<PAGE>

                                                                      EXHIBIT 13

Financial Contents



Selected Financial Data                                                   22
Financial Report                                                          23
Consolidated Statements of Operations                                     28
Consolidated Balance Sheets                                               29
Consolidated Statements of Cash Flows                                     30
Consolidated Statements of Changes in Stockholders' Equity (Deficiency)   31
Notes to Consolidated Financial Statements                                32
Report of Independent Auditors                                            40
Report of Financial Responsibility                                        40
Corporate Information                                                     41


                                                                   ADVO, INC. 21
<PAGE>
 
                             Selected Financial Data



<TABLE> 
<CAPTION> 
                                                  Year ended      Year ended     Year ended     Year ended      Year ended
                                                 September 26,   September 27,  September 28,  September 30,   September 24,
(In millions, except per share data)                 1998            1997           1996           1995            1994
---------------------------------------------------------------------------------------------------------------------------
<S>                                            <C>            <C>            <C>              <C>              <C> 
Summary of Operations
Revenues                                       $ 1,046.5      $ 1,016.5      $   986.2        $ 1,011.9         $   920.3
Operating income                                    72.1           58.5           24.8(2)          46.3              39.7
Income from continuing operations                   35.6           26.8           11.3             30.9              24.6
Net income                                          35.6           26.8            3.1             25.0              25.2
Earnings per common share from continuing
   operations--assuming dilution (1)                1.55           1.09            .47             1.33              1.03
Earnings per common share--
   assuming dilution (1)                            1.55           1.09            .13             1.07(3)           1.05
Dividends declared per share                          --             --         10.025(4)           .10              .095
---------------------------------------------------------------------------------------------------------------------------
Weighted average diluted shares                     23.1           24.7           24.1             23.3              23.9
===========================================================================================================================
<CAPTION> 

                                                 September 26,   September 27,  September 28,  September 30,   September 24,
(In millions)                                        1998            1997           1996           1995            1994
---------------------------------------------------------------------------------------------------------------------------
<S>                                              <C>             <C>            <C>            <C>             <C> 
Balance Sheet Data
Cash, cash equivalents and marketable securities    $  8.7         $ 26.0         $ 13.3         $ 54.5        $ 71.1
Total assets                                         219.2          208.6          185.1          234.2         225.7
Long-term debt                                       167.8          140.7          161.1             --            --
Stockholders' equity (deficiency)                    (74.9)         (59.9)         (85.2)         130.4         108.0
===========================================================================================================================
<CAPTION> 
                                                  Year ended      Year ended     Year ended     Year ended      Year ended
                                                 September 26,   September 27,  September 28,  September 30,   September 24,
(In millions)                                        1998            1997           1996           1995            1994
---------------------------------------------------------------------------------------------------------------------------
<S>                                              <C>             <C>            <C>            <C>             <C> 
Other Financial Data
EBITDA (5)                                        $     95.7     $     76.1      $    51.7      $     60.6        $  53.0
===========================================================================================================================
</TABLE> 

(1) Earnings per common share from continuing operations and earnings per common
    share -- assuming dilution have been restated for fiscal years 1997-1994 in
    accordance with SFAS No. 128. (See Note 8 to the consolidated financial
    statements).

(2) Reflects nonrecurring charges of $12.1 million. (See Note 12 to the
    consolidated financial statements).

(3) Reflects a charge for the cumulative effect of an accounting change for
    postemployment benefits of $1.5 million, net of tax, or $.07 per share.

(4) Reflects a special $10 per share dividend declared in January of 1996. (See
    Note 7 to the consolidated financial statements).

(5) Represents income from continuing operations before interest, taxes,
    depreciation and amortization, and nonrecurring charges in fiscal 1996
    ("EBITDA"). Although EBITDA is not a measure of liquidity or performance
    calculated in accordance with generally accepted accounting principles
    ("GAAP"), the Company believes that EBITDA is an indicator and measurement
    of its debt service ability.


22  ADVO, INC.
<PAGE>
 
                                Financial Report



This section should be read in conjunction with the Company's Consolidated
Financial Statements and the notes thereto.

Financial Overview

ADVO, Inc. ("ADVO" or the "Company") concluded another year of growth. Fiscal
1998 was highlighted by record revenues, operating income and diluted earnings
per common share. Revenues increased 3%, operating income rose 23% and diluted
earnings per common share reached $1.55, reflecting growth of 42% over fiscal
1997. Underlying fiscal 1998 results were the growth in average pieces per
package and revenue per thousand pieces, which represent key statistics of the
Company, strict fixed cost controls, improved branch operating efficiencies and
a strong performance from the Company's A.N.N.E. (ADVO National Network
Extension) brokered distribution program.

   Other fiscal 1998 highlights included the acquisition of The Mailhouse, Inc.,
a cooperative coupon envelope mail company which creates and distributes
cost-effective targeted coupons in a distinctive envelope format for local
neighborhood merchants via an extended network of franchise owners. Such company
was renamed MailCoups, Inc. ("MailCoups") and operates as a subsidiary of ADVO.
This acquisition also contributed positively to ADVO's fiscal 1998 results.

   The Company continued to purchase its common stock under the buyback program
announced on September 29, 1997. Initially, the Company purchased 1.9 million
shares from Warburg, Pincus Capital Partners, L.P. ("Warburg") (see Note 7 to
the consolidated financial statements) and an additional 0.8 million shares
throughout fiscal 1998 on the open market. At the end of the current fiscal
year, the Company announced a new stock buyback program for the purchase of up
to 1.0 million shares throughout fiscal 1999. This new program includes 0.4
million shares remaining from the Company's previous buyback program.

Fiscal 1998 Compared to Fiscal 1997

Revenues. Fiscal 1998 revenues increased $30.0 million over fiscal 1997 to
$1,046.5 million. The 3.0% revenue growth was driven by an increase in revenue
per thousand pieces, the growth in average pieces per package, the volume growth
associated with the Company's A.N.N.E. brokered distribution program, as well as
the acquisition of MailCoups. The increase in revenue per thousand pieces of
0.7% was attributable to increases in product weights associated with the
Company's preprint customers, shifts in product mix and a general price increase
initiated early in fiscal 1998. Average pieces per package increased 1.9% to
8.69 in fiscal 1998 from 8.53 in fiscal 1997. Total shared mail packages
declined 1.8% to 3.1 billion when compared to the previous fiscal year as a
result of the Company's strategic decision to discontinue its "second-in-home
date" program in the Detroit market.

Operating Expenses. Cost of sales as a percentage of revenue decreased from
74.5% in fiscal 1997 to 73.5% in fiscal 1998. The decrease in cost of sales as a
percentage of revenue was the result of efficiencies and cost containment in the
Company's branch operations, lower postage expense and the flow through of the
price increase mentioned above. Cost of sales, in absolute terms, increased
$11.8 million over the prior fiscal year. This increase was attributable to
higher brokered print expense, as well as higher distribution and delivery costs
incurred as a result of the volume growth in A.N.N.E. and the acquisition of
MailCoups. These increases were somewhat offset by lower postage expense as a
result of the strategic reduction in shared mail packages.

   Selling, general and administrative costs, including the provision for bad
debts, as a percentage of revenue, decreased from 19.7% for the year ended 1997
to 19.6% for the year ended 1998. Fiscal 1998 selling, general and
administrative costs were $205.1 million, representing a $4.6 million increase
over the prior year. The increase was comprised of a $9.0 million increase in
general and administrative expenses offset by a $3.5 million decrease in selling
expense and $.9 million attributable to lower bad debt expense. Fewer sales
associates and lower advertising and promotional expenditures, as well as strict
cost controls contributed to the decrease in selling expense in the current
fiscal year. The general and administrative cost increase of $9.0 million
year-over-year was primarily the result of depreciation related to new systems,
software development and other technological enhancements, as well as
remediation costs associated with the Year 2000 program. Higher compensation
related expenses also contributed to the increase in general and administrative
expenses. Offsetting these increases, to a degree, were the Company's overall
cost control initiatives.

Operating Income. As a result of the aforementioned, the Company reported a
$13.6 million increase in operating income to $72.1 million in fiscal 1998
compared to $58.5 million in fiscal 1997, representing a 23.3% increase over the
prior year. As a percentage of revenue, operating income increased from 5.8% in
the fiscal year ended 1997 to 6.9% in the current fiscal year.

Interest Expense. Interest expense relating to the credit facilities totaled
$14.0 million for fiscal 1998 and $14.8 million for fiscal 1997. The decrease in
interest expense was the result of lower interest rates under a renegotiated
credit agreement, even though the Company's overall debt balance was higher
throughout the current year when compared to the prior year.

Income Taxes. The Company's effective tax rate was approximately 39% in both 
fiscal 1998 and 1997.

Earnings Per Common Share. Earnings per common share -- assuming dilution
increased 42.2% to $1.55 per share in fiscal 1998 from $1.09 per common share in
fiscal 1997 primarily related to the Company's improved operating results. The
Company adopted Statement of Financial Accounting Standards No. 128, "Earnings
Per Share" ("EPS") during the first quarter of fiscal 1998. As such, prior year
EPS amounts have been restated to conform to the provisions of the new
statement.


                                                                 ADVO, INC.  23
<PAGE>
 
                                Financial Report



   Weighted average common and diluted shares decreased from the prior period
primarily due to the Company's stock buyback program, including the purchase of
approximately 1.9 million shares of its common stock from Warburg during the
first quarter of fiscal 1998.

Fiscal 1997 Compared to Fiscal 1996
Basis of Presentation

In fiscal year 1995 the Company announced its plan to sell Marketing Force, its
in-store marketing segment. The sale of substantially all of the net assets of
this segment was completed in fiscal 1996. (See Note 3 to the consolidated
financial statements.) The Company's results of operations have been presented
for the period ended September 28, 1996 to separately reflect continuing and
discontinued operations in the consolidated statements of operations and cash
flows. In addition, the results of operations discussed in this Financial Report
exclude the revenues, cost of sales, selling, general and administrative costs
of the discontinued segment.

