At Trial, Valassis CEO Says Advo Held Back Key Info on Finances

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Executives of Advo Inc. withheld information about the finances of the nation’s largest direct mail marketer before the company agreed to be acquired by Valassis Communications Inc., the chief executive of Valassis testified Monday.

Alan Schultz was the first witness called in the trial of a lawsuit in which Livonia, Mich.-based Valassis is seeking to back out of a $1.3 billion acquisition of Advo announced in July.

Valassis has accused Windsor, Conn.-based Advo of withholding and fabricating financial information. Advo has countersued in the Delaware Court of Chancery, saying Valassis is simply suffering from buyer’s remorse and is trying to drive down the purchase price.

Vice chancellor Leo Strine Jr. will determine after the trial, which is expected to take two weeks, whether the deal should go through. Strine is the same judge who in 2001 rejected an attempt by Tyson Foods Inc. to nullify its $4.7 billion acquisition of IBP Inc., a South Dakota-based beef and pork distributor. Tyson argued that a “material adverse change” had occurred in IBP’s circumstances and altered its long-term value. IBP countered that Tyson had buyer’s remorse.

Advo shares closed down 84 cents at $29.01 in trading Monday on the New York Stock Exchange, while Valassis shares rose 21 cents to $16.46.

Schultz testified that in a May meeting with Advo officials, Advo Chief Financial Officer Jeffrey Epstein failed to disclose that the company had downgraded its forecast for 2006 earnings before taxes to $54 million from $76 million.

Instead, Epstein said changes made by Advo to a February business forecast, when the companies were still exploring a merger of equals, were “minimal,” and expressed “tremendous confidence” in Advo’s 2007 forecast, Schultz said.

“My takeaway was that 2007 was a number we could take to the bank. Of course, literally we were going to do that,” Schultz said.

Schultz was unaware that Advo sales and marketing executive Stephanie Molnar had told her board two weeks earlier that the company was facing challenges with data needed to develop a realistic business forecast.

“It certainly would have made me question Jeff Epstein’s presentation, because obviously his presentation was totally opposite of what Ms. Molnar was talking about two weeks sooner,” Schultz said.

Schultz also said he was never told about an e-mail sent by Epstein the day before Valassis agreed to acquire Advo, in which Epstein informed colleagues that Advo’s postal expenses for the most recent quarter had been understated by $1.5 million. Schultz said the discrepancy amounted to overstating $9 million in operating income on an annualized basis, and represented a valuation of $171 million based on the premium Valassis was paying for Advo.

“They had extracted every penny they possibly could out of us,” Schultz said, adding that Valassis officials were shocked when they learned in late July that Advo would come up at least 30 percent short in operating income for the quarter ending in June.

“The June miss would have had to been absolutely spectacular to miss by that much,” said Schultz, who directed a team of Valassis officials to investigate the numbers they had been given.

“The bottom line is at this point, they suspected that a fraud had taken place,” he said.

Under cross-examination by Advo attorney George Conway, Schultz admitted that he had long thought as Valassis CEO that a consolidation of the marketing services industry would be beneficial, and that Advo seemed to be a good fit for Valassis.

Valassis relies heavily on freestanding advertising inserts, such as those delivered with newspapers and in consumer packaging. Advo, in contrast, specializes in direct mailings that often compete with newspapers in the distribution of preprinted advertising.

“You made it clear that you were pretty eager to do a deal, correct?” Conway asked Schultz.

Conway noted that Schultz had told his board that a long, drawn-out sale process could hurt employee morale and motivation, and that he told Advo CEO Scott Harding he wanted to move quickly. Schultz pursued the deal even after Advo missed its second-quarter earnings mark and Citigroup downgraded its rating for Advo, Conway said.

Schultz replied that Harding assured him Advo had taken steps to respond to ad cancellations in late 2005 that hurt the company’s performance.

Conway pointed out to Schultz that his own company adjusted its earnings guidance in June and has missed its earnings per share target for three consecutive quarters.

“Sometimes we make a prediction in business and it turns out to be wrong, right?” Conway asked Schultz.

“Yes,” Schultz replied.

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