AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 13, 1998.
REGISTRATION NO. 333-60989
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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AKI, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 2799 13-3785856
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
1815 EAST MAIN STREET
CHATTANOOGA, TENNESSEE 37404
(423) 624-3301
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
KENNETH A. BUDDE
CHIEF FINANCIAL OFFICER
AKI, INC.
1815 EAST MAIN STREET
CHATTANOOGA, TENNESSEE 37404
(423) 624-3301
(Name, address, including zip code, and telephone number
including area code, of agent for service)
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COPIES TO:
EDWARD D. SOPHER, ESQ.
AKIN, GUMP, STRAUSS, HAUER & FELD, L.L.P.
590 MADISON AVENUE
NEW YORK, NEW YORK 10022
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF SECURITIES TO THE
PUBLIC: As soon as practicable after the effective date of this Registration
Statement.
If any of the securities being registered on this Form are to be offered
in connection with the formation of a holding company and there is compliance
with General Instruction G, check the following box. [ ]
If any of the securities being registered on this form are being offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, check the following box: [X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [ ]
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CALCULATION OF REGISTRATION FEE (1)
- ------------------------------------------------------------------------------------------------------------
PROPOSED
PROPOSED MAXIMUM
MAXIMUM AGGREGATE AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE OFFERING REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED PER UNIT (2) PRICE (2) FEE
- ------------------------------------------------------------------------------------------------------------
10 1/2% Senior Notes Due 2008 ......... $115,000,000 100% $115,000,000 $33,925 (3)
- ------------------------------------------------------------------------------------------------------------
(1) This Registration Statement covers both the Prospectus filed hereby in
connection with the Exchange Offer for the New Notes and the Prospectus
filed hereby in connection with certain market making activities by an
affiliate of the Registrant.
(2) Estimated solely for the purpose of calculating the registration fee.
(3) Fee previously paid.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
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EXPLANATORY NOTE
This Registration Statement covers the registration of an aggregate
principal amount of $115,000,000 of New 10 1/2% Senior Notes due 2008 (the "New
Notes") of AKI, Inc. (the "Company") that may be exchanged for equal principal
amounts of the Company's outstanding 10 1/2% Senior Notes due 2008 (the "Old
Notes") (the "Exchange Offer"). This exchange offer registration statement (the
"Exchange Offer Registration Statement") also covers the registration of the
New Notes for resale by Donaldson, Lufkin & Jenrette Securities Corporation in
market-making transactions. The complete Prospectus relating to the Exchange
Offer (the "Exchange Offer Prospectus") follows immediately after this
Explanatory Note. Following the Exchange Offer Prospectus are certain pages of
the Prospectus relating solely to such market-making transactions (the
"Market-Making Prospectus"), including alternate front and back cover pages, an
alternate "Available Information" section, a section entitled "Risk
Factors--Trading Market for the New Notes" to be used in lieu of the section
entitled "Risk Factors--No Public Market for the New Notes," a new section
entitled "Use of Proceeds" and alternate sections entitled "Certain U.S.
Federal Income Tax Considerations for Non-U.S. Holders" and "Plan of
Distribution." In addition, the Market-Making Prospectus will not include the
following captions (or the information set forth under such captions) in the
Exchange Offer Prospectus: "Prospectus Summary--Summary of Terms of the
Exchange Offer," "Risk Factors--Consequences of the Exchange Offer on
Non-Tendering Holder of the Old Notes" and "The Exchange Offer." All other
sections of the Exchange Offer Prospectus will be included in the Market-Making
Prospectus. In order to register under Rule 415 of the Securities Act of 1933
those New Notes that will be offered and sold in market-making transactions,
the appropriate box on the cover page of the Registration Statement has been
checked and the undertakings required by Item 512(a) of Regulation S-K have
been included in Item 22 of Part II.
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF ANY OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO ANY REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY STATE.
SUBJECT TO COMPLETION DATED NOVEMBER 13, 1998
PROSPECTUS
OFFER TO EXCHANGE
NEW 10 1/2% SENIOR NOTES DUE 2008 FOR UP TO $115,000,000
IN PRINCIPAL AMOUNT OUTSTANDING
10 1/2% SENIOR NOTES DUE 2008
OF
AKI, INC.
-----------
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME,
ON , 1998, UNLESS EXTENDED
AKI, Inc., a Delaware corporation (the "Company"), hereby offers, upon the
terms and subject to the conditions set forth in this Prospectus and the
accompanying letter of transmittal (the "Letter of Transmittal," and together
with this Prospectus, the "Exchange Offer"), to exchange $1,000 principal
amount of its New 10 1/2% Senior Notes due 2008 (the "New Notes") for each
$1,000 principal amount of the outstanding 10 1/2% Senior Notes due 2008 (the
"Old Notes") of the Company, of which $115,000,000 principal amount is
outstanding from the holders thereof (the "Holders"). The New Notes will be
obligations of the Company issued pursuant to the Indenture under which the Old
Notes were issued (the "Indenture"). The form and terms of the New Notes are
the same as the form and terms of the Old Notes except that (i) the New Notes
will have been registered under the Securities Act of 1933, as amended (the
"Securities Act"), pursuant to an Exchange Offer Registration Statement (as
defined herein) of which this Prospectus is a part, and thus will not bear
legends restricting their transfer pursuant to the Securities Act, (ii) Holders
of the New Notes will not be entitled to certain rights of Holders of the Old
Notes under the Registration Rights Agreement (as defined herein) which rights
will terminate upon the consummation of the Exchange Offer and (iii) for
certain contingent liquidated damages provisions. See "The Exchange Offer." The
New Notes and the Old Notes are collectively referred to herein as the "Notes."
The New Notes will mature on July 1, 2008. Interest on the New Notes will
be payable semi-annually on January 1 and July 1 of each year, commencing on
January 1, 1999, at a rate of 10 1/2% per annum. Holders of Old Notes whose Old
Notes are accepted for exchange will be deemed to have waived the right to
receive any payment in respect of interest accrued from June 25, 1998 to the
date of issuance of the New Notes. The New Notes will be redeemable at the
option of the Company, in whole or in part, at anytime on or after July 1,
2003, in cash at the redemption prices set forth herein, plus accrued and
unpaid interest and Liquidated Damages (as defined herein), if any, thereon to
the date of redemption. In addition, at any time prior to July 1, 2001, the
Company may on any one or more occasions redeem up to 35% of the aggregate
principal amount of New Notes originally issued at a redemption price equal to
110.5% of the principal amount thereof, plus accrued and unpaid interest and
Liquidated Damages, if any, thereon to the redemption date, with the net cash
proceeds of one or more Public Equity Offerings (as defined herein); provided
that at least 65% of the aggregate principal amount of New Notes originally
issued remains outstanding immediately after the occurrence of any such
redemption. See "Description of New Notes--Optional Redemption." In addition,
upon the occurrence of a Change of Control (as defined herein), each holder of
Notes will have the right to require the Company to repurchase all or any part
of such Holder's Notes at an offer price in cash equal to 101% of the aggregate
principal amount thereof, plus accrued and unpaid interest and Liquidated
Damages, if any, thereon to the date of repurchase. See "Description of New
Notes--Repurchase at the Option of Holders--Change of Control." There can be no
assurance that, in the event of a Change of Control, the Company would have
sufficient funds to purchase all Notes tendered. See "Risk Factors--Limitations
on Ability to Make Change of Control Payment."
(Continued on next page)
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SEE "RISK FACTORS" BEGINNING ON PAGE 13 OF THIS PROSPECTUS FOR A
DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY HOLDERS PRIOR TO
TENDERING THEIR OLD NOTES IN THE EXCHANGE OFFER.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THE PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is , 1998
The New Notes will be general unsecured obligations of the Company, will
rank pari passu in right of payment to all existing and future senior unsecured
indebtedness of the Company and will rank senior in right of payment to all
existing and future subordinated indebtedness of the Company. As of September
30, 1998, the Company had $16.7 million of other outstanding liabilities
(including trade payables, accrued liabilities and deferred taxes), all of
which ranks pari passu in right of payment with the New Notes. The New Notes,
however, will be effectively subordinated to all secured obligations of the
Company, including borrowings under the Credit Agreement (as defined herein),
to the extent of the assets securing such obligations. As of September 30,
1998, the Company had no outstanding secured obligations, other than
outstanding letters of credit in the amount of $0.6 million under the Credit
Agreement and $1.9 million outstanding under a capitalized lease. In addition,
as of such date borrowings of up to approximately $19.4 million were available
under the Credit Agreement, subject to certain conditions.
The New Notes are being offered hereunder in order to satisfy certain
obligations of the Company contained in the Registration Rights Agreement. The
Old Notes were originally issued and sold on June 25, 1998 in transactions not
registered under the Securities Act in reliance upon the exemption provided in
Section 4(2) of the Securities Act. Accordingly, the Old Notes may not be
reoffered, resold or otherwise pledged, hypothecated or transferred in the
United States unless so registered or unless an applicable exemption from the
requirements of the Securities Act is available. Based upon interpretations by
the staff of the Securities and Exchange Commission (the "Commission") set
forth in no-action letters issued to unrelated third parties, the Company
believes that New Notes issued pursuant to the Exchange Offer in exchange for
Old Notes may be offered for resale, resold and otherwise transferred by a
Holder thereof (other than a "Restricted Holder," being (i) a broker-dealer who
purchases such Old Notes directly from the Company to resell pursuant to Rule
144A or any other available exemption under the Securities Act or (ii) a person
that is an affiliate of the Company within the meaning of Rule 405 under the
Securities Act), without compliance with the registration and prospectus
delivery provisions of the Securities Act, provided that the Holder is
acquiring the New Notes in the ordinary course of its business and is not
participating, does not intend to participate and has no arrangement or
understanding with any person to participate, in a distribution of the New
Notes. Eligible Holders wishing to accept the Exchange Offer must represent to
the Company that such conditions have been met. Each broker-dealer that
receives New Notes for its own account pursuant to the Exchange Offer must
acknowledge that it will deliver a prospectus in connection with any resale of
such New Notes. The Letter of Transmittal relating the Exchange Offer states
that by so acknowledging and by delivering a prospectus, a broker-dealer will
not be deemed to admit that it is an "underwriter" within the meaning of the
Securities Act. This Prospectus, as it may be amended or supplemented from time
to time, may be used by a broker-dealer in connection with resales of New Notes
received in exchange for Old Notes where such Old Notes were acquired by such
broker-dealer as a result of market-making activities or other trading
activities. The Company has agreed that it will make this Prospectus available
to any broker-dealer for use in connection with any such resale for a period
from the date of this Prospectus until 180 days after the consummation of the
Exchange Offer, or such shorter period as will terminate when all Old Notes
acquired by broker-dealers for their own accounts as a result of market-making
activities or other trading activities have been exchanged for New Notes and
resold by such broker-dealers. See "The Exchange Offer" and "Plan of
Distribution."
Any Old Notes not tendered and accepted in the Exchange Offer will remain
outstanding. To the extent that Old Notes are tendered and accepted in the
Exchange Offer, a holder's ability to sell untendered Old Notes could be
adversely affected. Following consummation of the Exchange Offer, the holders
of Old Notes will continue to be subject to the existing restrictions on
transfer thereof and the Company will have no further obligation to such
holders to provide for the registration under the Securities Act of the Old
Notes. See "Risk Factors--Consequences of Exchange Offer on Non-Tendering
Holders of the Old Notes."
Prior to the Exchange Offer, there has been only a limited secondary
market and no public market for the Old Notes. If a market for the New Notes
should develop, the New Notes could trade at a discount from their principal
amount. The Company does not intend to list the New Notes on a national
securities exchange or to apply for quotation of the New Notes through the
National Association of Securities
i
Dealers Automated Quotation System. Accordingly, there can be no assurance as
to the development or liquidity of any public market for the New Notes. The
Company has been advised by Donaldson, Lufkin & Jenrette Securities Corporation
("DLJ") as the initial purchaser (the "Initial Purchaser"), that the Initial
Purchaser intends to make a market for the New Notes. However, the Initial
Purchaser is not obligated to do so and any market-making activities with
respect to the New Notes may be discontinued at any time without notice. See
"Risk Factors--No Public Market for the Notes" and "Plan of Distribution."
The Company will not receive any proceeds from the Exchange Offer. See
"Use of Proceeds." The Company will accept for exchange any and all Old Notes
that are validly tendered on or prior to 5:00 p.m. New York City time, on the
date the Exchange Offer expires, which will be , 1998, unless the
Exchange Offer is extended (the "Expiration Date"). The exchange of New Notes
for Old Notes will be made promptly following the Expiration Date. Tenders of
Old Notes may be withdrawn at any time prior to 5:00 p.m., New York City time,
on the Expiration Date, unless previously accepted for exchange. The Exchange
Offer is not conditioned upon any minimum principal amount of Old Notes being
tendered for exchange. However, the Exchange Offer is subject to certain
conditions which may be waived by the Company. See "The Exchange Offer." The
Company has agreed to pay the expenses of the Exchange Offer (which shall not
include the expenses of any Holder of the Notes in connection with resales of
the New Notes).
Old Notes initially purchased by qualified institutional buyers were
initially represented by a single, global Note in registered form, registered
in the name of a nominee of The Depository Trust Company ("DTC"), as
depository. The New Notes exchanged for Old Notes represented by the global
Note will be represented by one or more global New Notes in registered form,
registered in the name of the nominee of DTC. New Notes in global form will
trade in DTC's Same-Day Funds Settlement System, and secondary market trading
activity in such New Notes will therefore settle in immediately available
funds. See "Description of New Notes--Form, Denomination and Book-Entry
Procedures."
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THE EXCHANGE OFFER IS NOT BEING MADE TO, NOR WILL THE COMPANY ACCEPT
SURRENDERS FOR EXCHANGE FROM, HOLDERS OF OLD NOTES IN ANY JURISDICTION IN WHICH
THE EXCHANGE OFFER OR THE ACCEPTANCE THEREOF WOULD NOT BE IN COMPLIANCE WITH
THE SECURITIES OR BLUE SKY LAWS OF SUCH JURISDICTION.
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NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THIS EXCHANGE OFFER COVERED BY THIS PROSPECTUS OR THE
ACCOMPANYING LETTER OF TRANSMITTAL. IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY. THIS PROSPECTUS AND THE ACCOMPANYING LETTER OR TRANSMITTAL DOES NOT
CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE EXCHANGE
NOTES IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO
MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS OR
THE ACCOMPANYING LETTER OF TRANSMITTAL, NOR ANY SALE MADE HEREUNDER SHALL,
UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS NOT BEEN ANY
CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS OF THE
COMPANY SINCE THE DATE HEREOF.
ii
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AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 (the "Exchange Offer Registration Statement") under the Securities Act with
respect to the New Notes being offered by this Prospectus. This Prospectus does
not contain all of the information set forth in the Exchange Offer Registration
Statement and the exhibits and schedules thereto, certain portions of which
have been omitted pursuant to the rules and regulations of the Commission.
Statements made in this Prospectus as to the contents of any contract,
agreement or other document are not necessarily complete. With respect to each
such contract, agreement or other document filed or incorporated by reference
as an exhibit to the Exchange Offer Registration Statement, reference is made
to such exhibit for a more complete description of the matter involved, and
each such statement is qualified in its entirety by such reference.
The Exchange Offer Registration Statement and the exhibits and schedules
thereto may be inspected and copied at the public reference facilities
maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549 and will also be available for inspection and
copying at the regional offices of the Commission located at 7 World Trade
Center, New York, New York 10048 and at 500 West Madison Street (Suite 1400),
Chicago, Illinois 60661. Copies of such material may also be obtained from the
Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. The Commission maintains a web site
(http://www.sec.gov) that contains reports, proxy statements and other
information regarding registrants that file electronically with the Commission.
Under the terms of the Indenture pursuant to which the Old Notes were, and the
New Notes will be issued, the Company has agreed that, whether or not it is
required to do so by the rules and regulations of the Commission, for so long
as any of the Notes remain outstanding, it will furnish to the Trustee and
Holders of the Notes (i) all quarterly and annual financial information that
would be required to be contained in such a filing with the Commission on Forms
10-Q and 10-K if the Company was required to file such forms, including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and, with respect to the annual information only, a report thereon
by the Company's certified independent public accountants and (ii) all reports
that would be required to be filed with the Commission on Form 8-K if the
Company was required to file such reports. Following the consummation of the
Exchange Offer, the Company has agreed to file a copy of all such information
and reports with the SEC for public availability and to make such information
available to the Trustee, securities analysts and prospective investors upon
request. In addition, for so long as any of the Notes remain outstanding, the
Company has agreed to make available to any prospective purchaser of the Notes
or Holder of the Notes in connection with any sale thereof, the information
required by Rule 144A(d)(4) under the Securities Act.
iii
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CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
The information herein contains forward-looking statements that involve a
number of risks and uncertainties. A number of factors could cause actual
results, performance, achievements of the Company, or industry results to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. These factors include,
but are not limited to: the competitive environment in the sampling industry in
general and in the Company's specific market areas; changes in prevailing
interest rates; inflation; changes in costs of goods and services; economic
conditions in general and in the Company's specific market areas; changes in or
failure to comply with postal regulations or other federal, state and/or local
government regulations; liability and other claims asserted against the
Company; changes in operating strategy or development plans; the ability of the
Company to effectively implement its cost reduction program; the ability to
attract and retain qualified personnel; the significant indebtedness of the
Company; labor disturbances; changes in the Company's capital expenditure
plans; and other factors referenced herein. In addition, such forward-looking
statements are necessarily dependent upon assumptions, estimates and dates that
may be incorrect or imprecise and involve known and unknown risks,
uncertainties and other factors. Accordingly, any forward-looking statements
included herein do not purport to be predictions of future events or
circumstances and may not be realized. Forward-looking statements can be
identified by, among other things, the use of forward-looking terminology such
as "believes," "expects," "may," "will," "should," "seeks," "pro forma,"
"anticipates," "intends" or the negative of any thereof, or other variations
thereon or comparable terminology, or by discussions of strategy or intentions.
Given these uncertainties, Holders of Notes are cautioned not to place undue
reliance on such forward-looking statements. The Company disclaims any
obligations to update any such factors or to publicly announce the results of
any revisions to any of the forward-looking statements contained herein to
reflect future events or developments.
iv
PROSPECTUS SUMMARY
The following summary does not purport to be complete and is qualified in
its entirety by the more detailed information and Consolidated Financial
Statements of the Company, together with the notes thereto, contained elsewhere
herein. Unless the context otherwise requires, all references herein to (i)
"Acquisition Corp." shall mean AHC I Acquisition Corp., (ii) "Holding" shall
mean AKI Holding Corp., a wholly-owned subsidiary of Acquisition Corp., (iii)
the "Company" shall mean AKI, Inc., a wholly-owned subsidiary of Holding, and
its predecessors and subsidiaries and (iv) the "Offering" or the "Note
Offering" shall mean the offering of the Old Notes. Prior to commencement of
the Offering, Acquisition Corp. contributed all of its ownership interest in
the Company to Holding and all financial information contained herein gives
effect to such contribution. As used herein, the terms "Fiscal 1996," "Fiscal
1997," "Fiscal 1998," and " Fiscal 1999" when used with respect to the Company
refer to the Company's fiscal years ended June 30, 1996, 1997, 1998 and 1999,
respectively. Fiscal 1998 includes the period prior to the acquisition of the
Company by Acquisition Corp. on December 15, 1997.
THE COMPANY
The Company is the leading global marketer and manufacturer of cosmetics
sampling products, including fragrance, skin care and makeup samplers based
upon the number of units sold. The Company produces a range of proprietary and
patented product samplers that can be incorporated into various print media
principally designed to reach the consumer in the home, such as magazine
inserts, catalog inserts, remittance envelopes, statement enclosures and
blow-ins. The Company is positioned to provide complete marketing and sampling
programs to its customers, including creative content and sample production and
distribution. The Company's customers include most of the world's largest
cosmetics companies, such as Calvin Klein Cosmetics (Unilever Plc), Chanel,
Inc., Christian Dior Perfumes Inc., Coty Inc., Elizabeth Arden (Unilever Plc),
Estee Lauder, Inc., Giorgio Beverly Hills (The Procter & Gamble Company),
L'Oreal S.A./Cosmair, Inc. and Sanofi Beaute, Inc.
Sampling is one of the most effective and widely used promotional
practices for consumer products. Product sampling usage has increased faster
than any other form of consumer promotional usage from 1992 to 1996, the last
year for which data is available. Product sampling is particularly critical to
the cosmetics industries, where consumers generally must try products prior to
purchase because of their uniquely personal nature. The Company's introduction
in 1979 of the ScentStrip (Registered Trademark) sampler, the first pull-apart
microencapsulated fragrance sampler, transformed the fragrance industry by
providing the first cost-effective means to reach consumers in their homes on a
mass scale by combining advertising and product sampling. All of the Company's
sampling products are approved by the U.S. Postal Service for inclusion in
subscription magazines at periodical postage rates, which is a more
cost-effective means of reaching consumers than alternatives such as direct
mail or newsstand magazine distribution. While the microencapsulated fragrance
sampler remains the most widely used technology in the sampling industry, the
Company continues to be the leading innovator in the sampling industry through
its development of alternative sampling technologies, all of which are designed
for cost-effective mass distribution.
In recent years, the Company has complemented its fragrance sampling
business by focusing its research and development efforts on new product
technologies and sampling solutions for the skin care, makeup and consumer
products markets. While product sampling is critical to the success of these
products, sampling programs for these products have been constrained
historically by the characteristics of the available sampling alternatives.
Most sampling programs have consisted of relatively limited in-store or direct
mail efforts because existing samples have been too costly to produce in mass
quantities and have been incapable of being efficiently incorporated into
magazines, catalogs and other print advertising. Since June 1997, the Company
has introduced three innovative product sampling technologies to address this
need, providing the first cost-effective means to reach consumers in their
homes on a
1
mass scale with samples of these products. Management believes these new
technologies have fundamentally altered the economics and efficiencies of
product sampling in these markets. Existing customers such as Chanel, Christian
Dior, Estee Lauder and L'Oreal/Cosmair have utilized these new technologies in
sampling programs for their cosmetics products, such as skin care and liquid
makeup. The Company has also created and produced initial sampling programs for
new consumer products customers.
On June 22, 1998, the Company acquired (the "3M Acquisition") the
fragrance sampling business of the Industrial and Consumer Products division of
Minnesota Mining and Manufacturing Company ("3M") for approximately $7.25
million in cash and the assumption of a certain liability. 3M's fragrance
sampling business was predominantly a sales and distribution business as it
outsourced the production of the majority of the products it sold. The Company
did not assume such outsourcing arrangements and relocated such operations to
its existing facilities in Chattanooga to utilize current excess capacity at
such facilities. Except for several sales and technical employees, the Company
did not extend employment to any employees from 3M. Management believes that in
order to properly service the incremental sales volume associated with the 3M
Acquisition, several additional sales and technical employees will be hired.
RISK FACTORS
Holders of Old Notes should take into account the specific considerations
set forth under "Risk Factors" as well as the other information set forth in
this Prospectus before tendering Old Notes in Exchange for New Notes. Certain
of the considerations the Holders should consider include: (i) the substantial
amount of the Company's outstanding debt and debt service obligations; (ii) the
effective subordination of the Notes to the debt of the Company and its
subsidiaries; (iii) the material adverse effect that certain changes in postal
regulations could have on the Company's competitiveness in subscription
magazine sampling inserts; and (iv) the Company's reliance on a few number of
customers to generate a majority of its sales and the lack of long term
contracts with such customers.
COMPETITIVE ADVANTAGES
Founded in 1902 as a printing company, the Company has been the market
leader in fragrance sampling since its introduction of the ScentStrip sampler
almost two decades ago and has recently expanded the application of its
sampling technologies to new markets. Management believes that the Company has
significant competitive advantages compared to other sampling companies:
o Full product line. The Company is unique in the breadth of its product
line, which includes a full range of fragrance sampling products and
innovative new technologies for sampling skin care and makeup products.
o Technological leadership. The Company is the technological leader in the
cosmetics sampling industry, and has introduced almost every major
fragrance sampling technology to the market since its introduction of
the ScentStrip sampler in 1979.
o Low cost, highest quality producer. Management believes the Company's
high degree of vertical integration, together with the Company's high
volume, provides the Company with certain cost and quality advantages.
o Strong customer relationships. More than 72% of Fiscal 1998 net sales
were generated by sales to customers that have been doing business with
the Company for the past five years or longer, although the Company does
not have any long-term contracts with any of its customers.
o Superior customer service. Managing sampling programs is highly service
intensive and the Company has the most experienced customer service
representatives in the industry.
o Sole global provider. The Company is the only sampling company to
provide local sales, service and production capabilities on a global
basis.
2
BUSINESS STRATEGY
Management's goal is to enhance the Company's position as the leading
global marketer and manufacturer of cosmetics sampling products and position
itself for growth in the consumer products sampling market, while increasing
its profitability. To achieve this goal, management is pursuing a strategy
based on the following elements:
o Leverage existing customer relationships to expand into new cosmetics
categories. Management believes that its recent innovative and cost
effective developments in product sampling technologies for make-up and
skin care categories, together with its established cosmetics industry
customer relationships, position the Company for future growth in this
area.
o Penetrate the consumer products market. Management believes that the
Company has significant opportunities to increase its existing sampling
business by applying its cost-effective sampling technologies to new
end-user categories within the consumer products market. The consumer
products market is significantly larger than the Company's traditional
fragrance market.
o Continue implementation of cost reduction program. The Company is
implementing a comprehensive program to reduce annual operating costs by
approximately $4.0 million. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Cost Reduction Program."
o Increase international sales. Given the Company's product innovations,
the increasing globalization of the cosmetics industry and the success
of sampling techniques in the U.S. market, the Company believes it can
increase its international sales.
3
THE TRANSACTIONS
THE ACQUISITION
DLJ Merchant Banking Partners II, L.P. and certain related investors
(collectively, "DLJMBII") and certain members of the Company's management
organized Acquisition Corp. to acquire (the "Acquisition") of all the
outstanding equity interests of the Company. The Acquisition was completed on
December 15, 1997. The total cost of the Acquisition (including related fees,
expenses and cash for working capital) was approximately $205.7 million.
Included in the total cost of the Acquisition were approximately $6.2 million
in non-cash costs comprised of (i) the assumption of a promissory note issued
by the Company in connection with the 1995 acquisition of Scent Seal, Inc. (the
"Scent Seal Note") and certain capital lease obligations and (ii) the exchange
of stock options to acquire Preferred Stock in the Company by the Company's
Chief Executive Officer to acquire preferred stock in Acquisition Corp. See
"Description of Certain Indebtedness." To provide the $199.5 million of cash
necessary to fund the Acquisition, including the equity purchase price and the
retirement of all previously existing preferred stock and debt of the Company
not assumed, (i) the Company issued $123.5 million in Senior Increasing Rate
Notes (the "Bridge Notes") to Scratch & Sniff Funding, Inc. (the "Bridge
Lender"), an affiliate of DLJMBII and the Initial Purchaser and (ii)
Acquisition Corp. received $76.0 million from debt and equity (common and
preferred) financings, including equity investments by certain prior
stockholders. See "The Transactions--The Acquisition." As of September, 1998,
(i) DLJMBII held an aggregate of approximately 81.3% of the outstanding common
stock of Acquisition Corp. and (ii) the Company's Chief Executive Officer held
an aggregate of approximately 12.1% of the outstanding common stock of
Acquisition Corp. See "Risk Factors--Control by DLJMBII, Conflicts of Interest"
"Security Ownership of Certain Beneficial Owners and Management" and "The
Acquisition." Acquisition Corp. has adopted a stock option plan for management
of Acquisition Corp., Holding and the Company and granted options thereunder to
the Company's Chief Executive Officer. See "Management--Equity-Based
Compensation."
3M ACQUISITION
On June 22, 1998, the Company acquired (the "3M Acquisition") the
fragrance sampling business of the Industrial and Consumer Products division of
Minnesota Mining and Manufacturing Company ("3M") for $7.25 million in cash and
the assumption of a liability of $182,000 to one of the customers of the
business. 3M's fragrance sampling business was predominantly a sales and
distribution business as it outsourced the production of the majority of the
products it sold. The Company did not assume such outsourcing arrangements and
relocated such operations to its existing facilities in Chattanooga to utilize
current excess capacity at such facilities. Except for several sales and
technical employees, the Company did not extend employment to any employees
from 3M. Many of 3M's existing customers are also existing customers of the
Company. The Company anticipates that as a result of the 3M Acquisition its
sales volume from these customers will increase. Management believes that in
order to properly service such an increase in sales volume, several additional
sales and technical employees will be hired. The Company financed the 3M
Acquisition with borrowings under the Credit Agreement. Such borrowings were
subsequently repaid with the proceeds of the Equity Contribution and the Note
Offering.
THE OFFERINGS
On June 25, 1998, the Company consummated the Note Offering. The Old Notes
were sold pursuant to exemptions from, or in transactions not subject to, the
registration requirements of the Securities Act. In addition, on June 25, 1998,
Holding issued and sold $50,000,000 in aggregate principal amount at maturity
of debentures (the "Debentures") (the "Debenture Offering") for gross proceeds
of $26.0 million. The Debentures were sold pursuant to exemptions from, or in
transactions not subject to, the registration requirements of the Securities
Act. The consummation of the Note Offering occurred concurrently with and was
conditioned upon, the consummation of the Debenture Offering. The majority of
the proceeds from the Debenture Offering were used to fund a capital
contribution to the Company (the "Equity Contribution"). The Equity
Contribution, together with the proceeds from the Note Offering, were used by
the Company repay the Bridge Notes, to fund working capital requirements and
for general corporate purposes, including repayment of borrowings under the
Credit Agreement to fund the 3M Acquisition (collectively, the "Refinancing").
4
SUMMARY OF TERMS OF THE EXCHANGE OFFER
The Exchange Offer relates to the exchange of up to $115,000,000 aggregate
principal amount of Old Notes for up to an equal aggregate principal amount of
New Notes. The form and terms of the New Notes are identical in all material
respects to the form and terms of the Old Notes except (i) that the New Notes
have been registered under the Securities Act, (ii) that the New Notes are not
entitled to certain registration rights which are applicable to the Old Notes
under the Registration Rights Agreement and (iii) for certain contingent
Liquidated Damages provisions. The Old Notes and the New Notes are collectively
referred to herein as the "Notes." See "Description of New Notes."