Continuing Operations

Revenues. Fiscal 1997 revenues increased $30.3 million to $1,016.5 million over
the comparable revenues of fiscal 1996. Volume gains were the largest
contributor to the 3.1% increase in revenues. The volume growth was driven by
the 8.8% increase in average shared mail pieces per package from 7.84 pieces in
fiscal 1996 to 8.53 pieces in fiscal 1997. Offsetting these volume gains, to a
degree, was the strategically driven decision to discontinue the "second in-home
date" programs in specified markets and the closing of unprofitable markets.
Total shared mail packages for fiscal 1997 were 3.1 billion, down 2.7%, and
revenue per thousand pieces decreased 3.2% as compared to fiscal 1996. The
decline in revenue per thousand pieces was the result of shifts in product mix,
volume related declines in price and, earlier in the year, a decrease in product
weights associated with the Company's preprint customers.

Operating Expenses. Cost of sales decreased $4.1 million from fiscal 1996. As a
percentage of revenues, cost of sales decreased 2.7% from 77.2% in fiscal 1996
to 74.5% in fiscal 1997. The decrease in cost of sales for the fiscal year ended
1997 was equally attributable to both lower print and paper costs and lower
postage costs. Print and paper costs were lower in fiscal 1997 when compared to
fiscal 1996 as a result of reduced paper prices and the decline in turnkey
volume. Postage costs were favorably impacted by the postage reclassification
implemented by the United States Postal Service in July 1996 and to a lesser
extent by the decline in preprint product weights. These postage savings were
offset to a degree by additional overweight postage costs incurred with the
volume gains, as demonstrated by the growth in shared mail pieces distributed to
26.5 billion pieces, a 6.0% increase from the prior year.

   During fiscal 1997, selling expense, including the provision for bad debts,
increased $8.4 million over the prior fiscal period. Increases in commission
expense, sales support costs, and additional bad debt expense resulting from the
revenue growth were the major elements in the higher selling expense. As a
percentage of revenues, selling expense increased from 13.3% in fiscal 1996 to
13.7% in fiscal 1997.

   General and administrative costs increased $4.4 million or 7.7% in fiscal
1997 over fiscal 1996. As a percentage of revenues, general and administrative
costs were 6.0% for fiscal 1997 versus 5.7% for fiscal 1996. Continued cost
savings associated with the Company's reengineering effort were offset by
increases in severance and incentive wages as well as investments in
technological improvements.

Operating Income.  As a result of the aforementioned, the Company reported a
58.7% increase in operating income from $36.9 million (excluding nonrecurring
charges) in fiscal 1996 to $58.5 million in fiscal 1997. Operating income as a
percentage of revenue increased to 5.8% in fiscal 1997 versus 3.7% in the prior
year (excluding nonrecurring charges).

Interest Expense. Interest expense relating to the Company's credit facilities
totaled $14.8 million for fiscal 1997. In the prior year, at the onset of the
facilities, interest expense totaled $9.7 million.

Interest Income and Other Expense. Interest income results primarily from the
investment of excess cash and amounted to $.7 million in fiscal 1997 versus $1.3
million in fiscal 1996. The decrease was a result of the liquidation of
available-for-sale securities during fiscal 1996. Other expense increased
slightly to $.7 million in fiscal 1997.

Income Taxes. The effective tax rate was approximately 39% for the Company's
continuing operations in both fiscal 1997 and fiscal 1996.

Earnings Per Common Share.  Earnings per common share from continuing operations
-- assuming dilution increased from $.47 in fiscal 1996 to $1.09 in fiscal 1997.
Adjusting for the nonrecurring charges in fiscal 1996, earnings per common share
from continuing operations -- assuming dilution would have been $.78 in fiscal
1996 versus $1.09 in fiscal 1997. This 39.7% increase was a result of the
Company's improved operating results.

Financial Position

Working Capital. The Company's working capital ratio remained consistent with
the prior year at approximately 1.0. Decreases in current assets of $4.8 million
were offset by decreases in current liabilities of $4.5 million. The decrease in
current assets was caused mainly by a decline in cash and cash equivalents of
approximately $17.2 million, offset in part by an increase in accounts
receivable of $13.5 million. The change in cash and cash equivalents is
attributable to capital spending for equipment, acquisitions, and treasury stock
purchases under the Company's


24  ADVO, INC.
<PAGE>
 
                                Financial Report



buyback program, offset to a degree by cash provided by operating activities and
net borrowings under the Company's credit agreement. The increase in accounts
receivable is a result of revenue growth and the timing of customer payments.
Revenue growth alone for the last month of the year increased substantially over
the prior year and therefore accounted for a large part of the increase in
accounts receivable. The change in current liabilities is related to decreases
in accounts payable associated with changes in the timing of vendor payments to
take advantage of payment term discounts, decreases in accrued compensation and
benefits associated with a change in the payment structure to the sales force,
and reductions in federal and state taxes payable due to the timing of estimated
tax payments. These decreases were offset in part by an increase in the current
portion of long-term debt reflective of scheduled debt repayments.

Property, Plant and Equipment.  Acquisitions of property, plant and equipment
totaled $29.3 million for fiscal year 1998. A majority of these purchases were
aimed at improving operating performance and efficiencies throughout the
Company. The Company continued to transition to new computerized mail sorters,
which are more efficient and effective in their targeting capabilities. The
Company also continued to upgrade computer hardware throughout the Company to
support the requirements of the financial and operational software currently
being developed, as well as allow for the implementation of a wide area network.
Some of these projects are designed to address the Company's system needs, while
simultaneously addressing Year 2000 issues. Of the total fiscal 1998 property,
plant and equipment expenditures, approximately $2.2 million relates to the
development of a human resource/payroll system, which was accelerated in order
to be Year 2000 compliant. The total cost of this system is estimated to be
approximately $4.0 million.

   The Company's fiscal 1999 capital plan estimates expenditures to be
approximately $38.0 million. Cash provided by operating activities is the
expected source of financing for these capital expenditures, as it was in fiscal
1998.

Stockholders' Deficiency.  Stockholders' deficiency increased $15.0 million to
$74.9 million at September 26, 1998 from $59.9 million at September 27, 1997.
The increase in the net deficiency was primarily attributable to the $60.8
million of common stock purchased by the Company, offset by net income of $35.6
million, $8.9 million of employee stock plan activity and related tax benefits,
and $1.3 million from the amortization of deferred compensation.

   The treasury stock purchases of $60.8 million during fiscal 1998 are
comprised of $55.2 million related to buyback programs and $5.6 million pursuant
to elections by employees to satisfy withholding requirements under the
Company's restricted stock and stock option plans.

   Purchases of common stock for treasury of $55.2 million under the Company's
buyback programs include $20.4 million of open market purchases and $34.8
million purchased from Warburg. During the first quarter of fiscal 1998, the
Company increased its previously announced stock repurchase program to allow for
the purchase of approximately 1.9 million shares of common stock for treasury
from Warburg, the Company's largest shareholder at September 27, 1997, for $34.8
million. The Company financed this transaction through available credit
commitments under its renegotiated credit agreement.

   On September 8, 1998, the Company announced a new stock buyback program for
up to 1.0 million shares through fiscal 1999. This new program includes
approximately 0.4 million shares remaining from the Company's previous buyback
program. As of September 26, 1998 there are approximately 0.8 million shares
available for purchase under the buyback program.

Liquidity. Cash flows generated from operating activities are the Company's
primary source of liquidity to fund working capital and investing activities.
The Company also has available commitments under its credit agreement which may
be used to fund operating activities.

   Cash flows generated from operating activities decreased by $12.2 million
from the prior year. The growth in operating income was more than offset by the
year-over-year increase in accounts receivable as a result of revenue growth and
timing of customer payments. Also contributing were the decrease in accounts
payable due to the decision to take advantage of vendor discounts and the
decline in accrued compensation and benefits specifically related to changes in
the payment structure of the sales force. Cash provided by operating activities
during fiscal 1997 increased by $22.6 million over fiscal 1996. The major
factors affecting the increase were; the year-over-year change in accounts
receivable and accounts payable due to the timing of customer receipts and
payments, and the increase in accrued compensation related to the associate
incentive program as a result of improved operating results.

   Overall cash and cash equivalents decreased $17.2 million from the prior
year. This decrease was mainly attributable to cash used in investing and
financing activities, offset in part by cash generated from operating
activities. The Company's investments included $29.3 million for property, plant
and equipment purchases and $10.7 million related to the acquisition of
MailCoups. Financing activities of the Company included $60.8 million in
treasury stock purchases, which were financed in part by increased net
borrowings of $33.2 million under the credit agreement.

Financing Arrangements. On September 29, 1997, the Company renegotiated the
terms of its credit agreement dated March 4, 1996. The significant amendments
made to the agreement (the "Amended Agreement") were an increase in available
commitments from $250 million to $300 million, a decrease in interest rates and
an increase in the authorized amount of the Company's capital stock that it may
purchase from $40 million to $100 million.

   The Amended Agreement provides for credit facilities consisting of a $135
million term loan and a $165 million


                                                                 ADVO, INC.  25
<PAGE>
 
                                Financial Report



reducing revolving line of credit, maturing at various dates through September
2003. Available commitments under the Amended Agreement totaled $93.5 million as
of September 26, 1998. Subsequent to year end, the Company had additional net
borrowings of $12 million through fiscal month end November 1998.

   The debt bears interest at either the London Interbank Offered Rate ("LIBOR")
or at the bank's "base rate", whichever the Company chooses for each tranche due
at various maturity dates, plus an "applicable margin" (based on certain
financial ratios). Under the current agreement the "applicable margin" ranges
from .50% to 1.50% on the LIBOR rate and 0% to .25% on the base rate. Under the
previous agreement in effect during fiscal 1997, the applicable margin ranged
from 1.50% to 3.00% and .25% to 1.75%, respectively. Interest is payable
quarterly or upon the maturity of the LIBOR contracts, whichever period is
shorter.

   The Company is required to maintain certain financial ratios under the
Amended Agreement. In addition, the Amended Agreement also places restrictions
on disposal of assets, mergers and acquisitions, dividend payments, investments
and additional debt.

