10-Q 1 b319879_10q.txt QUARTERLY AND TRANSITION REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2002 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _________ to _________. Commission file number: 333-23519 VESTCOM INTERNATIONAL, INC. (Exact name of registrant as specified in its charter) New Jersey 22-3477425 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5 Henderson Drive West Caldwell, New Jersey 07006 (Address of principal executive office, including zip code) 973-882-7000 (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- Indicate by check mark whether registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The number of shares of common stock outstanding as of August 1, 2002 was 9,056,806 shares. VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED June 30, 2002 INDEX

2 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS As of December 31, 2001 and June 30, 2002 ASSETS

The accompanying notes to condensed consolidated financial statements are an integral part of these balance sheets. 3 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS For the Three and Six Months Ended June 30, 2001 and 2002 (unaudited)

The accompanying notes to condensed consolidated financial statements are an integral part of these statements. 4 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Six Months Ended June 30, 2001 and 2002 (unaudited)

The accompanying notes to condensed consolidated financial statements are an integral part of these statements. 5 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (1) BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and six-month periods ended June 30, 2002 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2002. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company and the related notes thereto contained in Vestcom's Annual Report on Form 10-K for the year ended December 31, 2001. (2) EARNINGS PER SHARE (EPS) Basic EPS is calculated by dividing income available to common shareholders by the weighted average number of shares of common stock outstanding during the period. The weighted average number of shares of common stock used in determining basic EPS was 9,056,806 for the three and six months ended June 30, 2002 and 2001, respectively. Diluted EPS is calculated by dividing income available to common shareholders by the weighted average number of shares of common stock outstanding, plus additional common shares that could be issued in connection with potentially dilutive securities (i.e., stock options). The weighted average number of shares of common stock used in determining diluted EPS was 9,056,806 and 9,056,962 for the three months ended June 30, 2002 and 2001, respectively; and 9,056,806 and 9,060,110 for the six months ended June 30, 2002 and 2001, respectively. Options covering approximately 389,571, 1,799,642, 781,784 and 1,662,490 shares of Common Stock were not included in computing earnings per share for the three months ended June 30, 2002 and 2001 and the six months ended June 30, 2002 and 2001, respectively, because their effects were antidilutive. In addition, options covering 184,743and 89,815 shares, for the three and six month ended June 30, 2002, respectively, were excluded due to the net losses for those periods. (3) COMPREHENSIVE INCOME (LOSS): Comprehensive income (loss) includes foreign currency translation gains and losses. The balance sheet translation adjustment was $147,800 and $81,757 for the three months ended June 30, 2002 and 2001, respectively; and $141,777 and ($60,995) for the six months ended June 30, 2002 and 2001, respectively. 6 (4) RECENT ACCOUNTING REQUIREMENTS: In July 2001, the Financial Accounting Standards Board (FASB) issued FASB Statements Nos. 141 and 142 (FAS 141 and FAS 142), "Business Combinations" and "Goodwill and Other Intangible Assets". FAS 141 replaces APB16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. FAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under FAS 142, goodwill will be tested annually and whenever events or circumstances occur that indicate the Company's goodwill might be impaired. FAS 141 and FAS 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of FAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under FAS 141 will be reclassified to goodwill. Companies are required to adopt FAS 142 for fiscal years beginning after December 15, 2001, and early adoption is permitted in some cases. The Company adopted FAS 142 on January 1, 2002 and no longer is amortizing goodwill and indefinite-lived intangible assets. In connection with the adoption of FAS 142, and with the proposed acquisition by Cornerstone Equity Investors IV, L.P., (see Note 6) the Company determined that an impairment loss on the Company's intangible assets was probable and that a reasonable estimate of such loss could be made as of June 30, 2002. Accordingly, the Company has recognized an estimated loss of $32,000,000 net of tax as a Cumulative Effect of a Change in Accounting Principle. This amount, which is based on the difference between the expected goodwill to be recorded in connection with the proposed acquisition of Vestcom and the value of the Company's existing goodwill, will be subject to adjustment in subsequent reporting periods based on the measurement of the impairment process. Below is a reconciliation of net income adjusted to exclude amortization expense for 2001.