THE EXCHANGE OFFER.......... $1,000 principal amount of New Notes will be
issued in exchange for each $1,000 principal
amount of Old Notes validly tendered pursuant to
the Exchange Offer. The exchange of New Notes for
Old Notes will be made with respect to all Old
Notes validly tendered and not withdrawn on or
prior to the Expiration Date promptly following
the Expiration Date. As of the date hereof,
$115,000,000 in aggregate principal amount of Old
Notes are outstanding.
RESALE...................... Based on interpretations by the staff of the
Commission set forth in no-action letters issued
to unrelated third parties, the Company believes
that New Notes issued pursuant to the Exchange
Offer in exchange for Old Notes may be offered
for resale and resold or otherwise transferred by
Holders thereof (other than any Restricted
Holder) without compliance with the registration
and prospectus delivery provisions of the
Securities Act, provided that such New Notes are
acquired in the ordinary course of such Holders'
business and such Holders are not participating,
do not intend to participate and have no
arrangement or understanding with any person to
participate in a distribution of such New Notes.
See "Sherman & Sterling," SEC No-Action Letter
(available July 2, 1993); "Morgan Stanley & Co.,
Incorporated," SEC No-Action Letter (available
June 5, 1991); and "Exxon Capital Holdings
Corporation," SEC No-Action Letter (available
May 13, 1988). Each broker-dealer that receives
New Notes for its own account in exchange for
Old Notes, where such Old Notes were acquired by
such broker-dealer as a result of market-making
activities or other trading activities, must
acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes.
See "The Exchange Offer" and "Plan of
Distribution."
If any person were to participate in the
Exchange Offer for the purpose of distributing
securities in a manner not permitted by the
preceding paragraph, such person could not rely
on the position of the staff of the Commission
and must comply with the prospectus delivery
requirements of the Securities Act in connection
with a secondary resale transaction. Therefore,
each holder of Old Notes who accepts the
Exchange Offer must represent in the Letter of
Transmittal that it meets the conditions
described above. See "The Exchange
Offer--Purpose and Effects of the Exchange
Offer."
5
EXPIRATION DATE............. 5:00 p.m., New York City time, on , 1998
unless the Exchange Offer is extended, in which
case the term "Expiration Date" means the latest
date and time to which the Exchange Offer is
extended. See "The Exchange Offer--Expiration
Date; Extensions; Amendments."
ACCRUED INTEREST ON THE NEW
NOTES AND THE OLD NOTES..... Interest will accrue on the New Notes from June
25, 1998 or from the most recent interest payment
date on the Old Notes surrendered in exchange
therefor. Holders of Old Notes whose Old Notes
are accepted for exchange will be deemed to have
waived the right to receive any payment in
respect of interest accrued from June 25, 1998 to
the date of issuance of the New Notes. See "The
Exchange Offer--Interest on New Notes."
CONDITIONS TO THE
EXCHANGE OFFER.............. The Exchange Offer is subject to certain
customary conditions, which may be waived by the
Company in whole or in part and from time to time
in its sole discretion. See "The Exchange
Offer--Conditions." The Exchange Offer is not
conditioned upon any minimum aggregate principal
amount of Old Notes being tendered for exchange.
PROCEDURE FOR TENDERING
OLD NOTES................... Each Holder of Old Notes wishing to accept the
Exchange Offer must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, in
accordance with the instructions contained herein
and therein, and mail or otherwise deliver such
Letter of Transmittal, or such facsimile,
together with the Old Notes (unless such tender
is being effected pursuant to the procedures for
book-entry transfer described below) to be
exchanged and any other required documentation to
the Exchange Agent (as defined herein) at the
address set forth herein and therein. See "The
Exchange Offer--Procedure for Tendering."
SPECIAL PROCEDURES FOR
BENEFICIAL OWNERS........... Any beneficial owner whose Old Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other nominee
and who wishes to tender in the Exchange Offer
should contact such registered Holder promptly
and instruct such registered holder to tender on
such beneficial owner's behalf. If such
beneficial owner wishes to tender on his own
behalf, such beneficial owner must, prior to
completing and executing the Letter of
Transmittal and delivering his Old Notes, either
make appropriate arrangements to register
ownership of the Old Notes in such Holder's name
or obtain a properly completed bond power from
the registered Holder. The transfer of record
ownership may take considerable time and may not
be able to be completed prior to the Expiration
Date. See "The Exchange Offer--Procedure for
Tendering."
GUARANTEED DELIVERY
PROCEDURES.................. Holders of Old Notes who wish to tender their Old
Notes and whose Old Notes are not immediately
available or who cannot
6
deliver their Old Notes, the Letter of
Transmittal or any other documents required by
the Letter of Transmittal to the Exchange Agent
prior to the Expiration Date must tender their
Old Notes according to the guaranteed delivery
procedures set forth in "The Exchange
Offer--Guaranteed Delivery Procedures."
WITHDRAWAL RIGHTS........... Tenders of Old Notes may be withdrawn at any
time prior to 5:00 p.m., New York City time, on
the Expiration Date, unless previously accepted
for exchange. See "The Exchange Offer--Withdrawal
of Tenders."
ACCEPTANCE OF OLD NOTES AND
DELIVERY OF NEW NOTES....... The Company will accept for exchange any and
all Old Notes which are validly tendered in the
Exchange Offer prior to 5:00 p.m., New York City
time, on the Expiration Date. The New Notes
issued pursuant to the Exchange Offer will be
delivered promptly following the Expiration Date.
See "The Exchange Offer--Terms of the Exchange
Offer."
CONSEQUENCE OF FAILURE
TO EXCHANGE.................. Holders of Old Notes who do not exchange their
Old Notes for New Notes pursuant to the Exchange
Offer will continue to be subject to the
restrictions on transfer of such Old Notes as set
forth on the legend thereon. In addition, if the
Exchange Offer is consummated, the Company does
not intend to file further registration
statements for the sale or other disposition of
the Old Notes. See "Risk Factors--No Public
Market for the Notes" and "Risk
Factors--Consequences of the Exchange Offer on
Non-Tendering Holders of the Old Notes."
REGISTRATION RIGHTS AGREEMENT;
EFFECT ON HOLDERS........... The Old Notes were sold by the Company on June
25, 1998 to DLJ, as the initial purchaser (the
"Initial Purchaser") pursuant to a Purchase
Agreement dated June 22, 1998 between the Company
and the Initial Purchaser (the "Purchase
Agreement"). The Initial Purchaser subsequently
sold the Old Notes to qualified institutional
buyers and non-U.S. persons in reliance on Rule
144A and Regulation S, respectively, under the
Securities Act. Pursuant to the Purchase
Agreement, the Company and the Initial Purchaser
entered into a Registration Rights Agreement
dated as of June 25, 1998 (the "Registration
Rights Agreement") which grants the Holders of
the Old Notes certain exchange and registration
rights. The Exchange Offer is being made to
satisfy this contractual obligation of the
Company. The Holders of New Notes are not
entitled to any exchange or registration rights
with respect to the New Notes. See "The Exchange
Offer--Purpose and Effects of the Exchange
Offer."
U.S. FEDERAL INCOME TAX
CONSEQUENCES................ In the opinion of Akin, Gump, Strauss, Hauer &
Feld, L.L.P., legal counsel to the Company, the
exchange of Old Notes for
7
New Notes by tendering holders will not be a
taxable exchange for federal income tax
purposes, and such holders will not recognize
any taxable gain or loss or any interest income
for federal income tax purposes as a result of
such exchange. See "U.S. Federal Income Tax
Consequences."
EXCHANGE AGENT.............. IBJ Schroder Bank & Trust Company, the Trustee
under the Indenture, is serving as exchange agent
(the "Exchange Agent") in connection with the
Exchange Offer. The address of the Exchange Agent
is P.O. Box 84, Bowling Green Station, New York,
New York 10274-0084. Hand and overnight
deliveries should be directed to the Exchange
Agent at One State Street, New York, New York
10004, Attn: Securities Processing Window,
Subcellar One (SC-1). For information with
respect to the Exchange Offer, call (212)
858-2103. See "The Exchange Offer--Exchange
Agent."
USE OF PROCEEDS............. The Company will not receive any cash proceeds
from the exchange of the New Notes for the Old
Notes pursuant to the Exchange Offer. The net
proceeds from the sale of Old Notes of
approximately $110.2 million (after deducting
underwriting discounts and expenses of the
Offering) have been used, together with the
Equity Contribution, (i) to repay the entire
outstanding principal amount of, and accrued and
unpaid interest on, the Bridge Notes, which were
issued to an affiliate of DLJMBII and the Initial
Purchaser in connection with the Acquisition and
(ii) to fund working capital requirements and for
general corporate purposes, including funding the
purchase price of the 3M Acquisition. See "Use of
Proceeds" and "The Transactions--3M Acquisition."
8
SUMMARY DESCRIPTION OF NEW NOTES
SECURITIES OFFERED.......... $115.0 million in aggregate principal amount of
the Company's 10 1/2% Senior Notes due 2008 (the
"New Notes").
MATURITY DATE............... July 1, 2008.
INTEREST RATE............... The New Notes will bear interest at the rate of
10 1/2% per annum, payable semi-annually in cash
in arrears on January 1 and July 1 of each year,
commencing January 1, 1999.
OPTIONAL REDEMPTION......... The New Notes will be redeemable at the option
of the Company, in whole or in part, at any time
on or after July 1, 2003, in cash at the
redemption prices set forth herein, plus accrued
and unpaid interest and Liquidated Damages, if
any, thereon to the date of redemption. In
addition, at any time prior to July 1, 2001, the
Company may on any one or more occasions redeem
up to 35% of the aggregate principal amount of
New Notes originally issued at a redemption price
equal to 110.5% of the principal amount thereof,
plus accrued and unpaid interest and Liquidated
Damages, if any, thereon to the redemption date,
with the net cash proceeds of one or more Public
Equity Offerings; provided that at least 65% of
the aggregate principal amount of New Notes
originally issued remain outstanding immediately
after the occurrence of such redemption. See
"Description of New Notes--Optional Redemption."
CHANGE OF CONTROL........... Upon the occurrence of a Change of Control,
each Holder of New Notes will have the right to
require the Company to repurchase all or any part
of such Holder's New Notes at an offer price in
cash equal to 101% of the aggregate principal
amount thereof, plus accrued and unpaid interest
and Liquidated Damages, if any, thereon to the
date of repurchase. See "Description of New
Notes--Repurchase at the Option of
Holders--Change of Control." There can be no
assurance that, in the event of a Change of
Control, the Company would have sufficient funds
to repurchase all New Notes tendered. See "Risk
Factors--Limitations on Ability to Make Change of
Control Payment."
RANKING..................... The New Notes will be general unsecured
obligations of the Company, will rank pari passu
in right of payment to all existing and future
unsecured senior indebtedness of the Company and
will rank senior in right of payment to all
existing and future subordinated indebtedness of
the Company. As of September 30, 1998, the
Company had (i) $16.7 million in other unsecured
obligations (including trade payables, accrued
liabilities and deferred taxes), all of which
ranks pari passu in right of payment with the
Notes (ii) no outstanding liabilities ranking
junior to the Notes (however, the Debentures of
Holdings effectively rank junior to the Notes),
and (iii) no outstanding liabilities ranking
senior to the Notes. The New Notes, however, will
be effectively subordinated to all secured
obligations of the Company, including borrowings
under the Credit Agreement, to the extent of the
assets securing such obligations. As of September
9
30, 1998, the Company had no outstanding secured
obligations, other than outstanding letters of
credit in the amount of $0.6 million under the
Credit Agreement and $1.9 million outstanding
under a capitalized lease. In addition, as of
such date, borrowings of up to approximately
$19.4 million were available under the Credit
Agreement, subject to certain conditions.
CERTAIN COVENANTS........... The Indenture contains certain covenants that
will limit, among other things, the ability of
the Company to: (i) pay dividends, redeem capital
stock or make certain other restricted payments
or investments; (ii) incur additional
indebtedness or issue preferred equity interests;
(iii) merge, consolidate or sell all or
substantially all of its assets; (iv) create
liens on assets; and (v) enter into certain
transactions with affiliates or related persons.
See "Description of New Notes--Certain
Covenants."
------------
The Company is a wholly owned subsidiary of Holding. Holding is a wholly
owned subsidiary of Acquisition Corp. The Company operates under the trade name
"Arcade Marketing, Inc." and its principal executive offices are located at
1815 East Main Street, Chattanooga, Tennessee 37404 and its telephone number is
(423) 624-3301.
10
SUMMARY HISTORICAL AND PRO FORMA CONSOLIDATED FINANCIAL DATA
Set forth below are summary historical and pro forma consolidated
financial data of the Company and the predecessor of the Company (the
"Predecessor") as of the dates and for the periods presented. The summary
historical consolidated financial data of the Predecessor were derived from the
audited consolidated financial statements of the Predecessor, except for the
data for the three months ended September 30, 1997, which were derived from the
unaudited consolidated interim financial statements of the Predecessor. The
summary historical consolidated financial data of the Company as of June 30,
1998 and for the period from December 16, 1997 to June 30, 1998 have been
derived from the audited consolidated financial statements of the Company. The
summary historical consolidated financial data of the Company as of September
30, 1998 and three months then ended have been derived from the unaudited
consolidated interim financial statements of the Company. In the opinion of
management, the unaudited consolidated interim financial statements of the
Predecessor and the Company include all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the financial
condition and results of operations as of such dates and for such periods. The
pro forma consolidated financial data give effect to the Acquisition, the
Refinancing and the 3M Acquisition and have been derived from the Unaudited Pro
Forma Condensed Consolidated Financial Data appearing elsewhere herein. The
information contained in this table should be read in conjunction with
"Selected Historical Consolidated Financial Data," "Management's Discussion and
Analysis of Financial Condition and Results of Operations," the Company's
Unaudited Pro Forma Condensed Consolidated Statements of Operations and the
notes thereto, the Company's Consolidated Financial Statements and the notes
thereto and the other information contained elsewhere in this Prospectus.
PREDECESSOR
--------------------------------------------------------
FISCAL YEAR ENDED JUNE THREE MONTHS JULY 1, 1997
30, ENDED TO
------------------------- SEPTEMBER 30, DECEMBER 15,
1996 1997 1997 1997
------------ ------------ --------------- --------------
(DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Net sales ...................... $ 73,486 $ 77,723 $ 21,928 $ 35,186
Cost of goods sold ............. 49,862 49,467 13,622 22,809
-------- -------- -------- --------
Gross profit ................... 23,624 28,256 8,306 12,377
Selling, general and
administrative expenses ....... 10,655 13,353 3,322 5,712
Amortization of goodwill ....... 1,214 1,214 304 559
-------- -------- -------- --------
Income from operations ......... 11,755 13,689 4,680 6,106
Interest expense ............... 6,762 6,203 1,451 2,646
OTHER DATA (1):
Capital
expenditures .................. 2,051 2,462 448 807
Ratio of earnings to fixed
charges (2) ................... 1.6x 2.1x 3.1x 2.2x
THE COMPANY
------------------------------------------
PRO FORMA
------------
DECEMBER 16, FISCAL
1997 YEAR THREE MONTHS
TO ENDED ENDED
JUNE 30, JUNE 30, SEPTEMBER 30,
1998 1998 1998
-------------- ------------ --------------
(DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Net sales ...................... $36,066 $ 81,831 $ 24,024
Cost of goods sold ............. 24,518 52,127 15,421
------- -------- --------
Gross profit ................... 11,548 29,704 8,603
Selling, general and
administrative expenses ....... 5,601 12,350 3,121
Amortization of goodwill ....... 2,087 4,030 1,008
------- -------- --------
Income from operations ......... 3,860 13,324 4,474
Interest expense ............... 11,269 13,049 3,210
OTHER DATA (1):
Capital
expenditures .................. 514 1,321 678
Ratio of earnings to fixed
charges (2) ................... -- 1.0x 1.4x
THE COMPANY
---------------------------
AT AT
JUNE 30, SEPTEMBER 30,
1998 1998
---------- --------------
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and cash equivalents ........... $ 1,641 $ 1,341
Working capital ..................... 12,845 14,444
Total assets ........................ 211,064 213,725
Total debt .......................... 118,428 116,951
Total stockholder's equity .......... 79,621 80,090
11
- ----------
(1) EBITDA for the Predecessor was $16,177 and $18,773 for the fiscal years
ended June 30, 1996 and 1997, respectively, $6,081 for the three months
ended September 30, 1997 and $8,562 for July 1, 1997 through December 15,
1997. EBITDA for the Company was $8,714 for December 16, 1997 through
June 30, 1998, $6,523 for the three months ended September 30, 1998 and
$20,713 on a pro forma basis for the fiscal year ended June 30, 1998.
EBITDA is defined as income from operations plus depreciation and
amortization of goodwill and other intangibles. EBITDA is discussed
because it is a widely accepted financial indicator used by certain
investors and analysts, and the Company believes that it is useful, to
analyze and compare companies on the basis of operating performance.
EBITDA is not intended to represent cash flows for the period, nor has it
been presented as an alternative to operating income as an indicator of
operating performance and should not be considered in isolation or as a
substitute for measures of performance prepared in accordance with
generally accepted accounting principles ("GAAP") in the United States
and is not indicative of operating income of cash flow from operations as
determined under GAAP. EBITDA is not necessarily comparable with
similarly titled measures for other companies.
Pro forma EBITDA for the fiscal year ended June 30, 1998 has not been
adjusted for the following unusual items: (i) $307 of legal costs and
royalty payments associated with a successful patent infringement claim
against a competitor; (ii) costs totaling $155 incurred in connection
with centralizing certain acquired technologies; and (iii) costs totaling
$16 related to former stockholder expenses and severance costs at the
Company's European subsidiary.
Net cash provided by (used in) operating activities for the Predecessor
was $5,337 and $8,942 for the fiscal years ended June 30, 1996 and 1997,
respectively, ($2,237) for the three months ended September 30, 1997 and
$4,928 for July 1, 1997 through December 15, 1997. Net cash provided by
(used in) operating activities for the Company was $(8,821) for December
16, 1997 through June 30, 1998 and $1,855 for the three months ended
September 30, 1998. Net cash provided by operating activities for the
Company was $3,146 on a pro forma basis for the fiscal year ended June
30, 1998.
Net cash used in investing activities for the Predecessor was $12 and
$2,424 for the fiscal years ended June 30, 1996 and 1997, respectively,
$448 for the three months ended September 30, 1997 and $807 for July 1,
1997 through December 15, 1997. Net cash used in investing activities for
the Company was $141,917 for December 16, 1997 through June 30, 1998,
$678 for the three months ended September 30, 1998 and $1,321 on a pro
forma basis for the fiscal year ended June 30, 1998.
Net cash provided by (used in) financing activities for the Predecessor
was ($8,895) and ($6,841) for the fiscal years ended June 30, 1996 and
1997, respectively, $3,896 for the three months ended September 30, 1997
and $57 for July 1, 1997 through December 15, 1997. Net cash provided by
(used in) financing activities for the Company was $152,379 for December
16, 1997 through June 30, 1998 and ($1,477) for the three months ended
September 30, 1998. Net cash used by financing activities was $657 on a
pro forma basis for the fiscal year ended June 30, 1998.
Depreciation and amortization of goodwill and other intangibles for the
Predecessor was $4,422 and $5,084 for the fiscal years ended June 30,
1996 and 1997, respectively, $1,401 for the three months ended September
30, 1997 and $2,456 for July 1, 1997 through December 15, 1997.
Depreciation and amortization of goodwill and other intangibles for the
Company was $3,954 for December 16, 1997 through June 30, 1998, $2,049
for the three months ended September 30, 1998, and pro forma depreciation
and amortization of goodwill and other intangibles was $7,389 for the
fiscal year ended June 30, 1998.
(2) For purposes of calculating the ratio of earnings to fixed charges,
"earnings" represent income (loss) before income taxes plus fixed
charges. "Fixed charges" consist of interest on all indebtedness and
amortization of deferred financing costs. In accordance with Regulation
S-K, the calculation of the ratio of earnings to fixed charges for the
pro forma fiscal year ended June 30, 1998 includes the effects of the
Acquisition and the Refinancing but does not include the effects of the
3M Acquisition. Earnings were not sufficient to cover fixed charges by
$7,487 and $4,094 for the period from December 16, 1997 to June 30, 1998
and the pro forma fiscal year ended June 30, 1998, respectively.
12
RISK FACTORS
Holders of Old Notes should carefully consider the following factors,
together with the other information set forth in this Prospectus, before
tendering Old Notes in exchange for New Notes. However, the risk factors set
forth herein may not be exhaustive and these or other factors could have a
material adverse effect on the ability of the Company to service its
indebtedness, including principal and interest payments on the New Notes.
SUBSTANTIAL LEVERAGE; RESTRICTIVE COVENANTS
The Company has substantial indebtedness and debt service obligations. As
of September 30, 1998 the Company had total consolidated indebtedness of
approximately $116.9 million and the Company's deficiency of earnings available
to cover fixed charges for Fiscal 1998, on a pro forma basis for the
Acquisition and the Refinancing was $4.1 million. In addition, as of such date,
the Company had a maximum of $19.4 million of availability under the Credit
Agreement. The Indenture and the Credit Agreement permit the Company and its
Restricted Subsidiaries, in each case, to incur additional indebtedness,
subject to certain limitations.
The level of the Company's indebtedness could have important consequences
to holders of the New Notes, including, but not limited to, the following: (i)
a substantial portion of cash flow from operations must be dedicated to debt
service and will not be available for other purposes; (ii) additional debt
financing in the future for working capital, capital expenditures or
acquisitions may be limited; (iii) the level of indebtedness could limit
flexibility in reacting to changes in the operating environment and economic
conditions generally; (iv) the level of indebtedness could restrict the
Company's ability to increase manufacturing capacity; (v) the Company may face
difficulties in satisfying its obligations with respect to its indebtedness;
and (vi) a portion of the Company's borrowings bear interest at variable rates
of interest, which could result in higher interest expense in the event of an
increase in market interest rates.
The ability of the Company to pay principal and interest on the New Notes
and to satisfy its other debt obligations will depend upon the Company's future
operating performance, which will be affected by prevailing economic conditions
and financial, business and other factors, certain of which are beyond the
Company's control, as well as the availability of revolving credit borrowings
available under the Credit Agreement. The Company anticipates that its
operating cash flow, together with borrowings under the Credit Agreement, will
be sufficient to meet its operating expenses and to service its debt
requirements as they become due. However, if the Company is unable to service
its indebtedness, the Company may be required to take action such as reducing
or delaying capital expenditures, selling assets, restructuring or refinancing
its indebtedness or seeking additional equity capital. There can be no
assurance that any of these remedies can be effected on satisfactory terms, if
at all.
The Indenture and the Credit Agreement contain certain covenants that,
among other things, limit the ability of the Company and its Restricted
Subsidiaries to (i) pay dividends or make certain restricted payments; (ii)
incur additional indebtedness and issue preferred stock; (iii) create liens;
(iv) incur dividend and other payment restrictions affecting subsidiaries; (v)
enter into mergers, consolidations or sales of all or substantially all of the
assets of the Company; (vi) enter into certain transactions with affiliates;
and (vii) sell certain assets. In addition, the Credit Agreement requires the
Company to maintain specified financial ratios and satisfy certain financial
condition tests. The Company's ability to meet those financial ratios and tests
can be affected by events beyond its control, and there can be no assurance
that the Company will meet those tests. See "Description of New Notes" and
"Description of Certain Indebtedness--Credit Agreement."
13
EFFECTIVE SUBORDINATION; ASSETS SUBJECT TO SECURITY INTEREST
Under the terms of the Credit Agreement, Heller Financial, Inc. (the
"Lender") has a security interest in all of the capital stock of the Company
and the Company has granted to the Lender security interests in substantially
all of the current and future assets of the Company (other than the issued and
outstanding shares of capital stock of the Company's subsidiaries). In the
event of a default under the Credit Agreement (whether as a result of the
failure to comply with a payment or other covenant, a cross-default or
otherwise), such Lender will have a prior secured claim on the capital stock of
the Company and the encumbered assets of the Company. As a result, the
encumbered assets of the Company would be available to pay obligations on the
Notes only after borrowings under the Credit Agreement and any other secured
indebtedness have been paid in full. If the Lender should attempt to foreclose
on their collateral, the Company's financial condition and the value of the New
Notes will be materially adversely affected and could be eliminated. See
"Description of Certain Indebtedness." As of June 30, 1998, the Company had no
outstanding obligations (other than outstanding letters of credit in the amount
of $0.6 million) under the Credit Agreement. In addition, as of such date,
borrowings of up to approximately $19.4 million were available under the Credit
Agreement, subject to certain conditions.
POSTAL REGULATION
The Company's sampling products are approved by the U.S. Postal Service
for inclusion in subscription magazines mailed at periodical postage rates. The
Company's products have a significant cost advantage over certain competing
sampling products, such as miniatures, vials, packettes, sachets and
blisterpacks, because such competing products cause an increase from periodical
postage rates to the higher third class rates for the magazine's entire
circulation. Subscription magazine sampling inserts delivered to consumers
through the U.S. Postal Service accounted for approximately 35% of the
Company's net sales in Fiscal 1998. There can be no assurance that the U.S.
Postal Service will not approve other competing types of sampling products for
use in subscription magazines without requiring a postal surcharge, or that the
U.S. Postal Service will not reclassify the Company's sampling products such
that they would incur a postal surcharge. Any such action by the U.S. Postal
Service could have a material adverse effect on the Company's results of
operations and financial condition.
RELIANCE UPON SIGNIFICANT CUSTOMERS
The Company's top ten customers by sales generated accounted for
approximately 58% of the Company's net sales in Fiscal 1998. None of the
Company's customers other than Estee Lauder accounted for 10% or more of net
sales in Fiscal 1998. Although the Company has long-established relationships
with most of its major customers, the Company does not have long-term contracts
with any of its customers. The Company may be required by certain customers to
qualify its manufacturing operations under certain supplier standards. There
can be no assurance that the Company will be able to qualify under such
supplier standards or that such customers will continue to purchase sampling
products from the Company if the Company's manufacturing operations are not so
qualified. An adverse change in its relationships with significant customers,
including Estee Lauder, could have a material adverse effect on the Company's
results of operations and financial condition.
COMPETITION
The Company's competitors, some of whom have substantially greater capital
resources than the Company, are actively engaged in manufacturing certain
products similar to those of the Company. The Company's principal competitors
in the cosmetic sampling market are Webcraft, a subsidiary of Big Flower
Holdings, Inc., Orlandi Inc., Retail Communications Corp., Quebecor Printing
(USA) Corp., Nord'est, Marietta Corp., Klocke, Color Prelude, Rotocon, Drescher
Ascent and Appliquessence. The Company also competes with numerous
manufacturers of miniatures, vials, packettes, sachets, blisterpacks, and
scratch and sniff products. In addition, certain cosmetic companies produce
sampling products for their own cosmetic products. Competition in the Company's
market is based upon product quality, product technologies, customer
relationships, price and customer service. The future success of the Company's
business will depend in large part upon its ability to market and manufacture
products and
14
services that meet customer needs on a cost-effective and timely basis. There
can be no assurance that capital will be available for these purposes, that
investments in new technology will result in commercially viable products or
that the Company will be successful in generating sales on commercially
favorable terms, if at all.
In addition, the Company's success, competitive position and revenues will
depend, in part, upon its ability to protect its proprietary technologies and
to operate without infringing on the proprietary rights of others. Although the
Company has certain patents and has filed, and expects to continue to file,
other patent applications, there can be no assurance that the Company's issued
patents are enforceable or that its patent applications will mature into issued
patents. The expense involved in litigation regarding patent protection or a
challenge thereto has been and could be significant and any future expense, if
any, cannot be estimated by the Company. A portion of the Company's
manufacturing processes are not covered by any patent or patent application. As
a result, the business of the Company may be adversely affected by competitors
who independently develop technologies substantially equivalent to those
employed by the Company. See "Business--Competition."
DEPENDENCE ON FRAGRANCE INDUSTRY; SEASONALITY
The advertising budgets of the Company's customers, and therefore the
revenues of the Company, are susceptible to prevailing economic and market
conditions that affect advertising expenditures, the performance of the
products of the Company's customers in the marketplace and certain other
factors. See the discussion of net sales for the three months ended September
30, 1998 compared to the three months ended September 30, 1997, Fiscal 1998
compared to Fiscal 1997, and Fiscal 1997 compared to Fiscal 1996 in
"Management's Discussion of Financial Condition and Results of
Operations--Results of Operations." There can be no assurance that further
reductions in advertising spending will not occur, which could have a material
adverse effect on the Company's results of operations and financial condition.
In addition, the Company's sales and operating results have historically
reflected seasonal variations. Such seasonal variations are based on the timing
of the Company's customers' advertising campaigns, which have traditionally
been concentrated prior to the Christmas and spring holiday seasons. As a
result, a higher level of sales are reflected in the Company's first two fiscal
quarters ended December 31 when sales from such advertising campaigns are
principally recognized while the Company's fourth fiscal quarter ended June 30
typically reflects the lowest sales level of the fiscal year. These seasonal
fluctuations require the Company to accurately allocate its resources to manage
the Company's manufacturing capacity, which often operates at full capacity
during peak seasonal demand periods.
SOLE SUPPLIER OF CERTAIN RAW MATERIALS
Paper is the primary raw material utilized by the Company in producing its
sampling products. Paper costs represented approximately one-third of the
Company's cost of goods sold in each of Fiscal 1996, 1997 and 1998. During the
five years prior to Fiscal 1996, the Company had not experienced any
significant increases in paper prices. In Fiscal 1996, a series of significant
price increases for paper occurred, which increased the Company's average price
of paper by 14.8% as compared to Fiscal 1995. The magnitude and close proximity
of such increases prevented the Company from recovering all of such increased
paper costs from its customers and had an adverse impact on the Company's
results of operations. Future significant increases in paper costs could have a
material adverse effect on the Company's results of operations and financial
condition to the extent that the Company is unable to price its products to
reflect such increases. There can be no assurance that the Company's customers
would accept such price increases or the extent to which such price increases
would impact their decision to utilize the Company's sampling products.
All of the Company's encapsulated sampling products, which accounted for a
majority of the Company's net sales in Fiscal 1998, utilize specific grades of
paper that are produced exclusively for the Company by Westvaco Corporation.
However, the Company does not have a supply contract with such supplier. The
Company is currently researching methods of replicating the advantages of these
specific grades of paper with other less costly grades of paper available from
multiple suppliers. Until such
15
methods are developed, a loss of such supply of paper could have a material
adverse effect on the Company's results of operations and financial condition
to the extent that the Company is unable to obtain such paper elsewhere.