   In connection with the Amended Agreement, the Company is required to maintain
Interest Rate Protection Agreements to protect itself against three-month LIBOR
rates exceeding 8.0% per annum as to a notional principal amount equal to the
lesser of $100 million or 50% of the aggregate principal amount of the loans
made on the effective date for a period of at least two years. During fiscal
1998, the Company entered into two separate three-year interest rate swap
transaction agreements to hedge notional amounts totaling $100 million. The rate
is fixed at approximately 5.7%. The Company believes the interest rate swap
transaction agreements limit substantial risk should interest rates fluctuate.
The interest rate swap agreements had no material effect on interest expense
during fiscal 1998. During fiscal 1996, the Company entered into two separate
two-year Interest Rate Collar Agreements to hedge notional amounts totaling $150
million. The cap rates ranged from 7.39% to 8.0% with the floor rate ranging
from 5.0% to 5.5%. The interest rate collar agreements had no effect on interest
expense in either fiscal 1998 or 1997.

   The total fiscal 1999 maturities of long-term debt of $16.2 million, as well
as future scheduled repayments, are expected to be paid through funds generated
from ongoing operations.

Market Risk. The Company's interest expense is sensitive to changes in the
general level of interest rates. In this regard, changes in interest rates
affect the interest paid on its debt. To mitigate the impact of interest rate
fluctuations, the Company maintains interest rate swap agreements on notional
amounts totaling $100 million, which is currently over 50% of its outstanding
debt balance. (See Financing Arrangements.)

   The Company believes that the interest rate swap agreements limit substantial
risk if interest rates should fluctuate. If interest rates should change by 2%
in 1999 from those rates in effect at September 26, 1998, assuming no change in
the outstanding debt balance and considering the effects of the Company's
interest rate swap agreements, the effect on interest expense would be
immaterial. These amounts are determined by considering the hypothetical
interest rates on the Company's borrowing cost and interest rate swap
agreements. This analysis does not consider the effects of actions management
would take if interest rates were to fluctuate by such a significant degree. The
sensitivity analysis also assumes no changes in the Company's financial
structure.

Year 2000 Readiness.  The Company has been addressing the effect of the Year
2000 issue on computer and production systems. The Year 2000 issue arose because
many systems, application software, facilities and equipment were constructed/
written with two, rather than four, digits to identify the appropriate year. On
or before January 1, 2000, these systems may incorrectly process critical data
or stop processing altogether.

State of Readiness

At the beginning of 1998, the Company established a Year 2000 program management
office comprised of dedicated project managers and key resources from various
strategic process areas within the Company. The team's objective has been to
coordinate and identify systems, applications, processes and software programs
that will be required to be modified or replaced in order for the Company's
computer and production systems to function properly with respect to dates in
the Year 2000 and thereafter.

   After the initial assessment, the team identified three areas of compliance
which are affected by the Year 2000 issue; information technology ("IT")
systems, non-IT systems (such as production facilities and machinery containing
embedded systems) and third parties (i.e., vendors, customers and business
partners, and other parties that provide services to the Company). The team
identified five phases to resolve the Year 2000 issue for the three compliance
areas mentioned above: 1) identification of systems, both IT and non-IT, and
third parties, 2) assessment and analysis, 3) modification or replacement, 4)
testing, and 5) implementation.

   Phase 1 was completed by February 1998 and the Company is concurrently
working on Phases 2,3,4 and 5 for specific sub-categories within the three
compliance areas listed above. The Company is currently proceeding on schedule
in its overall Year 2000 program and is approximately 40% complete as of
November 30, 1998. The remainder of the project has been targeted for staggered
completion ending no later than September 1999. The Company will continue to
utilize both internal and external resources to complete the Year 2000
modifications and/or replacements.

   The Company's analysis of IT systems included mainframe and client server
applications, the computer desktop (personal computers and desktop software) and
the technical architecture and infrastructure (i.e., network, servers, e-mail).
All mainframe and client server applications have been assessed and plans have
been put in place for the required conversion of those computer programs.
Several converted programs have been tested and placed into operation. In
addition, the Company is making a concerted effort to update its computer
desktops and technical infrastructure by updating non-compliant components.


26  ADVO, INC.
<PAGE>
 
                                Financial Report



The Company is proceeding in accordance with its plans to ensure all IT
systems are compliant and expects to have sub-categories completed by various
dates through September 1999.

   The Year 2000 issue also affects certain aspects of the Company's facilities
and production equipment containing embedded technology. While the Company has
largely completed its assessment of these non-IT systems, remediation and
testing are scheduled to be completed by various dates through September 1999.

   As part of the third party relationship assessment, the Company is sending
out questionnaires and surveying third parties who were identified in Phase 1 to
ensure their products, services and interfaces are in compliance or expected to
be in compliance no later than September 1999. The Company is actively pursuing
responses from the remainder of those third parties which have not responded or
whose responses were deemed unsatisfactory. The Company is developing
contingency plans to mitigate exposure resulting from non-compliance of third
parties, such as considering the substitution of vendors in the event that a
vendor provides an unacceptable response.

Costs

The Company's total cost of modifying the required systems for Year 2000
compliance is currently estimated from inception in fiscal 1998 through
completion in September 1999 to be approximately $12 million and will be
expensed as incurred. Of these costs, $3.2 million were incurred during fiscal
1998. These costs have been budgeted and will be funded through the shifting of
existing resources through 1999 and by cash provided from operating activities.
The process of evaluating the Company's systems, especially those which contain
embedded technology, and third party relationships is an ongoing process and,
therefore, estimated costs may increase as the project progresses. Costs
associated with replacements of systems will be capitalized under the Company's
normal capitalization policy. (See discussion under Property, Plant and
Equipment).

Risks and Contingency Plans

The Company's greatest risk for material impact lies in the potential disruption
of its service delivery process through the United States Postal Service
("USPS"). Although the USPS has expressed to the Company its intention to be
Year 2000 compliant, the failure of the USPS to achieve Year 2000 compliance
could have an adverse effect on the operation of the Company's business,
financial position, results of operations, and cash flows. Because the number of
scenarios is extensive, it is not possible to assess them all; however, the
severity of the impact could vary widely. It should be noted that approximately
85% of ADVO's mail bypasses almost all of the USPS' systems and is delivered
directly by ADVO to the USPS' local post offices for carrier distribution.
Therefore, the Company has somewhat mitigated its risk. In addition, in order to
further mitigate any material effects, the Company is continually monitoring the
USPS' Year 2000 progress through monthly status meetings, and eventually will
include the testing of common interfaces.

   The Company also relies on print vendors for the printing of certain direct
mail products. The Company has sent out letters requiring certification from all
print vendors ensuring they are Year 2000 compliant. The failure of all of the
Company's print vendors could have a material adverse effect on the Company.
Unlike the USPS, the Company will identify alternate sources of suppliers for
similar print services through the contingency planning process.

   Currently, the Company is developing formal contingency plans for
non-compliance that could have an adverse effect on the Company's business,
financial position and results of operation. These plans will continue to be
refined as the Company completes the evaluation, modification and/or replacement
of its IT and non-IT systems and as it receives and evaluates information from
third parties.

   The Company currently believes that with timely modifications to existing
software and conversions to new software, the Year 2000 issue will not pose
significant operational problems for its computer and production systems and
will not have a material impact on the Company's consolidated financial position
or results of operations. The project is estimated to be completed no later than
September 1999. At this point, the Company intends to have its internal
application systems, technical infrastructure, building control systems and
production equipment and third party relationships/interfaces fully Year 2000
compliant.

   The implementation, modifications and/or replacements, effectiveness,
estimated costs and the date on which the Company believes it will complete the
Year 2000 compliance efforts are based on management's best estimates at the
present time. These estimates were derived utilizing numerous assumptions of
future events including continued availability of certain resources, third party
remediation plans, and other factors. However, due to the inherent complexity of
the issues, possible unidentified risks and changing environment there can be no
guarantee that these estimates will be accurate or achieved and therefore,
actual costs and results could materially differ from those estimated.

Forward Looking Statements. Except for the historical information stated herein,
the matters discussed in this Financial Report contain forward looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended. Such forward looking statements are subject to cautionary
factors which could cause the Company's actual results to differ materially from
those in the forward looking statements. Such factors include but are not
limited to: changes in customer demand; the possibility of consolidation
throughout the retail sector; postal and paper prices; the realization of
benefits associated with the Company's reengineering initiative; possible
governmental regulation or legislation affecting aspects of the Company's
business; the efficiencies achieved with technology upgrades; the amount of
shares the Company will repurchase in the future under its buyback program; the
successful completion and estimated costs of the Year 2000 program; fluctuations
in interest rates related to the outstanding debt and other general economic
factors.

                                                                 ADVO, INC.  27
<PAGE>
 
                      Consolidated Statements of Operations


<TABLE> 
<CAPTION> 
                                                                    Year ended          Year ended            Year ended
                                                                   September 26,       September 27,         September 28,
(In thousands, except per share data)                                  1998                1997                  1996
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>                <C>                    <C> 
Revenues                                                           $1,046,511           $1,016,492            $  986,162
Costs and expenses:                                                                                  
   Cost of sales                                                      769,256              757,413               761,506
   Selling, general and administrative                                200,662              195,196               184,084
   Nonrecurring charges                                                    --                   --                12,082
   Provision for bad debts                                              4,459                5,374                 3,701
---------------------------------------------------------------------------------------------------------------------------
Operating income                                                       72,134               58,509                24,789
Gain on sale of business line                                              --                   --                 2,687
Interest income (1)                                                       949                  687                 1,285
Interest expense                                                       14,043               14,820                 9,669
Other expense                                                             613                  660                   556
---------------------------------------------------------------------------------------------------------------------------
Income before income taxes                                             58,427               43,716                18,536
Provision for income taxes                                             22,787               16,918                 7,229
---------------------------------------------------------------------------------------------------------------------------
Income from continuing operations                                      35,640               26,798                11,307
---------------------------------------------------------------------------------------------------------------------------
Loss on disposal of discontinued operations, net of tax                    --                   --                (8,199)
---------------------------------------------------------------------------------------------------------------------------
Net income                                                         $   35,640           $   26,798            $    3,108
===========================================================================================================================
                                                                                                     
Earnings per common share (2):                                                                       
     Earnings from continuing operations                           $     1.59           $     1.10            $      .50
     Loss on disposal of discontinued operations, net of tax               --                   --                  (.36)
---------------------------------------------------------------------------------------------------------------------------
        Earnings per common share                                  $     1.59           $     1.10            $      .14
---------------------------------------------------------------------------------------------------------------------------
Earnings per common share--assuming dilution (2):                                                  
     Earnings from continuing operations                           $     1.55           $     1.09            $      .47
     Loss on disposal of discontinued operations, net of tax               --                   --                  (.34)
---------------------------------------------------------------------------------------------------------------------------
        Earnings per common share--assuming dilution               $     1.55           $     1.09            $      .13
---------------------------------------------------------------------------------------------------------------------------
Dividends declared per share                                       $       --           $       --            $   10.025
---------------------------------------------------------------------------------------------------------------------------
                                                                                                     
Weighted average common shares                                         22,427               24,320                22,803
Weighted average diluted shares                                        23,056               24,688                24,126
===========================================================================================================================
</TABLE> 

(1) Includes interest income from related party of $458,000 and $1,219,000 in
    fiscal 1997 and 1996, respectively.