Emerging Issues Task Force Issue No. 01-14 (EITF 01-14), formerly topic D-103, "Income Statement Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses Incurred", requires that reimbursements received for freight and other "out-of-pocket" expenses be characterized as revenue. Companies are required to apply this announcement in financial reporting periods beginning after December 15, 2001. Vestcom adopted EITF 01-14 effective January 2002, and has reclassified approximately $1,400,000 and $1,500,000 for the three month periods ended June 30, 2002 and 2001, respectively; and approximately $3,800,000 and $3,100,000 for the six month periods ended June 30, 2002 and 2001, respectively to revenues from costs of revenues. The Company also manages postage costs on behalf of customers, and requires postage deposits in advance, which it does not believe meet the requirements of the EITF for classification as revenues and cost of revenues, and accordingly has not reflected approximately $16,400,000 and $19,300,000 of these costs as revenues or cost of revenues in the accompanying statements of income for the three month periods ended June 30, 2002 and 2001, respectively and approximately $34,300,000 and $36,200,000 for the six month periods ended June 30, 2002 and 2001, respectively. These amounts have no impact on gross profit or income from operations or net income. 7 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES In July 2002, The FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 will spread out the reporting of expenses related to restructurings initiated after 2002 because a commitment to a plan to exit an activity or dispose of long-lived assets will no longer be enough to record a liability for the anticipated costs. Instead, companies will record exit and disposal costs when they are "incurred" and can be measured at fair value, and they will subsequently adjust the recorded liability for the changes in estimated cash flows. We are required to adopt SFAS 146, effective calendar year 2003. We do not expect the adoption of SFAS 146 to have a material impact on our future consolidated operations or financial position, as we are now constituted. (5) IMPAIRMENT OF LONG LIVED ASSETS: During the second quarter of 2002, the Company decided to shutdown its Randolph, NJ facility and relocate all production to its West Caldwell, NJ site. This decision supports the strategic plan of reducing the Company's operating cost structure by reducing the number of facilities. In connection therewith, the Company recorded an impairment charge of $2,555,924 for the write-down of fixed assets, primarily leasehold improvements, associated with the Randolph facility. In addition to these charges, the Company also incurred lease exit costs of $275,000, which were recorded in the second quarter of 2002. The Company will also incur additional lease costs to close the facility and severance costs for the termination of employees related to the closing and/or relocation of the operating facility, which the Company expects will occur during the third quarter of 2002. (6) MERGER AGREEMENT: On June 12, 2002 the Company announced that it had entered into a definitive agreement to be acquired by a newly formed corporation organized by Cornerstone Equity Investors IV, L.P. The agreement provides that the acquirer will pay $6.25 in cash for each outstanding share of the Company's Common Stock. The aggregate value of the transaction, including the amount of debt to be repaid, is expected to be approximately $75,000,000. Consummation of the Cornerstone transaction is contingent on receiving shareholder approval and obtaining the necessary financing. As of August 13, 2002, adequate financing to pay the merger consideration and estimated fees associated with the transaction had not been fully obtained. General Electric Capital Corporation has indicated to Cornerstone that it currently is prepared to fund the senior debt portion of the required transaction amount at a level that may be slightly less than what is currently estimated to be required to close the transaction. Cornerstone currently is engaged in discussions with other possible lenders and has received a proposal letter for a sufficient amount of funding from one of them. Although no assurance can be given that the transaction will close, Cornerstone has indicated that it remains committed to the $6.25 per share merger consideration and confident that it will obtain adequate financing for the transaction, and the Company hopes to close the transaction at the end of the third quarter or the beginning of the fourth quarter of 2002. Certain management shareholders have agreed to reinvest in the transaction and to vote in favor of the transaction. The transaction, which is structured as a cash merger, was approved by the Company's Board of Directors, acting upon the unanimous recommendation of a Special Committee of the Board comprised of five non-employee directors. In connection with the proposed transaction, the Company has capitalized approximately $276,000 of acquisition related costs incurred on behalf of the acquirer. In the event the transaction does not close the Company would be required to expense such costs. 