DEPENDENCE UPON SENIOR MANAGEMENT
The Company is substantially dependent on the personal efforts,
relationships and abilities of Roger L. Barnett, the Company's President and
Chief Executive Officer. Barry W. Miller, the Company's Chief Operating
Officer, joined the Company in May 1998 and, consequently, the Company has
limited operating history under such senior manager upon which holders of New
Notes may base an evaluation of his performance. The Company has entered into
employment agreements with Messrs. Barnett and Miller. The Company does not
maintain key person life insurance on any member of senior management of the
Company. The loss of Mr. Barnett's services or the services of any other member
of senior management could have a material adverse effect on the Company. See
"Management."
RISKS OF INTERNATIONAL OPERATIONS; CURRENCY FLUCTUATIONS
Approximately 13.3% of the Company's net sales in Fiscal 1998 were
generated outside the United States. Foreign operations are subject to certain
risks inherent in conducting business abroad, including, among others, exposure
to foreign currency fluctuations and devaluations or restrictions on money
supplies, foreign and domestic export law and regulations, price controls,
taxation, tariffs, import restrictions, and other political and economic events
beyond the Company's control. The Company has not experienced any material
effects of these risks as of yet, but there can be no assurance that they will
not have such an effect in the future.
CONTROL BY DLJMBII; CONFLICTS OF INTEREST
DLJMBII has the power to elect a majority of the directors of Acquisition
Corp. and generally exercises control over the business, policies and affairs
of Acquisition Corp., Holding and the Company through its ownership of
Acquisition Corp. By reason of such ownership, DLJMBII may have interests that
could be in conflict with those of the holders of New Notes. A portion of the
net proceeds from the Offering and the Equity Contribution have been used to
repay the Bridge Notes, which were issued to an affiliate of DLJMBII and the
Initial Purchaser. See "Use of Proceeds," "Security Ownership of Certain
Beneficial Owners and Management" and "Certain Relationships and Related
Transactions."
LIMITATIONS ON ABILITY TO MAKE CHANGE OF CONTROL PAYMENT
Upon the occurrence of a Change of Control, each holder of New Notes will
have the right to require the Company to purchase all or any part of such
holder's New Notes at an offer price in cash equal to 101% of the aggregate
principal amount thereof, plus accrued and unpaid interest and Liquidated
Damages, if any, to the date of purchase. The prepayment of the New Notes
following a Change of Control would constitute a default under the Credit
Agreement. In the event that a Change of Control occurs, the Company would
likely be required to refinance the indebtedness outstanding under the Credit
Agreement and the New Notes. There can be no assurance that the Company would
be able to refinance such indebtedness or, if such refinancing were to occur,
that such refinancing would be on terms favorable to the Company. See
"Description of New Notes--Repurchase at the Option of Holders--Change of
Control."
LABOR RELATIONS; EXPIRATION OF COLLECTIVE BARGAINING AGREEMENT
As of September 30, 1998, approximately 67% of the Company's employees
worked under a collective bargaining agreement that expires on April 1, 1999.
While the Company believes that its relations with its employees are good,
there can be no assurance that the Company's collective bargaining agreement
will be renewed in the future. A prolonged labor dispute (which could include a
work stoppage) could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Employees."
16
RISK OF FRAUDULENT TRANSFER LIABILITY
If a court of competent jurisdiction in a suit by an unpaid creditor or a
representative of creditors (such as a trustee in bankruptcy or a
debtor-in-possession) were to find that either the Company did not receive fair
consideration or reasonably equivalent value for issuing the Notes and, at the
time of the incurrence of indebtedness represented by the New Notes, the
Company was insolvent, was rendered insolvent by reason of such incurrence, was
engaged in a business or transaction for which its remaining assets constituted
unreasonably small capital, intended to incur, or believed that it would incur,
debts beyond its ability to pay as such debts matured, or intended to hinder,
delay or defraud its creditors, such court could avoid such indebtedness,
subordinate such indebtedness to other existing and future indebtedness of the
Company or take other action detrimental to the holders of the New Notes. The
measure of insolvency for purposes of the foregoing will vary depending upon
the law of the relevant jurisdiction. Generally, however, a company would be
considered insolvent for purposes of the foregoing if the sum of such company's
debts is greater than all the company's property at a fair valuation, or if the
present fair saleable value of the company's assets is less than the amount
that will be required to pay its probable liability on its existing debts as
they become absolute and matured.
YEAR 2000 ISSUES
The Company evaluated its information technology systems and its
non-information technology systems in order to assess its exposure to Year 2000
issues. The Company expects to make the necessary modifications or changes to
its information systems to enable proper processing of transactions relating to
the Year 2000 and beyond before January 1, 2000. While the Company is not
substantially dependent upon the proper function of its computer systems, a
failure of its systems could cause, among other things inaccurate or incomplete
accounting, the inability to bill customers and the inability to process
incoming orders which may cause business interruption or financial loss. If
third parties with whom the Company interacts have Year 2000 problems which are
not resolved, the Company could experience, among other things, the disruption
of services including telecommunications and electrical power or financial or
accounting difficulties. The Company currently estimates that the total cost of
Year 2000 compliance will be less than $100,000. There can be no assurance that
the Company's Year 2000 program will be effective or that the Company will not
experience disruption or difficulties resulting from Year 2000 problems of
third parties. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Year 2000 Issues."
NO PUBLIC MARKET FOR THE NEW NOTES
There has previously been only a limited secondary market and no public
market for the Old Notes, and there can be no assurance as to the liquidity of
any market that may develop for the New Notes, the ability of Holders of the
New Notes to sell their New Notes, or the prices at which the Holders of the
New Notes would be able to sell their New Notes. In addition, because the
Exchange Offer is not conditioned upon any minimum number of Old Notes being
tendered for exchange, the number of New Notes tendered could be quite small
which could have an adverse effect on the liquidity of the New Notes. The
Initial Purchaser has advised the Company that it currently intends to make a
market in the New Notes. The Initial Purchaser is not obligated to do so,
however, and any market-making with respect to the New Notes may be
discontinued at any time without notice. Also, to the extent that Old Notes are
tendered and accepted in the Exchange Offer, a holder's ability to sell
untendered Old Notes could be adversely affected. Therefore, no assurance can
be given as to the liquidity of the trading market for the New Notes. The
Company does not intend to list the New Notes on a national securities exchange
or to apply for quotation of the New Notes through the National Association of
Securities Dealers Automated Quotation System. However, it is expected that the
New Notes will be eligible for trading in the Private Offerings, Resales and
Trading through Automated Linkages ("PORTAL") Market upon issuance.
CONSEQUENCES OF THE EXCHANGE OFFER ON NON-TENDERING HOLDERS OF THE OLD NOTES
The Company intends for the Exchange Offer to satisfy its registration
obligations under the Registration Rights Agreement. If the Exchange Offer is
consummated, the Company does not intend to
17
file further registration statements for the sale or other disposition of Old
Notes. Old Notes that are not exchanged for New Notes will remain restricted
securities within the meaning of Rule 144 of the Securities Act. Consequently,
following completion of the Exchange Offer, Holders of Old Notes seeking
liquidity in their investment would have to rely on an exemption to the
registration requirements under applicable securities laws, including the
Securities Act, with respect to any sale or other disposition of the Old Notes.
USE OF PROCEEDS
The Company will not receive any cash proceeds from the exchange of the
New Notes for the Old Notes pursuant to the Exchange Offer. As consideration
for issuing the New Notes offered hereby the Company will receive, in exchange,
Old Notes in like principal amount, which will be canceled and as such will not
result in any increase in indebtedness of the Company.
The net proceeds to the Company from the sale of the Old Notes, after
deducting discounts and commissions and other estimated expenses of the
Offering, were approximately $110.2 million. The net proceeds from the Offering
have been used, together with the Equity Contribution, (i) to repay the entire
outstanding principal amount of, and accrued and unpaid interest on, the Bridge
Notes, which were issued to the Bridge Lender and the Initial Purchaser in
connection with the Acquisition and (ii) to fund working capital requirements
and for general corporate purposes, including the repayment of $7.25 million of
borrowings under the Credit Agreement used to fund the purchase price of the 3M
Acquisition. As of June 24, 1998, the interest rate on the Bridge Notes which
were to mature on December 15, 1998 (subject to certain extension provisions)
was 11.75% and the interest rate on outstanding borrowings under the Credit
Agreement was 9.25%. The Credit Agreement terminates on December 31, 2002. See
"Certain Relationships and Related Transactions," "Description of Certain
Indebtedness" and "Plan of Distribution."
18
THE EXCHANGE OFFER
PURPOSE AND EFFECTS OF THE EXCHANGE OFFER
The Old Notes were sold by the Company on the Closing Date to the Initial
Purchaser, pursuant to the Purchase Agreement. The Initial Purchaser
subsequently resold the Old Notes to qualified institutional buyers within the
meaning of Rule 144A under the Securities Act and to non-U.S. persons pursuant
to Regulation S under the Securities Act. As a condition to the Purchase
Agreement, the Company and the Initial Purchasers entered into the Registration
Rights Agreement on June 25, 1998. The Registration Rights Agreement required
the Company to file with the Commission following the Closing, a registration
statement relating to an exchange offer pursuant to which notes that are
substantially identical to the Old Notes would be offered in exchange for the
then outstanding Old Notes tendered at the option of the Holders thereof. The
form and terms of the New Notes are identical in all material respects to the
form and terms of the Old Notes except (i) that the New Notes have been
registered under the Securities Act, (ii) that the New Notes are not entitled
to certain registration rights which are applicable to the Old Notes under the
Registration Rights Agreement, and (iii) that certain contingent interest rate
provisions applicable to the Old Notes are generally not applicable to the New
Notes. In the event that the applicable interpretations of the staff of the
Commission do not permit the Company to effect the Exchange Offer, the Company
agreed to use its reasonable best efforts to cause to become effective a shelf
registration statement with respect to the resale of the Old Notes ("the Shelf
Registration Statement") and to keep such Shelf Registration Statement
effective for a period of up to three years. The Exchange Offer is being made
to satisfy the contractual obligations of the Company under the Registration
Rights Agreement. The Holders of any Old Notes not tendered in the Exchange
Offer will not be entitled to require the Company to file the Shelf
Registration Statement.
The Registration Rights Agreement provides that (i) the Company will file
an Exchange Offer Registration Statement with the Commission on or prior to 45
days after the Closing Date, (ii) the Company will use its reasonable best
efforts to have the Exchange Offer Registration Statement declared effective by
the Commission on or prior to 180 days after the Closing Date, (iii) unless the
Exchange Offer would not be permitted by applicable law or Commission policy,
the Company will commence the Exchange Offer and use its reasonable best
efforts to issue on or prior to 30 business days after the date on which the
Exchange Offer Registration Statement was declared effective by the Commission,
New Notes in exchange for all Notes tendered prior thereto in the Exchange
Offer and (iv) if obligated to file the Shelf Registration Statement, the
Company will use its reasonable best efforts to file the Shelf Registration
Statement with the Commission on or prior to 45 days after such filing
obligation arises and to cause the Shelf Registration to be declared effective
by the Commission on or prior to 180 days after such obligation arises. If (a)
the Company fails to file any of the Registration Statements required by the
Registration Rights Agreement on or before the date specified for such filing,
(b) any of such Registration Statements is not declared effective by the
Commission on or prior to the date specified for such effectiveness (the
"Effectiveness Target Date"), (c) the Company fails to consummate the Exchange
Offer within 30 business days of the Effectiveness Target Date with respect to
the Exchange Offer Registration Statement or (d) the Shelf Registration
Statement or the Exchange Offer Registration Statement is declared effective
but thereafter ceases to be effective or usable in connection with resales of
Transfer Restricted Securities during the periods specified in the Registration
Rights Agreement (each such event referred to in clauses (a) through (d) above
a "Registration Default"), then the Company will pay liquidated damages
("Liquidated Damages") to each Holder of Notes, with respect to the first
90-day period immediately following the occurrence of the first Registration
Default in an amount equal to $.05 per week per $1,000 principal amount of
Notes held by such Holder. The amount of the Liquidated Damages will increase
by an additional $.05 per week per $1,000 principal amount of Notes with
respect to each subsequent 90-day period until all Registration Defaults have
been cured, up to a maximum amount of Liquidated Damages of $.25 per week per
$1,000 principal amount of Notes. All accrued Liquidated Damages will be paid
by the Company on each Damages Payment Date to the Global Note Holder by wire
transfer of immediately available funds or by federal funds check and to
Holders of Certificated Notes by mailing checks to their registered addresses.
Following the cure of all Registration Defaults, the accrual of Liquidated
Damages will cease.
19
Based on an interpretation by the staff of the Commission set forth in
no-action letters issued to unrelated third parties, the Company believes the
New Notes issued pursuant to the Exchange Offer in exchange for Old Notes may
be offered for resale, resold and otherwise transferred by the Holders thereof
(other than a Restricted Holder) without compliance with the registration and
prospectus delivery provisions of the Securities Act, provided that such New
Notes are acquired in the ordinary course of such holders' business and such
Holders are not participating, do not intend to participate and have no
arrangement or understanding with any person to participate, in a distribution
of such New Notes. See "Shearman & Sterling," SEC No-Action Letter (available
July 2, 1993); "Morgan Stanley and Co., Incorporated," SEC No-Action Letter
(available June 5, 1991); and "Exxon Capital Holdings Corporation," SEC
No-Action Letter (available May 13, 1998). Each broker-dealer that receives New
Notes for its own account in exchange for Old Notes, where such Old Notes were
acquired by such broker-dealer as a result of market-making activities or other
trading activities, must acknowledge that it will deliver a prospectus in
connection with any sale of such New Notes. See "Plan of Distribution."
If any person were to participate in the Exchange Offer for the purpose of
distributing securities in a manner not permitted by the preceding paragraph,
such person could not rely on the position of the staff of the Commission and
must comply with the Prospectus delivery requirements of the Securities Act in
connection with a secondary resale transaction. Therefore, each Holder of Old
Notes who accepts the Exchange Offer must represent in the Letter of
Transmittal that it meets the conditions described above.
The Exchange Offer shall be deemed to have been consummated upon the
earlier to occur of (i) the Company having exchanged New Notes for all
outstanding Old Notes (other than Old Notes held by a Restricted Holder)
pursuant to such Exchange Offer and (ii) the Company having exchanged, pursuant
to such Exchange Offer, New Notes for all Old Notes that have been validly
tendered and not withdrawn on the Expiration Date. In such event, Holders of
Old Notes seeking liquidity in their investment would have to rely on
exemptions to registration requirements under applicable securities laws,
including the Securities Act.
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the accompanying Letter of Transmittal, the Company will accept all Old
Notes validly tendered prior to 5:00 p.m., New York City time, on the
Expiration Date. The Exchange of New Notes for Old Notes will be made with
respect to all Old Notes validly tendered and not withdrawn on or prior to the
Expiration Date, promptly following the Expiration Date. The New Notes issued
pursuant to the Exchange Offer will be delivered promptly following the
Expiration Date. The Company will issue $1,000 principal amount of New Notes in
exchange for $1,000 principal amount of outstanding Old Notes accepted in the
Exchange Offer. Holders may tender some or all of their Old Notes pursuant to
the Exchange Offer in denominations of $1,000 and integral multiples of $1,000
in excess thereof.
As of the date of this Prospectus, $115,000,000 aggregate principal amount
of the Old Notes is outstanding.
This Prospectus, together with the Letter of Transmittal, is being sent to
all registered Holders of Old Notes as of , 1998 (the "Record Date").
The Company shall be deemed to have accepted validly tendered Old Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering Holders
of Old Notes for the purpose of receiving New Notes from the Company and
delivering New Notes to such Holders.
If any tendered Old Notes are not accepted for exchange because of an
invalid tender or the occurrence of certain other events set forth herein,
certificates for any such unaccepted Old Notes will be returned, without
expense, to the tendering Holder thereof as promptly as practicable after the
Expiration Date.
The registration expenses to be incurred in connection with the Exchange
Offer, including fees and expenses of the Exchange Agent and Trustee and
accounting and legal fees, will be paid by the Company.
20
The Company has agreed to pay, subject to the instructions in the Letter of
Transmittal, all transfer taxes, if any, relating to the sale or disposition of
such Holders' Old Notes pursuant to the Exchange Offer. See "--Fees and
Expenses."
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term "Expiration Date" shall mean , 1998, unless the Company, in
its sole discretion, extends the Exchange Offer, in which case the term
"Expiration Date" shall mean the latest date to which the Exchange Offer is
extended.
In order to extend the Expiration Date, the Company will notify the
Exchange Agent of any extension by oral or written notice and will mail to the
record Holders of Old Notes an announcement thereof, each prior to 9:00 a.m.,
New York City time, on the next business day after the previously scheduled
Expiration Date. Such announcement may state that the Company is extending the
Exchange Offer for a specified period of time.
The Company reserves the right (i) to delay acceptance of Old Notes, to
extend the Exchange Offer or to terminate the Exchange Offer and to refuse to
accept Old Notes not previously accepted, if any of the conditions set forth
herein under "--Conditions" shall have occurred and shall not have been waived
by the Company, by giving oral or written notice of such delay, extension or
termination to the Exchange Agent, and (ii) to amend the terms of the Exchange
Offer in any manner deemed by it to be advantageous to the Holders of the Old
Notes. Any such delay in acceptance, extension, termination or amendment will
be followed as promptly as practicable by oral or written notice thereof. If
the Exchange Offer is amended in a manner determined by the Company to
constitute a material change, the Company will promptly disclose such amendment
in a manner reasonably calculated to inform the Holders of the Old Notes of
such amendment, and if appropriate, the Company will file a post-effective
amendment to the Registration Statement of which this Prospectus forms part.
Without limiting the manner in which the Company may choose to make public
announcements of any delay in acceptance, extension, termination or amendment
of the Exchange Offer, the Company shall have no obligation to publish,
advertise, or otherwise communicate any such public announcement, other than by
making a timely release to a financial news service.
INTEREST ON NEW NOTES
Interest will accrue on the New Notes from June 25, 1998, or from the most
recent interest payment date on the Old Notes surrendered in exchange therefor,
and will be payable semi-annually in cash and arrears on January 1 and July 1
of each year, commencing on January 1, 1999 at the rate of 10 1/2% per annum.
Holders of Old Notes whose Old Notes are accepted for exchange will be deemed
to have waived the right to receive any payment in respect of interest accrued
from June 25, 1998 to the date of issuance of the New Notes.
PROCEDURE FOR TENDERING
To tender in the Exchange Offer, a Holder must complete, sign and date the
Letter of Transmittal, or a facsimile thereof and mail or otherwise deliver
such Letter of Transmittal or such facsimile, together with the Old Notes
(unless such tender is being effected pursuant to the procedure for book-entry
transfer described below) and any other required documents, to the Exchange
Agent prior to 5:00 p.m., New York City time, on the Expiration Date.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the case
may be, must be guaranteed by a member firm of a registered national securities
exchange or of the National Association of Securities Dealers, Inc., a
commercial bank or trust company having an office or correspondent in the
United States or an "eligible guarantor institution" as defined by Rule 17Ad-15
under the Exchange Act (any of the foregoing hereinafter referred to as an
"Eligible Institution") unless the Old Notes tendered pursuant thereto are
tendered (i) by a registered Holder who has not completed the box entitled
"Special Issuance Instructions" or "Special Delivery Instructions" on the
Letter of Transmittal or (ii) for the account of an Eligible Institution.
21
Any financial institution that is a participant in DTC's Book-Entry
Transfer Facility system may make book-entry delivery of the Old Notes by
causing DTC to transfer such Old Notes into the Exchange Agent's account in
accordance with DTC's procedure for such transfer. Although delivery of Old
Notes may be effected through book-entry transfer into the Exchange Agent's
account at DTC, the Letter of Transmittal (or facsimile thereof), with any
required signature guarantees and any other required documents, must, in any
case, be transmitted to and received or confirmed by the Exchange Agent at its
addresses set forth herein prior to 5:00 p.m., New York City time, on the
Expiration Date. DELIVERY OF DOCUMENTS TO DTC IN ACCORDANCE WITH ITS PROCEDURES
DOES NOT CONSTITUTE DELIVERY TO THE EXCHANGE AGENT.
The tender by a Holder of Old Notes will constitute an agreement between
such Holder and the Company in accordance with the terms and subject to the
conditions set forth herein and in the Letter of Transmittal.
Delivery of all documents must be made to the Exchange Agent at its
address set forth herein. Holders may also request that their respective
brokers, dealers, commercial banks, trust companies or nominees effect such
tender for such Holders.
THE METHOD OF DELIVERY OF OLD NOTES AND THE LETTER OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK OF
THE HOLDERS. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE AN
OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT TIME SHOULD BE
ALLOWED TO ASSURE TIMELY DELIVERY. NO LETTER OF TRANSMITTAL OR OLD NOTES SHOULD
BE SENT TO THE COMPANY.
Only a Holder of Old Notes may tender such Old Notes in the Exchange
Offer. The term "Holder" with respect to the Exchange Offer means any person in
whose name Old Notes are registered on the books of the Company or any other
person who has obtained a properly completed bond power from the registered
holder or any person whose Old Notes are held of record by DTC who desires to
deliver such Old Notes at DTC.
Any beneficial Holder whose Old Notes are registered in the name of his
broker, dealer, commercial bank, trust company or other nominee and who wishes
to tender his Old Notes should contact the registered Holder promptly and
instruct such registered Holder to tender on his behalf. If such beneficial
Holder wishes to tender on his own behalf, such beneficial Holder must, prior
to completing and executing the Letter of Transmittal and delivering his Old
Notes, either make appropriate arrangements to register ownership of the Old
Notes in such Holder's name or obtain a properly completed bond power from the
registered Holder. The transfer of record ownership may take considerable time.
If the Letter of Transmittal is signed by a person other than the
registered Holder of any Old Notes listed therein, such Old Notes must be
endorsed or accompanied by appropriate bond powers which authorize such person
to tender the Old Notes on behalf of the registered holder, in either case
signed as the name of the registered Holder or Holders appears on the Old
Notes.
If the Letter of Transmittal or any Old Notes or bond powers are signed by
trustees, executors, administrators, guardians, attorneys-in-fact, officers of
a corporation or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of the tendered Old Notes will be
determined by the Company in its sole discretion, which determination will be
final and binding. The Company reserves the absolute right to reject any and
all Old Notes not validly tendered or any Old Notes the Company's acceptance of
which would, in the opinion of counsel for the Company, be unlawful. The
Company also reserves the absolute right to waive any irregularities or
conditions of tender as to particular Old Notes. The Company's interpretation
of the terms and conditions of the Exchange Offer (including the instructions
in the Letter of Transmittal) will be final and binding on all parties. Unless
waived, any defects or irregularities in connection with tenders of Old Notes
must be cured within such time as the Company shall determine. Neither the
Company, the
22
Exchange Agent nor any other person shall be under any duty to give
notification of defects or irregularities with respect to tenders of Old Notes
nor shall any of them incur any liability for failure to give such
notification. Tenders of Old Notes will not be deemed to have been made until
such irregularities have been cured or waived. Any Old Notes received by the
Exchange Agent that are not validly tendered and as to which the defects or
irregularities have not been cured or waived will be returned by the Exchange
Agent without cost to the tendering holder of such Old Notes unless otherwise
provided in the Letter of Transmittal, as soon as practicable following the
Expiration Date.
By tendering, each Holder will represent to the Company that, among other
things (i) the New Notes acquired pursuant to the Exchange Offer are being
obtained in the ordinary course of such Holder's business, (ii) such Holder is
not participating, does not intend to participate and has no arrangement or
understanding with any person to participate, in a distribution of such New
Notes, (iii) such Holder is not an "affiliate," as defined under Rule 405 of
the Securities Act, of the Company and (iv) such Holder is not a broker-dealer
who acquired Old Notes directly from the Company to resell pursuant to Rule
144A or any other available exemption under the Securities Act.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Old Notes and (i) whose Old Notes are not
immediately available or (ii) who cannot deliver their Old Notes, the Letter of
Transmittal or any other required documents to the Exchange Agent prior to the
Early Exchange Date or the Expiration Date, may effect a tender if:
(a) The tender is made through an Eligible Institution;
(b) Prior to the Expiration Date, the Exchange Agent receives from such
Eligible Institution a properly completed and duly executed notice of guarantee
delivery (the "Notice of Guaranteed Delivery") (by facsimile transmission, mail
or hand delivery) setting forth the name and address of the Holder of the Old
Notes, the certificate number or numbers of such Old Notes and the principal
amount of Old Notes, the certificate number or numbers of such Old Notes and
the principal amount of Old Notes tendered, stating that the tender is being
made thereby, and guaranteeing that, within three business days after the date
of execution of the Notice of Guaranteed Delivery, the Letter of Transmittal
(or facsimile thereof), together with the certificate(s) representing the Old
Notes to be tendered in proper form for transfer and any other documents
required by the Letter of Transmittal, will be deposited by the Eligible
Institution with the Exchange Agent; and
(c) Such properly completed and executed Letter of Transmittal (or
facsimile thereof), together with the certificate(s) representing all tendered
Old Notes in proper form for transfer (or confirmation of a book-entry transfer
into the Exchange Agent's account at DTC of Old Notes delivered electronically)
and all other documents required by the Letter of Transmittal are received by
the Exchange Agent within three business days after the date of execution of
the Notice of Guaranteed Delivery.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Old Notes may be withdrawn
at any time prior to 5:00 p.m., New York City time, on the Expiration Date,
unless previously accepted for exchange.
To withdraw a tender of Old Notes in the Exchange Offer, a written or
facsimile transmission notice of withdrawal must be received by the Exchange
Agent at its address set forth herein prior to 5:00 p.m., New York City time,
on the Expiration Date and prior to acceptance for exchange by the Company. Any
such notice of withdrawal must (i) specify the name of the person having
deposited the Old Notes to be withdrawn (the "Depositor"), (ii) identify the
Old Notes to be withdrawn (including the certificate number or numbers and
principal amount of such Old Notes), (iii) be signed by the Depositor in the
same manner as the original signature on the Letter of Transmittal by which
such Old Notes were tendered (including required signature guarantees) or be
accompanied by documents of transfer sufficient to permit the trustee with
respect to the Old Notes to register the transfer of such Old Notes into the
name of the Depositor withdrawing the tender and (iv) specify the name in which
any such Old Notes are to be registered, if different from that of the
Depositor. All questions as to the validity, form and eligibility
23
(including time of receipt) of such withdrawal notices will be determined by
the Company, whose determination shall be final and binding on all parties. Any
Old Notes so withdrawn will be deemed not to have been validly tendered for
purposes of the Exchange Offer and no New Notes will be issued with respect
thereto unless the Old Notes so withdrawn are validly retendered. Any Old Notes
which have been tendered but which are not accepted for exchange will be
returned by the Exchange Agent to the holder thereof without cost to such
holder as soon as practicable after withdrawal, rejection of tender or
termination of the Exchange Offer. Properly withdrawn Old Notes may be
retendered by following one of the procedures described above under
"--Procedure for Tendering" at any time prior to the Expiration Date.
CONDITION
Notwithstanding any other term of the Exchange Offer, the Company will not
be obligated to consummate the Exchange Offer if the New Notes to be received
will not be tradeable by the holder, other than in the case of Restricted
Holders, without restriction under the Securities Act and the Exchange Act and
without material restrictions under the Blue Sky or securities laws of
substantially all of the states of the United States. Such condition will be
deemed to be satisfied unless a holder provides the Company with an opinion of
counsel reasonably satisfactory to the Company to the effect that the New Notes
received by such holder will not be tradeable without restriction under the
Securities Act and the Exchange Act and without material restrictions under the
Blue Sky laws of substantially all of the states of the United States. The
Company may waive this condition.
If the condition described above exists, the Company will be entitled to
refuse to accept any Old Notes and, in the case of such refusal, will return
tendered Old Notes to exchanging holders of Old Notes. See "--Terms of the
Exchange Offer."
EXCHANGE AGENT
IBJ Schroder Bank & Trust Company, the Trustee under the Indenture, has
been appointed as Exchange Agent for the Exchange Offer. Questions and requests
for assistance and requests for additional copies of this Prospectus or of the
Letter of Transmittal should be directed to the Exchange Agent addressed as
follows:
By Hand and Overnight Delivery:
IBJ Schroder Bank & Trust Company
One State Street
New York, New York 10044
Attn: Securities Processing Window,
Subcellar One (SC-1)
By Registered or
Certified mail:
IBJ Schroder Bank & Trust Company
P.O. Box 84
Bowling Green Station
New York, New York 10274-0084
Attn: Reorganization Operations Department
Telephone: (212) 858-2103
Facsimile: (212) 858-2611
(212) 858-2103 to confirm facsimile transmissions
24
FEES AND EXPENSES
The expenses of soliciting tenders pursuant to the Exchange Offer will be
borne by the Company. The principal solicitation for tenders pursuant to the
Exchange Offer is being made by mail. Additional solicitations may be made by
officers and regular employees of the Company and its affiliates in person, by
facsimile or telephone.
The Company will not make any payments to brokers, dealers or other
persons soliciting acceptances of the Exchange Offer. The Company, however,
will pay the Exchange Agent reasonable and customary fees for its services and
will reimburse the Exchange Agent for its reasonable out-of-pocket expenses in
connection therewith.
The registration expenses to be incurred in connection with the Exchange
Offer, including fees and expenses of the Exchange Agent and Trustee and
accounting and legal fees, will be paid by the Company. The Company has agreed
to pay, subject to the instructions in the Letter of Transmittal, all transfer
taxes, if any, relating to the sale or disposition of such Holders' Old Notes
pursuant to the Exchange Offer. If, however, certificates representing New
Notes or Old Notes for principal amounts not tendered or accepted for exchange
are to be delivered to, or are to be registered or issued in the name of any
person other than the registered Holder of the Old Notes tendered, or if
tendered Old Notes are registered in the name of any person other than the
person signing the Letter of Transmittal, or if a transfer tax imposed for any
reason other than the exchange of Old Notes pursuant to the Exchange Offer,
then the amount of any such transfer taxes (whether imposed on the registered
Holder or any other persons) will be payable by the tendering Holder. If
satisfactory evidence of payment of such taxes or exemption therefrom is not
submitted with the Letter of Transmittal, the amount of such transfer taxes
will be billed directly to such tendering holder.
ACCOUNTING TREATMENT
No gain or loss for accounting purposes will be recognized by the Company
upon the consummation of the Exchange Offer. The expenses of the Exchange Offer
will be amortized by the company over the term of the New Notes under generally
accepted accounting principles.