(2) The Company adopted Statement of Financial Accounting Standards No. 128,
    "Earnings Per Share" ("EPS") during the first quarter of fiscal 1998. As
    such, prior year EPS amounts have been restated to conform to the provisions
    of the new statement.

See accompanying Notes to Consolidated Financial Statements

28  ADVO, INC.
<PAGE>
 
                           Consolidated Balance Sheets

<TABLE> 
<CAPTION> 
                                                                                         September 26,       September 27,
(In thousands, except  share data)                                                           1998                1997
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                                     <C>                  <C> 
Assets
Current assets:
   Cash and cash equivalents (1)                                                        $     8,724           $   25,963
   Accounts receivable, less allowances of $4,624 in 1998 and $5,160 in 1997                 80,140               66,664
   Inventories                                                                                3,740                4,149
   Prepaid expenses and other current assets                                                  4,886                4,759
   Deferred income taxes                                                                     13,535               14,248
---------------------------------------------------------------------------------------------------------------------------
     Total Current Assets                                                                   111,025              115,783
Property, plant and equipment--net                                                           85,790               76,092
Other assets                                                                                 22,391               16,678
---------------------------------------------------------------------------------------------------------------------------
     Total Assets                                                                         $ 219,206            $ 208,553
===========================================================================================================================

Liabilities and Stockholders' Deficiency 
Current liabilities:
   Current portion of long-term debt                                                      $  16,200            $  10,125
   Accounts payable                                                                          37,586               44,644
   Accrued compensation and benefits                                                         27,473               29,245
   Customer advances                                                                          3,892                3,409
   Federal and state income taxes payable                                                     5,270                7,080
   Accrued other expenses                                                                    20,628               21,080
---------------------------------------------------------------------------------------------------------------------------
     Total Current Liabilities                                                              111,049              115,583
Long-term debt                                                                              167,766              140,666
Deferred income taxes                                                                        12,035                9,589
Other liabilities                                                                             3,230                2,636
Stockholders' deficiency:
   Series A Convertible Preferred Stock, $.01 par value
     (Authorized 5,000,000 shares, none issued)                                                  --                   --
   Common Stock, $.01 par value (Authorized 40,000,000 shares,
     Issued 29,237,700 in 1998 and 28,428,952 in 1997)                                          292                  284
   Additional paid-in capital                                                               173,433              163,317
   Accumulated deficit                                                                     (119,473)            (155,113)
   Less shares of common stock held in treasury at cost,
     7,001,271 in 1998 and 4,077,371 in 1997                                               (129,126)             (68,409)
---------------------------------------------------------------------------------------------------------------------------
     Total Stockholders' Deficiency                                                         (74,874)             (59,921)
---------------------------------------------------------------------------------------------------------------------------
     Total Liabilities and Stockholders' Deficiency                                       $ 219,206            $ 208,553
===========================================================================================================================
</TABLE> 

(1) Includes cash and cash equivalents invested with related party of
    $11,613,000 at September 27, 1997.

See accompanying Notes to Consolidated Financial Statements


                                                                  ADVO, INC.  29
<PAGE>
 
                      Consolidated Statements of Cash Flows

<TABLE> 
<CAPTION> 
                                                                     Year ended           Year ended          Year ended
                                                                    September 26,        September 27,       September 28,
(In thousands)                                                          1998                 1997                1996
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>                  <C>                 <C> 
Cash flows from continuing operating activities:
   Net income                                                          $ 35,640           $  26,798           $    3,108
   Less: Loss from discontinued operations                                   --                  --               (8,199)
---------------------------------------------------------------------------------------------------------------------------
Income from continuing operations                                        35,640              26,798               11,307
Adjustments to reconcile net income to
   net cash flows from continuing operating activities:
     Cashless option exercises and option repricing                          --                  --                8,747
     Depreciation                                                        21,031              16,150               12,967
     Amortization                                                         3,524               2,096                2,203
     Deferred income taxes                                                3,159               4,562               (2,275)
     Provision for bad debts                                              4,459               5,374                3,701
     Gain on sale of business lines                                          --                  --               (2,687)
     Other                                                                  708                 528                    1
Change in operating assets and liabilities, net of effects of 
  acquisitions:
     Accounts receivable                                                (16,130)             (9,370)              (5,280)
     Inventories                                                            898               3,369                  470
     Prepaid expenses and other current assets                              461                (247)                 539
     Other assets                                                         1,050              (1,367)                 332
     Accounts payable                                                    (7,973)              6,776               13,401
     Accrued compensation and benefits                                   (2,087)              6,353               (2,815)
     Customer advances                                                      483              (2,551)              (4,350)
     Federal and state income taxes payable                               4,262               1,732                4,486
     Other liabilities                                                     (531)                950               (2,155)
---------------------------------------------------------------------------------------------------------------------------
     Net cash provided by continuing operating activities                48,954              61,153               38,592
---------------------------------------------------------------------------------------------------------------------------

Cash flows from continuing investing activities:
   Proceeds from sale of business lines                                      --                  --                  742
   Acquisitions, net of cash acquired                                   (10,720)                 --                   --
   Expenditures for property, plant and equipment                       (29,271)            (28,615)             (17,679)
   Proceeds from disposals of property and equipment                         22                  18                   10
   Available-for-sale securities--purchases                                  --                  --              (49,604)
   Available-for-sale securities--sales and maturities                       --                  --               80,482
---------------------------------------------------------------------------------------------------------------------------
     Net cash (used) provided by continuing investing activities        (39,969)            (28,597)              13,951
---------------------------------------------------------------------------------------------------------------------------
Cash flows from continuing financing activities:
   Proceeds from long-term borrowings--term loans                            --                  --              155,000
   Payments on long-term borrowings--term loans                         (12,525)            (17,559)              (1,650)
   Revolving line of credit--net                                         45,700                  --               15,000
   Payment of debt issue costs                                           (1,349)                 --               (5,458)
   Proceeds from exercise of warrants                                        --                  --                7,200
   Proceeds from exercise of stock options                                2,757               2,323                2,473
   Purchases of common stock for treasury                               (60,807)             (4,660)                (741)
   Cash dividends paid                                                       --                  --             (240,561)
---------------------------------------------------------------------------------------------------------------------------
     Net cash used by continuing financing activities                   (26,224)            (19,896)             (68,737)
---------------------------------------------------------------------------------------------------------------------------
     Net cash provided by discontinued operations                            --                  --                5,648
---------------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash and cash equivalents                        (17,239)             12,660              (10,546)
---------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of year                           25,963              13,303               23,849
---------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                              $   8,724           $  25,963            $  13,303
===========================================================================================================================
</TABLE> 

See accompanying Notes to Consolidated Financial Statements


30  ADVO, INC.
<PAGE>
 
     Consolidated Statements of Changes in Stockholders' Equity (Deficiency)

<TABLE> 
<CAPTION> 
                                                                                        Unrealized                            
                                                                                      gains (losses)                          
                                                                          Additional  on available-  Accumulated   Total   
(In thousands, except              Common stock       Treasury stock       paid-in      for-sale      earnings     equity    
per share data)                   Shares   Amount    Shares     Amount     capital     securities     (deficit) (deficiency)     
---------------------------------------------------------------------------------------------------------------------------
<S>                              <C>       <C>      <C>        <C>        <C>         <C>            <C>        <C> 
Balance--
   September 30, 1995            24,583     $246    (3,759)    $(63,533)    $138,735     $(62)     $   55,020   $ 130,406
Purchase of common                                                                                           
   stock for treasury                                  (45)        (741)                                             (741)
Cancellation of restricted stock     (5)                                                                     
Exercise of stock options                                                                                    
   and warrants                   3,323       33                              18,387                               18,420
Tax effect--                                                                                                 
   employee stock plans                                                        2,973                                2,973
Amortization of deferred                                                                                     
   compensation (1)                                                              609                                  609
Cash dividends declared                                                                                      
   ($10.025 per share)                                                                               (240,042)   (240,042)
Unrealized gains on                                                                                          
   available-for-sale                                                                                        
   securities                                                                              62                          62
Net Income                                                                                              3,108       3,108
---------------------------------------------------------------------------------------------------------------------------

Balance--
   September 28, 1996            27,901     $279    (3,804)   $ (64,274)    $160,704    $   0       $(181,914) $  (85,205)
Purchase of common                                                                                           
   stock for treasury                                 (304)      (4,660)                                           (4,660)
Grants of restricted stock           31                 30          506         (506)                        
Exercise of stock options           497        5         1           19        2,299                                2,323
Tax effect--                                                                                                
   employee stock plans                                                          529                                  529
Amortization of deferred                                                                                     
   compensation and other (1)                                                    291                        3         294
Net Income                                                                                             26,798      26,798
---------------------------------------------------------------------------------------------------------------------------

Balance--
   September 27, 1997            28,429     $284    (4,077)   $ (68,409)    $163,317    $   0       $(155,113) $  (59,921)
Purchase of common                                                                                           
   stock for treasury                               (2,928)     (60,807)                                          (60,807)
Cancellation of restricted stock     (4)                                                                               --
Grants of restricted stock           72        1         4           90           (4)                                  87
Exercise of stock options           741        7                               2,750                                2,757
Tax effect--                                                                                                
   employee stock plans                                                        6,074                                6,074
Amortization of deferred                                                                                     
   compensation (1)                                                            1,296                                1,296
Net Income                                                                                             35,640      35,640
---------------------------------------------------------------------------------------------------------------------------

Balance--
   September 26, 1998            29,238     $292    (7,001)   $(129,126)    $173,433    $   0      $ (119,473) $  (74,874)
===========================================================================================================================
</TABLE> 

(1) Unamortized deferred compensation at September 26, 1998, September 27, 1997,
    and September 28, 1996 was $940,000, $780,000, and $140,000, respectively.

