of $130.0 million of trade accounts receivable to be sold at any time based on the level of eligible receivables. Under the A/R Facility, the Company sells its trade accounts receivable through a bankruptcy-remote wholly-owned subsidiary. However, the Company maintains an interest in the receivables and has been contracted to service the accounts receivable. The Company received cash proceeds for servicing of $0.8 million in both the three months ended 2005 and 2004, respectively. These proceeds are fully offset by servicing costs.

At March 31, 2005 and December 31, 2004, accounts receivable of $114.2 million and $130.0 million, respectively, had been sold under the facility and, as such, are reflected as reductions of accounts receivable. At March 31, 2005 and December 31, 2004, the Company retained an interest in the pool of receivables in the form of overcollateralization and cash reserve accounts of $43.9 million and $58.0 million, respectively, which is included in Accounts receivable, net on the condensed consolidated balance sheet at allocated cost, which approximates fair value. The proceeds from collections reinvested in securitizations amounted to $375.7 million and $372.5 million in the first quarter of 2005 and 2004, respectively.

Fees for the program under the facility vary based on the amount of interests sold and the London Inter Bank Offered Rate (“LIBOR”) plus an average margin of 90 basis points. The loss on sale, which approximated the fees, totaled $1.0 million in the first quarter of 2005 and $0.6 million in the first quarter of 2004, and is included in Other, net.

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6.   INVENTORIES

Inventories consisted of the following:

		March 31,					December 31,
		2005					2004
		(in thousands)
Paper			$	32,060				$	30,312
Work in process			4,688					5,707
Ink and chemicals			3,672					3,091
Other			4,794					5,491
			$	45,214				$	44,601

 

7.   SEGMENT INFORMATION

The Company operates in two business segments, as follows:

·       Vertis North America—provides a full array of targeted advertising, media and marketing services such as advertising insert programs; newspaper products such as TV magazines, Sunday magazines, and color comics; creative services for advertising insert page layout and design; customized one-to-one marketing programs; direct mail production with varying levels of personalization; and media planning and placement.

·       Vertis Europe—provides European customers, principally in the United Kingdom, with most of the same products and services offered in North America.

 

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Additionally, the Company has a General Corporate segment where costs associated with the Company’s executive officers are recorded as well as certain transactions that don’t specifically relate to the Company’s business segments.

Following is information regarding the Company’s segments:

				Three months ended,
				March 31,
				2005			2004
				(in thousands)
Net sales		Vertis North America		$	353,889		$	353,748
		Vertis Europe		31,937			36,870
		Consolidated		$	385,826		$	390,618
EBITDA		Vertis North America		$	25,029		$	41,473
		Vertis Europe		(99,478		)	1,269
		General Corporate		(5,631		)	(1,986		)
		Consolidated EBITDA		(80,080		)	40,756
		Depreciation and amortization of intangibles		17,303			19,069
		Interest expense, net		32,287			32,717
		Income tax expense		258			223
		Consolidated Net Loss		$	(129,928	)	$	(11,253	)
Restructuring charges		Vertis North America		$	8,318		$	862
		Vertis Europe		491
		General Corporate		1,199
		Consolidated EBITDA		$	10,008		$	862
Depreciation and amortization of intangibles		Vertis North America		$	15,503		$	17,190
		Vertis Europe		1,800			1,879
		Consolidated		$	17,303		$	19,069

 

8.   NEW ACCOUNTING PRONOUNCEMENTS

In November 2004, the FASB issued SFAS No.151, “Inventory Costs—an amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends Accounting Research Bulletin (“ARB”) No. 43, Chapter 4, “Inventory Pricing,” to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this Statement shall be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In December 2004, the FASB issued SFAS No. 153 “Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29”. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the

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exchange. The provisions of this Statement shall be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date this Statement is issued. The provisions of this Statement shall be applied prospectively. The adoption of this Statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In December 2004, the FASB issued SFAS No. 123 (revised), “Share-Based Payments” (“SFAS 123R”) which replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS 123R requires all share-based payments to employees, including grants of employee stock options and restricted stock, to be recognized in the financial statements based on their grant date fair values. The proforma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. Under SFAS 123R, companies must determine the transition method, either retroactive or prospective, to be used at the date of adoption; the appropriate fair value model to be used for valuing share-based payments; and the amortization method for compensation cost. The provisions of this Statement shall be effective for the Company beginning January 1, 2006. The Company is currently evaluating the provisions of this statement and has not yet determined the impact that this Statement will have on its results of operations or financial position.

In March 2005, the FASB issued FIN 47, “Accounting for Conditional Asset Retirement Obligations”, an interpretation of FASB Statement No. 143. FIN 47 requires that Companies recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. This interpretation is effective no later than the end of fiscal years ending after December 15, 2005. Retrospective application for interim financial information is permitted but is not required. Early adoption of this Interpretation is encouraged. The Company is currently evaluating the provisions of this statement and has not yet determined the impact that this Statement will have on its results of operations or financial position.