25
CAPITALIZATION
The following table sets forth the consolidated cash and cash equivalents
and capitalization of the Company at September 30, 1998 on a historical basis
(which includes the effects of the Acquisition, the Refinancing and the 3M
Acquisition as such events occurred prior to September 30, 1998). This table
should be read in conjunction with "Use of Proceeds," the Company's
Consolidated Financial Statements and notes thereto and the Company's Unaudited
Pro Forma Condensed Consolidated Statements of Operations and notes thereto
included elsewhere in this Prospectus.
AT SEPTEMBER 30, 1998
----------------------
(IN THOUSANDS)
Cash and cash equivalents ................. $ 1,341
=========
Debt:
Notes offered hereby ...................... 115,000
Capital lease obligation .................. 1,951
---------
Total debt ............................. 116,951
---------
Stockholder's equity:
Common stock .............................. --
Additional paid-in capital ................ 100,862
Accumulated deficit ....................... (5,097)
Cumulative translation adjustment ......... 55
Carryover basis adjustment ................ (15,730)
---------
Total stockholder's equity ............. 80,090
---------
Total capitalization ...................... $ 197,041
=========
26
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The selected historical consolidated financial data presented below as of
November 3, 1993 and for the period from July 1, 1993 through November 3, 1993
have been derived from the historical consolidated financial statements of the
original predecessor of the Company (the "Original Predecessor") prior to its
acquisition by the Predecessor. The selected historical consolidated financial
data presented below as of June 30, 1994, 1995, 1996 and 1997, September 30,
1997 and December 15, 1997, and for the fiscal years ended June 30, 1995, 1996
and 1997 and the periods from November 4, 1993 through June 30, 1994, the three
months ended September 30, 1997 and from July 1, 1997 through December 15, 1997
have been derived from the historical consolidated financial statements of the
Predecessor. The selected historical consolidated financial data presented
below as of June 30, 1998 and September 30, 1998 and for the period from
December 16, 1997 through June 30, 1998 and the three months ended September
30, 1998 have been derived from the historical consolidated financial
statements of the Company. The historical financial data as of June 30, 1997
and 1998 and December 15, 1997, the period from July 1, 1997 through December
15, 1997 and the period from December 16, 1997 through June 30, 1998 have been
derived from the audited consolidated financial statements of the Predecessor
and the Company. The historical financial data as of September 30, 1997 and
1998 and for each of the three month periods then ended have been derived from
the unaudited consolidated interim financial statements of the Predecessor and
the Company, which, in the opinion of management, include all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of the financial condition and results of operations as of such
dates and for such periods. The information contained in this table should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and the Company's Consolidated Financial
Statements and the notes thereto included elsewhere in this Prospectus.
ORIGINAL
PREDECESSOR PREDECESSOR
------------- ------------------------------------------------
JULY 1, NOVEMBER 4,
1993 1993
THROUGH THROUGH FISCAL YEAR ENDED JUNE 30,
NOVEMBER 3, JUNE 30, ----------------------------------
1993 1994 1995 1996 1997
------------- ------------- ---------- ---------- ------------
(DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Net sales .......................... $19,941 $ 18,213 $61,794 $ 73,486 $ 77,723
Cost of goods sold ................. 11,172 12,042 38,333 49,862 49,467
------- -------- ------- -------- ----------
Gross profit ....................... 8,769 6,171 23,461 23,624 28,256
Selling, general and
administrative expenses ........... 2,950 4,809 8,483 10,655 13,353
Amortization of goodwill ........... 78 723 1,113 1,214 1,214
------- -------- ------- -------- ----------
Income from operations ............. 5,741 639 13,865 11,755 13,689
Interest expense, net .............. -- 3,718 6,170 6,762 6,203
Fees to stockholders ............... 102 197 470 470 470
Other, net ......................... 2,462 2,754 (22) 244 (101)
Income tax expense
(benefit) ......................... 1,310 (1,946) 3,114 2,101 3,135
------- -------- ------- -------- ----------
Net income (loss) .................. $ 1,867 $ (4,084) $ 4,133 $ 2,178 $ 3,982
======= ======== ======= ======== ==========
BALANCE SHEET DATA (AT END OF
PERIOD):
Cash and cash equivalents .......... $ 68 $ 3,728 $ 4,196 $ 626 $ 303
Working capital (deficit) .......... 2,288 3,593 39 (4,685) (36,957)
Total assets ....................... 28,320 72,754 85,695 82,395 77,142
Total debt and redeemable
preferred stock ................... 850 61,025 64,655 60,736 54,964
Total stockholder's equity ......... 16,940 2,927 6,572 7,932 11,225
OTHER DATA:
Capital expenditures ............... 1,109 1,184 1,325 2,051 2,462
Ratio of earnings to fixed
charges (1) ....................... n/m -- 2.2x 1.6x 2.1x
PREDECESSOR THE COMPANY
------------------------------ ----------------------------
JULY 1, DECEMBER 16,
THREE MONTHS 1997 1997 THREE MONTHS
ENDED THROUGH THROUGH ENDED
SEPTEMBER 30, DECEMBER 15, JUNE 30, SEPTEMBER 30,
1997 1997 1998 1998
--------------- -------------- ------------- --------------
(DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Net sales .......................... $ 21,928 $ 35,186 $ 36,066 $ 24,024
Cost of goods sold ................. 13,622 22,809 24,518 15,421
---------- -------- -------- ---------
Gross profit ....................... 8,306 12,377 11,548 8,603
Selling, general and
administrative expenses ........... 3,322 5,712 5,601 3,121
Amortization of goodwill ........... 304 559 2,087 1,008
---------- -------- -------- ---------
Income from operations ............. 4,680 6,106 3,860 4,474
Interest expense, net .............. 1,451 2,646 11,269 3,210
Fees to stockholders ............... 118 215 125 63
Other, net ......................... 28 11 (47) --
Income tax expense
(benefit) ......................... 1,287 1,441 (2,033) 844
---------- -------- -------- ---------
Net income (loss) .................. $ 1,796 $ 1,793 $ (5,454) $ 357
========== ======== ======== =========
BALANCE SHEET DATA (AT END OF
PERIOD):
Cash and cash equivalents .......... $ 1,514 $ 4,481 $ 1,641 $ 1,341
Working capital (deficit) .......... (35,853) (4,959) 12,845 14,444
Total assets ....................... 83,518 77,399 211,064 213,725
Total debt and redeemable
preferred stock ................... 59,142 55,408 118,428 116,951
Total stockholder's equity ......... 12,860 12,716 79,621 80,090
OTHER DATA:
Capital expenditures ............... 448 807 514 678
Ratio of earnings to fixed
charges (1) ....................... 3.1x 2.2x -- 1.4x
- ---------
(1) For purposes of calculating the ratio of earnings to fixed charges,
"earnings" represent income (loss) before income taxes plus fixed
charges. "Fixed charges" consist of interest on all indebtedness and
amortization of deferred financing costs. Earnings were not sufficient to
cover fixed charges by $6,030 and $7,487 for the periods from November 4,
1993 to June 30, 1994 and from December 16, 1997 to June 30, 1998,
respectively.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the more
detailed information and Consolidated Financial Statements of the Company
included elsewhere in this Prospectus.
GENERAL
The Company's sales are derived from the sale of sampling products to
cosmetics and consumer products companies. Substantially all of the Company's
sales are made directly to its customers while a small portion are made through
advertising agencies. Each customer's sampling program is unique and pricing is
negotiated based on estimated costs plus a margin. While the Company and its
customers do not enter into long-term contracts, the Company has had
long-standing relationships with the majority of its customer base.
Historically, the Company's sales have been derived from the Company's
traditional fragrance sampling products, while sales from several of the
Company's new products, such as BeautiSeal, PowdaTouch and LiquaTouch, are
included in the Company's results of operations for only a portion of the
periods discussed below or are included in such periods at initial levels of
sales that reflect only introductory product volumes.
The Company's sales are seasonal due to the timing of its customers' major
advertising campaigns, which have traditionally been concentrated prior to the
Christmas and spring holiday seasons. Sales are recognized when products are
shipped. As a result, a higher level of sales are reflected in the Company's
first two fiscal quarters ended December 31 when sales from such advertising
campaigns are principally recognized while the Company's fourth fiscal quarter
ended June 30 typically reflects the lowest sales level of the fiscal year.
Sampling programs are generally quoted to the Company's customers, based on
their specifications, four to six months prior to production and firm orders
are generally received by the Company one to two months prior to production.
See "Risk Factors--Dependence on Fragrance Industry; Seasonality."
Cost of goods sold, which represented 66.5% of net sales in Fiscal 1998,
consists principally of materials (paper, plastic, foil, ink, packaging
materials and outsourced materials), direct labor, depreciation and overhead
costs. Materials and direct labor are variable components while overhead is
principally fixed. Fixed overhead costs (excluding depreciation) represented
approximately 9.6% of net sales in Fiscal 1998 and include indirect
departmental compensation, occupancy costs and equipment maintenance.
Paper is the primary raw material utilized by the Company and accounted
for approximately one-third of cost of goods sold in Fiscal 1998. During the
10-month period from November 1994 to September 1995, paper prices to the
Company increased approximately 36.0%. The average price of paper was
approximately 14.8% greater in Fiscal 1996 than in Fiscal 1995 and had an
adverse impact on the Company's results of operations in Fiscal 1996. As a
result of the paper price increases in Fiscal 1996, the Company changed its
pricing policy for sampling program quotes to customers and made them subject
to paper price increases. However, since the change in such policy, the Company
has not sought to change quoted prices to a customer based on paper price
increases and there can be no assurance that a customer would accept such
change. Accordingly, the Company seeks to reduce its exposure to changes in
paper prices by managing its paper inventory and the time between the quoting
and actual production of sampling campaigns while still attempting to preserve
the ability to adjust quoted pricing based on paper price increases. See "Risk
Factors--Sole Supplier of Certain Raw Materials."
Selling, general and administrative expenses, which represented 15.8% of
net sales in Fiscal 1998, consist mainly of employee compensation, marketing
and advertising expenses, professional and legal fees and occupancy costs of
the sales and laboratory facilities.
The cosmetics industry has experienced, and is continuing to experience,
significant consolidation. Management believes that such consolidation
positively impacts the sampling market, since larger cosmetics companies tend
to spend more on product sampling to support their brands throughout the
product life cycle, compared with smaller cosmetics companies, which tend to
use sampling primarily in
28
new product launches. However, industry consolidation has also negatively
impacted the sampling market by temporarily decreasing the amount that smaller
companies, which are targets of consolidation, spend on sampling products in
anticipation of, and during, the consolidation process.
The Acquisition was accounted for using the purchase method of accounting
and resulted in the recognition of $153.9 million of goodwill and a significant
increase in amortization expense. The Company has evaluated the amortization
period of the goodwill in accordance with Accounting Principles Board Opinion
No. 17, "Intangible Assets" ("APB No. 17"). Based upon the guidance set forth
in APB No. 17, the Company is amortizing the resulting goodwill over 40 years
based upon the characteristics of the fragrance sampling industry and the
composition of the customer base of the Company. The fragrance sample industry
has experienced little change in its competitive environment, with each
competitor servicing a similar and relatively small customer base, since the
Company entered the industry in the early 1970s. The fragrance sampling
business is comprised of relatively few competitors, each serving a similar and
relatively small customer base, and has experienced little change in its
competitive environment and customers since the Company entered the industry in
1979. The customers comprising the majority of the revenue base of the Company
are primarily large national and multinational cosmetics companies that have
been in operation and utilizing the services of the Company for a significant
length of time.
Also in conjunction with purchase accounting, the remaining useful lives
of the Company's property, plant and equipment were reevaluated, and inventory
and property, plant and equipment were recorded at their respective fair values
at the date of Acquisition in accordance with Accounting Principles Board
Opinion No. 16, "Business Combinations" (APB No. 16). The adjustments to
property, plant and equipment and inventory have the result of reducing
depreciation expense and increasing cost of goods sold in periods subsequent to
the Acquisition.
COST REDUCTION PROGRAM
The Company is implementing a comprehensive program designed to reduce
annual operating costs by up to $4.0 million. The comprehensive cost reduction
program was developed by the Company in connection with an evaluation of its
operations conducted by manufacturing consultants with significant experience
in the printing industry and is designed to improve the Company's operating
efficiency through (i) reduced materials cost derived from scrap/waste
reduction and from more effective purchasing (savings of approximately $1.2
million annually), (ii) streamlined manufacturing processes that reduce the
amount of time required to prepare for successive production runs utilizing the
same equipment and that reduce the amount of time equipment is under utilized
by improved scheduling of production runs (savings of approximately $2.2
million annually), and (iii) rationalized staffing in the product support area
(savings of approximately $0.6 million annually). Management expects the
benefit of the materials cost reductions and rationalized staffing which were
implemented in July 1998 will begin to be realized early in Fiscal 1999, while
the streamlined manufacturing process is not expected to be fully implemented
and realized until the fiscal year ended June 30, 2000. Because this program is
still being implemented, no significant cost savings have been achieved to
date.
RESULTS OF OPERATIONS
The discussion of results of operations for the three months ended
September 30, 1998 compared to the three months ended September 30, 1997
compares the results of operations of the Company for the three months ended
September 30, 1998 with the results of operations of the Predecessor for the
three months ended September 30, 1997. For purposes of the following
discussion, the results of operations for Fiscal 1998 reflect the combination
of the results of operations of the Predecessor for the period July 1, 1997
through December 15, 1997, the date of the Acquisition, with the results of
operations of the Company for the period December 16, 1997 through June 30,
1998. Because of the effects of purchase accounting applied in the Acquisition
and the additional interest expense associated with the debt incurred to
finance the Acquisition, the results of operations of the Company are not
comparable in all respects to the results of operations of the Predecessor.
29
Three Months Ended September 30, 1998 Compared to Three Months Ended
September 30, 1997
Net Sales. Net sales for the three months ended September 30, 1998
increased $2.1 million, or 9.6%, to $24.0 million as compared to $21.9 million
for the three months ended September 30, 1997. The increase in net sales was
attributable to increases in the sales of fragrance sampling products in the
domestic market, which benefited from the 3M Acquisition, and growth of the
Company's European sales. Domestic sales of sampling products to other
categories of the cosmetics industry also increased.
Gross Profit. Gross profit for the three months ended September 30, 1998
increased $0.3 million, or 3.6%, to $8.6 million as compared to $8.3 million
for the three months ended September 30, 1997. Gross profit as a percentage of
net sales decreased to 35.8% in the three months ended September 30, 1998 from
37.9% in the three months ended September 30, 1997. The increase in gross
profit is primarily attributable to the increase in net sales discussed above.
The decrease in gross profit as a percentage of net sales is due to changes in
product sales mix, increased costs associated with the outsourcing of European
production and increased costs associated with the initial production runs of
certain customer products, offset by reductions in raw materials costs and
improved margins resulting from increased sales due to the 3M Acquisition.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended September 30, 1998 decreased
$0.2 million, or 6.1%, to $3.1 million as compared to $3.3 million for the
three months ended September 30, 1997. The decrease in selling, general and
administrative expenses was primarily due to staff reductions and realized
gains from foreign currency transactions in Europe, offset partially by the
costs associated with the transition of the 3M Acquisition.
Income from Operations. Income from operations for the three months ended
September 30, 1998 decreased $0.2 million, or 4.3%, to $4.5 million as compared
to $4.7 million for the three months ended September 30, 1997. Income from
operations as a percentage of net sales decreased to 18.8% in the three months
ended September 30, 1998 from 21.5% in the three months ended September 30,
1997, principally as a result of the increase in amortization of goodwill
resulting from the Acquisition and the 3M Acquisition and the factors described
above.
Interest Expense. Interest expense for the three months ended September
30, 1998 increased $1.7 million, or 113.3% to $3.2 million as compared to $1.5
million for the three months ended September 30, 1997. Interest expense as a
percentage of net sales increased to 13.3% in the three months ended September
30, 1998 from 6.9% in the three months ended September 30, 1997. The increase
in interest expense is a result of the recapitalization of the Company in
connection with the Acquisition.
Other Income/Expense and Management Fees. Other income/expense and
management fees for the three months ended September 30, 1998 were $0.1 million
as compared to $0.1 million for the three months ended September 30, 1997.
Other income/expense and management fees as a percentage of net sales were
relatively constant as a percentage of sales in the three months ended
September 30, 1998 and 1997.
Income Tax Expense. Income tax expense for the three months ended
September 30, 1998 decreased $0.5 million or 38.5% to $0.8 million as compared
to $1.3 million for the three months ended September 30, 1997. The Company's
effective tax rate, after consideration of non-deductible goodwill, was 39.0%
in the three months ended September 30, 1998 and 38.0% in the three months
ended September 30, 1997.
EBITDA. EBITDA for the three months ended September 30, 1998 increased
$0.4 million, or 6.6%, to $6.5 million as compared to $6.1 million for the
three months ended September 30, 1997, principally as a result of the factors
described above.
Fiscal 1998 Compared to Fiscal 1997
Net Sales. Net sales for Fiscal 1998 decreased $6.4 million, or 8.2%, to
$71.3 million as compared to $77.7 million for Fiscal 1997. The majority of
this decrease was attributable to three core customers' advertising decreases
on new product launches and existing products as a result of a management
restructuring at two of these customers and the sale of one of them. In
addition there was a decrease in
30
domestic sales of products for fragrance sampling. These decreases were
partially offset by increased domestic and European sales of sampling products
to other categories of the cosmetics industry as well as increased sales to the
consumer products market.
Gross Profit. Gross profit for Fiscal 1998 decreased $4.4 million, or
15.5%, to $23.9 million as compared to $28.3 million for Fiscal 1997. Gross
profit as a percentage of net sales decreased to 33.5% in Fiscal 1998 from
36.4% in Fiscal 1997. The gross profit decline was primarily attributable to
the absorption of fixed overhead, depreciation costs and equipment
reconfiguration costs created by shorter production runs due to lower volume
and the increase in cost of goods sold in the period subsequent to the
Acquisition from the write-up of inventory in purchase accounting.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for Fiscal 1998 decreased $2.1 million, or 15.7%, to
$11.3 million as compared to $13.4 million for Fiscal 1997. The decrease in
selling, general and administrative expenses was primarily attributable to a
decrease in sales commissions resulting from the decreased level of sales and a
decrease in legal costs related to the Company's pursuit of a patent
infringement claim in Fiscal 1997. In addition, the Company also had decreased
expenses in Fiscal 1998 versus Fiscal 1997 related to the consolidation of
certain acquired technologies and certain expenses relating to reorganizing the
management structure at the Company's European subsidiary. As a result of these
factors, selling, general and administrative expenses as a percentage of net
sales decreased to 15.8% in Fiscal 1998 from 17.2% in Fiscal 1997.
Income from Operations. Income from operations for Fiscal 1998 decreased
$3.7 million, or 27.0%, to $10.0 million as compared to $13.7 million for
Fiscal 1997. Income from operations as a percentage of net sales decreased to
14.0% in Fiscal 1998 from 17.6% in Fiscal 1997 principally as a result of the
factors described above and the increase in amortization of goodwill resulting
from the Acquisition.
Interest Expense. Interest expense for Fiscal 1998 increased $7.7 million,
or 124.2% to $13.9 million as compared to $6.2 million for Fiscal 1997.
Interest expense as a percentage of net sales increased to 19.5% in Fiscal 1998
from 8.0% in Fiscal 1997. The increase in interest expense is a result of the
refinancing of the Company in connection with the Acquisition.
Other Income/Expense and Management Fees. Other income/expense and
management fees for Fiscal 1998 decreased $0.1 million, or 25.0% to $0.3
million as compared to $0.4 million for Fiscal 1997. Other income/expense and
management fees as a percentage of net sales decreased to 0.4% in Fiscal 1998
from 0.5% in Fiscal 1997. The decrease in other income/expense and management
fees is related to the decrease in management/advisory fees subsequent to the
sale of the Company.
Income Tax Expense. Income tax expense for Fiscal 1998 decreased $3.7
million or 119.4% to $(0.6) million as compared to $3.1 million for Fiscal
1997. The Company's effective tax rate, after consideration of non-deductible
goodwill, was 36.8% in Fiscal 1998 and 37.6% in Fiscal 1997.
EBITDA. EBITDA for Fiscal 1998 decreased $2.4 million, or 12.8%, to $16.4
million as compared to $18.8 million for Fiscal 1997, principally as a result
of the factors described above. EBITDA is income from operations plus
depreciation and amortization of goodwill and other intangibles.
Fiscal 1997 Compared to Fiscal 1996
Net Sales. Net sales for Fiscal 1997 increased $4.2 million, or 5.7%, to
$77.7 million as compared to $73.5 million in Fiscal 1996. The increase is
primarily attributable to volume increases related to core customers'
advertising expenditure increases on new product launches and existing
products.
Gross Profit. Gross profit for Fiscal 1997 increased $4.7 million, or
19.9%, to $28.3 million, as compared to $23.6 million in Fiscal 1996. Gross
profit as a percentage of net sales improved to 36.4% in Fiscal 1997 from 32.1%
in Fiscal 1996. Gross profit improvements reflected decreased materials costs
as a result of paper price decreases and increased operating efficiency gained
from moving the production of an acquired business from outside sources to
internal facilities.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for Fiscal 1997 increased $2.7 million, or 25.2%, to
$13.4 million as compared to $10.7 million in Fiscal 1996.
31
The increase in selling, general and administrative expenses was primarily
attributable to an increase in legal costs as the Company pursued a patent
infringement claim against a competitor. Additional increases were related to
reorganizing the management structure of the Company's European subsidiary,
increases in customer service and sales staffing and increased commissions
related to sales volume increases. As a result of these factors, selling,
general and administrative expenses as a percentage of net sales increased to
17.2% in Fiscal 1997 from 14.6% in Fiscal 1996.
Income from Operations. Income from operations for Fiscal 1997 increased
$1.9 million, or 16.1%, to $13.7 million as compared to $11.8 million in Fiscal
1996. Income from operations as a percentage of net sales increased to 17.6% in
Fiscal 1997 from 16.1% in Fiscal 1996 principally as a result of the factors
described above.
Interest Expense. Interest expense for Fiscal 1997 decreased $0.6 million,
or 8.8% to $6.2 million as compared to $6.8 million for Fiscal 1996. Interest
expense as a percentage of net sales decreased to 8.0% in Fiscal 1997 from 9.3%
in Fiscal 1996. The decrease in interest expense is primarily attributable to
the decrease in the outstanding principal balance of the Scent Seal notes,
capitalized lease obligations and Senior Loan Agreement including a decrease in
the related interest rate due to a decrease in the prime rate, partially offset
by increased borrowings against the revolving credit line.
Other Income/Expense and Management Fees. Other income/expense and
management fees for Fiscal 1997 decreased $0.3 million, or 42.9% to $0.4
million as compared to $0.7 million for Fiscal 1996. Other income/expense and
management fees as a percentage of net sales decreased to 0.5% in Fiscal 1997
from 1.0% in Fiscal 1996. The decrease in other income/expense and management
fees was due to a loss on the disposal of equipment in 1996 and a gain in 1997
related to the purchase and resale of preproduction material.
Income Tax Expense. Income tax expense for Fiscal 1997 increased $1.0
million, or 47.6% to $3.1 million as compared to $2.1 million for Fiscal 1996.
The Company's effective tax rate, after consideration of non-deductible
goodwill, was 37.6% in Fiscal 1997 and 38.2% in Fiscal 1996.
EBITDA. EBITDA for Fiscal 1997 increased $2.6 million, or 16.0% to $18.8
million as compared to $16.2 million in Fiscal 1996, principally as a result of
the factors described above. EBITDA is income from operations plus depreciation
and amortization of goodwill and other intangibles.
Fiscal 1996 Compared to Fiscal 1995
Net Sales. Net sales for Fiscal 1996 increased $11.7 million, or 18.9%, to
$73.5 million as compared to $61.8 million in Fiscal 1995. The Company acquired
a new product technology at the end of Fiscal 1995, which was marketed and sold
to the Company's customers and accounted for approximately $9.7 million of the
increase in net sales. The remaining increase was attributable to sales of
another new product in the first year subsequent to its introduction.
Gross Profit. Gross profit for Fiscal 1996 increased $0.1 million, or
0.4%, to $23.6 million, as compared to $23.5 million in Fiscal 1995. Gross
profit as a percentage of net sales decreased to 32.1% in Fiscal 1996 from
38.0% in Fiscal 1995. The decline in the gross profit percentage was primarily
attributable to increases in paper prices and the higher cost of temporarily
outsourcing production of product technologies acquired at the end of Fiscal
1995 as compared to the cost of internal production. In addition, plant
overhead costs increased primarily as a result of additional plant management
personnel and quality control staff required to serve the increased sales
volume; shipping costs also increased as new products were sent from U.S.
production facilities to the European market.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for Fiscal 1996 increased $2.2 million, or 25.9%, to
$10.7 million as compared to $8.5 million in Fiscal 1995. The increase was
primarily attributable to the acquisition of a new product technology,
restructuring costs following the reacquisition of the Company's European
license and increased staff and consultant costs related to product improvement
and development. As a result of these factors, selling, general and
administrative expenses as a percentage of net sales increased to 14.6% in
Fiscal 1996 from 13.8% in Fiscal 1995.
32
Income from Operations. Income from operations for Fiscal 1996 decreased
$2.1 million, or 15.1%, to $11.8 million as compared to $13.9 million in Fiscal
1995. Income from operations as a percentage of net sales decreased to 16.1% in
Fiscal 1996 from 22.5% in Fiscal 1995 principally as a result of the factors
described above.
Interest Expense. Interest expense for Fiscal 1996 increased $0.6 million,
or 9.7% to $6.8 million as compared to $6.2 million for Fiscal 1995. Interest
expense as a percentage of net sales decreased to 9.3% in Fiscal 1996 from
10.0% in Fiscal 1995. The increase in interest expense is due to full year
interest expense associated with the Scent Seal acquisition and capitalized
lease related to new manufacturing equipment.
Other Income/Expense and Management Fees. Other income/expense and
management fees for Fiscal 1996 increased $0.3 million, or 75.0% to $0.7
million as compared to $0.4 million for Fiscal 1995. Other income/expense and
management fees as a percentage of net sales increased to 1.0% in Fiscal 1996
from 0.6% in Fiscal 1995. The increase in other income/expense and management
fees was due to the loss incurred on the disposal of certain manufacturing
equipment.
Income Tax Expense. Income tax expense for Fiscal 1996 decreased $1.0
million or 32.3% to $2.1 million as compared to $3.1 million for Fiscal 1995.
The Company's effective tax rate, after consideration of non-deductible
goodwill, was 38.2% in Fiscal 1996 and 37.2% in Fiscal 1995.
EBITDA. EBITDA for Fiscal 1996 decreased $1.3 million, or 7.4% to $16.2
million as compared to $17.5 million in Fiscal 1995, principally as a result of
the factors described above. EBITDA is income from operations plus depreciation
and amortization of goodwill and other intangibles.
LIQUIDITY AND CAPITAL RESOURCES
The Company has substantial indebtedness and significant debt service
obligations. As of September 30, 1998, the Company had consolidated
indebtedness in an aggregate amount of $116.9 million. For certain information
regarding the Company's outstanding indebtedness, see "Description of Certain
Indebtedness" and "Description of New Notes." The Indenture under which the Old
Notes were and the New Notes will be issued and the Credit Agreement referred
to below permit the Company and its Restricted Subsidiaries to incur additional
indebtedness, subject to certain limitations.
In addition, the Indenture contains certain covenants that, among other
things, limit the ability of the Company and its Restricted Subsidiaries to:
(i) pay dividends or make certain restricted payments; (ii) incur additional
indebtedness and issue preferred stock; (iii) create liens; (iv) incur dividend
and other payment restrictions affecting subsidiaries; (v) enter into mergers,
consolidations or sales of all or substantially all of the assets of the
Company; (vi) enter into certain transactions with affiliates; and (vii) sell
certain assets. In addition, the Credit Agreement requires the Company to
maintain specified financial ratios and satisfy certain financial condition
tests. At June 30, 1998, the Company was not in compliance with one such
financial condition and obtained a waiver under the Credit Agreement with
respect to such requirement effective through September 30, 1998. The Company
and the Lender entered into a second amendment to the Credit Agreement dated
October 30, 1998. This amendment to the Credit Agreement retroactively amended
certain of the financial condition tests under the Credit Agreement and as of
September 30, 1998 the Company was in compliance with all financial condition
tests under the Credit Agreement, as amended. See "Description of Certain
Indebtedness" and "Description of New Notes--Certain Covenants".
Borrowings under the Credit Agreement are limited to a maximum amount
equal to $20.0 million. Currently, the Company has letters of credit
outstanding under the Credit Agreement in the amount of $0.6 million and has
borrowings of approximately $19.4 million available, subject to a borrowing
base calculation and the achievement of certain financial ratios and compliance
with certain conditions. The interest rate for borrowings under the Credit
Agreement are determined from time to time based on the Company's choice of
formulas, plus a margin. The Credit Agreement will mature on December 31, 2002.
See "Description of Certain Indebtedness--Credit Agreement."
33
The Company's principal liquidity requirements are for (i) debt service
requirements under the Notes, the Credit Agreement and the Scent Seal Note,
(ii) obligations under the Company's capital leases, (iii) working capital
needs and capital expenditures and (iv) certain royalty payments. Historically,
the Company has funded its capital, debt service and operating requirements
with a combination of net cash provided by operating activities, which were
$5.3 million and $8.9 million for Fiscal 1996 and Fiscal 1997, respectively,
together with borrowings under revolving credit facilities. In Fiscal 1998,
cash totaling $3.9 million was used by operating activities primarily due to
the assumption, and subsequent settlement, of a $5.8 million current liability
arising from, and directly attributable to the Acquisition. Cash provided by
operating activities was $1.8 million for the three months ended September
1998.
Net cash provided by operating activities in Fiscal 1996 and Fiscal 1997
resulted mainly from net income before depreciation and amortization. Key
elements of changes in net cash from operating activities were decreases in
trade accounts receivable that were principally offset by decreases in income
taxes, accounts payable and accrued expenses. Net cash provided by operating
activities during the three months ended September 30, 1998 resulted from net
income before depreciation and amortization and the collection of an income tax
refund receivable. These factors were partially offset by increased accounts
receivable and inventory levels necessary to accommodate the Company's seasonal
sales levels.
In Fiscal 1997, Fiscal 1998, and the three months ended September 30,
1998, the Company had capital expenditures of approximately $2.5 million, $1.3
million, and $0.7 million, respectively. These capital expenditures consisted
primarily of the purchase and maintenance of manufacturing equipment and
furniture and fixtures and maintaining and upgrading its computer systems.