See accompanying Notes to Consolidated Financial Statements


                                                                  ADVO, INC.  31
<PAGE>
 
                  Notes to Consolidated Financial Statements


Note 1  Summary of Accounting Policies

Organization. ADVO, Inc. ("ADVO" or the "Company") is a direct mail marketing
firm primarily engaged in soliciting and processing printed advertising from
retailers, manufacturers and service companies for targeted distribution by both
shared and solo mail to consumer households in the United States on a national,
regional and local basis. Founded in 1929 as a hand delivery company, ADVO
entered the direct mail industry as a solo mailer in 1946 and began its shared
mail program in 1980. The Company currently is the largest commercial user of
third-class mail in the United States.
   ADVO's direct mail products and services include shared mail and solo mail.
ADVO also provides ancillary services in conjunction with its direct mail
programs. The Company's predominant source of revenue is from its shared mail
programs. In these programs, the advertisements of several advertisers are
combined in a single mail package. This offers the features of penetration and
targeted marketing at a significant cost reduction when compared to mailing on
an individual or solo mail basis. The Company's client base consists of national
and local grocers, fast food chains, drug stores and local retailers.

Principles of Consolidation. The consolidated financial statements include the
accounts of ADVO and its subsidiaries. All significant intercompany transactions
and balances among ADVO and its subsidiaries have been eliminated. Certain
reclassifications have been made in the fiscal 1997 and 1996 financial
statements to conform with the fiscal 1998 presentation. ADVO's fiscal closing
date is the last Saturday in September.

Cash and Cash Equivalents. Cash and cash equivalents include highly liquid
investment instruments with original maturities of three months or less when
purchased. These investments are valued at cost, which approximates market.

Inventories. Inventories, which consist of raw materials, finished goods and
spare parts, are valued at the lower of cost (first-in, first-out method) or
market.

Property, Plant and Equipment. Property, plant and equipment are recorded at
cost and include amounts associated with the development of software for
internal use. Depreciation and amortization are computed generally by the
straight-line method over the estimated useful lives of the respective assets
(ranging from 2 to 35 years) or over the terms of the related leases for
leasehold improvements.

Intangible Assets. The excess of cost over net assets acquired (goodwill) and
other intangible assets related to acquisitions are being amortized over their
expected useful lives which range from 3 to 20 years. The Company continually
monitors its goodwill and its other intangibles to determine whether any
impairment of these assets has occurred. In making such determination, the
Company evaluates the performance, on an undiscounted basis, of the underlying
assets which gave rise to such amount.

Revenues. Revenues are recognized when services are rendered and are presented
in the financial statements net of sales allowances and adjustments. The
Company's services are considered rendered when all printing, sorting, labeling
and ancillary services have been provided and the mailing material has been
received by the United States Postal Service.

Interest Rate Swaps. The Company enters into interest rate swap agreements to
modify the interest characteristics of a portion of its outstanding debt. These
agreements involve the exchange of amounts based on the London Interbank Offered
Rate ("LIBOR") for amounts based on a fixed interest rate over the life of the
agreement, without an exchange of the notional amount upon which the payments
are based. The differential to be paid or received as interest rates change is
accrued and recognized as an adjustment of interest expense. The related amount
payable or receivable from counter parties is included in accrued other
expenses. The fair value of these agreements is not recognized in the financial
statements.

Stock Based Compensation. The Company has elected to follow Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB Opinion No. 25") and related interpretations in accounting for its
employee stock plans.

Earnings Per Share. In 1997 the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share" ("EPS"). Statement No. 128 replaced the previously reported primary and
fully diluted earnings per share with earnings per common share (basic) and
earnings per common share -- assuming dilution (diluted). Earnings per common
share exclude common stock equivalents, such as stock options, and is computed
by dividing net income by the weighted average number of common shares
outstanding for the period. Earnings per common share -- assuming dilution
reflects the potential dilution that could occur if common stock equivalents,
such as stock options, were exercised. As required, the Statement was adopted in
fiscal 1998 and, where appropriate, proper periods have been restated to conform
to the related provisions.

Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. While management believes that the estimates and related
assumptions used in the preparation of these financial statements are
appropriate, actual results could differ from those estimates.

32 ADVO, INC.
<PAGE>
 
                  Notes to Consolidated Financial Statements



Note 2  Acquisitions

On February 27, 1998 the Company acquired The Mailhouse, Inc., a cooperative
coupon envelope mail company for approximately $10.7 million. This acquisition
has been accounted for under the purchase method of accounting and, accordingly,
the results of operations of the acquired company have been included in the
consolidated statements of operations from its acquisition date. The acquired
assets have been recorded at their estimated fair values. This acquisition did
not have a material pro forma effect on operations for periods prior to the
acquisition.
   The excess of the purchase price of all acquisitions over the estimated fair
values of all net assets acquired of $10.8 million and $4.5 million, net of
accumulated amortization, is reflected in other assets at September 26, 1998 and
September 27, 1997, respectively. Also included in other assets at September 26,
1998 and September 27, 1997 is $2.4 million and $2.8 million, respectively, of
other intangible assets, net of accumulated amortization, which were acquired in
the acquisitions. As of September 26, 1998 and September 27, 1997, accumulated
amortization of goodwill and other intangibles was $9.1 million and $7.8
million, respectively.

Note 3  Discontinued Operations

In September 1995, the Company initiated a plan to sell its in-store marketing
segment. Through the date of the preparation of the fiscal 1995 financial
statements, the Company was in the process of negotiating the sale. At that
time, management estimated its loss on disposal to be $1.4 million ($.9 million
net of tax) consisting of a provision for anticipated operating losses during
the phase out period and other costs directly related to the sale.
   On March 1, 1996 the Company completed the sale of substantially all of the
net operating assets of this segment. The net assets were sold at book value in
exchange for $5.0 million in cash and a long-term note receivable for $10.8
million. The operating results of the segment through the date of disposal were
worse than anticipated, which caused losses in excess of the estimates provided
in fiscal 1995. The additional losses affected the ultimate terms of the
transaction, including the terms of the related note, and caused substantial
doubt as to whether the note could be paid by the buyer. Accordingly, the
Company ultimately determined that the sale price should not reflect the note
and immediately wrote it off. This write off, together with the additional
operating losses, were reflected in the fiscal 1996 loss on disposal of
discontinued operations, net of tax. The Company did not provide any debt or
contract performance guarantees on behalf of the business sold.

   The results of the discontinued operations reflected in the fiscal 1996
consolidated statement of operations include revenues of $19.3 million, losses
to disposal date of $13.8 million and a related income tax benefit of $5.6
million.

Note 4  Property, Plant and Equipment

Balances of major classes of property, plant and equipment and accumulated
depreciation and amortization are as follows:

<TABLE> 
<CAPTION> 
                                                    September 26, September 27, 
(In thousands)                                          1998           1997 
--------------------------------------------------------------------------------
<S>                                                 <C>           <C> 
Land, buildings and building
  improvements                                        $  8,733     $  8,083  
Leasehold improvements                                  13,209       11,867  
Machinery and equipment                                 81,018       71,844  
Furniture and fixtures                                  15,984       17,719  
Computer hardware                                       31,878       33,145  
Computer software and                                                        
  software development costs                            38,416       24,333  
-------------------------------------------------------------------------------
  Total                                               $189,238     $166,991  
Less accumulated depreciation                                                
  and amortization                                     103,448       90,899  
-------------------------------------------------------------------------------
Property, plant and equipment-net                     $ 85,790     $ 76,092  
-------------------------------------------------------------------------------
</TABLE> 

Note 5  Accrued Compensation and Benefits

The composition of accrued compensation and benefits is as follows:

<TABLE> 
<CAPTION> 
                                                    September 26, September 27, 
(In thousands)                                          1998          1997
--------------------------------------------------------------------------------
<S>                                                 <C>           <C> 
Employee compensation                                  $14,874      $18,316     
Workers' compensation                                    6,263        5,638    
Employee withholdings and                                                      
  other benefits                                         6,336        5,291    
-------------------------------------------------------------------------------
  Total                                                $27,473      $29,245    
--------------------------------------------------------------------------------
</TABLE> 

Note 6  Financing Arrangements

The Company has credit facilities consisting of a $135 million term loan and a
$165 million reducing revolving line of credit, maturing at various dates
through September 2003. The commitment levels on the revolving line range from a
high of $165 million from inception through December 1999 to a low of $22.5
million for the period June 2003 through September 2003. Mandatory repayments of
debt in defined amounts are required in the event of certain events including
the sale of certain assets. The Company and its subsidiaries have pledged all of
their assets as collateral under the credit agreement.
   The debt bears interest at either the LIBOR or at the bank's "base rate,"
whichever the Company chooses for each tranche due at various maturity dates,
plus an "applicable margin" (based on certain financial ratios). Under the
current agreement the