8 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the Company's Condensed Consolidated Financial Statements and the related notes thereto appearing elsewhere herein. DISCLOSURES REGARDING FORWARD LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended that are based on the beliefs of Vestcom's management as well as assumptions made by and information currently available to Vestcom's management. Such statements reflect the current views of Vestcom with respect to future events based on currently available information and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated in such forward-looking statements. Factors that could cause actual results to differ materially from Vestcom's expectations include, but are not limited to, the following: the ability of the Company to execute and manage its growth strategy, the results of the Company's investment spending, the ability to effectively consolidate production facilities and functions as part of the Company's integration program, the ability to realize reduced overhead costs, increased production capacity and operating efficiencies, improved financial results, operational synergies and enhanced services at the newly consolidated facilities, acceptance of Vestcom's products and services, including electronic and Internet related services, in the marketplace, the entry of new competitors in the marketplace, the ability to attract and retain key customers, the ability to positively modify its revenue mix, variations in quarterly results, the sufficiency of the Company's working capital, changes in the business communications industry, the availability of suitable acquisition candidates and the assimilation of new acquisitions with existing business. Other factors are described from time to time in Vestcom's public filings with the Securities and Exchange Commission, news releases and other communications. Also, when Vestcom uses the words "believes", "expects", "anticipates," "estimates," "plans," "intends," "objectives," "goals," "aims," "projects" or similar words or expressions, Vestcom is making forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Vestcom does not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. RESULTS OF OPERATIONS Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2001 ----------------------------------------------------------------------------- Due to the Company's adoption of EITF 01-14, effective January 2002, certain 2001 amounts have been reclassified from cost of revenues to revenues in order to conform to the 2002 presentation. Revenues decreased $3,262,000, or 8%, from $39,113,000 for the three months ended June 30, 2001 to $35,851,000 for the three months ended June 30, 2002. This decrease was primarily attributable to lower volumes of business communications services as a result of general economic conditions especially in the financial services market. In addition, 2001 results included a one-time privacy mailing. The adoption of EITF 01-14 had no material effect on the change in revenue over the prior year. 9 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES Gross profit decreased $2,546,000, or 24%, from $10,430,000 for the three months ended June 30, 2001 to $7,884,000 for the three months ended June 30, 2002. The gross profit margin decreased from 27% for the three months ended June 30, 2001 to 22% for the same period in 2002. The decreases in the gross profit and the gross profit percentage were primarily due to decreased equipment utilization as a result of the lower volumes in the Company's business communications services. In addition, the Company reclassified certain expenses for the second quarter of 2002 to cost of revenues. These expenses were previously classified as general and administrative costs. The Company believes that these expenses relate more directly to revenue generation activities and more accurately reflect gross margins. Selling, general and administrative expenses decreased $1,170,000, or 13%, from $8,718,000 for the three months ended June 30, 2001 to $7,548,000 for the three months ended June 30, 2002. As a percentage of revenues, selling general and administrative expenses decreased from 22% in 2001 to 21% in 2002. The decrease in selling, general and administrative expenses relates primarily to lower personnel and facility costs as a result of the Company's ongoing facilities consolidation efforts. In addition, certain expenses, for the second quarter of 2002, were reclassified from general and administrative costs to cost of revenues as discussed above. Effective January 1, 2002 the Company adopted SFAS 