On June 22, 1998, the Company closed the 3M Acquisition, pursuant to which
the Company acquired the fragrance sampling business of the Industrial and
Consumer Products division of 3M for approximately $7.25 million in cash and
the assumption of a liability associated with a credit of $182,000 issued by 3M
in favor of one of its customers. The Company has relocated all of the
production operations previously outsourced by 3M to its existing facilities to
utilize excess capacity at such facilities. See "The Transactions." The
purchase price for the 3M Acquisition was financed with borrowings under the
Credit Agreement which were subsequently repaid with funds from the Equity
Contribution and the Note Offering.
The Company may from time to time evaluate other potential acquisitions.
The Company expects that funding for future acquisitions may come from a
variety of sources, depending on the size and nature of any such acquisition.
Potential sources of capital include cash generated from operations, borrowings
under the Credit Agreement, additional equity investments or other external
debt or equity financings. There can be no assurance that such additional
capital sources will be available to the Company on terms that the Company
finds acceptable, or at all.
As of September 30, 1998, the Company had (i) $16.7 million in other
unsecured obligations (including trade payables, accrued liabilities and
deferred taxes), all of which ranks pari passu in right of payment with the
Notes (ii) no outstanding liabilities ranking junior to the Notes (however, the
Debentures of Holdings effectively rank junior to the Notes), and (iii) no
outstanding liabilities ranking senior to the Notes. The New Notes, however
will be effectively subordinated to all secured obligations of the Company,
including borrowings under the Credit Agreement, to the extent of the assets
securing such obligation. As of September 30, 1998, the Company had no
outstanding secured obligations, other than outstanding letters of credit in
the amount of $0.6 million under the Credit Agreement and $1.9 million
outstanding under a capitalized lease.
Capital expenditures for the fiscal year ending June 30, 1999 ("Fiscal
1999") are budgeted to be approximately $3.0 million. Based on borrowings
outstanding as of September 30, 1998, the Company expects total cash payments
for debt service in Fiscal 1999 to be approximately $14.3 million, consisting
of $12.1 million in interest payments on the Notes, the $1.3 million repayment
of the Scent Seal Note on July 1, 1998, $0.8 million in capital lease
obligations, and $0.1 million in fees under the Credit Agreement. The Company
also expects to make royalty payments of approximately $1.0 million during
Fiscal 1999. The Company believes that, in the absence of future acquisitions,
its liquidity, capital resources and cash flows from existing operations will
be sufficient to fund budgeted capital expenditures, working capital
34
requirements and interest and principal payments on its indebtedness, including
the Notes for Fiscal 1999. In the event the Company consummates any additional
acquisitions it may seek additional debt or equity financings subject to
compliance with the terms of the Indenture.
INFLATION
Inflation has not had nor is it expected to have a significant effect on
the Company's business or operations.
SEASONALITY
Historically, the Company's sales and operating results have reflected
seasonal variations. The seasonality of the Company's sales and operating
results is significantly influenced by the timing of its customers' advertising
campaigns, which have traditionally been concentrated prior to the Christmas
and spring holiday seasons. See "Risk Factors--Dependence on Fragrance
Industry; Seasonality."
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 130 ("SFAS No. 130"),
"Reporting Comprehensive Income." The Company adopted the provisions of this
Statement on July 1, 1998. This Statement establishes standards for reporting
and displaying comprehensive income and its components in the financial
statements. This Statement also requires that comparative information for
earlier periods be reclassified. As the Company only has two items of
comprehensive income, net income and foreign currency translations, adoption of
this statement did not have a material effect upon the Company's financial
position or results of operations.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131 ("SFAS No. 131"), "Disclosures about Segments of an Enterprise and
Related Information." SFAS No. 131 established standards for the way that
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. This Statement also established standards for related disclosures
about products and services, geographic areas and major customers. The Company
adopted the provisions of this Statement effective July 1, 1997. Based upon a
review of its operations, management believes that the Company operated in only
one reportable segment during each of the three years ended June 30, 1998 and
the three months ended September 30, 1998.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging
Activities" which is effective for fiscal years beginning after June 15, 1999.
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. The Company has only utilized derivative
financial instruments to hedge the Company's exposure to certain foreign
currencies. Such hedging activity has historically been minor and, as a result,
adoption of this Statement is not expected to have a material impact on the
Company's financial condition or results of operations. The Company will adopt
the provisions of this Statement on July 1, 1999.
YEAR 2000 ISSUES
The Company is currently working to resolve the potential impact of the
Year 2000 on its information technology systems and its non-information
technology systems so they will properly recognize and utilize dates beyond
December 31, 1999. The Year 2000 problem is the result of computer systems and
microprocessors with data functions being written using two digits (rather than
four) to define the applicable year.
The Company has in place a Year 2000 program which is being executed by a
project team which is not relying to a significant degree on outside
consultants. The objective of the Year 2000 program is to
35
determine and assess the risks of the Year 2000 issue and to plan and institute
mitigating actions to minimize those risks to acceptable levels. If, however,
all necessary actions are not taken on a timely basis to ensure Year 2000
compliance, the Year 2000 issue could have a material adverse effect on the
Company.
To date, all of the Company's systems have been assessed for Year 2000
compliance. The Company relies on five computerized systems all of which
required remediation, two of which are maintained internally and the others are
maintained by third party vendors. The Company estimates that 80% of these
systems are currently Year 2000 compliant. In the fourth quarter of calendar
1998 the Company will complete the upgrade of its primary computer system and
programs and receive certification from its key software supplier regarding
Year 2000 compliance. The Company's personnel will conduct testing to ensure
Year 2000 compliance. Upon review of the Company's non-information technology
systems the Company believes that none of its manufacturing equipment is date
sensitive. Of the remaining non-information technology systems, the Company
believes all such systems are Year 2000 compliant. To date, the Company has
spent $11,000 on Year 2000 compliance and expects additional expenditures of
approximately $40,000 during Fiscal 1999. Although the Company expects the
above referenced expenditures will be sufficient to ensure the Company is Year
2000 compliant, the Company anticipates budgeting an additional $49,000 for any
unforeseen problems arising with respect to Year 2000 compliance between
July 1, 1999 and the Year 2000. All expenditures with respect to Year 2000
compliance will be funded from working capital.
The Company is communicating with its significant customers and vendors to
understand their Year 2000 issues and how they might prepare themselves to
manage those issues as they relate to the Company. To date, no significant
customers or vendors have informed the Company that a material Year 2000 issue
exists which will have a material effect on the Company. See "Risk
Factors--Year 2000 Issues."
The Company has not formulated a contingency plan in the event it or its
significant customers or vendors are not Year 2000 compliant.
EUROPEAN MONETARY UNIT
The Company has not implemented a strategy to address European monetary
unit issues related to its computer system. Management does not expect that any
costs related to such strategy will require material expenditures on the part
of the Company.
ENVIRONMENTAL AND SAFETY REGULATION
The Company's operations are subject to extensive laws and regulations
relating to the storage, handling, emission, transportation and discharge of
materials into the environment and the maintenance of safe conditions in the
workplace. The Company's policy is to comply with all legal requirements of
applicable environmental, health and safety laws and regulations, and the
Company believes it is in general compliance with such requirements and has
adequate professional staff and systems in place to remain in compliance,
although there can be no assurances that this is the case. The Company
considers costs for environmental compliance to be a normal cost of doing
business, and includes such costs in pricing decisions.
36
BUSINESS
THE COMPANY
The Company is the leading global marketer and manufacturer of cosmetics
sampling products, including fragrance, skin care and makeup samplers. The
Company produces a range of proprietary and patented product samplers that can
be incorporated into various print media principally designed to reach the
consumer in the home, such as magazine inserts, catalog inserts, remittance
envelopes, statement enclosures and blow-ins. The Company is the only sampling
company positioned to provide complete marketing and sampling programs to its
customers, including creative content and sample production and distribution.
The Company's customers include most of the world's largest cosmetics
companies, such as Calvin Klein Cosmetics (Unilever Plc), Chanel, Inc.,
Christian Dior Perfumes Inc., Coty Inc., Elizabeth Arden (Unilever Plc), Estee
Lauder, Inc., Giorgio Beverly Hills (The Procter & Gamble Company), L'Oreal
S.A./Cosmair, Inc., and Sanofi Beaute, Inc.
Sampling is one of the most effective and widely used promotional
practices for consumer products. Product sampling usage has increased faster
than any other form of consumer promotional usage from 1992 to 1996, the last
year for which data is available. Product sampling is particularly critical to
the cosmetics industries, where consumers generally must try products prior to
purchase because of their uniquely personal nature. The Company's introduction
in 1979 of the ScentStrip (Registered Trademark) sampler, the first pull-apart
microencapsulated fragrance sampler, transformed the fragrance industry by
providing the first cost-effective means to reach consumers in their homes on a
mass scale by combining advertising and product sampling. All of the Company's
sampling products are approved by the U.S. Postal Service for inclusion in
subscription magazines at periodical postage rates, which is a more
cost-effective means of reaching consumers than alternatives such as direct
mail or newsstand magazine distribution. While the microencapsulated fragrance
sampler remains the most widely used technology in the sampling industry, the
Company continues to be the leading innovator in the sampling industry through
its development of alternative sampling technologies, all of which are designed
for cost-effective mass distribution.
In recent years, the Company has complemented its fragrance sampling
business by focusing its research and development efforts on new product
technologies and sampling solutions for the skin care, makeup and consumer
products markets. While product sampling is critical to the success of these
products, sampling programs for these products have been constrained
historically by the characteristics of the available sampling alternatives.
Most sampling programs have consisted of relatively limited in-store or direct
mail efforts because existing samples have been too costly to produce in mass
quantities and have been incapable of being efficiently incorporated into
magazines, catalogs and other print advertising. Since June 1997, the Company
has introduced three innovative product sampling technologies to address this
need, providing the first cost-effective means to reach consumers in their
homes on a mass scale with samples of these products. Management believes these
new technologies have fundamentally altered the economics and efficiencies of
product sampling in these markets. Existing customers such as Chanel, Christian
Dior, Estee Lauder and L'Oreal/Cosmair have utilized these new technologies in
sampling programs for their cosmetics products, such as skin care and liquid
makeup. The Company has also created and produced initial sampling programs for
new consumer products customers.
On June 22, 1998, the Company closed the 3M Acquisition, pursuant to which
the Company acquired the fragrance sampling business of the Industrial and
Consumer Products division of 3M for approximately $7.25 million in cash and
the assumption of certain liabilities. See "The Transactions."
COMPETITIVE ADVANTAGES
Founded in 1902 as a printing company, the Company has been the market
leader in fragrance sampling since its introduction of the ScentStrip sampler
almost two decades ago and has recently expanded the application of its
sampling technologies to new markets. Management believes that the Company has
significant competitive advantages compared to other sampling companies:
o Full product line. The Company is unique in the breadth of its product
line, which includes a full range of fragrance sampling products and
innovative new technologies for sampling skin care and
37
makeup products. The Company offers nine distinct sampling products,
while none of the Company's major competitors offers more than three
sampling technologies. Although most major cosmetics companies generate
significant revenues in each of the fragrance, makeup and skin care
categories, the Company is the only sampling provider that offers
sampling products for all such categories of products.
o Technological leadership. The Company is the technological leader in the
cosmetics sampling industry, and has introduced almost every major
fragrance sampling technology to the market since its introduction of the
ScentStrip sampler in 1979. Management believes that its product
development program is the largest and most effective in the cosmetics
sampling industry. Over the past three years, the Company's increased
emphasis on new product research and development has expanded the size of
the potential sampling market through the introduction of new
technologies, such as BeautiSeal (Trade Mark) , LiquaTouch (Trade Mark)
and PowdaTouch (Trade Mark) samplers, which target the skin care and
makeup categories. Seven of the Company's nine major sampling
technologies are patented or have patents pending, and all are approved
by the U.S. Postal Service for inclusion in subscription magazines.
Competing sampling technologies that are not approved for inclusion in
subscription magazines are more expensive to mass distribute. In
addition, the Company has developed certain proprietary manufacturing
techniques that management believes provide the Company with a
competitive advantage.
o Low cost, highest quality producer. The Company is the most vertically
integrated manufacturing company in the sampling industry as all of its
major competitors source all or part of their products from third-party
manufacturers. Management believes that the Company's high degree of
vertical integration, together with the Company's high volume provides
the Company with certain cost and quality advantages. In addition, unlike
some of its major competitors, which are divisions of large companies,
management believes that the Company's focus on the product sampling
industry allows it to produce the highest quality product offering in the
industry. Management believes this focus on quality is a competitive
advantage because the Company's customers are reluctant to jeopardize an
expensive product launch by using an unproven sampling source that may
not provide consumers with an accurate first exposure to a sampled
product.
o Strong customer relationships. More than 72% of Fiscal 1998 net sales
were generated by sales to customers that have been doing business with
the Company for the past five years or longer although the Company does
not have long-term contracts with any of its customers. The Company is
proactive in proposing innovative campaigns and sampling solutions, which
result in strong relationships with its customers. The Company has
long-standing relationships with the key marketing, purchasing and
technical executives at most of the world's leading cosmetics companies.
It has also developed relationships with flavor and fragrance companies,
media companies and leading retailers servicing the cosmetics industry.
o Superior customer service. Managing sampling programs is highly service
intensive and the Company has the most experienced customer service
representatives in the industry. As cosmetics companies seek to
streamline their purchasing operations, the Company's ability to provide
complete marketing and sampling programs is becoming increasingly
important. Management believes that the Company's ability to provide
excellent customer service is a competitive advantage for the Company,
particularly with regard to department store sampling programs, such as
catalog inserts, billing enclosures and remittance envelopes, which
require significant coordination with individual retailers.
o Sole global provider. The Company is the only sampling company to provide
local sales, service and production capabilities on a global basis. The
major cosmetics companies are increasingly global, and the Company's
ability to service these customers in Europe, the United States and
Southeast Asia is becoming increasingly important. The Company currently
has sales offices in New York, San Francisco, Paris, France and London,
England and sales agents in Sydney, Australia and Caracas, Venezuela. In
addition, the Company has third-party manufacturing capabilities in
Europe and Australia to complement its established domestic manufacturing
operations.
38
BUSINESS STRATEGY
Management's goal is to enhance the Company's position as the leading
global marketer and manufacturer of cosmetics sampling products and position
itself for growth in the consumer products sampling market, while increasing
its profitability. To achieve this goal, management is pursuing a strategy
based on the following elements:
o Leverage existing customer relationships to expand into new cosmetics
categories. Almost all of the Company's sales have historically been in
the fragrance category, but for many of the Company's cosmetics
customers, fragrance represents a small portion of their total sales.
Management estimates that skin care and makeup sales account for
approximately two-thirds of all cosmetics industry sales, while sampling
for such products accounts for less than one-fourth of all cosmetics
sampling units. Historically, most skin care and makeup sampling programs
have consisted of relatively limited in-store or direct mail efforts
because existing samples have been too costly to produce in mass
quantities and too expensive to incorporate into subscription magazines
and other forms of distribution. Since June 1997, the Company has
introduced three innovative product sampling technologies for the makeup
and skin care categories, which provide a cost effective means to reach
consumers in their homes. Management believes that these innovative new
technologies, together with its established cosmetics industry customer
relationships, position the Company for future growth in this area.
o Penetrate the consumer products market. Management believes that the
Company has significant opportunities to increase its existing sampling
business by applying its cost-effective sampling technologies to new
end-user categories within the consumer products market. The consumer
products market is significantly larger than the Company's traditional
fragrance market.
o Continue implementation of cost reduction program. The Company is
implementing a comprehensive program to reduce annual operating costs by
approximately $4.0 million. The comprehensive cost reduction program was
developed by the Company in connection with an evaluation of its
operations conducted by manufacturing consultants with significant
experience in the printing industry and is designed to improve the
Company's operating efficiency through (i) reduced materials cost derived
from scrap/waste reduction and from more effective purchasing, (ii)
streamlined manufacturing processes that reduce the amount of time
required to prepare for successive manufacturing jobs utilizing the same
equipment and (iii) rationalized staffing in the product support area.
Management expects the benefit of the materials cost reductions and
rationalized staffing will begin to be realized in the short term, while
the benefits of a streamlined manufacturing process are expected to be
realized incrementally through June 1999.
o Increase international sales. Since reacquiring its European license with
respect to its sampling technologies in August 1994, the Company has
significantly increased revenues from European customers and is the
leading fragrance sampling company in Europe. Management estimates that
the fragrance sampling industry in Europe is only approximately 20% of
the size of the fragrance sampling industry in the United States, even
though the size of the fragrance markets in Europe and the United States
are comparable. Management believes that European cosmetics companies
have preferred fragrance renditions that contain alcohol rather than
microencapsulated renditions. Given product innovations such as the
Company's Scent Seal (Registered Trademark) and LiquaTouch samplers
(which are alcohol-based sampling systems), the increasing globalization
of the cosmetics industry and the success of sampling techniques in the
U.S. market, management believes that the use of sampling will continue
to become more widespread in Europe.
SAMPLING INDUSTRY
Market and industry data used throughout this section were obtained from
internal surveys and industry publications. Industry publications generally
indicate that the information contained therein has been obtained from sources
believed by the Company to be reliable, but that the accuracy and completeness
of such information is not guaranteed. The Company has not independently
verified such market data. Similarly, internal surveys, while believed by the
Company to be reliable, have not been verified by any independent source.
39
Sampling is utilized by 90% of packaged goods manufacturers in their
consumer promotion mix in support of both established and new products. Product
sampling expenditures have increased faster than any other form of consumer
promotional expenditure from 1992 to 1996, the last year for which data is
available, and is particularly important in the fragrance and cosmetics
industries, where consumers generally try products prior to purchase because of
the uniquely personal nature of such products. (The industry's past growth rate
is not necessarily indicative of the Company's future growth rate.)
Management believes that the fundamentals of the sampling industry are
attractive. Declining store traffic has made the distribution of samples to
consumers' homes increasingly important. In addition, cosmetics products have
been characterized by shorter product life cycles and increased dependence on
new products for growth, both of which tend to increase manufacturer demand for
product samples to generate initial product trials. The cosmetics industry has
experienced, and is continuing to experience, significant consolidation.
Management believes that such consolidation positively impacts the sampling
market, since larger cosmetics companies tend to spend more on product sampling
to support their brands throughout the product life cycle, compared with
smaller cosmetics companies, which tend to use sampling primarily in new
product launches. However, industry consolidation has also negatively impacted
the sampling market by temporarily decreasing the amount that smaller
companies, which are targets of consolidation, spend on sampling products in
anticipation of, and during, the consolidation process.
Fragrance sampling market. The introduction in 1979 of the ScentStrip
sampler, the first pull-apart microencapsulated fragrance sampler, had a
significant impact on the fragrance category of the cosmetics industry by
providing the first cost-effective means to reach the consumer on a mass scale
through subscription magazines or direct mail, rather than relying on store
traffic to hand out vials or scented blotter cards. This development
contributed to significant growth in the U.S. fragrance category from
approximately $2.0 billion in 1980 to approximately $6.0 billion in 1996.
Shorter product lives and increased reliance on large product launches
require more promotional spending by manufacturers in order to distinguish new
fragrances. Between approximately $10.0 million and $25.0 million are spent to
launch a major new fragrance, with approximately 20% to 30% of the budget
allocated to sampling programs.
Skin care and makeup sampling market. The skin care category generated
approximately $4.5 billion in sales in the United States during 1996 and is one
of the fastest growing categories in the cosmetics industry. Such growth is
based primarily on changing consumer demographics, as aging baby boomers look
for ways to maintain a youthful appearance, and the fast pace of product
innovation. Cosmetics companies launched more than 700 new skin care products
in 1996, approximately ten times the number of fragrances introduced that year.
The makeup category accounted for approximately $3.5 billion in annual sales in
the United States in 1996. The skin care category generally includes skin
lotions, treatments, toners and astringents, and the makeup category generally
includes liquid and powder makeup.
Historically, most cosmetic sampling programs have consisted of relatively
limited in-store or direct-mail efforts because traditional sampling
alternatives including miniatures, vials, packettes, sachets and blisterpacks,
have been too costly to produce in mass quantities and too inefficient to
incorporate into magazines, catalogs and other print advertising. Management
estimates that skin care and makeup sales account for approximately two-thirds
of all cosmetics industry sales, while sampling for such products account for
less than one-fourth of all cosmetics sampling units.
The Company's new product sampling technologies allow marketers for the
first time to cost-effectively reach consumers in their homes through
subscription magazines. Home sampling for skin care products and makeup is
important because such products are ideally sampled on clean skin in the
morning or evening. In addition, mass marketers have had limited opportunities
to sample their products in-store because there is generally no in-store
service person and most current methods of in-store sampling are viewed by
consumers as unsanitary. By providing cost-effective sampling technologies that
can be delivered on a mass scale to consumers' homes in a sanitary manner,
management believes that the Company's new sampling technologies will rapidly
become the industry standard for skin care and makeup sampling.
40
Consumer products sampling market. The consumer products market is
significantly larger than the Company's traditional fragrance market. The
Company believes the household and personal care products industry alone is
approximately $75.0 billion, or approximately 12 times the size of the
Company's traditional fragrance market. By comparison, the U.S. fragrance
market is approximately $6.0 billion, and the entire U.S. cosmetics and
toiletries market is approximately $29.0 billion. The Company has a significant
opportunity to apply its technology to the food, beverage, household and
personal care markets.
International sampling market. The fragrance sampling industry in Europe
is only approximately 20% of the fragrance sampling industry in the United
States, although the size of the fragrance markets in Europe and the United
States are comparable in size. Management believes that European cosmetics
companies have preferred fragrance renditions that contain alcohol rather than
traditional microencapsulated renditions, and the Company's alcohol-based
sampling systems, such as Scent Seal samplers and LiquaTouch samplers have been
very successful as a result. Scent Seal technology is the leading fragrance
sampling product in Europe, and the LiquaTouch technology is being well
received as a cost-effective alternative to fragrance vials and miniatures.
Management believes that this market will grow as sampling formats successfully
used in the United States are adopted in Europe.
PRODUCTS
The Company offers a broad and unique line of sampling product
technologies for the fragrance, skin care, makeup and consumer products
markets. The Company's major technologies are described below, including a
description of the patent protection of each such product technologies. See
"Risk Factors--Competition." Each of the Company's products is a cosmetic
sample delivery device, generally designed to perform the same basic function,
and is generally sold to the same category of customers.
YEAR OF PATENT TARGET
PRODUCT INTRODUCTION ORIGIN PROTECTION MARKET
- -------------------------------- -------------- ---------------------- ---------------- -------------------------------------
Fragrance Samplers:
ScentStrip .................... 1979 internally developed -- fragrance, consumer products
ScentStrip Plus ............... mid 1980's internally developed -- fragrance
DiscCover ..................... 1994 licensed patented fragrance, consumer products
Scent Seal .................... 1995 acquired patented fragrance
Resealable ScentStrip ......... 1997 internally developed patent pending fragrance, consumer products
New Products:
BeautiSeal .................... 1997 internally developed patent pending liquid makeup, skin care (lotions,
treatments)
PowdaTouch .................... 1997 internally developed patent pending powder cosmetics
LiquaTouch .................... 1997 internally developed patent pending liquid fragrance, skin care (toners,
astringents)
LipSeal ....................... pending internally developed patent pending lipstick
Fragrance samplers. The Company has five different traditional fragrance
sampling products, which have historically accounted for substantially all of
the Company's sales. While the ScentStrip product technology continues to be
the most widely used technology in the fragrance sampling industry, management
believes that the Company's new fragrance sampling technologies have maintained
the Company's competitive position as an innovator in the industry. As a
result, the Company has played a sampling role in most major fragrance launches
in recent years, including such high-profile campaigns as Calvin Klein
Cosmetics' launch of CK One in 1994, Estee Lauder's launches of Pleasures in
1996 and Pleasures for Men in 1997, and Tommy Hilfiger's launch of Tommy in
1996 and Tommy Girl in 1997. Other examples of the Company's diverse experience
in the fragrance industry include successful sampling programs for (i) private
label retailers, including The Gap and Victoria's Secret, (ii) Donna Karan to
introduce its home fragrance line and (iii) Coty to introduce its aromatherapy
products with an innovative combination of Resealable ScentStrip Plus and Scent
Seal samplers.
o ScentStrip: The Company's original pull-apart microencapsulated fragrance
sampler. ScentStrip delivers to the consumer the most cost-effective
rendition of a fragrance.
o ScentStrip Plus: Adds a powdery texture to the microencapsulated
fragrance of ScentStrip.
41
o Resealable ScentStrip: Adds an innovative closure to ScentStrip that
opens and reseals up to 25 times.
o DiscCover: A "peel and reveal," non-encapsulated fragrance label sampling
technology that opens and reseals up to 25 times, which is versatile and
color printable and can be die-cut to nearly any shape and size.
o Scent Seal: A heat-sealed, pouch-like label technology that peels open to
reveal a moist, wearable gel sample that consumers can actually
experience on skin. Scent Seal samplers are the leading fragrance
sampling technology in the European market.
New products. The Company has recently introduced three innovative new
products, which management expects to account for a significant portion of the
Company's sales in the future. The Company is also in the final stages of
developing LipSeal, a lipstick sampler, which management expects to market at
the end of 1998. All of these new sampling technologies have been approved by
the U.S. Postal Service for inclusion in subscription magazines at periodical
postage rates.
o BeautiSeal: A heat-sealed, pouch-like label technology that peels open to
deliver cream and lotion treatments, liquid makeup and lipstick directly
into the hands of consumers in an inexpensive, spill-proof format. The
BeautiSeal sampler is less expensive and more versatile than existing
skin care sampling alternatives. For example, a two-sided, printed insert
incorporating a BeautiSeal sampler generally costs less than half the
cost to manufacture and distribute in magazines than an equivalent sample
packette. This product is the only skin treatment and liquid makeup
sampling technology approved by the U.S. Postal Service for inclusion in
subscription magazines at periodical postage rates. Because of these
advantages, management believes that the BeautiSeal technology has been
extremely well received in the market to date and is a particularly
attractive sampling vehicle for mass-cosmetic marketers who have very few
cost-effective alternatives to mass sample their products. The product
was introduced in featured advertisements for Estee Lauder's flagship
skin care product, Fruition Extra, in the August 1997 editions of several
magazines. Though the BeautiSeal technology was at the time untested,
management believes that Estee Lauder's BeautiSeal campaign was the
largest skin treatment sampling program in the history of Estee Lauder.
o PowdaTouch: Offers color marketers a superior rendition of the actual
powder shade, texture, application and finish of their products.
PowdaTouch applies up to four different shades to sample a single item
shade range or a complete color line at a much lower cost than competing
technologies. Management estimates that PowdaTouch samplers can be
produced at a rate that is approximately ten times faster than competing
products and at a reduced production cost.
o LiquaTouch: The only sampling technology containing an alcohol-formulated
fragrance with an applicator that is approved by the U.S. Postal Service
for inclusion in subscription magazines at periodical postage rates.
LiquaTouch is a finalist of the Fragrance Foundation's prestigious award
for "Innovation of the Year" for 1997. Equally appropriate for liquid
skin care treatment products, LiquaTouch samplers allow consumers to
experience product texture, application and benefit in a format that can
be die-cut to nearly any shape or bottle replica. Management believes
that this new form of sampling will compete very favorably with fragrance
sampling in vials and sachets, in-store handouts and direct-mail pieces
in addition to providing a new opportunity for subscription magazines.
Management expects to generate additional fragrance and skin treatment
sales from its LiquaTouch technology. While BeautiSeal samplers are
ideally suited for treatment creams, LiquaTouch samplers are expected to
be very attractive for clear liquid products, such as cleansers,
astringents and toners.
FORMATS
The Company's products are versatile and can be incorporated into
virtually any print media. All of the Company's sampling products are currently
approved by the U.S. Postal Service for inclusion in subscription magazines at
periodical postage rates. The most common formats for the Company's products
are described below.
42
Magazine Inserts. Magazine inserts are available in half-, full-, two- and
four-page formats, can be die-cut and can contain any of the Company's product
sampling technologies. Magazine inserts are the most common format for the
Company's products, accounting for approximately 41% of Fiscal 1998 sales.
Catalog Inserts. This format consists of full color inserts available in a
variety of sizes for insertion into catalogs. They are produced with or without
built-in return envelopes, which are generally used to order products from the
catalog as well as the advertised fragrance or other cosmetics product. Inserts
may also be custom imprinted with retail store information. The Company has the
capability to develop and fill catalog insert orders for complicated designs
and formats.
Remittance Envelopes. The Company is the only sampling company to produce
remittance envelopes in-house. This is a highly customized service business,
which reinforces the Company's position as the only full-service supplier of
samplers. The Company can incorporate each of its product technologies (other
than BeautiSeal) into this format. Remittance envelopes are inserted into store
statement mailings and are customized with the store logo. The Company also
provides unscented envelopes.
Statement Enclosures. Statement enclosures are available in various
formats and sizes. For fragrance sampling, enclosures may contain a single
scent in their fold, one or two scents under the fragrance panel, or they may
be die-cut so that the fragrance can be sampled by removing the desired die
shape. Enclosures are normally imprinted with the individual store logos and
product pricing information. The six-inch enclosure is the Company's design and
has become the industry's standard size.
Blow-Ins. Blow-ins incorporating all of the Company's sampling
technologies have become popular in the past two years. These pieces are
loosely inserted into store catalogs and newspaper or magazine formats instead
of being bound in and are available in all formats and sizes.
In-Store Handouts. The Company has made significant inroads into replacing
and expanding current methods of in-store cosmetic and fragrance sampling.
Because of the lower cost and design flexibility of the Company's products
relative to other sampling technologies, marketers of cosmetics and fragrances
have greatly expanded the number and type of in-store samples. New and creative
formats that the Company has originated in cooperation with its customers
include scented postcards, scented stickers, scented wristbands, scented
bookmarks and scented CD inserts. Management expects a significant in-store
handout business for the BeautiSeal and PowdaTouch technologies (to sample
shade ranges and formulae) and for the LiquaTouch technology as an alternative
to fragrance vials.
PATENTS AND PROPRIETARY TECHNOLOGY
The Company currently holds patents covering the proprietary manufacturing
processes used to produce two of its products and has submitted applications
for patents covering six additional manufacturing processes. The Company has
ongoing research efforts and expects to seek additional patents in the future
covering patentable results of such research. There can be no assurance that
any pending patent applications filed by the Company will result in patents
being issued or that any patents now or hereafter owned by the Company will
afford protection against competitors with similar technology, will not be
infringed upon or designed around by others or will not be challenged by others
and held to be invalid or unenforceable. In addition, many of the Company's
manufacturing processes are not covered by any patent or patent application. As
a result, the business of the Company may be adversely affected by competitors
who independently develop technologies substantially equivalent to those
employed by the Company. See "Risk Factors--Competition."