                                                                   ADVO, INC. 33

<PAGE>
 
                   Notes to Consolidated Financial Statements



   "applicable margin" ranges from .50% to 1.50% of the LIBOR rate and 0% to
 .25% on the base rate. Under a previous agreement in effect during fiscal 1997,
the applicable margin ranged from 1.50% to 3.00% and .25% to 1.75%,
respectively. Interest is payable quarterly or upon the maturity of the LIBOR
contracts, whichever period is shorter.
   The outstanding facilities' balance and related interest rates inclusive of
applicable margins are as follows :

<TABLE> 
<CAPTION>
                                         LIBOR        Base Rate       Total    
September 26, 1998                     Interest       Interest     Outstanding
(In thousands)                           6.32%         8.50%        Facilities 
--------------------------------------------------------------------------------
<S>                                    <C>            <C>          <C> 
Term loan                              $120,000       $  2,475       $122,475
Revolving line of credit                 50,791         10,700         61,491
--------------------------------------------------------------------------------
                                       $170,791       $ 13,175        183,966
Less: Current portion
  of long-term debt                                                    16,200
--------------------------------------------------------------------------------
                                                                     $167,766
--------------------------------------------------------------------------------
</TABLE> 

<TABLE> 
<CAPTION> 
                                         LIBOR       Base Rate        Total    
September 27, 1997                     Interest      Interest      Outstanding
(In thousands)                           7.21%        8.71%         Facilities 
--------------------------------------------------------------------------------
<S>                                    <C>            <C>          <C> 
Term loans                             $ 52,165       $ 83,626       $135,791
Revolving line of credit                 15,000                        15,000
--------------------------------------------------------------------------------
                                       $ 67,165       $ 83,626        150,791
Less: Current portion
  of long-term debt                                                    10,125
--------------------------------------------------------------------------------
                                                                     $140,666
--------------------------------------------------------------------------------
</TABLE> 

The Company is required to maintain certain financial ratios under the
facilities. In addition, the facilities also place restrictions on disposal of
assets, mergers and acquisitions, dividend payments, investments and additional
debt.
   In connection with the facilities, the Company is required to maintain
Interest Rate Protection Agreements to protect itself against three-month LIBOR
rates exceeding 8.0% per annum as to a notional principal amount equal to the
lesser of $100 million or 50% of the aggregate principal amount of the loans
made on the effective date for a period of at least two years. During fiscal
1998, the Company entered into two separate three-year interest rate swap
transaction agreements to hedge notional amounts totaling $100 million. The rate
is fixed at approximately 5.7%. The Company believes the interest rate swap
transaction agreements limit substantial risk should interest rates fluctuate.
The interest rate swap agreements had no material effect on interest expense in
fiscal 1998. During fiscal 1996, the Company entered into two separate two-year
Interest Rate Collar Agreements to hedge notional amounts totaling $150 million.
The cap rates ranged from 7.39% to 8.0% with the floor rate ranging from 5.0% to
5.5%. The interest rate collar agreements had no effect on interest expense in
either fiscal 1998 or 1997.

   The Company pays fees on the unused commitments under the facilities at a
rate ranging from .175% to .375% depending on the Company's total leverage
ratio, as defined. As of September 26, 1998, $93.5 million of the revolver was
available for future borrowings.
   Total maturities of long-term debt which are due over the next five fiscal
years at September 26, 1998 are as follows :

<TABLE> 
<CAPTION> 
(In thousands)
--------------------------------------------------------------------------------
<S>                                               <C> 
1999                                              $ 16,200
2000                                                20,250
2001                                                22,950
2002                                                27,002
2003                                                97,564 
--------------------------------------------------------------------------------
Total maturities                                  $183,966
--------------------------------------------------------------------------------
</TABLE> 

The revolving line of credit has been classified as long-term since management
has the intent and ability to maintain the September 26, 1998 outstanding
balance throughout fiscal 1999.
   The Company capitalized debt issue costs directly associated with the
issuance of the debt of $5.5 million under a previous agreement in fiscal 1996
and $1.3 million for fiscal 1998 under the renegotiated agreement. These costs
are included in other assets and are being amortized over the term of the debt
agreement. At September 26, 1998 and September 27, 1997, unamortized costs
totaled $4.8 million and $4.4 million, respectively.
   The Company has outstanding letters of credit of approximately $6.3 million
under separate agreements primarily related to its workers' compensation
program.
   Carrying amounts of the financing arrangements approximate fair value.

Note 7  Stockholders' Equity (Deficiency)

On August 27, 1986, 2,301,780 warrants to purchase shares of ADVO common stock
were issued to Warburg, Pincus Capital Partners, L.P. ("Warburg"), Welsh,
Carson, Anderson & Stowe IV (WCAS IV) and WCAS Venture Partners (WCAS VP)
(together, the "Investors") for $1,000,000. On February 15, 1996, Warburg, who
was the Company's largest shareholder at September 27, 1997, exercised the last
outstanding warrants and purchased 2,666,667 shares of common stock at an
exercise price of $2.70 per share.
   The Company has a Shareholder Protection Rights Plan (the "Rights Plan") to
protect shareholders from potential unfair hostile takeovers. Pursuant to the
Rights Plan, common shareholders have one Right for each share of common stock
held. The Rights become exercisable only in the event that any person acquires
or commences a tender offer to acquire 20% or more of the Company's common
stock, as defined.


34 ADVO, INC.
<PAGE>
 
                   Notes to Consolidated Financial Statements



   On January 17, 1996 the Company announced the declaration of a Special
Dividend of $10 per share of common stock to shareholders of record on February
20, 1996. The announcement was a result of the Company's initiative to explore
strategic alternatives aimed at increasing shareholder value, which began at the
end of fiscal 1995. Total shares outstanding as of the record date were
approximately 24 million resulting in dividends of approximately $240 million,
which were paid on March 5, 1996. The Company also recorded noncash compensation
expense totaling $8.8 million relating to the Special Dividend (see Note 12.)
   In fiscal 1997 the Company announced a stock buyback program to purchase up
to 2.0 million shares of the Company's common stock. During fiscal 1998 the
Company increased its stock buyback program authorization to 3.8 million shares
under two separate announcements. In connection with the increased
authorization, the Company purchased 1.9 million shares of its common stock from
Warburg for $34.8 million. In fiscal 1998 and 1997, the Company purchased 2.7
million shares for $55.2 million and 0.2 million shares for $3.4 million,
respectively, in connection with the buyback programs. As of September 26, 1998,
there were 0.8 million shares remaining to be purchased.
   At September 26, 1998 there are 1.8 million shares of common stock reserved
for issuance upon the exercise of stock options.

Note 8  Earnings Per Common Share

The following table sets forth the computation of earnings per common share and
earnings per common share -- assuming dilution:

<TABLE> 
<CAPTION> 
                                   Year ended     Year ended    Year ended  
(In thousands,                    September 26,  September 27, September 28,
except per share data)                1998           1997          1996  
----------------------------------------------------------------------------
<S>                               <C>            <C>           <C>     
Net Income                           $35,640       $26,798       $ 3,108
Weighted average
  common shares                       22,427        24,320        22,803
Effect of dilutive securities:
  Stock options                          598           357           462
  Warrants                                --            --           844
  Restricted stock                        31            11            17
----------------------------------------------------------------------------
Dilutive potential
  common shares                          629           368         1,323

Weighted average
  diluted shares                      23,056        24,688        24,126
----------------------------------------------------------------------------
Earnings per
  common share                       $  1.59       $  1.10       $   .14
----------------------------------------------------------------------------
Earnings per
  common share --
  assuming dilution                  $  1.55       $  1.09       $   .13
----------------------------------------------------------------------------
</TABLE> 

Note 9  Gain on Sale of Business Line

Midcoast Press, the Company's commercial web offset printer, was sold during
fiscal 1996 for $4.2 million, of which $3.5 million was in the form of a
non-recourse note. The note was structured to require interim interest payments
with a balloon payment to be paid in full on December 31, 2002. The note will be
paid off earlier if specific criteria are met regarding the cash flows of the
divested company. The note bears interest at the rate of 7% per annum. The
Company recognized a pre-tax gain of $2.7 million ($1.7 million after tax or
$.07 per share) in conjunction with the sale in fiscal 1996.

Note 10  Savings Plans

The Company has a savings plan for salaried employees which qualifies as a
profit sharing plan under the Internal Revenue Code of 1986, as amended, and
other non-qualified savings plans. All plans feature both employee and employer
matching contributions. The expense for matching contributions was $3.7 million,
$3.4 million, and $3.7 million for fiscal 1998, 1997, and 1996, respectively.

Note 11  Stock Compensation Plans

As of September 26, 1998 the Company has five stock based compensation plans,
three are fixed stock option plans (the "1986 Stock Option Plan", the "1988
Stock Option Plan" and the "1995 Non-Employee Directors' Stock Option Plan") and
two are nonvested stock plans (the "1986 Employee Restricted Stock Plan" and the
"1990 Non-Employee Directors' Restricted Stock Plan"). All the plans are
detailed below. The Company applies APB Opinion No. 25 in accounting for its
plans. Since all options are granted with an exercise price equal to the fair
market value on the date of the grant, no compensation cost has been recognized
for the fixed option stock grants. The market value of shares at the date of the
nonvested stock award in excess of cash consideration received is charged to
operations over the stock award's restriction period. The compensation costs
associated with the nonvested stock plans are disclosed below.
   Pro forma information regarding net income and earnings per share is required
by SFAS No. 123 "Accounting for Stock-Based Compensation", and has been
determined as if the Company had accounted for its employee stock options under
the fair value method of the statement. The fair value of the fixed stock
options was estimated at the date of grant using a Black-Scholes option pricing
model with the following weighted average assumptions for 1998, 1997, and 1996:

                                                                  ADVO, INC. 35 
<PAGE>
 
                   Notes to Consolidated Financial Statements

<TABLE> 
<CAPTION> 
                                     September 26, September 27, September 28, 
                                          1998         1997         1996
--------------------------------------------------------------------------------
<S>                                  <C>           <C>           <C>    
Risk free rate of interest                5.8%         5.5%         5.8%
Dividend yield                            0.0%         0.0%         0.0%
Volatility factor                          36%          32%          36%
Expected life of
  option (years)                          4.4          4.3          4.9
--------------------------------------------------------------------------------
</TABLE> 

The weighted average fair value of options granted was $8.47 in 1998 and $4.61
for both 1997 and 1996.