9.   LONG-TERM DEBT

Long-term debt consisted of the following:

		March 31,			December 31,
		2005			2004
		(in thousands)
Revolving credit facility		$	78,573			$	48,801
93¤4% senior secured second lien notes, net of discount		343,633				343,235
107¤8% senior notes, net of discount		348,489				348,399
131¤2% senior subordinated notes		293,495				293,495
Discount—131¤2% senior subordinated credit facility		(9,392		)		(9,895		)
Other notes		6				13
		1,054,804				1,024,048
Current portion		(6		)		(6		)
		$	1,054,798			$	1,024,042

 

The revolving credit facility (the “Credit Facility”) consists of a multicurrency revolving credit facility of up to $200 million that provides for issuances of up to $45 million in letters of credit and borrowings of up to $150 million in alternate currencies. The Credit Facility matures December 22, 2008 with no repayment of principal until maturity.

The maximum availability under the Credit Facility is $200 million, limited to a borrowing base calculated as follows: 85% of the Company’s eligible receivables; 65% of the net amount of eligible raw

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materials, finished goods, maintenance parts, unbilled receivables and the residual interest in the Company’s $130 million trade receivables securitization (see Note 5); and 45% of eligible machinery, equipment and owned real estate. The eligibility of such assets included in the calculation is set forth in the credit agreement. In addition, as is customary in asset-based agreements, there is a provision for the agent, in its reasonable credit judgment, to establish reserves against availability based on a change in circumstances. The agent’s right to alter existing reserves requires written consent from the borrowers when Bank EBITDA, as defined below, is in excess of $180 million on a quarterly trailing twelve-month basis. The agent is not required to obtain written consent when Bank EBITDA on a quarterly trailing twelve-month basis is less than $180 million. At March 31, 2005, the Company’s borrowing base was calculated to be $203.8 million.

“Bank EBITDA” is the EBITDA as reflected in Note 7 to these financial statements adjusted for certain items as defined in the credit agreement.

The interest rate on the Credit Facility is either (a) the US Prime rate or Britain Prime rate, depending on the currency the Company is borrowing in, plus a margin which fluctuates based on the Company’s senior secured leverage ratio (“Leverage Ratio”), defined as the ratio of senior secured debt to Bank EBITDA, or (b) the US or Britain LIBOR rate plus a margin that fluctuates based on the Company’s Leverage Ratio. At March 31, 2005, the margin was 275 basis points above LIBOR.

The Company had a senior subordinated credit facility (the “Senior Facility”), which was a term loan bearing interest of 131¤2% expiring on December 7, 2009. Pursuant to the Senior Facility, the Company issued an aggregate of $293.5 million of 131¤2% senior subordinated notes due December 7, 2009 (the “Exchange Notes”) in exchange for the term loans held by the holders requesting the exchange. The Exchange Notes pay interest semi-annually on June 1 and December 1 of each year. The $293.5 million represents the entire amount of term notes under the Senior Facility. At March 31, 2005 there remains a $9.4 million discount associated with approximately 700,000 detachable warrants issued in February 2002 to the holders of the Senior Facility entitling them to purchase one share of Vertis Holdings stock for $0.01 per share. These warrants expire on June 30, 2011 and the discount is being amortized over the original life of the Senior Facility.

The Credit Facility, the 107¤8% notes, the 93¤4% notes and the Exchange Notes contain customary covenants including restrictions on capital expenditures, dividends, and investments. In particular, these debt instruments all contain customary high-yield debt covenants imposing limitations on the payment of dividends or other distributions on or in respect of the Company or the capital stock of its restricted subsidiaries. Substantially all of the Company’s assets are pledged as collateral for the outstanding debt under the Credit Facility, and, on a second lien basis, the 93¤4% notes. All of the Company’s debt has customary provisions requiring prepayment in the event of a change in control and from the proceeds of asset sales, as well as cross-default provisions. In addition, the Credit Facility requires the Company to maintain Bank EBITDA of $160 million on a trailing twelve-month basis. At March 31, 2005, the Company’s trailing twelve-month Bank EBITDA as calculated under the credit agreement is $173.0 million. If the Company is unable to maintain this minimum Bank EBITDA amount, the bank lenders could require the Company to repay any amounts owing under the Credit Facility. At March 31, 2005, the Company was in compliance with its debt covenants.

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10.   RETIREMENT PLANS

The following table provides the components of net periodic benefit cost for the Company’s defined benefit plans, including pension and supplemental executive retirement plans, for the three months ended March 31, 2005 and 2004.