CUSTOMERS
The Company sells its products to prestige and mass cosmetics companies,
consumer product companies, department stores and specialty retailers including
Calvin Klein Cosmetics (Unilever Plc), Chanel, Inc., Christian Dior Perfumes,
Inc., Coty, Inc., Elizabeth Arden (Unilever Plc), Estee Lauder, Inc., Giorgio
Beverly Hills (The Procter & Gamble Company), L'Oreal S.A./Cosmair, Inc., and
Sanofi Beaute, Inc. The Company's top ten customers accounted for approximately
58% of total sales in Fiscal
43
1998. None of the Company's customers other than Estee Lauder accounted for 10%
or more of net sales in Fiscal 1998. The Company believes that its technical
expertise, manufacturing reliability and customer support capabilities have
enabled it to develop strong relationships with its customers. The Company
employs sales and marketing personnel who possess the requisite technical
backgrounds to communicate effectively with both prospective customers and the
Company's manufacturing personnel. Historically, the Company has had long-term
relationships with its major customers. See "Risk Factors--Reliance Upon
Significant Customers."
SALES AND MARKETING
The Company's President and Chief Executive Officer and the Company's
Senior Vice President of Sales and Marketing closely supervise the Company's
sales and marketing efforts, which are organized geographically. The U.S. sales
and marketing group includes five senior officers, six senior account
executives and three sales support staff. In Europe, the sales and marketing
group consists of two senior officers, two senior account representatives and
three sales support staff. In addition, the Company has ten customer service
representatives who manage production details and magazine and store approvals.
All sales are organized geographically and by account, with each major account
being serviced by one account representative and two customer service
representatives. All Company sales representatives and a portion of the
Company's customer service representatives are compensated on a commission
basis in addition to a base level of compensation.
The Company's marketing activities include direct contact with senior
executives in the cosmetic and fragrance industry, major support of industry
events, extensive joint marketing programs with magazines, retailers and oil
houses, press coverage in industry trade publications, trade shows and
seminars, advertising in trade publications and promotional pieces. In
addition, the Company focuses its sales efforts toward three principal groups
within its customer's organization that management believes influence the
customer's purchasing decision: (i) marketing, which selects the sampling
technology and controls the promotional budget; (ii) product development, which
approves the Company's sampling rendition and approves stability testing; and
(iii) purchasing, the group responsible for buying the sampling pieces and
controlling quality. Management believes that as the pressure for creativity
increases with each new product introduction, fragrance marketers are
increasingly looking for their vendors to contribute to the overall
strategy-building effort for a new fragrance. The Company's executives
routinely introduce new sampling formats and ideas based on the Company's
technologies to the marketing departments of its customers. The Company's
in-house creative and marketing expertise and complete product line provides
customers with maximum flexibility in designing promotional programs.
MANUFACTURING
The Company's manufacturing processes are highly technical and largely
proprietary. The Company's sampling products must meet demanding performance
specifications regarding fidelity to the product being sampled, shelf-life,
resistance to pressure and temperature variations and various other
requirements. The manufacturing processes can be broken into three phases: (i)
formulation of cosmetic and fragrance bulk in the Company's slurry laboratories
for use in sampling products; (ii) manufacturing the sampler, which consists of
either printing an encapsulated slurry onto paper or producing sampling labels
that contain fragrance or other cosmetic bulk; and (iii) for labeling
technologies (DiscCover, Scent Seal, BeautiSeal, LiquaTouch), affixing the
labels onto a piece preprinted by the Company or a third party contract
supplier.
Management believes that the Company's formulation capabilities are the
best in the cosmetics sampling industry. The formulation process is highly
complex because the Company is trying to replicate the fragrance of a product
in a bottle containing an alcohol solution using primarily essential oils and
paper. This translation process is very difficult to achieve particularly as
the Company's customers have become much more demanding about which particular
notes of fragrance they wish the Company to emphasize in its fragrance
formulations. Formulation approval is an iterative process between the Company
and its customers that can take up to 75 submissions, as the Company uses
different formulations to replicate the overall smell of the fragrance and
emphasize those fragrance notes which are
44
most important to the customer. The Company has more than 50 different,
proprietary formulations that it utilizes in replicating different
characteristics of the fragrance to obtain a customer-approved rendition.
Certain of these formulations are patented and the majority of the formulation
process is based on unique and proprietary methods. Because a supplier of
fragrance samples must have its formulation approved before it can be
considered for a sampling program, the Company's formulation expertise
typically allows it to become the first fragrance sampler manufacturer approved
on a new fragrance. Formulation of the fragrance and cosmetic bulk is performed
under very strict tolerances and in complete conformity to the formula that the
customer has preapproved. Formulation is conducted in the Company's specially
designed formulation laboratories by trained specialists.
The Company has two different sampling component manufacturing processes:
(i) for its formulated paper samplers (ScentStrip, ScentStrip Plus, PowdaTouch)
and (ii) for its formulated label samplers (DiscCover, Scent Seal, BeautiSeal,
LiquaTouch). Formulated paper samplers are produced in the Company's primary
facility where the Company carefully applies microencapsulated slurry onto the
paper during the printing process and, in a continuous in-line operation,
folds, cuts and trims the samplers for packing. The Company's manufacturing
line consists of printing equipment that has been specially modified to apply
fragrance or powder in a controllable form. The Company has 24-hour quality
control personnel who check the application of the sampling formulation every
hour on every press to ensure conformity and rendition with the original,
customer-approved formula. This quality control function and hourly
accountability provide significant value to the product development personnel
at the Company's customers, who are responsible for sample quality.
All sampling in a label form is produced on specially modified label and
finishing equipment in the Company's second facility. In addition to the
patents pending on certain of its manufacturing processes, the Company uses a
number of proprietary techniques in producing label samplers. Similar to the
formulated paper operation, sampling quality control personnel evaluate all
samples by roll and provide full accountability for the Company's production.
The artwork for all printed pieces is typically furnished by the customer
or its advertising agency. The Company's prepress department has a camera and
plate-making department that follows extensive quality control procedures. The
Company has the capability to produce printed materials of the highest quality,
including the covers of major fashion magazines in connection with fragrance
samplers on the inside.
SOURCES AND AVAILABILITY OF RAW MATERIALS
Historically, the raw materials used by the Company in the manufacturing
of its products have been readily available from numerous suppliers and have
been purchased by the Company at prices that the Company believes are
competitive. Substantially all of the Company's encapsulated paper products for
the domestic market products utilize specific grades of paper that are produced
exclusively for the Company by one supplier. The Company has not experienced
any material supply shortages nor are any anticipated. See "Risk Factors--Sole
Supplier of Certain Raw Materials."
COMPETITION
The Company's competitors, some of whom have substantially greater capital
resources than the Company, are actively engaged in manufacturing certain
products similar to, or in competition with, those of the Company. Competition
in the Company's markets is based upon product quality, product technologies,
customer relationships, price and customer service. The Company's principal
competitors in the printed fragrance sampler market are Webcraft, a subsidiary
of Big Flower Holdings, Inc., Orlandi Inc., Retail Communications Corp.,
Quebecor Printing (USA) Corp., Nord'est, Marietta Corp., Klocke, Color Prelude,
Rotocon, Drescher Ascent, and Appliquesence. The Company also competes with
numerous manufactures of miniatures, vials, packettes, sachets, blisterpacks
and scratch and sniff products. In addition, certain cosmetics companies
produce sampling products for their own cosmetic products. See "Risk
Factors--Competition" and "--The Company."
45
ENVIRONMENTAL AND SAFETY REGULATION
The Company's operations are subject to extensive laws and regulations
relating to the storage, handling, emission, transportation and discharge of
materials into the environment and the maintenance of safe conditions in the
workplace. The Company's policy is to comply with all legal requirements of
applicable environmental, health and safety laws and regulations, and the
Company believes it is in general compliance with such requirements and has
adequate professional staff and systems in place to remain in compliance,
although there can be no assurances that this is the case. The Company
considers costs for environmental compliance to be a normal cost of doing
business, and includes such costs in pricing decisions.
FACILITIES
The Company owns the land and buildings in Chattanooga, Tennessee that are
used for production, administration and warehousing. The Company's executive
offices and primary facility at 1815 East Main Street are located on 2.55 acres
and encloses approximately 67,900 square feet. A second facility housing
product development and additional manufacturing areas at 1600 East Main Street
is located three blocks away on 2.49 acres and encloses approximately 36,700
square feet.
The Company currently has a number of web printing presses with
multi-color capability as well as envelope-converting machines and other
ancillary equipment. The Company operates a fully equipped production lab for
the manufacture of microcapsules and slurry and separate laboratories for the
Company's Encapsulated Products Division and the Company's research and
development facility. The Company also has a fully staffed and equipped label
manufacturing facility, which includes state-of-the-art label manufacturing
machines that have been specially modified to produce the Company's products
and a complete label attaching operation. The Company also maintains sales
offices in New York, San Francisco, Paris, France and London, England.
EMPLOYEES
As of September 30, 1998, the Company employed 325 persons, which includes
218 hourly and 107 salaried and management personnel. Substantially all of the
Company's hourly employees are represented by the Graphics Communications
International Union (GCIU) local 197M. Management considers its relations with
the union to be good. The current union contract was signed in 1996 and will be
in effect through April 1, 1999.
LEGAL PROCEEDINGS
The Company does not believe that there are any pending legal proceedings
that, if adversely determined, would have a material adverse effect on the
financial condition or results of operations of the Company, taken as a whole.
46
THE TRANSACTIONS
THE ACQUISITION
Prior to the Acquisition, the Company was controlled by two private
investment firms and certain members of management. In 1997, the private
investment firms decided to sell their equity interests to DLJMBII and certain
affiliates. In connection with this activity, DLJMBII, certain members of the
Company's management and certain stockholders in the Predecessor organized
Acquisition Corp. to acquire all of the outstanding equity interests of the
Company. The Acquisition was completed on December 15, 1997.
The total cost of the Acquisition (including related fees, expenses and
cash for working capital) was approximately $205.7 million. Included in the
total cost of the Acquisition were approximately $6.2 million of non-cash costs
comprised of (i) the assumption of the Scent Seal Note and certain capital
lease obligations and (ii) the exchange of stock options to acquire common
stock in the Company by the Company's Chief Executive Officer for stock options
to acquire preferred stock in Acquisition Corp. See "Description of Certain
Indebtedness and "Certain Relationships and Related Transactions." To provide
the $199.5 million of cash necessary to fund the Acquisition, including the
equity purchase price and the retirement of all previously existing preferred
stock and debt of the Company not assumed, (i) the Company issued $123.5
million in Bridge Notes to an affiliate of DLJMBII and the Initial Purchaser
and (ii) Acquisition Corp. received $76.0 million from debt and equity (common
and preferred) financings, including equity investments by certain prior
stockholders including the Company's Chief Executive Officer and Liberty
Partners Holdings 4, L.L.C. As of September 30, 1998, (i) DLJMBII held an
aggregate of approximately 81.3% of the outstanding common stock of Acquisition
Corp. and (ii) the Company's Chief Executive Officer held an aggregate of
approximately 12.1% of the outstanding common stock of Acquisition Corp. See
"Risk Factors--Control by DLJMBII" and "Security Ownership of Certain
Beneficial Owners and Management." Acquisition Corp. has adopted a stock option
plan for management of Acquisition Corp., Holding and the Company and granted
options thereunder to the Company's Chief Executive Officer. See
"Management--Equity-Based Compensation."
3M ACQUISITION
On June 22, 1998, the Company closed the 3M Acquisition. 3M's fragrance
sampling business was predominantly a sales and distribution business as it
outsourced the production of the majority of the products it sold. The Company
did not assume such outsourcing arrangements and relocated such operations to
its existing facilities in Chattanooga to utilize current excess capacity at
such facilities. Except for several sales and technical employees, the Company
did not extend employment to any employees from 3M. Many of 3M's existing
customers are also existing customers of the Company. The Company anticipates
that as a result of the 3M Acquisition its sales volume from these customers
will increase. Management believes that in order to properly service such an
increase in sales volume associated with the 3M Acquisition, several additional
sales and technical employees will be hired. However, the Company believes that
due to the similarity of its existing customers and 3M's existing customers, no
other additional employee hiring will be required as a result of the 3M
Acquisition. The Company financed the 3M Acquisition with borrowings under the
Credit Agreement. Such borrowings were subsequently repaid with the proceeds of
the Equity Contribution and the Note Offering.
THE OFFERINGS
On June 25, 1998, the Company consummated the Note Offering. The Old Notes
were sold pursuant to exemptions from or in transactions not subject to, the
registration requirements of the Securities Act. In addition, on June 25, 1998,
Holding consummated the Debenture Offering. The Debentures were sold pursuant
to exemptions from, or in transactions not subject to, the registration
requirements of the Securities Act. The consummation of the Note Offering
occurred concurrently with and was conditioned upon, the consummation of the
Debenture Offering. The majority of the proceeds from the Debenture Offering
were used to fund the Equity Contribution. The Equity Contribution, together
with the proceeds from the Note Offering, was used by the Company to fund the
Refinancing.
47
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information with respect to the
directors and executive officers of the Company.
NAME AGE POSITION
- ---- --- --------
Thompson Dean ................ 40 Chairman of the Board and Director
Roger L. Barnett ............. 34 President, Chief Executive Officer and Director
Barry W. Miller .............. 46 Chief Operating Officer
Kenneth A. Budde ............. 50 Chief Financial Officer
Hugh R. Kirkpatrick .......... 61 Director
Mark Michaels ................ 38 Director
David M. Wittels ............. 33 Director
THOMPSON DEAN has served as Chairman of the Board and director of the
Company since December 1997. Mr. Dean is the Managing Partner of DLJ Merchant
Banking II, Inc. ("DLJ Merchant Banking"), the general partner of DLJ Merchant
Banking Partners II, L.P. and an affiliate of the Initial Purchaser. Mr. Dean
serves as a director of Commvault Inc., Von Hoffman Press, Inc., Manufacturers'
Services Limited and Phase Metrics, Inc.
ROGER L. BARNETT has served as President of the Company since 1995 and
director of the Company since November 1993. From 1994 to 1995, Mr. Barnett
served as Senior Vice President and Vice President of the Company. From 1991
until his employment by the Company, Mr. Barnett was a member of the banking
group at Lazard Freres & Company, an investment banking firm.
BARRY W. MILLER has served as Chief Operating Officer of the Company since
May 1998. From 1994 to 1997, Mr. Miller served as President of Precision
Printing and Packaging, Inc., a subsidiary of Anheuser-Busch Companies, Inc.
Prior to that, Mr. Miller served as Chief Executive Officer of International
Label from 1987 to 1993.
KENNETH A. BUDDE has served as Chief Financial Officer of the Company
since November 1994. From October 1988 to June 1994, Mr. Budde served as
Controller and Chief Financial Officer of Southwestern Publishing Company.
Prior to that, Mr. Budde spent 12 years with KPMG Peat Marwick.
HUGH R. KIRKPATRICK has served as a director of the Company since June
1998. Mr. Kirkpatrick is a former director of International Flavors &
Fragrances, Inc. where he served as Senior Vice President and President,
Worldwide Fragrance Division, from 1991 through his retirement in 1996.
MARK MICHAELS has served as director of the Company since June 1998. Mr.
Michaels has been a Principal of DLJ Merchant Banking since 1997. Prior
thereto, Mr. Michaels was a consultant with McKinsey & Company, Inc. from 1987
to 1996.
DAVID M. WITTELS has served as a director of the Company since December
1997. Mr. Wittels is a Principal of DLJ Merchant Banking and has served in
various capacities with DLJ Merchant Banking since 1986. Mr. Wittels serves as
a director of McCulloch Corp. and Wilson Greatbatch Limited.
COMPENSATION OF DIRECTORS
Except for Hugh R. Kirkpatrick, directors of the Company will not receive
compensation for services rendered in that capacity, but will be reimbursed for
out-of-pocket expenses incurred by them in connection with their travel to and
attendance at board meetings and committees thereof. Mr. Kirkpatrick will
receive an annual fee of $20,000 per year plus reasonable out-of-pocket
expenses in connection with his travel to and attendance at meetings of the
Board of Directors and committees thereof. In addition, it is expected Mr.
Kirkpatrick will be granted options to purchase shares of common stock, par
value $.01 per share, of Acquisition Corp. ("Acquisition Corp. Common Stock")
under the Option Plan (as defined) on terms to be established by the Board of
Directors.
48
EXECUTIVE COMPENSATION
The following table sets forth certain information for the three most
recently completed fiscal years with respect to the compensation of the
Company's Chief Executive Officer and its other most highly compensated
executive officers (collectively, the "named executive officers") whose total
annual compensation exceeded $100,000.
SUMMARY COMPENSATION TABLE
LONG TERM
ANNUAL COMPENSATION COMPENSATION
----------------------------------- --------------------
FISCAL SECURITIES ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS UNDERLYING OPTIONS COMPENSATION(1)
- ----------------------------------- -------- ----------- ---------- -------------------- ----------------
Roger L. Barnett .................. 1998 $367,083 $ -- 32,500(2) $3,670
President, Chief Executive Officer 1997 210,000 275,000 -- 5,700
and Director 1996 210,000 225,000 -- 6,856
Hugh F. Brown (3) ................. 1998 145,000 100,000 -- 3,384
Executive Vice President 1997 145,000 100,000 -- 5,700
Manufacturing 1996 145,000 100,000 -- 5,636
Kenneth A. Budde .................. 1998 120,000 75,000 -- --
Chief Financial Officer 1997 100,000 50,000 -- --
1996 100,000 20,000 -- --
- ----------
(1) Represents amounts contributed on behalf of the named executive to the
Company's 401(k) retirement savings plan.
(2) Option to purchase shares of Acquisition Corp. Common Stock. See
"--Equity-Based Compensation."
(3) Mr. Brown resigned from the Company in July 1998. Mr. Brown is expected
to become a consultant to the Company.
The following table contains information concerning the share options
grants made to each of the named executive officers of the Company during the
fiscal year ended June 30, 1998.
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
SHARE PRICE
APPRECIATION FOR
INDIVIDUAL GRANTS OPTION TERM (2)
-------------------------------------------------------- -----------------------
% OF TOTAL
NUMBER OF OPTIONS
SECURITIES GRANTED TO
UNDERLYING EMPLOYEES EXERCISE OR
OPTIONS IN FISCAL BASE PRICE EXPIRATION
GRANTED(1) YEAR ($/SH) DATE 5% 10%
------------ ----------- ------------ ------------ ---------- ----------
Roger L. Barnett ......... 32,500 100 $ 1.00 06/17/2008 $20,439 $51,797
Hugh F. Brown ............ -- -- -- -- -- --
Kenneth A. Budde ......... -- -- -- -- -- --
- ----------
(1) The option to purchase 32,500 shares of Acquisition Corp. Common Stock
was granted under Acquisition Corp.'s 1998 Stock Option Plan. See
"--Equity-Based Compensation."
(2) These amounts are based on compounded annual rates of share price
appreciation of five and ten percent over the 10-year term of the
options, as mandated by rules of the Securities and Exchange Commission,
and are not indicative of expected share price performance. Actual gains,
if any, on share option exercises are dependent on future performance of
the overall market conditions, as well as the option holders' continued
employment throughout the vesting period. The amount reflected in this
table may not necessarily be achieved or may be exceeded. The indicated
amounts are net of the option exercise price but before taxes that may be
payable upon exercise.
49
EMPLOYMENT AGREEMENTS
Barnett Agreement
The Company entered into an employment agreement with Mr. Barnett dated as
of June 17, 1998 (the "Barnett Agreement"). Pursuant to the Barnett Agreement,
Mr. Barnett will serve as President and Chief Executive Officer of the Company
for a term of three years. Mr. Barnett will receive an annual base salary of
$500,000 plus an annual bonus of up to 100% of his base salary contingent upon
the Company achieving certain financial performance targets set forth in the
Barnett Agreement. Mr. Barnett is also entitled to receive certain perquisites
commensurate with his position with the Company.
In the event of Mr. Barnett's resignation with "good reason" or
termination by the Company for any reason other than "cause" (each as defined
in the Barnett Agreement) or Mr. Barnett's death or disability, Mr. Barnett
will be entitled to certain severance payments in an amount equal to Mr.
Barnett's annual base salary for the fiscal year prior to the fiscal year of
termination and the amount equal to the bonus, if any, due or paid for the
fiscal year prior to the fiscal year of termination. The Barnett Agreement also
includes a non-competition provision pursuant to which Mr. Barnett may be
prohibited for a specified period of time from engaging in certain activities
that are competitive with the Company's business.
Mr. Barnett has also entered into a put option agreement with Acquisition
Corp. and DLJMBII dated June 17, 1998 (the "Put Option Agreement"). Pursuant to
the Put Option Agreement, Acquisition Corp. granted Mr. Barnett an irrevocable
option (the "Put Option") to require Acquisition Corp. to purchase certain
preferred equity interests of Mr. Barnett representing 80,000 shares of
preferred stock of Acquisition Corp. for $2.0 million in cash. Mr. Barnett
exercised the Put Option on July 30, 1998.
Miller Agreement
Mr. Miller is presently retained as Chief Operating Officer pursuant to an
employment agreement that provides for an annual base salary of $220,000 and an
annual bonus of up to 100% of his base salary upon achievement by the Company
of certain financial performance targets. The Company also supplies Mr. Miller
with other customary benefits and perquisites as generally made available to
other senior executives of the Company. The term of the employment agreement,
which expires on June 30, 2001, automatically renews for additional
twelve-month terms, unless either Mr. Miller or the Company elects otherwise.
EQUITY-BASED COMPENSATION
Acquisition Corp. has adopted a 1998 Stock Option Plan (the "Option Plan")
for certain key employees and directors of Acquisition Corp. and any parent or
subsidiary corporation of Acquisition Corp. The objectives of the Option Plan
are (i) to retain the services of persons holding key positions and to secure
the services of persons capable of filling such positions and (ii) to provide
persons responsible for the future growth of Acquisition Corp. an opportunity
to acquire a proprietary interest in the Company and thus create in such key
employees an increased interest in and a greater concern for the welfare of the
Company.
The Option Plan authorizes the issuance of options to acquire up to 80,000
shares of Acquisition Corp. Common Stock. The Option Plan will be administered
by the Board of Directors or the Compensation Committee thereof designated by
the Board of Directors (the "Committee"). Pursuant to the Option Plan,
Acquisition Corp. may grant options, including options that become exercisable
as performance standards determined by the Committee are met, to key employees
and directors of Acquisition Corp. and any parent or subsidiary corporation.
The terms of any such grant will be determined by the Committee and set forth
in a separate grant agreement. The exercise price will be at least equal to the
fair market value per share of Acquisition Corp. Common Stock on the date of
grant, provided that the exercise price shall not be less than $1.00 per share.
Options may be exercisable for up to ten years. The Committee has the right to
accelerate the right to exercise any option granted under the Option Plan
without effecting the expiration date thereof. Upon the occurrence of a change
in control (as defined therein) of Acquisition Corp., each option may, at the
discretion of the Committee, be terminated
50
upon notice to the holder thereof and each such holder will receive, in respect
of each share of Acquisition Corp. Common Stock for which such option is then
exercisable, an amount equal to the excess of the then fair market value of
such share of Acquisition Corp. Common Stock over the per share exercise price.
On June 17, 1998, Acquisition Corp. granted to Mr. Barnett options to
purchase 32,500 shares of Acquisition Corp. Common Stock under the Option Plan,
pursuant to option letter agreements between Acquisition Corp. and Mr. Barnett
(the "Option Agreements"). Under the terms of the Option Agreements, 16,250 of
the options granted to Mr. Barnett are designated as "time-vesting" options
(the "Time-Vesting Options") and 16,250 of the options granted to Mr. Barnett
are designated as "standard" options (the "Standard Options"). All of the
Time-Vesting and Standard Options have an exercise price of $1.00 per share.
The Time-Vesting Options become exercisable as to one-third of the
Acquisition Corp. Common Shares subject thereto on June 30, 1999, and are
thereafter exercisable as to an additional one-third of such Acquisition Corp.
Common Shares on June 30, 2000 and 2001, respectively. To the extent not
previously exercised or exercisable, upon a Change In Control (as defined in
the Option Agreements), the Time-Vesting Options shall immediately become
exercisable to purchase 100% of the Acquisition Corp. Common Shares subject
thereto.
The Standard Options become exercisable as to various percentages of the
Acquisition Corp. Common Shares subject thereto beginning June 30, 1999 and on
June 30, 2000 and June 30, 2001, based on the achievement of certain
established financial performance targets for the years then ended; provided
that the Standard Options become exercisable as to 100% of the Shares subject
thereto on June 16, 2006. Upon a Change In Control, 100% of the Standard
Options eligible to become vested on the date of such Change In Control shall
automatically vest and become exercisable if DLJMBII shall have realized
certain returns on their equity investment in Acquisition Corp.
While no final determinations have been made, it is expected that Mr.
Miller and certain other members of management will be granted options under
the Option Plan to purchase shares of Acquisition Corp. Common Stock. It is
expected that a portion of these options will be Time-Vesting Options and the
remainder will be Standard Options.
51
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
All of the Company's issued and outstanding capital stock is owned by
Holding. All of Holding's issued and outstanding capital stock is owned by
Acquisition Corp. The following table sets forth certain information as of the
date of this Prospectus with respect to the beneficial ownership of Acquisition
Corp. Common Stock by (i) owners of more than five percent of such Acquisition
Corp. Common Stock, (ii) each director and named executive officer of the
Company and (iii) all directors and executive officers of Acquisition Corp.,
Holding and the Company, as a group.
PERCENTAGE OF
OUTSTANDING
SHARES ACQUISITION CORP.
BENEFICIAL OWNER BENEFICIALLY OWNED COMMON STOCK
---------------- ------------------ ------------
DLJ Merchant Banking Partners II, L.P. and related investors (1) (2).... 903,111 81.3%
Thompson Dean (3) ...................................................... -- --
Roger L. Barnett (2) ................................................... 134,325 12.1
Hugh F. Brown .......................................................... 2,625 0.2
Hugh R. Kirpatrick ..................................................... -- --
Mark Michaels (3) ...................................................... -- --
David M. Wittels (3) ................................................... -- --
Barry W. Miller ........................................................ -- --
Kenneth A. Budde ....................................................... -- --
All directors and executive officers as a group (2) (3) ................ 136,950 12.3
- ----------
(1) Consists of shares held directly by the following affiliated investors:
DLJ Merchant Banking Partners II, L.P.; DLJ Merchant Banking Partners
II-A, L.P. ("DLJMBII-A"); DLJ Offshore Partners II, C.V. ("Offshore
Partners II"); DLJ Diversified Partners, L.P. ("Diversified Partners");
DLJ Diversified Partners-A, L.P. ("Diversified Partners-A"); DLJMB
Funding II, Inc. ("DLJ Funding II"); DLJ Millennium Partners, L.P.
("Millennium Partners"); DLJ Millennium Partners-A, L.P., ("Millennium
Partners-A"); DLJ EAB Partners, L.P. ("EAB Partners"); UK Investment Plan
1997 Partners ("UK Partners"); and DLJ First ESC L.P. ("First ESC"). See
"Certain Relationships and Related Transactions--Transactions with
DLJMBII and their Affiliates" and "Plan of Distribution." The address of
each of DLJMBII, DLJMBII-A, Diversified Partners, Diversified Partners-A,
DLJ Funding II, Millennium Partners, Millennium Partners-A, EAB Partners
and First ESC is 277 Park Avenue, New York, New York 10172. The address
of Offshore Partners II is John B. Gorsiraweg 14, Willemstad, Curacao,
Netherlands Antilles. The address of UK Partners is 2121 Avenue of the
Stars, Fox Plaza, Suite 3000, Los Angeles, California 90067. Does not
include 18,000 shares of Acquisition Corp. Common Stock held directly by
the Bridge Lender, an affiliate of DLJMBII and the Initial Purchaser.
(2) See "Certain Relationships and Related Transactions."
(3) Messrs. Dean, Michaels and Wittels are officers of DLJ Merchant Banking,
an affiliate of DLJMBII and the Initial Purchaser. Share data shown for
such individuals excludes shares shown as held by DLJMBII, as to which
such individuals disclaim beneficial ownership. The address of each of
Messrs. Dean, Michaels and Wittels is 277 Park Avenue, New York, New York
10172.
52
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH DLJMBII AND THEIR AFFILIATES
Messrs. Dean, Michaels and Wittels, who are directors of the Company and
officers and directors of Holding and Acquisition Corp., are officers of DLJ
Merchant Banking. DLJ Merchant Banking, together with DLJMBII, beneficially
own, in the aggregate, approximately 81.3% of the outstanding Acquisition Corp.
Common Stock. See "Risk Factors--Control by DLJMBII; Conflicts of Interests."
The Initial Purchaser is also an affiliate of DLJ Merchant Banking and
DLJMBII and has acted as financial advisor to the Company in connection with
the structuring of the Acquisition. For these financial advisory services, the
Initial Purchaser received a customary fee of $2.0 million and was reimbursed
for its out-of-pocket expenses. In addition, pursuant to an agreement between
the Initial Purchaser and Acquisition Corp., the Initial Purchaser will receive
an annual fee of $250,000 for acting as the exclusive financial and investment
banking advisor to the Company ending December 31, 2002. The Company has agreed
to indemnify the Initial Purchaser in connection with its acting as Initial
Purchaser and as financial advisor. In addition, the Initial Purchaser received
discounts and commissions of approximately $1.0 million in connection with the
offering of the Old Debentures and approximately $3.5 million in connection
with the offering of the Old Notes, which amounts the Company believes are
comparable to the discounts and commissions which would have been payable to an
unrelated third party. See "Plan of Distribution."
The Bridge Lender, an affiliate of DLJ Merchant Banking, DLJMBII and the
Initial Purchaser, made the loans under and was the holder of all of the $123.5
million principal amount of the Bridge Notes, all of which were repaid by the
Company with the proceeds of the Equity Contribution, together with the net
proceeds of the Note Offering. The Bridge Notes were issued in order to finance
the Acquisition. In connection with issuing the Bridge Notes, the Bridge Lender
received customary fees. The Company believes that the terms of the Bridge
Notes and the fees paid in connection therewith were comparable to those that
could have been obtained from an unaffiliated third party. See "Use of
Proceeds," "Description of Certain Indebtedness--Bridge Notes" and "Plan of
Distribution."