<TABLE> 
<CAPTION> 
                              Year ended     Year ended           Year ended   
(In thousands, except        September 26,  September 27,        September 28, 
per share data)                  1998           1997                  1996
--------------------------------------------------------------------------------
<S>                          <C>            <C>                <C>     
Pro forma net income         $   33,326       $   25,386       $    2,802
Pro forma
  earnings per share
  --assuming dilution        $     1.46       $     1.04       $      .12
--------------------------------------------------------------------------------
</TABLE> 

For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the fixed stock options' vesting period
ranging from 1 to 4 years. The pro forma information during the initial phase-in
period, as required by SFAS No. 123, was based on fixed stock options granted
during fiscal 1996, 1997 and 1998. Therefore, the pro forma information may not
be indicative of the effects of compensation cost on pro forma net income and
net earnings per share in future years since the options vest over several years
and new grants are possible.

Fixed Stock Option Plan. The 1986 Stock Option Plan and the 1988 Stock Option
Plan provide for the granting of non-qualified options for the purchase of up to
5,825,000 shares of common stock to key employees. The terms of the options may
not exceed ten years, and the option prices shall not be less than the fair
market value of the common stock on the date of grant. Options generally are
exercisable 25% each year, cumulatively, beginning one year from date of grant.
Certain grants also stipulate that the market price of the Company's common
stock must reach certain levels before the options become exercisable in
addition to the 25% per year time vesting provisions. The Company's common stock
reached this level during the first quarter of fiscal 1998.
   These plans contain a reload option feature which allows for the exercise of
options in "stock-for-stock" transactions enabling the employee to retain any
further appreciation in the market value of shares traded in to pay the exercise
price of the options and to satisfy tax withholding requirements. The expiration
date of a reload option would be the same as that of the original option unless
otherwise determined by the Company's Compensation Committee or Board of
Directors. Reload options may be authorized with respect to options that are
themselves granted as reload options.
   In connection with the Special Dividend in fiscal 1996 (see Note 7), the
Company made equitable adjustments to outstanding options. As a result, 2.1
million options were repriced. The repriced options retained their original
vesting schedules and expiration dates.
   The 1995 Non-Employee Directors' Stock Option Plan provides for the granting
of non-qualified options for the purchase of shares of common stock. The terms
of the options may not exceed ten years, and the option prices shall not be less
than the fair market value of the common stock on the date of grant. Options
generally are exercisable 25% each year, cumulatively, beginning one year from
date of grant.
   At September 26, 1998 and September 27, 1997 there were 0.7 million and 0.6
million options available for future grant under the fixed stock option plans,
respectively.
   Information with respect to the Company's fixed stock option plans is
summarized below:

<TABLE> 
<CAPTION> 
                                                                Weighted Average
                                                  Shares         Exercise Price
--------------------------------------------------------------------------------
<S>                                             <C>             <C>     
Outstanding at September 30, 1995                2,705,208         $   15.672
Granted                                          2,871,129              9.869
Cancelled                                       (2,296,127)            18.122
Exercised                                         (939,560)             7.514
--------------------------------------------------------------------------------
Outstanding at September 28, 1996                2,340,650              9.425
Granted                                          1,222,227             13.665
Cancelled                                         (269,637)             9.619
Exercised                                       (1,032,802)             9.078
--------------------------------------------------------------------------------
Outstanding at September 27, 1997                2,260,438             11.853
Granted                                            960,247             23.077
Cancelled                                         (251,599)            12.217
Exercised                                       (1,127,958)            11.594
--------------------------------------------------------------------------------
Outstanding at September 26, 1998                1,841,128         $   17.816
--------------------------------------------------------------------------------
</TABLE> 

                               Options Outstanding

<TABLE> 
<CAPTION> 
                                              Weighted Average
                          Outstanding as of      Remaining      Weighted Average
Range of Exercise Prices  September 26, 1998  Contractual Life   Exercise Price
--------------------------------------------------------------------------------
<S>                       <C>                 <C>               <C>     
$  6.375 - $ 8.625             180,723              4.4            $  7.978
   9.100 -  12.250             343,262              6.4              11.891
  12.625 -  18.500             421,726              8.1              15.164
  18.625 -  21.500             444,100              9.1              21.253
  22.500 -  24.875             240,352              5.5              22.833
  27.063 -  29.875             210,965              7.8              28.232
--------------------------------------------------------------------------------
                             1,841,128              7.3            $ 17.816
--------------------------------------------------------------------------------
</TABLE> 

                               Options Exercisable

<TABLE> 
<CAPTION> 
                                          Exercisable as of     Weighted Average
Range of Exercise Prices                  September 26, 1998    Exercise Price 
--------------------------------------------------------------------------------
<S>                                       <C>                   <C>     
$  6.375 - $ 8.625                              115,596            $  8.022
    9.100 - 12.250                              116,512              11.723
  12.625 -  18.500                               81,801              15.779
  18.625 -  21.500                                9,500              18.724
  22.500 -  24.875                                   --                  --
  27.063 -  29.875                                   --                  --
--------------------------------------------------------------------------------
                                                323,409             $11.632
--------------------------------------------------------------------------------
</TABLE> 

36 ADVO, INC.
<PAGE>
 
                   Notes to Consolidated Financial Statements


Nonvested Stock Plans. The 1986 Employee Restricted Stock Plan and 1990
Non-Employee Directors' Restricted Stock Plan provide for the granting of up to
2,692,500 shares of common stock to executives who, with certain exceptions, are
subject to specified periods of continuous employment (generally vesting
one-third per year over three years) and to directors. These shares are votable
by the holders, and the vesting period is determined by the Board of Directors
at the date of the grant. The compensation cost charged against income over the
restriction period was $1.3 million, $.3 million, and $.6 million for the years
ended September 26, 1998, September 27, 1997 and September 28, 1996,
respectively. Unamortized deferred compensation was $.9 million at September 26,
1998. There are 0.2 million shares available for future grant under these plans
at September 26, 1998. The weighted average grant price of shares granted during
fiscal 1998 and fiscal 1997 was $21.049 and $18.431, respectively. There were no
shares granted during fiscal 1996.
   Certain participants in the 1986 Employee Restricted Stock Plan were given
the opportunity to reinvest the Special Dividend applicable to restricted shares
in the Company's common stock. Any such reinvestment was distributed when the
restricted shares vested.
   Information with respect to the Company's nonvested stock plans are
summarized below:

<TABLE> 
<CAPTION> 
                                                                     Shares
<S>                                                                <C>     
--------------------------------------------------------------------------------
Outstanding at September 30, 1995                                  2,423,246
Cancelled                                                             (5,001)
--------------------------------------------------------------------------------
Outstanding at September 28, 1996                                  2,418,245
Granted                                                               31,000
Cancelled                                                               (333)
--------------------------------------------------------------------------------
Outstanding at September 27, 1997                                  2,448,912
Granted                                                               72,000
Cancelled                                                             (4,000)
--------------------------------------------------------------------------------
Outstanding at September 26, 1998                                  2,516,912
--------------------------------------------------------------------------------
</TABLE> 

During fiscal 1997, 30,000 nonvested shares were awarded to an employee. These
shares take on the same characteristics as the shares in the 1986 Employee
Restricted Stock Plan.

Note 12  Nonrecurring Charges

In connection with the fiscal 1996 Special Dividend (see Note 7), the Company
made equitable adjustments to outstanding unexercised employee stock options.
Generally, the equitable adjustments were reductions in the exercise price of
the outstanding unexercised employee stock options equal to the $10 per share
Special Dividend payment. No modifications were made to any other terms of the
options. This repricing changed the intrinsic value of the outstanding options
and resulted in the Company recording $8.8 million of noncash compensation
expense. Also included as nonrecurring charges were $3.3 million in legal and
various other fees incurred as a result of the Company's exploration of
strategic alternatives to enhance shareholder value which resulted in the
payment of the Special Dividend.

Note 13  Restructure Reserve

In fiscal 1993, the Company recorded a $25.8 million charge for a plan of
restructuring. The plan included the shutdown/relocation of certain operating
facilities aimed at repositioning their location in more geographically
strategic areas, the reorganization and centralization of the Company's
operations, and the discontinuance of certain unprofitable micromarketing
initiatives. All significant elements of the Company's plan of restructure were
completed by the end of its fiscal 1997 year.
   For fiscal 1997 and 1996, $1.6 million, and $7.3 million, respectively, was
charged to the restructuring accrual for cash payments related to severance
costs and other termination based arrangements for exited activities and the
centralization of operations. For fiscal 1997 and 1996, $.1 million and $.6
million, respectively, was charged for cash payments related to facility closure
and downsizing costs. For the three year period ended September 27, 1997, a
total of 480 employees were terminated from all functions of the organization
(representing approximately 20% of the salaried workforce) under the
restructuring plan.