142, "Goodwill and Other Intangible Assets", under which goodwill is no longer amortized for financial reporting purposes. The 2001 second quarter results included amortization expense of $687,000. During the second quarter of 2002, the Company decided to shutdown its Randolph, NJ facility and relocate all production to its West Caldwell, NJ site. This decision supports the strategic plan of reducing the Company's operating cost structure by reducing the number of facilities. In connection therewith, the Company recorded an impairment charge of $2,555,924 for the write-down of fixed assets, primarily leasehold improvements, associated with the Randolph facility. In addition to these charges, the Company also incurred lease exit costs of $275,000, which were recorded in the second quarter of 2002. The Company will also incur additional lease costs to close the facility and severance costs for the termination of employees related to the closing and/or relocation of the operating facility, which the Company expects will occur during the third quarter of 2002. Interest expense decreased $277,000, or 53%, from $526,000 for the three months ended June 30, 2001 to $249,000 for the three months ended June 30, 2002. This decrease was attributable to lower interest rates and decreased outstanding balances on the Company's credit facility, as compared to the same period in the prior year. Other income decreased $24,000, from income of $23,000 for the three months ended June 30, 2001 to expense of $1,000 for the three months ended June 30, 2002. The decrease is primarily due to losses on disposals of fixed assets during the quarter. Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 ------------------------------------------------------------------------- Due to the Company's adoption of EITF 01-14, effective January 2002, certain 2001 amounts have been reclassified from cost of revenues to revenues in order to conform to the 2002 presentation. Revenues decreased $1,723,000, or 2%, from $79,168,000 for the six months ended June 30, 2001 to $77,445,000 for the six months ended June 30, 2002. This decrease was primarily attributable to lower volumes of business communications services as a result of general economic conditions especially in the financial services market. Excluding the adoption of EITF 01-14, revenues decreased 3% for the six-month period over the prior year. 10 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES Gross profit decreased $2,661,000, or 13%, from $20,923,000 for the six months ended June 30, 2001 to $18,262,000 for the six months ended June 30, 2002. The gross profit margin decreased from 26% for the six months ended June 30, 2001 to 24% for the same period in 2002. The decreases in the gross profit and the gross profit percentage were primarily due to decreased equipment utilization as a result of the lower volumes in the Company's business communications services and increased outsourcing activities as a result of the current revenue mix. In addition, the Company reclassified certain expenses in 2002 to cost of revenues, which were previously classified as general and administrative costs. The Company believes that these expenses relate more directly to revenue generation activities and more accurately reflect gross margins. Selling, general and administrative expenses decreased $2,172,000, or 12%, from $17,879,000 for the six months ended June 30, 2001 to $15,707,000 for the six months ended June 30, 2002. As a percentage of revenues, selling general and administrative expenses decreased from 23% in 2001 to 20% in 2002. The decrease in selling, general and administrative expenses relates primarily to lower personnel and facility costs as a result of the Company's ongoing facilities consolidation efforts. In addition, certain expenses in 2002 were reclassified from general and administrative costs to cost of revenues as discussed above. Effective January 1, 2002 the Company adopted FAS 142, "Goodwill and Other Intangible Assets", under which goodwill is no longer amortized for financial reporting purposes. The six months ended June 30, 2001 results included amortization expense of $1,373,000. During the second quarter of 2002, the Company recorded an impairment loss of $2,556,000 and lease exit fees of $275,000 related to its decision to shutdown the Randolph, NJ site. See the discussion under the Three months Ended June 30, 2002 Compared to the Three Months Ended June 30, 2001. Interest expense decreased $516,000, or 48%, from $1,067,000 for the six months ended June 30, 2001 to $551,000 for the six months ended June 30, 2002. This decrease was attributable to lower interest rates and decreased outstanding balances on the Company's credit facility, as compared to the same period in the prior year. Other income decreased $116,000, from income of $86,000 for the six months ended June 30, 2001 to expense of $30,000 for the six