STOCKHOLDERS AGREEMENT
In connection with the Acquisition, Acquisition Corp., DLJMBII, certain
former investors (the "Prior Investors") in the Company prior to the
Acquisition, including Roger L. Barnett and Hugh F. Brown (the "Management
Investors") and certain other signatories thereto, entered into a Stockholders
Agreement, dated as of December 15, 1997 (the "Stockholders Agreement"), that
sets forth certain rights and restrictions relating to the ownership of the
capital stock of Acquisition Corp. (including securities exercisable for or
convertible or exchangeable into capital stock of Acquisition Corp.) and
agreements among the parties thereto as to the governance of Acquisition Corp.
and, indirectly, Holding and the Company.
Pursuant to the Stockholders Agreement, the Board of Directors of
Acquisition Corp. consists of six members. DLJMBII has the right to nominate
four of the Directors of Acquisition Corp. and the Prior Investors have the
right to nominate one Director of Acquisition Corp., provided that DLJMBII and
the Prior Investors maintain a specified minimum level of equity investment in
Acquisition Corp. In addition, the Stockholders Agreement provides that the
Chief Executive Officer of Acquisition Corp. be nominated as a Director of
Acquisition Corp.
The Stockholders Agreement contains restrictions on the ability of each
holder of capital stock of Acquisition Corp. to transfer any capital stock of
Acquisition Corp. to any person designated by the Board of Directors of
Acquisition Corp. to be an "Adverse Person". In addition, the Prior Members are
restricted in their ability to transfer capital stock of Acquisition Corp.
prior to the date that is the earlier of (i) the consummation of a qualifying
initial public offering or (ii) December 15, 2002, except (x) to DLJMBII or a
party who is a Prior Investor, or (y) pursuant to an offering of equity
securities registered under the Securities Act.
The other material provisions of the Stockholders Agreement provide,
subject to certain exceptions, (i) certain preemptive rights to the holders of
capital stock of Acquisition Corp., (ii) "drag along" rights to DLJMBII to
require the remaining holders of capital stock of Acquisition Corp. to sell a
percentage of their ownership and (iii) "tag along" rights to the holders of
capital stock of Acquisition Corp., other than DLJMBII, with respect to sales
of capital stock of Acquisition Corp. by DLJMBII.
53
Pursuant to the Stockholders Agreement, DLJMBII was granted the right to
demand up to three (3) Registrations on Form S-1 or the equivalent to sell
Acquisition Corp. Common Stock (or if Acquisition Corp. is eligible to use Form
S-3, the number of demand rights is unlimited) and all holders of capital stock
of Acquisition Corp. were granted certain customary "piggyback" registration
rights to register their common stock in any registration statement filed by
Acquisition Corp.
THE ACQUISITION
In connection and contemporaneously with the closing of the Acquisition,
the Management Investors sold certain of their options to purchase common stock
of the Company to Acquisition Corp. at fair market value for approximately
$12.1 million in cash. Such amount does not include any consideration
indirectly attributable to the Management Investors.
Further, Roger L. Barnett purchased an aggregate of 134,325 shares of
Acquisition Corp. Common Stock for $1.00 per share at the same per share price
paid by DLJMBII in connection with the formation of Acquisition Corp. In
addition to his purchase of Acquisition Corp. Common Stock, Mr. Barnett
exchanged certain options to acquire common stock of the Company for options to
acquire preferred stock of Acquisition Corp. On July 30, 1998, Mr. Barnett
exercised his option to acquire such shares of preferred stock of Acquisition
Corp. See "--Employment Arrangements."
Mr. Barnett and DLJMBII also entered into an arrangement pursuant to which
certain of the equity interests held by Mr. Barnett could be purchased by
DLJMBII at a specified price upon notice from DLJMBII prior to June 30, 1998.
Alternatively, Mr. Barnett was given the right to compel DLJMBII to purchase
such equity interests at the same price upon notice to DLJMBII prior to June
30, 1998. Such arrangement was terminated in connection with the Barnett
Agreement. See "Management--Employment Agreements."
PRIOR STOCKHOLDER TRANSACTIONS
During Fiscal 1997 and during Fiscal 1998 prior to the Acquisition, the
Company made payments of approximately $612,000 and $160,000, respectively to a
company controlled by a significant prior stockholder for management fees,
bonuses and expense reimbursements. In addition, the Company made payments
totaling $120,000 and $55,000 to another significant prior stockholder for
management fees in Fiscal 1997 and in Fiscal 1998 prior to the Acquisition,
respectively.
EMPLOYMENT ARRANGEMENTS
Mr. Barnett is retained as President and Chief Executive Officer of the
Company pursuant to the Barnett Agreement which provides for an annual salary
of $500,000 per year. Mr. Barnett, Acquisition Corp. and DLJMBII have also
entered into the Put Option Agreement pursuant to which Mr. Barnett was granted
an irrevocable option to require Acquisition Corp. (or DLJMBII under certain
circumstances) to purchase certain preferred equity interests of Mr. Barnett
representing 80,000 shares of preferred stock of Acquisition Corp. for $2.0
million in cash. On July 30, 1998, Mr. Barnett exercised such option. See
"Management--Employment Agreements."
54
DESCRIPTION OF CERTAIN INDEBTEDNESS
CREDIT AGREEMENT
On April 30, 1996, the Company entered into the Credit Agreement with
Heller Financial, Inc. (the "Lender"), which was amended on December 12, 1997
and October 30, 1998, in connection with the Acquisition (the "Credit
Agreement"). The Credit Agreement provides for a revolving loan commitment up
to a maximum of $20.0 million (subject to a borrowing base calculation), which
commitment shall expire on December 31, 2002 or earlier under certain
circumstances. Borrowings under the Credit Agreement are an obligation of the
Company and are secured by the current and future assets of the Company.
Borrowings outstanding under the Credit Agreement will effectively rank senior
to the Notes. On June 30, 1998 the Company received a waiver for its inability
to meet one of its financial convenants. The Company and the Lender entered
into a second amendment to the Credit Agreement dated October 30, 1998. This
amendment to the Credit Agreement retroactively amended certain of the
financial convenants under the Credit Agreement and as of September 30, 1998
the Company was in compliance with all financial covenants under the Credit
Agreement, as amended. The following description of the material provisions of
the Credit Agreement does not purport to be complete and is qualified in its
entirety by reference to the full text of the Credit Agreement.
Borrowings under the Credit Agreement will bear interest at a variable
rate of interest per annum equal to, at the Company's option, prime plus 0.75%
per annum or LIBOR plus 2.50% per annum. The Company is required to pay
commitment fees on the unused portion of the revolving loan commitment at a
rate of approximately 0.5% per annum. In addition, the Company is required to
pay fees equal to 2.5% of the average daily outstanding amount of lender
guarantees. At September 30, 1998, there were no borrowings outstanding under
the Credit Agreement and outstanding letters of credit were $0.6 million.
The Credit Agreement contains customary restrictive covenants, which,
subject to certain exceptions, limit the ability of the Company to (i) incur
additional indebtedness and liens in connection therewith, (ii) to make
investments or loans in or to third parties, (iii) create or become liable for
contingent obligations, (iv) amend the terms of its indebtedness, (v) enter
into certain transactions with affiliates, (vi) pay dividends, redeem or retire
stock or pay or prepay the principal of its outstanding debts (provided that
the Company may make required repayments of interest under the Notes), (vii)
amend any material provision of its articles of incorporation or bylaws or,
consolidate, merge or effect certain asset sales, (viii) sell any of the stock
of its subsidiaries, and (ix) enter into new lines of business. Under the
Credit Agreement, the Company is also required to satisfy certain financial
covenants, which require it to maintain certain financial ratios and to comply
with certain financial tests.
The Credit Agreement contains certain events of default, including, among
others, those relating to failure to make payments when due, default as to
certain other indebtedness of the Company, non-performance of certain
covenants, bankruptcy or insolvency, judgments in excess of specified amounts,
any dissolution of the Company and certain "changes in control" (as defined in
the Credit Agreement). Upon a default under the Credit Agreement as the result
of bankruptcy or default pursuant to other indebtedness of the Company, the
unpaid principal amount and all accrued, unpaid interest will automatically
become immediately due and payable. With respect to default under the Credit
Agreement for any other reason, the Lender may declare all or a portion of the
outstanding borrowings due and payable and the revolving loan commitment shall
terminate.
SCENT SEAL NOTE
In connection with the acquisition of Scent Seal, Inc. in 1995, the
Company executed a Conditional Promissory Note (the "Scent Seal Note") in the
principal amount of $1.75 million in favor of the former stockholder of Scent
Seal, Inc. The Scent Seal Note did not bear interest. The principal amount of
the Scent Seal Note was amortized by quarterly principal payments in the amount
of $25,000 and the Company paid $1.33 million on July 1, 1998 in full
satisfaction of the Scent Seal Note. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources." The Scent Seal Note was secured by the Company's "Scent Seal"
trademark.
55
BRIDGE NOTES
Simultaneously with the Acquisition, the Company entered into a Securities
Purchase Agreement with the Bridge Lender, an affiliate of DLJMBII and the
Initial Purchaser, pursuant to which the Company issued $123.5 million
principal amount of Bridge Notes to the Bridge Lender. In connection with the
issuance of the Bridge Notes for the financing of the Acquisition, the Bridge
Lender received certain reasonable and customary fees and reimbursements.
Messrs. Dean, Michaels and Wittels are officers of DLJ Merchant Banking, an
affiliate of the Initial Purchaser and the Bridge Lender. The entire
outstanding principal amount of, and accrued and unpaid interest on the Bridge
Notes were repaid with the net proceeds of the Offering. See "Use of Proceeds."
THE DEBENTURES
The Debentures generated gross proceeds to Holding of approximately $26.0
million (before deducting discounts and commissions). The Debentures were
issued under an Indenture dated as of June 25, 1998 (the "Debenture Indenture")
between Holding and State Street Bank and Trust Company as trustee. The
Debentures are general unsecured obligations of Holding and are effectively
junior in right of payment to all existing and future senior unsecured
indebtedness of the Company.
The Debentures accrete at a rate of 13 1/2%, compounded semi-annually to
an aggregate principal amount of $50.0 million at July 1, 2003. The Debentures
accrue interest at the rate of 13 1/2% per annum, payable semi-annually on
January 1 and July 1 of each year, commencing January 1, 2004.
The Debentures are redeemable at the option of Holding, in whole or in
part, at any time on or after July 1, 2003 in cash at the redemption prices set
forth below, plus accrued and unpaid interest and Liquidated Damages (as
defined in the Debenture Indenture), if any, thereon to the date of redemption.
YEAR REDEMPTION PRICE
- ---- ----------------
2003 ............... 106.750%
2004 ............... 103.375%
2005 ............... 100.000%
Notwithstanding the foregoing, at any time prior to July 1, 2001, Holding
may on any one or more occasions redeem up to 35% of the aggregate principal
amount at maturity of Debentures originally issued at a redemption price equal
to 113.5% of the Accreted Value thereof (determined at the date of redemption),
plus Liquidated Damages, if any, thereon to the redemption date, with the net
cash proceeds of one or more Public Equity Offerings (as defined in the
Debenture Indenture); provided that at least 65% of the original aggregate
principal amount at maturity of Debentures remains outstanding immediately
after the occurrence of such redemption.
In the event of a Change of Control (as defined in the Debenture
Indenture), each holder of Debentures will have the right to require Holding to
repurchase all or any part of such holder's Debentures at an offer price in
cash equal to 101% of the Accreted Value thereof on the date of repurchase (if
such date of repurchase is prior to July 1, 2003) or 101% of the aggregate
principal amount thereof (if such date of repurchase is on or after July 1,
2003), plus, in each case, accrued and unpaid interest and Liquidated Damages,
if any, thereon to the date of repurchase.
The Debenture Indenture contains covenants substantially similar to that
of the Indenture.
56
DESCRIPTION OF NEW NOTES
GENERAL
The Old Notes were, and the New Notes will be, issued pursuant to an
indenture (the "Indenture") between the Company and the Trustee dated as of
June 25, 1998. The form and terms of the New Notes are identical in all
material respects to the form and terms of the Old Notes except (i) the New
Notes will have been registered under the Securities Act, and (ii) the holders
of the New Notes will not be entitled to certain rights of holders of the Old
Notes under the Registration Rights Agreement. The terms of the Notes include
those stated in the Indenture and those made part of the Indenture by reference
to the Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"). The
Notes are subject to all such terms, and Holders of Notes are referred to the
Indenture and the Trust Indenture Act for a statement thereof. The following
summary of the material provisions of the Indenture does not purport to be
complete and is qualified in its entirety by reference to the Indenture,
including the definitions therein of certain terms used below. Copies of the
Indenture and Registration Rights Agreement are available as set forth below
under "--Additional Information." The definitions of certain terms used in the
following summary are set forth below under "--Certain Definitions."
The New Notes will be general unsecured obligations of the Company, will
rank pari passu in right of payment with all existing and future senior
unsecured Indebtedness of the Company and will rank senior in right of payment
to all existing and future subordinated Indebtedness of the Company. As of
September 30, 1998, the Company had (i) $16.7 million in other unsecured
obligations (including trade payables, accrued liabilities and deferred taxes),
all of which ranks pari passu in right of payment with the Notes (ii) no
outstanding liabilities ranking junior to the Notes (however, the Debentures
effectively rank junior to the Notes), and (iii) no outstanding liabilities
ranking senior to the Notes. The Notes, however, will be effectively
subordinated to all secured obligations of the Company, including borrowings
under the Credit Agreement, to the extent of the assets securing such
obligations. As of September 30, 1998, the Company had no outstanding secured
obligations, other than outstanding letters of credit in the amount of $0.6
million under the Credit Agreement and $1.9 million outstanding under a
capitalized lease. The Indenture will permit the incurrence of additional
secured Indebtedness in the future.
Currently, each of the Company's subsidiaries, Arcade Europe S.A.R.L. and
Scent Seal Inc., are Restricted Subsidiaries. However, under certain
circumstances, the Company will be able to designate current or future
Subsidiaries as Unrestricted Subsidiaries. Unrestricted Subsidiaries will not
be subject to many of the restrictive covenants set forth in the Indenture.
PRINCIPAL, MATURITY AND INTEREST
The Notes are limited in aggregate principal amount to $115.0 million and
will mature on July 1, 2008. Interest on the Notes will accrue at the rate of
10 1/2% per annum from June 25, 1998 and will be payable semi-annually in
arrears on January 1 and July 1 of each year, commencing on January 1, 1999, to
Holders of record on the immediately preceding June 15 and December 15.
Interest on the Notes will accrue from the most recent date to which interest
has been paid or, if no interest has been paid, from the date of original
issuance. Interest will be computed on the basis of a 360-day year comprised of
twelve 30-day months. Principal, premium and Liquidated Damages, if any, and
interest on the Notes will be payable at the office or agency of the Company
maintained for such purpose within the City and State of New York or, at the
option of the Company, payment of interest and Liquidated Damages, if any, may
be made by check mailed to the Holders of the Notes at their respective
addresses set forth in the register of Holders of Notes; provided that all
payments of principal, premium and Liquidated Damages, if any, and interest
with respect to Notes represented by one or more permanent global Notes will be
paid by wire transfer of immediately available funds to the account of The
Depository Trust Company or any successor thereto. Until otherwise designated
by the Company, the Company's office or agency in New York will be the office
of the Trustee maintained for such purpose. The New Notes will be issued in
denominations of $1,000 and integral multiples thereof.
57
OPTIONAL REDEMPTION
Except as provided below, the Notes will not be redeemable at the
Company's option prior to July 1, 2003. Thereafter, the Notes will be subject
to redemption at any time at the option of the Company, in whole or in part,
upon not less than 30 nor more than 60 days' notice, at the redemption prices
(expressed as percentages of principal amount) set forth below plus accrued and
unpaid interest and Liquidated Damages thereon, if any, to the applicable
redemption date, if redeemed during the twelve-month period beginning on July 1
of the years indicated below:
YEAR PERCENTAGE
- ---- ----------
2003 ......................... 105.250%
2004 ......................... 102.625%
2005 and thereafter .......... 100.000%
Notwithstanding the foregoing, at any time prior to July 1, 2001, the
Company may on one or more occasions redeem up to 35% of the original aggregate
principal amount of Notes at a redemption price of 110.5% of the principal
amount thereof, plus accrued and unpaid interest and Liquidated Damages
thereon, if any, to the redemption date, with the net cash proceeds of one or
more Public Equity Offerings; provided that at least 65% of the original
aggregate principal amount of Notes remains outstanding immediately after the
occurrence of such redemption; and provided, further, that such redemption
shall occur within 90 days of the date of the closing of such Public Equity
Offering.
SELECTION AND NOTICE
If less than all of the Notes are to be redeemed at any time, selection of
Notes for redemption will be made by the Trustee in compliance with the
requirements of the principal national securities exchange, if any, on which
the Notes are listed, or, if the Notes are not so listed, on a pro rata basis,
by lot or by such method as the Trustee shall deem fair and appropriate;
provided that no Notes of $1,000 or less shall be redeemed in part. Notices of
redemption shall be mailed by first class mail at least 30 but not more than 60
days before the redemption date to each Holder of Notes to be redeemed at its
registered address. Notices of redemption may not be conditional. If any Note
is to be redeemed in part only, the notice of redemption that relates to such
Note shall state the portion of the principal amount thereof to be redeemed. A
new Note in principal amount equal to the unredeemed portion thereof will be
issued in the name of the Holder thereof upon cancellation of the original
Note. Notes called for redemption become due on the date fixed for redemption.
On and after the redemption date, interest ceases to accrue on Notes or
portions of them called for redemption.
MANDATORY REDEMPTION
Except as set forth below under "--Repurchase at the Option of Holders,"
the Company is not required to make mandatory redemption or sinking fund
payments with respect to the Notes.
REPURCHASE AT THE OPTION OF HOLDERS
Change of Control
Upon the occurrence of a Change of Control, each Holder of Notes will have
the right to require the Company to repurchase all or any part (equal to $1,000
or an integral multiple thereof) of such Holder's Notes pursuant to the offer
described below (the "Change of Control Offer") at an offer price in cash equal
to 101% of the aggregate principal amount thereof plus accrued and unpaid
interest and Liquidated Damages thereon, if any, to the date of purchase (the
"Change of Control Payment"). Within 60 days following any Change of Control,
the Company will mail a notice to each Holder describing the transaction or
transactions that constitute the Change of Control and offering to repurchase
Notes on the date specified in such notice, which date shall be no earlier than
30 days and no later than 60 days from the date such notice is mailed (the
"Change of Control Payment Date"), pursuant to the procedures required by the
Indenture and described in such notice. The Company will comply with the
requirements
58
of Rule 14e-1 under the Exchange Act and any other securities laws and
regulations thereunder to the extent such laws and regulations are applicable
in connection with the repurchase of the Notes as a result of a Change of
Control. To the extent that the provisions of any securities laws or
regulations conflict with the provisions of the Indenture relating to such
Change of Control Offer, the Company will comply with the applicable securities
laws and regulations and shall not be deemed to have breached its obligations
described in the Indenture by virtue thereof.
On the Change of Control Payment Date, the Company will, to the extent
lawful, (1) accept for payment all Notes or portions thereof properly tendered
pursuant to the Change of Control Offer, (2) deposit with the Paying Agent an
amount equal to the Change of Control Payment in respect of all Notes or
portions thereof so tendered and (3) deliver or cause to be delivered to the
Trustee the Notes so accepted together with an Officers' Certificate stating
the aggregate principal amount of Notes or portions thereof being purchased by
the Company. The Paying Agent will promptly mail to each Holder of Notes so
tendered the Change of Control Payment for such Notes, and the Trustee will
promptly authenticate and mail (or cause to be transferred by book entry) to
each Holder a new Note equal in principal amount to any unpurchased portion of
the Notes surrendered, if any; provided that each such new Note will be in a
principal amount of $1,000 or an integral multiple thereof.
The Change of Control provisions described above will be applicable
whether or not any other provisions of the Indenture are applicable. Except as
described above with respect to a Change of Control, the Indenture does not
contain provisions that permit the Holders of the Notes to require that the
Company repurchase or redeem the Notes in the event of a takeover,
recapitalization or similar transaction.
The Company will not be required to make a Change of Control Offer upon a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements set
forth in the Indenture applicable to a Change of Control Offer made by the
Company and purchases all Notes validly tendered and not withdrawn under such
Change of Control Offer.
The definition of Change of Control includes a phrase relating to the
sale, lease, transfer, conveyance or other disposition of "all or substantially
all" of the assets of the Company and its Subsidiaries taken as a whole.
Although there is a developing body of case law interpreting the phrase
"substantially all," there is no precise established definition of that phrase
under applicable law. Accordingly, the ability of a Holder of Notes to require
the Company to repurchase such Notes as a result of a sale, lease, transfer,
conveyance or other disposition of less than all of the assets of the Company
and its Subsidiaries taken as a whole to another Person or group may be
uncertain.
Asset Sales
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, consummate an Asset Sale unless (i) the
Company (or the Restricted Subsidiary, as the case may be) receives
consideration at the time of such Asset Sale at least equal to the fair market
value (evidenced by a resolution of the Board of Directors set forth in an
Officers' Certificate delivered to the Trustee) of the assets or Equity
Interests issued or sold or otherwise disposed of and (ii) at least 75% of the
consideration therefor received by the Company or such Restricted Subsidiary is
in the form of cash or Cash Equivalents; provided that the amount of (x) any
liabilities (as shown on the Company's or such Restricted Subsidiary's most
recent balance sheet) of the Company or any Restricted Subsidiary (other than
contingent liabilities and liabilities that are by their terms subordinated to
the Notes or any guarantee thereof) that are assumed by the transferee of any
such assets pursuant to a customary novation agreement that releases the
Company or such Restricted Subsidiary from further liability and (y) any
securities, notes or other obligations received by the Company or any such
Restricted Subsidiary from such transferee that are converted by the Company or
such Restricted Subsidiary into cash or Cash Equivalents within 180 days (to
the extent of the cash received), shall be deemed to be cash for purposes of
this provision; and provided further that the 75% limitation referred to in
clause (ii) above will not apply to any Asset Sale in which the cash or Cash
Equivalents portion of the consideration received therefrom, determined in
accordance with the foregoing proviso, is equal to or greater than what the
after-tax proceeds would have been had such Asset Sale complied with the
aforementioned 75% limitation.
59
Within 360 days after the receipt of any Net Proceeds from an Asset Sale,
the Company or any such Restricted Subsidiary may apply such Net Proceeds, at
its option, (a) to repay or repurchase pari passu Indebtedness of the Company
or any Indebtedness of any Restricted Subsidiary or (b) to the acquisition of a
controlling interest in another business, the making of a capital expenditure
or the acquisition of other long-term assets, in each case, in a Permitted
Business. Pending the final application of any such Net Proceeds, the Company
may temporarily reduce the revolving Indebtedness under the Credit Agreement or
otherwise invest such Net Proceeds in any manner that is not prohibited by the
Indenture. Any Net Proceeds from Asset Sales that are not applied or invested
as provided in the first sentence of this paragraph will be deemed to
constitute "Excess Proceeds." When the aggregate amount of Excess Proceeds
exceeds $10.0 million, the Company will be required to make an offer to all
Holders of Notes (an "Asset Sale Offer") to purchase the maximum principal
amount of Notes that may be purchased out of the Excess Proceeds, at an offer
price in cash in an amount equal to 100% of the principal amount thereof plus
accrued and unpaid interest and Liquidated Damages thereon, if any, to the date
of purchase, in accordance with the procedures set forth in the Indenture. To
the extent that the aggregate amount of Notes tendered pursuant to an Asset
Sale Offer is less than the Excess Proceeds, the Company may use any remaining
Excess Proceeds for general corporate purposes. If the aggregate principal
amount of Notes surrendered by Holders thereof exceeds the amount of Excess
Proceeds, the Trustee shall select the Notes to be purchased on a pro rata
basis. Upon completion of such offer to purchase, the amount of Excess Proceeds
shall be reset at zero.
To the extent that the provisions of any securities laws or regulations
conflict with the provisions of the Indenture relating to such Asset Sale
Offer, the Company will comply with the applicable securities laws and
regulations and shall not be deemed to have breached its obligations described
in the Indenture by virtue thereof.
CERTAIN COVENANTS
Restricted Payments
The Indenture provides that from and after the date of the Indenture the
Company will not, and will not permit any of its Restricted Subsidiaries to,
directly or indirectly: (i) declare or pay any dividend or make any other
payment or distribution on account of the Company's or any of its Restricted
Subsidiaries' Equity Interests (including, without limitation, any payment on
such Equity Interests in connection with any merger or consolidation involving
the Company) or to the direct or indirect holders of the Company's or any of
its Restricted Subsidiaries' Equity Interests in their capacity as such (other
than dividends or distributions payable in Equity Interests (other than
Disqualified Stock) of the Company); (ii) purchase, redeem or otherwise acquire
or retire for value (including without limitation, in connection with any
merger or consolidation involving the Company) any Equity Interests of the
Company or any direct or indirect parent of the Company (other than any such
Equity Interests owned by the Company or any Restricted Subsidiary of the
Company); (iii) make any payment on or with respect to, or purchase, redeem,
defease or otherwise acquire or retire for value any Indebtedness that is
subordinated to the Notes, except scheduled payments of interest or principal
at Stated Maturity of such Indebtedness; or (iv) make any Restricted Investment
(all such payments and other actions set forth in clauses (i) through (iv)
above being collectively referred to as "Restricted Payments"), unless, at the
time of and after giving effect to such Restricted Payment:
(a) no Default or Event of Default shall have occurred and be continuing
or would occur as a consequence thereof; and
(b) the Company would, after giving pro forma effect thereto as if such
Restricted Payment had been made at the beginning of the applicable
four-quarter period, have been permitted to incur at least $1.00 of additional
Indebtedness pursuant to the Fixed Charge Coverage Ratio test set forth in the
first paragraph of the covenant described below under the caption "--Incurrence
of Indebtedness and Issuance of Preferred Stock"; and
(c) such Restricted Payment, together with the aggregate amount of all
other Restricted Payments made by the Company and its Restricted Subsidiaries
after the date of the Indenture (excluding
60
Restricted Payments permitted by clauses (i), (ii), (iii), (iv), (viii) (other
than those permitted by clause (f) of the definition of "Permitted
Investments"), (ix), (xii) and (xiii) of the next succeeding paragraph), is
less than the sum of (i) 50% of the Consolidated Net Income of the Company for
the period (taken as one accounting period) from the beginning of the first
fiscal quarter commencing after the date of the Indenture to the end of the
Company's most recently ended fiscal quarter for which internal financial
statements are available at the time of such Restricted Payment (or, if such
Consolidated Net Income for such period is a deficit, less 100% of such
deficit), plus (ii) 100% of the aggregate net cash proceeds received by the
Company as a contribution to the Company's capital or received by the Company
from the issue or sale since the date of the Indenture of Equity Interests of
the Company (other than Disqualified Stock) or of Disqualified Stock or debt
securities of the Company that have been converted into such Equity Interests
(other than Equity Interests (or Disqualified Stock or debt securities) sold to
a Restricted Subsidiary of the Company and other than Disqualified Stock or
convertible debt securities that have been converted into Disqualified Stock),
plus (iii) to the extent that any Restricted Investment that was made after the
date of the Indenture is sold for cash or otherwise liquidated or repaid for
cash, the lesser of (A) the cash return of capital with respect to such
Restricted Investment (less the cost of disposition, if any) and (B) the
initial amount of such Restricted Investment, plus (iv) if any Unrestricted
Subsidiary (A) is redesignated as a Restricted Subsidiary, the fair market
value of such redesignated Subsidiary (as determined in good faith by the Board
of Directors) as of the date of its redesignation or (B) pays any cash
dividends or cash distributions to the Company or any of its Restricted
Subsidiaries, 50% of any such cash dividends or cash distributions made after
the date of the Indenture.
The foregoing provisions will not prohibit (i) the payment of any dividend
within 60 days after the date of declaration thereof, if at said date of
declaration such payment would have complied with the provisions of the
Indenture; (ii) the redemption, repurchase, retirement, defeasance or other
acquisition of any subordinated Indebtedness or Equity Interests of the Company
in exchange for, or out of the net cash proceeds of the substantially
concurrent sale or issuance (other than to a Restricted Subsidiary of the
Company) of, other Equity Interests of the Company (other than Disqualified
Stock); provided that the amount of any such net cash proceeds that are
utilized for any such redemption, repurchase, retirement, defeasance or other
acquisition shall be excluded from clause (c)(ii) of the preceding paragraph;
(iii) the defeasance, redemption, repurchase or other acquisition of
subordinated Indebtedness with the net cash proceeds from an incurrence of
Permitted Refinancing Indebtedness; (iv) the payment of any dividend by a
Restricted Subsidiary of the Company to the holders of its Equity Interests on
a pro rata basis; (v) the declaration or payment of dividends to Acquisition
Corp. or Holding for expenses incurred by Acquisition Corp. or Holding in their
capacity as holding companies or for services rendered on behalf of the
Company, including, without limitation, (a) customary salary, bonus and other
benefits payable to officers and employees of Acquisition Corp. or Holding, (b)
fees and expenses paid to members of the Board of Directors of Acquisition
Corp. or Holding, (c) general corporate overhead expenses of Acquisition Corp.
or Holding, (d) management, consulting or advisory fees paid to Acquisition
Corp. or Holding not to exceed $4.0 million in any fiscal year, and (e) the
repurchase, redemption or other acquisition or retirement for value of any
Equity Interests of Acquisition Corp. or Holding held by any member or former
member of Acquisition Corp.'s, Holding's or the Company's (or any of their
Restricted Subsidiaries') management pursuant to any management equity
subscription agreement, stockholders agreement or stock option agreement;
provided, however, the aggregate amount paid pursuant to the foregoing clauses
(a) through (e) does not exceed $5.0 million in any fiscal year (with any
unused amounts in any fiscal year being carried over to succeeding fiscal
years, subject to a maximum (without giving effect to the following clause (y))
of $10.0 million in any calendar year, plus (y) the aggregate cash proceeds
received by the Company from any reissuance of Equity Interests by Acquisition
Corp. or Holding to members of management of the Company and its Restricted
Subsidiaries; (vi) Investments in any Person (other than the Company or a
Restricted Subsidiary) engaged in a Permitted Business in an amount not to
exceed $5.0 million; (vii) other Investments in Unrestricted Subsidiaries
having an aggregate fair market value, taken together with all other
Investments made pursuant to this clause (vii) that are at that time
outstanding, not to exceed $2.0 million; (viii) Permitted Investments; (ix) the
declaration or payment of dividends or other payments to Acquisition Corp. or
Holding pursuant to any tax sharing agreement or other arrangement among
Acquisition Corp., Holding or other members of the affiliated corporations
61
of which Acquisition Corp. or Holding is the common parent; (x) other
Restricted Payments in an aggregate amount not to exceed $10.0 million; (xi) so
long as no Default or Event of Default has occurred and is continuing, the
declaration and payment of dividends on Disqualified Stock issued or after the
date of the Indenture, the incurrence of which satisfied the covenant set forth
in the first paragraph of "--Incurrence of Indebtedness and Issuance of
Preferred Stock" below; (xii) the declaration or payment of dividends to
Acquisition Corp. or Holding to satisfy any required purchase price adjustment
payment arising out of the Acquisition; and (xiii) the declaration or payment
of dividends or other payments to Acquisition Corp. or Holding in an amount not
to exceed $2.0 million to satisfy redemption obligations in respect of Equity
Interests of Acquisition Corp. or Holding that are held by management of
Acquisition Corp., Holding or the Company; provided that such amount shall not
be applied against expenses incurred pursuant to clause (v)(e) above.