Note 14  Income Taxes

   The components of the provision for income taxes on continuing operations are
as follows:

<TABLE> 
<CAPTION> 
                                    Year ended     Year ended     Year ended 
                                   September 26,  September 27,  September 28,
(In thousands)                         1998            1997           1996
--------------------------------------------------------------------------------
<S>                                <C>            <C>            <C>       
Federal:
  Current                            $17,527         $10,660         $ 5,494
  Deferred                             2,792           3,844             505
--------------------------------------------------------------------------------
  Total Federal                       20,319          14,504           5,999
--------------------------------------------------------------------------------

State:
  Current                              2,101           1,696             742
  Deferred                               367             718             488
--------------------------------------------------------------------------------
  Total State                          2,468           2,414           1,230
--------------------------------------------------------------------------------
  Total Provision                    $22,787         $16,918         $ 7,229
--------------------------------------------------------------------------------
</TABLE> 


                                                                   ADVO, INC. 37
<PAGE>
 
                   Notes to Consolidated Financial Statements




The Company's effective income tax rate for continuing operations differed from
the Federal statutory rate for the following reasons:

<TABLE> 
<CAPTION> 
                                    Year ended     Year ended     Year ended  
                                   September 26,  September 27,  September 28, 
                                        1998           1997          1996
--------------------------------------------------------------------------------
<S>                                <C>            <C>            <C>       
Federal statutory rate                  35.0%          35.0%        35.0%
State income taxes,                                                      
  net of federal benefit                 2.7            3.6          4.3 
Other                                    1.3             .1          (.3)
--------------------------------------------------------------------------------
Effective income tax rate               39.0%          38.7%        39.0% 
--------------------------------------------------------------------------------
</TABLE> 

Significant components of the Company's deferred tax assets and liabilities are
as follows:

<TABLE> 
<CAPTION> 
                                                   September 26,  September 27, 
(In thousands)                                         1998           1997
--------------------------------------------------------------------------------
<S>                                                <C>            <C>     
Deferred tax assets:
  Deferred compensation                             $  6,138        $  5,455
  Employee benefits                                    4,612           4,123
  Other                                                3,782           5,567
--------------------------------------------------------------------------------
   Total deferred tax assets                          14,532          15,145
--------------------------------------------------------------------------------
Deferred tax liabilities:
  Property, plant and equipment                      (13,032)        (10,486)
--------------------------------------------------------------------------------
Net federal and state deferred assets               $  1,500        $  4,659
--------------------------------------------------------------------------------
</TABLE> 

Note 15  Commitments and Contingencies

ADVO leases property and equipment under noncancellable operating lease
agreements which expire at various dates through 2007. The leases generally
provide that the Company pay the taxes, insurance and maintenance expenses
related to the leased assets. Rental commitments at September 26, 1998 under
long term noncancellable operating leases are as follows:

<TABLE> 
<CAPTION> 
(In thousands)
-------------------------------------------------------------------------------
Fiscal year:
<S>                                                <C>      
1999                                               $12,221
2000                                                 9,476
2001                                                 7,529
2002                                                 5,787
2003                                                 4,265
Thereafter                                           5,517
-------------------------------------------------------------------------------
Total minimum lease payments                       $44,795
-------------------------------------------------------------------------------
</TABLE> 

Certain of these leases contain renewal options and certain leases also provide
for cost escalation payments. Rental expense for the years ended September 26,
1998, September 27, 1997 and September 28, 1996 was approximately $16.7 million,
$17.1 million and $20.6 million, respectively.

   During fiscal 1996, the Company entered into a ten-year agreement with
Integrated System Solutions Corporation (d/b/a ISSC) now known as International
Business Machines Corporation ("IBM") Global Services to provide systems
development and technical support to the Company. The contract allows for
cancellation after the completion of the third year, subject to termination
charges ranging between $3.1 million and $.5 million depending on the year in
which the cancellation becomes effective. Total base charges under the term of
the agreement through the year 2006 would be $106.0 million. The agreement also
provides for the Company to pay a cost of living adjustment due to inflation
increases beginning in fiscal 1997. Cost of living adjustments for fiscal 1998
and 1997 totaled approximately $.6 million and $.3 million, respectively. Future
commitments for the noncancellable portion of the agreement, excluding
termination fees and the cost of living adjustments total $10.7 million for
fiscal year 1999. In addition, the Company may receive additional credits or
charges if the Company does not meet or exceeds certain baseline utilization
assumptions.
   During fiscal 1998, the Company entered into a five-year agreement with IBM
to provide a customer service support center for the Company. The contract
allows for cancellation after the completion of the third year, subject to
termination charges of $.6 million in year four and $.4 million in year five.
The annual service charges for the noncancellable portion of the agreement total
$3.6 million, $3.6 million, and $1.8 million, respectively, for fiscal years
1999, 2000, and 2001. The agreement also provides for the Company to pay a cost
of living adjustment due to inflation beginning in fiscal year 1999. In
addition, the Company may receive additional credits or charges if the Company
does not meet or exceeds certain baseline utilization assumptions as well as, if
IBM does not meet or exceeds certain service level standards.
   ADVO is party to various legal proceedings and claims related to its normal
business operations, including several suits in which it is a defendant. In the
opinion of management, the Company has substantial and meritorious defenses for
these claims and proceedings in which it is a defendant, and believes these
matters will be ultimately resolved without material adverse effect on the
consolidated financial position, results of operations or liquidity of the
Company.

Note 16  Related Party Transactions

The Company invests in money market mutual funds through an investment advisor,
Warburg, Pincus Counsellors, Inc. ("Counsellors"). The general partner of
Warburg who was the Company's largest shareholder, and considered a related
party at September 27, 1997, owns a majority interest in Counsellors.


38 ADVO, INC.
<PAGE>
 
                   Notes to Consolidated Financial Statements


Warburg ceased being a related party upon the Company's purchase of 1.9 million
shares of its common stock from Warburg. Income earned on investments managed by
Counsellors was $.5 million and $1.2 million in fiscal 1997 and 1996,
respectively. At September 27, 1997, $11.6 million was being managed by
Counsellors. Two Directors of the Company are officers of Warburg and another
Director is a Director of the various Counsellors managed mutual funds.

Note 17  Supplemental Cash Flow Information

Cash paid for income taxes was $16.0 million, $11.0 million and $3.2 million in
fiscal 1998, 1997 and 1996, respectively. Cash paid for interest expense in
fiscal 1998, 1997 and 1996 was $13.6 million, $14.4 million and $7.2 million,
respectively.
   Excluded from continuing investing activities was the effect of a certain
noncash activity in which the Company received a note for $3.5 million in
conjunction with the sale of a business line in fiscal 1996. (See Note 9.)

Note 18  Recent Accounting Pronouncements

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." This
Statement establishes standards for the way that public enterprises report
information about operating segments in annual financial statements and interim
financial stockholders' reports. The statement requires the Company to report
information by operating segment on the basis which it uses internally for
evaluating performance. The effective date of the Statement is for periods
beginning after December 15, 1997. The Company will adopt this Statement in
fiscal 1999.
   In June 1997, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes the accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. It requires recognition of all derivatives as either assets
or liabilities measured at the fair value. Depending on the intended use of the
derivative, changes in fair value will be reported in the period of change as
either a component of earnings or a component of other comprehensive income. The
Company has not quantified the impact of adoption on its financial statements.
The Company will adopt this statement in the first quarter of fiscal 2000.


Note 19  Quarterly Financial Data (Unaudited)

(In millions, except per share data)

<TABLE> 
<CAPTION> 
Fiscal year ended                  First       Second       Third      Fourth
September 26, 1998                Quarter     Quarter     Quarter     Quarter
--------------------------------------------------------------------------------
<S>                               <C>         <C>         <C>         <C>  
Revenues                          $ 262.1     $ 253.2     $ 269.0     $ 262.2
Gross profit                         67.2        63.9        74.9        71.2
Operating income                     17.2        12.5        23.2        19.2
Net income                            8.4         5.4        12.1         9.7
Earnings per common share             .37         .24         .54         .43
Earnings per common share
  --assuming dilution                 .36         .24         .52         .42
Common stock price
  High                             23 5/8    26 13/16    30 15/16      33 5/8
  Low                              17 3/4          19    24 11/16      22 1/4
--------------------------------------------------------------------------------

Fiscal year ended                     First      Second      Third     Fourth
September 27, 1997                   Quarter    Quarter    Quarter    Quarter
--------------------------------------------------------------------------------
Revenues                             $ 255.1    $ 242.5    $ 258.2    $ 260.7
Gross profit                            62.8       58.2       69.3       68.8
Operating income                        14.0        8.0       19.1       17.4
Net income                               6.2        2.6        9.4        8.6
Earnings per common share (1)            .26        .11        .39        .35
Earnings per common share
  --assuming dilution (1)                .25        .11        .38        .35
Common stock price
  High                                14 1/4     14 5/8   16 13/16    19 7/16
  Low                                     11     11 5/8     11 3/8     15 5/8
--------------------------------------------------------------------------------
</TABLE> 

(1) Reflects restated earnings per share in accordance with SFAS No. 128. 
(See Note 8.)


                                                                  ADVO, INC. 39 
<PAGE>
 
Report of Independent Auditors

To the Board of Directors and Stockholders of ADVO, Inc.
We have audited the accompanying consolidated balance sheets of ADVO, Inc. at
September 26, 1998 and September 27, 1997, and the related consolidated
statements of operations, cash flows, and changes in stockholders' equity
(deficiency) for each of the three years in the period ended September 26, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
   We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
   In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of ADVO, Inc. at
September 26, 1998 and September 27, 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
September 26, 1998 in conformity with generally accepted accounting principles.

/s/ Ernst & Young LLP

Hartford, Connecticut
October 20, 1998


Report of Financial Responsibility

To the Stockholders of ADVO, Inc.
The management of ADVO, Inc. is responsible for the integrity and objectivity of
the consolidated financial statements and other financial information presented
in this report. These statements have been prepared in accordance with generally
accepted accounting principles and necessarily include amounts based on
judgements and estimates by management.
   ADVO maintains internal accounting control policies and related procedures
designed to provide reasonable assurance that assets are safeguarded, that
transactions are executed in accordance with management's authorization and
properly recorded, and that accounting records may be relied upon for the
preparation of reliable published annual and interim financial statements and
other financial information. The design, monitoring, and revision of internal
accounting control systems involve, among other things, management's judgement
with respect to the relative cost and expected benefits of specific control
measures. The Company also maintains an internal auditing function which
evaluates and reports on the adequacy and effectiveness of internal accounting
controls and policies and procedures.
   The Company's consolidated financial statements have been audited by
independent auditors who have expressed their opinion with respect to the
fairness of these statements.
   The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with ADVO's management, internal auditors and
independent auditors to review matters relating to the quality of financial
reporting and internal accounting controls. Both the internal auditors and the
independent auditors have unrestricted access to the Committee.

/s/ Robert Kamerschen

Robert Kamerschen
Chairman and Chief Executive Officer


/s/ Donald E. McCombs 

Donald E. McCombs 
Senior Vice President and Chief Financial Officer


/s/ Julie A. Abraham 

Julie A. Abraham 
Vice President and Controller

October 20, 1998


40 ADVO, INC.