		Three months ended
		March 31,
		2005					2004
		(in thousands)
Service cost			$	193				$	172
Interest cost			571					540
Expected return on plan assets			(325		)			(256		)
Amortization of prior service cost			58					58
Amortization of net loss			219					178
Net periodic benefit cost			$	716				$	692

 

The Company made contributions of approximately $0.5 million to its pension plans in the three months ended March 31, 2005. The Company expects to contribute $2.4 million in 2005 as previously disclosed in its consolidated financial statements for the year ended December 31, 2004

11.   VERTIS HOLDINGS STOCK AWARD AND INCENTIVE PLAN

Employees of the Company participate in the Vertis Holdings 1999 Equity Award Plan (the “Stock Plan”), which authorizes grants of stock options, restricted stock, performance shares and other stock based awards. On April 6, 2004, the Company extended an offer to all eligible U.S.-based employees holding options under the Stock Plan the opportunity to exchange their outstanding eligible options for restricted common stock on a 4 for 1 basis. The restricted stock will vest immediately prior to a liquidity event, generally defined as a public offering of our common stock (where immediately following such offering, the aggregate number of shares of common stock held by the public, not including affiliates of the Company, represents at least 20% of the total number of outstanding shares), merger or other business combination, or a sale or other disposition of all or substantially all of our assets to another entity for cash and/or publicly traded securities. Of the 782,484 eligible Vertis Holdings options, 774,866 were exchanged. Pursuant to the exchange offer, on June 7, 2004 Vertis Holdings issued 193,739 restricted shares of stock. Additionally, 13,000 restricted shares were issued to certain officers and directors of Vertis outside of the exchange offer. Upon issuance, unearned compensation was charged to stockholders’ equity on Vertis Holdings balance sheet for the fair value of the restricted stock as determined by an independent valuation.

On June 14, 2004, the Company extended an offer to all eligible U.K.-based employees holding options under the Stock Plan the opportunity to exchange their outstanding eligible options for Nil Cost Options on a 4 for 1 basis. The Nil Cost Options give the holder a right to purchase shares of common stock subject to a nominal fee of £1. The Nil Cost Options will vest immediately prior to a liquidity event, as defined above. Of the 42,785 Vertis Holdings options eligible to be exchanged, 28,499 were exchanged. Pursuant to the exchange offer, on July 29, 2004 Vertis Holdings granted 7,126 Nil Cost Options.

The Company accounts for the Stock Plan under the intrinsic value method, which follows the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” No stock-based employee compensation cost is reflected in net income. Due to the uncertainty of the timing of a liquidity event, which would trigger the vesting of the restricted stock and the Nil Cost Options, and the fact that the number of shares that will actually vest is unknown, compensation expense will not be recorded until a liquidity event takes place, or an event is probable of occurring. For the 21,904 options not exchanged under both offers, variable accounting

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applies. There is no expense recorded for the three months ended March 31, 2005 or 2004 as the estimated fair value of the Company’s stock is not more than the exercise price of the options. The following table summarizes the effect of accounting for these awards as if the fair value recognition provisions of SFAS No. 123, “Accounting for Stock Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123,” had been applied.

		Three months ended March 31,
		2005			2004
		(in thousands)
Net loss:
As reported		$	(129,928	)	$	(11,253	)
Deduct: total stock-based compensation determined under the fair value based method for all awards, net of tax		(3		)	(124		)
Pro forma		$	(129,931	)	$	(11,377	)

 

12.   INTEREST EXPENSE, NET

Interest expense, net consists of the following:

		Three months ended
		March 31,
		2005			2004
		(In thousands)
Interest expense		$	30,611		$	30,793
Amortization of deferred financing fees		1,838			1,964
Interest income		(162		)	(40		)
		$	32,287		$	32,717

 

13.   OTHER, NET

Other, net for the three months ended March 31, 2005 consists primarily of $1.0 million in fees associated with the A/R Facility (see Note 5), $0.7 million in losses on the sale of property, plant and equipment, and $0.3 million in bank commitment fees.

Other, net for the three months ended March 31, 2004 consists primarily of $0.6 million in fees associated with the A/R Facility (see Note 5), $0.2 million in bank commitment fees and $0.1 million in miscellaneous charges, offset by $0.4 million in income earned on investments accounted for as leveraged leases.

14.   INCOME TAXES

The Company had approximately $159.7 million of net operating losses available to carryforward as of December 31, 2004. These carryforwards expire beginning in 2007 through 2025. The Company maintains a valuation allowance against its deferred tax assets. The valuation allowance reserves the net operating losses and tax credit carryovers that may not be offset by reversing taxable temporary differences. This treatment is required under SFAS No. 109, “Accounting for Income Taxes”. However, the carryovers may still be used to offset taxable income in future years, thereby lowering our cash tax obligations. The Company intends to maintain a valuation allowance until sufficient positive evidence exists to support its reversal. No additional tax benefit was recorded by the Company in the first quarter of 2005.