months ended June 30, 2002. The decrease is primarily due to losses on disposals of fixed assets during the six months. In connection with the adoption of FAS 142, and with the proposed acquisition by Cornerstone Equity Investors IV, L.P., (see Note 6) the Company determined that an impairment loss on the Company's intangible assets was probable and that a reasonable estimate of such loss could be made as of June 30, 2002. Accordingly, the Company has recognized an estimated loss of $32,000,000 net of tax as a Cumulative Effect of a Change in Accounting Principle. This amount, which is based on the difference between the expected goodwill to be recorded in connection with the proposed acquisition of Vestcom and the value of the Company's existing goodwill, will be subject to adjustment in subsequent reporting periods based on the measurement of the impairment process. LIQUIDITY AND CAPITAL RESOURCES At June 30, 2002, Vestcom had working capital of approximately $9,195,000 compared to approximately $9,378,000 at December 31, 2001. The decrease was primarily attributable to reductions in accounts receivable and partially offset by decreases in accrued expenses and accounts payable. Net cash provided by operating activities for the six months ended June 30, 2002, was approximately $7,191,000, which consisted primarily of net loss plus non-cash charges of approximately $32,000,000 from the Cumulative Effect of the Change in Accounting Principle, $4,558,000 generated from depreciation charges, and $2,556,000 from the write down of impaired assets from the Randolph facility shutdown, along with the reduction of accounts receivable, partially offset by the reduction of accounts payable and accrued expenses. Net cash used in investing activities for the six months ended June 30, 2002, was approximately $4,088,000, which consisted primarily of purchases of equipment and software. Net cash used in financing activities for the six months ended June 30, 2002, was approximately $3,464,000, primarily from the repayment of long-term debt. 11 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES The Company and Fleet Bank have entered into an Equipment Loan and Revolving Credit Agreement (the "Credit Facility"), as amended, in the amount of $31,500,000 with a maturity date of July 1, 2003. On June 30, 2002, $13,063,000 was outstanding and $14,773,000 remained available for borrowing under the Credit Facility. Under the terms of the Credit Facility, amounts paid back on equipment loans are not available for future borrowings. The Company manages postage costs on behalf of customers of approximately $2,000,000 to $6,000,000 each month. The Company collects such postage costs from its customers in advance. At June 30, 2002, the Company had postage advances from customers in the amount of approximately $5,781,000 and had prepaid postage and postage receivables of approximately $2,085,000. If, and to the extent the Company were unsuccessful in obtaining postage costs in advance, cash flow would be negatively affected and Vestcom may be required to utilize its working capital or credit facility to cover the cash outlay. Capital expenditures of approximately $8,000,000 are expected in 2002. The anticipated expenditures relate to technology and production equipment needs of the business as well as internally developed capitalized software. However, as additional revenue generating opportunities arise the Company may be required to expend additional capital to support those opportunities. As of June 30, 2002, the Company had incurred approximately $4,097,000 of such anticipated expenditures. While no assurance can be given, management believes that its anticipated cash flow from operations combined with existing cash and the availability of funds under the Credit Facility, and potential additional credit capacity, will be sufficient to meet its working capital, capital expenditure and debt service requirements and its current plans to acquire additional related businesses for the foreseeable future. The immediately preceding sentence constitutes a forward-looking statement. Item 3: - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable - no significant change from Annual Report on Form 10-K. Part II: Other Information Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits: None (b) Reports on Form 8-K: On July 23, 2002 the Company filed an 8-K for the Change in Accountants; on June 18, 2002 the Company filed an 8-K to Amend its Bylaws; on June 13, 2002 the Company filed an 8-K Announcing the Merger Agreement. 12 VESTCOM INTERNATIONAL, INC. AND SUBSIDIARIES Signature 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. VESTCOM INTERNATIONAL, INC. By: /s/ Michael D. Helfand -------------------------------------------------- Michael D. Helfand, Executive Vice President, Chief Financial Officer and Treasurer Dated: August 14, 2002 13

VESTCOM INTERNATIONAL INC 10-Q