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15.   GUARANTOR/NON-GUARANTOR CONDENSED CONSOLIDATING FINANCIAL INFORMATION

The Company has three series of notes (see Note 9) which are general obligations of Vertis, Inc., and are guaranteed by certain of Vertis, Inc.’s domestic subsidiaries. Accordingly, the following condensed consolidated financial information as of March 31, 2005 and December 31, 2004, and for the three months ended March 31, 2005 and 2004 are included for (a) Vertis, Inc. (the “Parent”) on a stand-alone basis, (b) the guarantor subsidiaries, (c) the non-guarantor subsidiaries and (d) 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.

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Condensed Consolidating Balance Sheet at March 31, 2005
In thousands

					Guarantor					Non-Guarantor
		Parent			Companies					Companies					Eliminations					Consolidated
ASSETS
Current Assets:
Cash and cash equivalents		$	2,146								$	2,812								$	4,958
Accounts receivable, net		111,258				$	19,248				28,179									158,685
Inventories		32,738				10,662					1,814									45,214
Maintenance parts		17,529				3,392														20,921
Prepaid expenses and other current assets		15,159				281					3,567									19,007
Total current assets		178,830				33,583					36,372									248,785
Intercompany receivable						49,982										$	(49,982	)
Investments in subsidiaries		135,833				79,097										(214,930		)
Property, plant and equipment, net		262,264				85,802					18,061									366,127
Goodwill		200,833				48,626					13,824									263,283
Deferred financing costs, net		25,045																		25,045
Other assets, net		22,497				695					758									23,950
Total Assets		$	825,302			$	297,785				$	69,015				$	(264,912	)		$	927,190
LIABILITIES AND STOCKHOLDER’S (DEFICIT) EQUITY
Current Liabilities:
Accounts payable		$	156,157			$	22,396				$	12,947								$	191,500
Compensation and benefits payable		31,660				6,871					421									38,952
Accrued interest		41,554									600									42,154
Accrued income taxes		10,739				(204		)			42									10,577
Current portion of long-term debt											6									6
Other current liabilities		16,822				3,436					7,993									28,251
Total current liabilities		256,932				32,499					22,009									311,440
Due to parent		7,755									47,268					$	(49,982	)		5,041
Long-term debt, net of current portion		1,006,225									48,573									1,054,798
Other long-term liabilities		32,873				1,507					14									34,394
Total liabilities		1,303,785				34,006					117,864					(49,982		)		1,405,673
Stockholder’s (deficit) equity		(478,483		)		263,779					(48,849		)			(214,930		)		(478,483		)
Total Liabilities and Stockholder’s (Deficit) Equity		$	825,302			$	297,785				$	69,015				$	(264,912	)		$	927,190

 

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Condensed Consolidating Balance Sheet at December 31, 2004
In thousands

		Parent					Guarantor Companies			Non-Guarantor Companies					Eliminations					Consolidated
ASSETS
Current Assets:
Cash and cash equivalents			$	297			$	33			$	2,308									$	2,638
Accounts receivable, net			123,752				18,611				36,287										178,650
Inventories			31,075				11,587				1,939										44,601
Maintenance parts			17,557				3,460														21,017
Prepaid expenses and other current assets			8,872				419				2,915										12,206
Total current assets			181,553				34,110				43,449										259,112
Intercompany receivable			20,812				21,268									$	(42,080	)
Investments in subsidiaries			209,042				107,251									(316,293		)
Property, plant and equipment, net			270,270				89,120				20,048										379,438
Goodwill			198,229				48,626				113,010										359,865
Deferred financing costs, net			26,815																		26,815
Other assets, net			23,673				744				148										24,565
Total Assets			$	930,394			$	301,119			$	176,655				$	(358,373	)			$	1,049,795
LIABILITIES AND STOCKHOLDER’S (DEFICIT) EQUITY
Current Liabilities:
Accounts payable			$	197,068			$	30,989			$	15,848									$	243,905
Compensation and benefits payable			29,089				7,615				271										36,975
Accrued interest			13,413								137										13,550
Accrued income taxes			10,490				(204		)		8										10,294
Current portion of long-term debt											6										6
Other current liabilities			18,468				(35		)		8,687										27,120
Total current liabilities			268,528				38,365				24,957										331,850
Due to parent											49,490					$	(42,080	)			7,410
Long-term debt, net of current portion			975,233								48,809										1,024,042
Other long-term liabilities			35,193				(154		)		14										35,053
Total liabilities			1,278,954				38,211				123,270					(42,080		)			1,398,355
Stockholder’s (deficit) equity			(348,560		)		262,908				53,385					(316,293		)			(348,560		)
Total Liabilities and Stockholder’s (Deficit) Equity			$	930,394			$	301,119			$	176,655				$	(358,373	)			$	1,049,795

 

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