The Board of Directors may designate any Restricted Subsidiary to be an
Unrestricted Subsidiary if such designation would not cause a Default. For
purposes of making such determination, all outstanding Investments by the
Company and its Restricted Subsidiaries (except to the extent repaid in cash)
in the Subsidiary so designated will be deemed to be Restricted Payments at the
time of such designation and will reduce the amount available for Restricted
Payments under the first paragraph of this covenant. All such outstanding
Investments will be deemed to constitute Investments in an amount equal to the
fair market value of such Investments at the time of such designation (as
determined in good faith by the Board of Directors). Such designation will only
be permitted if such Restricted Payment would be permitted at such time and if
such Restricted Subsidiary otherwise meets the definition of an Unrestricted
Subsidiary.
The amount of all Restricted Payments (other than cash) shall be the fair
market value on the date of the Restricted Payment of the asset(s) or
securities proposed to be transferred or issued by the Company or such
Subsidiary, as the case may be, pursuant to the Restricted Payment. The fair
market value of any non-cash Restricted Payment shall be determined in good
faith by the Board of Directors whose resolution with respect thereto shall be
delivered to the Trustee; such determination will be based upon an opinion or
appraisal issued by an accounting, appraisal or investment banking firm of
national standing if such fair market value exceeds $10.0 million. Not later
than the date of making any Restricted Payment, the Company shall deliver to
the Trustee an Officers' Certificate stating that such Restricted Payment is
permitted and setting forth the basis upon which the calculations required by
the covenant "--Restricted Payments" were computed, together with a copy of any
fairness opinion or appraisal required by the Indenture.
Incurrence of Indebtedness and Issuance of Preferred Stock
The Indenture provides that the Company will not, and will not permit any
of its Subsidiaries to, directly or indirectly, create, incur, issue, assume,
guarantee or otherwise become directly or indirectly liable, contingently or
otherwise, with respect to (collectively, "incur") any Indebtedness (including
Acquired Debt) and that the Company will not issue any Disqualified Stock and
will not permit any of its Subsidiaries to issue any shares of preferred stock;
provided, however, that the Company may incur Indebtedness (including Acquired
Debt) or issue shares of Disqualified Stock or preferred stock and the
Company's Restricted Subsidiaries may incur Indebtedness (including Acquired
Debt) and issue Disqualified Stock or preferred stock if the Fixed Charge
Coverage Ratio for the Company's most recently ended four full fiscal quarters
for which internal financial statements are available immediately preceding the
date on which such additional Indebtedness is incurred or such Disqualified
Stock is issued would have been at least 2.0 to 1, determined on a pro forma
basis (including a pro forma application of the net proceeds therefrom), as if
the additional Indebtedness had been incurred, or the Disqualified Stock or
preferred stock had been issued, as the case may be, at the beginning of such
four-quarter period.
The provisions of the first paragraph of this covenant will not apply to
the incurrence of any of the following items of Indebtedness (collectively,
"Permitted Debt"):
(i) the incurrence by the Company of Indebtedness and letters of credit
pursuant to the Credit Agreement; provided that the aggregate principal amount
of all such Indebtedness (with letters of credit
62
being deemed to have a principal amount equal to the maximum potential
liability of the Company thereunder) then classified as having been incurred in
reliance on this clause (i) that remains outstanding under the Credit Agreement
after giving effect to such incurrence does not exceed the sum of $20.0
million.
(ii) the incurrence by the Company and its Restricted Subsidiaries of the
Existing Indebtedness;
(iii) the incurrence by the Company of Indebtedness represented by the
Notes;
(iv) the incurrence by the Company or any of its Restricted Subsidiaries
of Indebtedness represented by Capital Lease Obligations, mortgage financings
or purchase money obligations, in each case incurred for the purpose of
financing all or any part of the purchase price or cost of construction or
improvement of property, plant or equipment used in the business of the Company
or such Restricted Subsidiary (whether through the direct purchase of assets or
the Capital Stock of any Person owning such Assets), in an aggregate principal
amount or accreted value, as applicable, not to exceed $10.0 million;
(v) the incurrence by the Company or any of its Restricted Subsidiaries of
Indebtedness in connection with the acquisition of assets or a new Restricted
Subsidiary; provided that such Indebtedness was incurred by the prior owner of
such assets or such Restricted Subsidiary prior to such acquisition by the
Company or one of its Subsidiaries and was not incurred in connection with, or
in contemplation of, such acquisition by the Company or one of its
Subsidiaries; provided further that the principal amount (or accreted value, as
applicable) of such Indebtedness, together with any other outstanding
Indebtedness incurred pursuant to this clause (v), does not exceed $5.0
million;
(vi) the incurrence by the Company or any of its Restricted Subsidiaries
of Permitted Refinancing Indebtedness in exchange for, or the net proceeds of
which are used to refund, refinance or replace Indebtedness that was permitted
by the Indenture to be incurred;
(vii) the incurrence by the Company or any of its Restricted Subsidiaries
of intercompany Indebtedness between or among the Company and any of its
Restricted Subsidiaries; provided, however, that (i) if the Company is the
obligor on such Indebtedness, such Indebtedness is expressly subordinated to
the prior payment in full in cash of all Obligations with respect to the Notes
and (ii)(A) any subsequent issuance or transfer of Equity Interests that
results in any such Indebtedness being held by a Person other than the Company
or a Restricted Subsidiary and (B) any sale or other transfer of any such
Indebtedness to a Person that is not either the Company or a Restricted
Subsidiary shall be deemed, in each case, to constitute an incurrence of such
Indebtedness by the Company or such Restricted Subsidiary, as the case may be;
(viii) the incurrence by the Company or any of its Restricted Subsidiaries
of Hedging Obligations that are incurred for the purpose of fixing or hedging
(i) interest rate risk with respect to any floating rate Indebtedness that is
permitted by the terms of this Indenture to be outstanding or (ii) exchange
rate risk with respect to any agreement or Indebtedness of such Person payable
in a currency other than U.S. dollars;
(ix) the Guarantee by the Company or any of its Restricted Subsidiaries of
Indebtedness of the Company or a Restricted Subsidiary of the Company that was
permitted to be incurred by another provision of this covenant;
(x) the incurrence by the Company's Unrestricted Subsidiaries of
Non-Recourse Debt; provided, however, that if any such Indebtedness ceases to
be Non-Recourse Debt of an Unrestricted Subsidiary, such event shall be deemed
to constitute an incurrence of Indebtedness by a Restricted Subsidiary of the
Company;
(xi) Indebtedness incurred by the Company or any of its Restricted
Subsidiaries constituting reimbursement obligations with respect to letters of
credit issued in the ordinary course of business, including without limitation
to letters of credit in respect to workers' compensation claims or self-
insurance, or other Indebtedness with respect to reimbursement type obligations
regarding workers' compensation claims; provided, however, that upon the
drawing of such letters of credit or the incurrence of such Indebtedness, such
obligations are reimbursed within 30 days following such drawing or incurrence;
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(xii) Indebtedness arising from agreements of the Company or a Restricted
Subsidiary providing for indemnification, adjustment of purchase price or
similar obligations, in each case, incurred or assumed in connection with the
disposition of any business, asset or Subsidiary, other than guarantees of
Indebtedness incurred by any Person acquiring all or any portion of such
business, assets or Subsidiary for the purpose of financing such acquisition;
provided that (x) such Indebtedness is not reflected on the balance sheet of
the Company or any Restricted Subsidiary (contingent obligations referred to in
a footnote or footnotes to financial statements and not otherwise reflected on
the balance sheet will not be deemed to be reflected on such balance sheet for
purposes of this clause (x)) and (y) the maximum assumable liability in respect
of such Indebtedness shall at no time exceed 50% of the gross proceeds
including non-cash proceeds (the fair market value of such non-cash proceeds
being measured at the time received and without giving effect to any such
subsequent changes in value) actually received by the Company and/or such
Restricted Subsidiary in connection with such disposition;
(xiii) obligations in respect of performance and surety bonds and
completion guarantees provided by the Company or any Restricted Subsidiary in
the ordinary course of business;
(xiv) guarantees incurred in the ordinary course of business in an
aggregate principal amount not to exceed $5.0 million at any time outstanding;
and
(xv) the incurrence by the Company or any of its Restricted Subsidiaries
of additional Indebtedness, including Attributable Debt incurred after the date
of the Indenture, in an aggregate principal amount (or accreted value, as
applicable) at any time outstanding, including all Permitted Refinancing
Indebtedness incurred to refund, refinance or replace any other Indebtedness
incurred pursuant to this clause (xv), not to exceed $20.0 million.
For purposes of determining compliance with this covenant, in the event
that an item of Indebtedness meets the criteria of more than one of the
categories of Permitted Debt described in clauses (i) through (xv) above or is
entitled to be incurred pursuant to the first paragraph of this covenant, the
Company shall, in its sole discretion, classify such item of Indebtedness in
any manner that complies with this covenant and such item of Indebtedness will
be treated as having been incurred pursuant to only one of such clauses or
pursuant to the first paragraph hereof. In addition, the Company may, at any
time, change the classification of an item of Indebtedness (or any portion
thereof) to any other clause or to the first paragraph hereof provided that the
Company would be permitted to incur such item of Indebtedness (or portion
thereof) pursuant to such other clause or the first paragraph hereof, as the
case may be, at such time of reclassification. Accrual of interest, accretion
or amortization of original issue discount and the accretion of accreted value
will not be deemed to be an incurrence of Indebtedness for purposes of this
covenant.
Liens
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, create, incur, assume or otherwise cause or
suffer to exist or become effective any Lien (other than Permitted Liens) upon
any of their property or assets, now owned or hereafter acquired.
Dividend and Other Payment Restrictions Affecting Restricted Subsidiaries
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, directly or indirectly, create or otherwise
cause or suffer to exist or become effective any encumbrance or restriction on
the ability of any Restricted Subsidiary to (i)(a) pay dividends or make any
other distributions to the Company or any of its Restricted Subsidiaries (1) on
its Capital Stock or (2) with respect to any other interest or participation
in, or measured by, its profits, or (b) pay any Indebtedness owed to the
Company or any of its Restricted Subsidiaries, (ii) make loans or advances to
the Company or any of its Restricted Subsidiaries or (iii) transfer any of its
properties or assets to the Company or any of its Restricted Subsidiaries,
except for such encumbrances or restrictions existing under or by reason of (a)
Existing Indebtedness as in effect on the date of the Indenture, (b) the Credit
Agreement as in effect as of the date of the Indenture, and any amendments,
modifications, restatements, renewals, increases, supplements, refundings,
replacements or refinancings thereof, provided that such amendments,
modifications, restatements, renewals, increases, supplements, refundings,
replacement or refinancings are no more restrictive in the aggregate (as
determined in the good faith judgment of the Company's Board of
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Directors) with respect to such dividend and other payment restrictions than
those contained in the Credit Agreement as in effect on the date of the
Indenture, (c) the Indenture and the Notes, (d) any applicable law, rule,
regulation or order, (e) any instrument of a Person acquired by the Company or
any of its Restricted Subsidiaries as in effect at the time of such acquisition
(except to the extent incurred in connection with or in contemplation of such
acquisition), which encumbrance or restriction is not applicable to any Person,
or the properties or assets of any Person, other than the Person, or the
property or assets of the Person, so acquired, provided that, in the case of
Indebtedness, such Indebtedness was permitted by the terms of the Indenture to
be incurred, (f) by reason of customary non-assignment provisions in leases
entered into in the ordinary course of business and consistent with past
practices, (g) purchase money obligations for property acquired in the ordinary
course of business that impose restrictions of the nature described in clause
(e) above on the property so acquired, (h) Permitted Refinancing Indebtedness,
provided that the material restrictions contained in the agreements governing
such Permitted Refinancing Indebtedness are no more restrictive, in the good
faith judgment of the Company's board of directors, taken as a whole, to the
Holders of Notes than those contained in the agreements governing the
Indebtedness being refinanced, (i) contracts for the sale of assets, including
without limitation customary restrictions with respect to a Subsidiary pursuant
to an agreement that has been entered into for the sale or disposition of all
or substantially all of the Capital Stock or assets of such Subsidiary, (j)
restrictions on cash or other deposits or net worth imposed by customers under
contracts entered into in the ordinary course of business and (k) other
Indebtedness or Disqualified Stock of Restricted Subsidiaries permitted to be
incurred subsequent to the Issuance Date pursuant to the provisions of the
covenant described under "--Incurrence of Indebtedness and Issuance of
Preferred Stock."
Merger, Consolidation, or Sale of Assets
The Indenture provides that the Company may not consolidate or merge with
or into (whether or not the Company is the surviving corporation), or sell,
assign, transfer, convey or otherwise dispose of all or substantially all of
its properties or assets in one or more related transactions, to another Person
unless (i) the Company is the surviving corporation or the Person formed by or
surviving any such consolidation or merger (if other than the Company) or to
which such sale, assignment, transfer, lease, conveyance or other disposition
shall have been made is a corporation organized or existing under the laws of
the United States, any state thereof or the District of Columbia; (ii) the
entity or Person formed by or surviving any such consolidation or merger (if
other than the Company) or the entity or Person to which such sale, assignment,
transfer, lease, conveyance or other disposition shall have been made assumes
all the obligations of the Company under the Notes and the Indenture pursuant
to a supplemental indenture in a form reasonably satisfactory to the Trustee;
(iii) immediately after such transaction no Default or Event of Default exists;
and (iv) the Company or the entity or Person formed by or surviving any such
consolidation or merger (if other than the Company), or to which such sale,
assignment, transfer, lease, conveyance or other disposition shall have been
made (a) will, at the time of such transaction and after giving pro forma
effect thereto as if such transaction had occurred at the beginning of the
applicable four-quarter period, be permitted to incur at least $1.00 of
additional Indebtedness pursuant to the Fixed Charge Coverage Ratio test set
forth in the first paragraph of the covenant described above under the caption
"--Incurrence of Indebtedness and Issuance of Preferred Stock" or (b) would
(together with its Restricted Subsidiaries) have a higher Fixed Charge Coverage
Ratio immediately after such transaction (after giving pro forma effect thereto
as if such transaction had occurred at the beginning of the applicable
four-quarter period) than the Fixed Charge Coverage Ratio of the Company and
its subsidiaries immediately prior to the transaction. The foregoing clause
(iv) will not prohibit (a) a merger between the Company and a Wholly Owned
Subsidiary of Acquisition Corp. or Holding created for the purpose of holding
the Capital Stock of the Company, (b) a merger between the Company and a Wholly
Owned Subsidiary or (c) a merger between the Company and an Affiliate
incorporated solely for the purpose of reincorporating the Company in another
state of the United States so long as, in each case, the amount of Indebtedness
of the Company and its Restricted Subsidiaries is not increased thereby. The
Indenture will also provide that the Company may not, directly or indirectly,
lease all or substantially all of its properties or assets, in one or more
related transactions, to any other Person. The provisions of this covenant will
not be applicable to a sale, assignment, transfer, conveyance or other
disposition of assets between or among the Company and its Wholly Owned
Restricted Subsidiaries.
65
Transactions with Affiliates
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, make any payment to, or sell, lease,
transfer or otherwise dispose of any of its properties or assets to, or
purchase any property or assets from, or enter into or make or amend any
transaction, contract, agreement, understanding, loan, advance or guarantee
with, or for the benefit of, any Affiliate (each of the foregoing, an
"Affiliate Transaction") unless (i) such Affiliate Transaction is on terms that
are no less favorable to the Company or the relevant Restricted Subsidiary than
those that would have been obtained in a comparable transaction by the Company
or such Restricted Subsidiary with an unrelated Person and (ii) the Company
delivers to the Trustee (a) with respect to any Affiliate Transaction or series
of related Affiliate Transactions involving aggregate consideration in excess
of $1.0 million, a resolution of the Board of Directors set forth in an
Officers' Certificate certifying that such Affiliate Transaction complies with
clause (i) above and that such Affiliate Transaction has been approved by a
majority of the disinterested members of the Board of Directors and (b) with
respect to any Affiliate Transaction or series of related Affiliate
Transactions involving either aggregate consideration in excess of $5.0 million
or an aggregate consideration in excess of $3.0 million where there are no
disinterested members of the Board of Directors, an opinion as to the fairness
to the Holders of such Affiliate Transaction from a financial point of view
issued by an accounting, appraisal or investment banking firm of national
standing; provided that the following shall not be deemed Affiliate
Transactions: (q) customary directors' fees, indemnification or similar
arrangements or any employment agreement or other compensation plan or
arrangement entered into by the Company or any of its Restricted Subsidiaries
in the ordinary course of business and consistent with the past practice of the
Company or such Restricted Subsidiary, (r) transactions between or among the
Company and/or its Restricted Subsidiaries, (s) Permitted Investments and
Restricted Payments that are permitted by the provisions of the Indenture
described above under the caption "--Restricted Payments," (t) customary loans,
advances, fees and compensation paid to, and indemnity provided on behalf of,
officers, directors, employees or consultants of the Company or any of its
Restricted Subsidiaries, (u) transactions pursuant to any contract or agreement
in effect on the date of the Indenture as the same may be amended, modified or
replaced from time to time so long as any such amendment, modification or
replacement is no less favorable to the Company and its Restricted Subsidiaries
than the contract or agreement as in effect on the Issue Date, (v) transactions
between the Company or its Restricted Subsidiaries on the one hand, and
Donaldson, Lufkin & Jenrette Securities Corporation or its Affiliates ("DLJ")
on the other hand, involving the provision of financial, advisory, placement or
underwriting services by DLJ; provided that fees payable to DLJ do not exceed
the usual and customary fees of DLJ for similar services, (w) insurance
arrangements among Acquisition Corp., Holding and its Subsidiaries that are not
less favorable to the Company or any of its Subsidiaries than those that are in
effect on the date hereof provided such arrangements are conducted in the
ordinary course of business consistent with past practices, (x) payments under
any tax sharing agreement or other arrangement among Acquisition Corp., Holding
and other members of the affiliated group of corporations of which either is
the common parent and (y) payments in connection with the Refinancing
(including the payment of fees and expenses with respect thereto).
Sale and Leaseback Transactions
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, enter into any sale and leaseback
transaction; provided that the Company or any Restricted Subsidiary may enter
into a sale and leaseback transaction if (i) the Company or such Restricted
Subsidiary could have (a) incurred Indebtedness in an amount equal to the
Attributable Debt relating to such sale and leaseback transaction pursuant to
the covenant described above under the caption "--Incurrence of Indebtedness
and Issuance of Preferred Stock" and (b) incurred a Lien to secure such
Indebtedness pursuant to the covenant described above under the caption
"--Liens," (ii) the gross cash proceeds of such sale and leaseback transaction
are at least equal to the fair market value (as determined in good faith by the
Board of Directors and set forth in an Officers' Certificate delivered to the
Trustee) of the property that is the subject of such sale and leaseback
transaction and (iii) the transfer of assets in such sale and leaseback
transaction is permitted by, and the Company applies the proceeds of such
transaction in compliance with, the covenant described above under the caption
"--Repurchase at the Option of Holders--Asset Sales."
66
Limitations on Issuances of Guarantees of Indebtedness
The Indenture provides that the Company will not permit any Restricted
Subsidiary, directly or indirectly, to incur Indebtedness or Guarantee or
pledge any assets to secure the payment of any other Indebtedness of the
Company or any Restricted Subsidiary unless either such Restricted Subsidiary
(x) is a Subsidiary Guarantor or (y) simultaneously executes and delivers a
supplemental indenture to the Indenture and becomes a Subsidiary Guarantor,
which Guarantee shall be senior to or pari passu with such Restricted
Subsidiary's other Indebtedness or Guarantee of or pledge to secure such other
Indebtedness. Notwithstanding the foregoing, any such Guarantee by a Restricted
Subsidiary of the Notes shall provide by its terms that it shall be
automatically and unconditionally released and discharged upon any sale,
exchange or transfer, to any Person not an Affiliate of the Company, of all of
the Company's stock in, or all or substantially all the assets of, such
Restricted Subsidiary, which sale, exchange or transfer is made in compliance
with the applicable provisions of the Indenture. The form of such Guarantee is
attached as an exhibit to the Indenture.
Additional Guarantees
The Indenture provides that (i) if the Company or any of its Restricted
Subsidiaries shall, after the date of the Indenture, transfer or cause to be
transferred, including by way of any Investment, in one or a series of
transactions (whether or not related), any assets, businesses, divisions, real
property or equipment having an aggregate fair market value (as determined in
good faith by the Board of Directors) in excess of $10.0 million to any
Restricted Subsidiary that is not a Subsidiary Guarantor or a Foreign
Subsidiary, (ii) if the Company or any of its Restricted Subsidiaries shall
acquire another Restricted Subsidiary other than a Foreign Subsidiary having
total assets with a fair market value (as determined in good faith by the Board
of Directors) in excess of $10.0 million, or (iii) if any Restricted Subsidiary
other than a Foreign Subsidiary shall incur Acquired Debt in excess of $10.0
million, then the Company shall, at the time of such transfer, acquisition or
incurrence, (i) cause such transferee, acquired Restricted Subsidiary or
Restricted Subsidiary incurring Acquired Debt (if not then a Subsidiary
Guarantor) to execute a Note Guarantee of the Obligations of the Company under
the Notes in the form set forth in the Indenture and (ii) deliver to the
Trustee an Opinion of Counsel, in accordance with the terms of the Indenture.
Business Activities
The Company will not, and will not permit any Restricted Subsidiary to,
engage in any business other than a Permitted Business, except to such extent
as would not be material to the Company and its Restricted Subsidiaries taken
as a whole.
Reports
The Indenture provides that, whether or not required by the rules and
regulations of the Commission, so long as any Notes are outstanding, the
Company will furnish to the Trustee and Holders of Notes (i) all quarterly and
annual financial information that would be required to be contained in a filing
with the Commission on Forms 10-Q and 10-K if the Company were required to file
such Forms, including a "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and, with respect to the annual
information only, a report thereon by the Company's certified independent
accountants and (ii) all current reports that would be required to be filed
with the Commission on Form 8-K if the Company were required to file such
reports. In addition, following the consummation of the Exchange Offer, whether
or not required by the rules and regulations of the Commission, the Company
will file a copy of all such information and reports with the Commission for
public availability (unless the Commission will not accept such a filing) and
make such information available to the Trustee, securities analysts and
prospective investors upon request. In addition, for so long as any of the
Notes remain outstanding, the Company has agreed to make available to any
prospective purchaser of the Notes or Holder of the Notes in connection with
the sale thereof, the information required by Rule 144A(d)(4) under the
Securities Act.
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EVENTS OF DEFAULT AND REMEDIES
The Indenture provides that each of the following constitutes an Event of
Default: (i) default for 30 days in the payment when due of interest on, or
Liquidated Damages with respect to, the Notes; (ii) default in payment when due
of the principal of or premium, if any, on the Notes; (iii) failure by the
Company to comply with the provisions described under the captions
"--Repurchase at the Option of Holders--Change of Control" or "--Certain
Covenants--Asset Sales"; (iv) failure by the Company for 30 days after notice
from the Trustee or at least 25% in principal amount of the Notes then
outstanding to comply with the provisions described under the captions
"--Restricted Payments" or "--Incurrence of Indebtedness and Issuance of
Preferred Stock"; (v) failure by the Company for 60 days after notice from the
Trustee or holders of at least 25% in principal amount of the Notes then
outstanding to comply with any of its other agreements in the Indenture or the
Notes; (vi) default under any mortgage, indenture or instrument under which
there may be issued or by which there may be secured or evidenced any
Indebtedness for money borrowed by the Company or any of its Restricted
Subsidiaries (or the payment of which is guaranteed by the Company or any of
its Restricted Subsidiaries) whether such Indebtedness or Guarantee now exists,
or is created after the date of the Indenture, which default (a) is caused by a
failure to pay principal of or premium, if any, or interest on such
Indebtedness prior to the expiration of the grace period provided in such
Indebtedness on the date of such default (a "Payment Default") or (b) results
in the acceleration of such Indebtedness prior to its express maturity and, in
each case, the principal amount of any such Indebtedness, together with the
principal amount of any other such Indebtedness under which there has been a
Payment Default or the maturity of which has been so accelerated, aggregates
$10.0 million or more; (vii) failure by the Company or any of its Subsidiaries
to pay final judgments aggregating in excess of $5.0 million, which judgments
are not paid, discharged or stayed for a period of 60 days; and (viii) certain
events of bankruptcy or insolvency with respect to the Company or any of its
Restricted Subsidiaries that are Significant Subsidiaries.
If any Event of Default occurs and is continuing, the Trustee or the
Holders of at least 25% in principal amount of the then outstanding Notes may
declare all the Notes to be due and payable immediately. Notwithstanding the
foregoing, in the case of an Event of Default arising from certain events of
bankruptcy or insolvency, with respect to the Company or any of its
Subsidiaries all outstanding Notes will become due and payable without further
action or notice. Holders of the Notes may not enforce the Indenture or the
Notes except as provided in the Indenture. Subject to certain limitations,
Holders of a majority in principal amount of the then outstanding Notes may
direct the Trustee in its exercise of any trust or power. The Trustee may
withhold from Holders of the Notes notice of any continuing Default or Event of
Default (except a Default or Event of Default relating to the payment of
principal or interest) if it determines that withholding notice is in their
interest.
In the case of any Event of Default occurring by reason of any willful
action (or inaction) taken (or not taken) by or on behalf of the Company with
the intention of avoiding payment of the premium that the Company would have
had to pay if the Company then had elected to redeem the Notes pursuant to the
optional redemption provisions of the Indenture, an equivalent premium shall
also become and be immediately due and payable to the extent permitted by law
upon the acceleration of the Notes. If an Event of Default occurs prior to July
1, 2003 by reason of any willful action (or inaction) taken (or not taken) by
or on behalf of the Company with the intention of avoiding the prohibition on
redemption of the Notes prior to July 1, 2003, then the premium specified in
the Indenture shall also become immediately due and payable to the extent
permitted by law upon the acceleration of the Notes.
The Holders of a majority in aggregate principal amount of the Notes then
outstanding by notice to the Trustee may on behalf of the Holders of all of the
Notes waive any existing Default or Event of Default and its consequences under
the Indenture except a continuing Default or Event of Default in the payment of
interest on, or the principal of, the Notes.
The Company is required to deliver to the Trustee annually a statement
regarding compliance with the Indenture, and the Company is required upon
becoming aware of any Default or Event of Default, to deliver to the Trustee a
statement specifying such Default or Event of Default.
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NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the
Company, as such, shall have any liability for any obligations of the Company
under the Notes, the Indenture or for any claim based on, in respect of, or by
reason of, such obligations or their creation. Each Holder of Notes by
accepting a Note waives and releases all such liability. The waiver and release
are part of the consideration for issuance of the Notes. Such waiver may not be
effective to waive liabilities under the federal securities laws and it is the
view of the Commission that such a waiver is against public policy.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have all of its
obligations discharged with respect to the outstanding Notes ("Legal
Defeasance") except for (i) the rights of Holders of outstanding Notes to
receive payments in respect of the principal of, premium and Liquidated
Damages, if any, and interest on such Notes when such payments are due from the
trust referred to below, (ii) the Company's obligations with respect to the
Notes concerning issuing temporary Notes, registration of Notes, mutilated,
destroyed, lost or stolen Notes and the maintenance of an office or agency for
payment and money for security payments held in trust, (iii) the rights,
powers, trusts, duties and immunities of the Trustee, and the Company's
obligations in connection therewith and (iv) the Legal Defeasance provisions of
the Indenture. In addition, the Company may, at its option and at any time,
elect to have the obligations of the Company released with respect to certain
covenants that are described in the Indenture ("Covenant Defeasance") and
thereafter any omission to comply with such obligations shall not constitute a
Default or Event of Default with respect to the Notes. In the event Covenant
Defeasance occurs, certain events (not including non-payment, bankruptcy,
receivership, rehabilitation and insolvency events) described under "--Events
of Default and Remedies" will no longer constitute an Event of Default with
respect to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (i)
the Company must irrevocably deposit with the Trustee, in trust, for the
benefit of the Holders of the Notes, cash in U.S. dollars, non-callable
Government Securities, or a combination thereof, in such amounts as will be
sufficient, in the opinion of a nationally recognized firm of independent
public accountants, to pay the principal of, premium and Liquidated Damages, if
any, and interest on the outstanding Notes on the stated maturity or on the
applicable redemption date, as the case may be, and the Company must specify
whether the Notes are being defeased to maturity or to a particular redemption
date; (ii) in the case of Legal Defeasance, the Company shall have delivered to
the Trustee an opinion of counsel in the United States reasonably acceptable to
the Trustee confirming that (A) the Company has received from, or there has
been published by, the Internal Revenue Service a ruling or (B) since the date
of the Indenture, there has been a change in the applicable federal income tax
law, in either case to the effect that, and based thereon such opinion of
counsel shall confirm that, subject to customary assumptions and exclusions,
the Holders of the outstanding Notes will not recognize income, gain or loss
for federal income tax purposes as a result of such Legal Defeasance and will
be subject to federal income tax on the same amounts, in the same manner and at
the same times as would have been the case if such Legal Defeasance had not
occurred; (iii) in the case of Covenant Defeasance, the Company shall have
delivered to the Trustee an opinion of counsel in the United States reasonably
acceptable to the Trustee confirming that, subject to customary assumptions and
exclusions, the Holders of the outstanding Notes will not recognize income,
gain or loss for federal income tax purposes as a result of such Covenant
Defeasance and will be subject to federal income tax on the same amounts, in
the same manner and at the same times as would have been the case if such
Covenant Defeasance had not occurred; (iv) no Default or Event of Default shall
have occurred and be continuing on the date of such deposit (other than a
Default or Event of Default resulting from the borrowing of funds to be applied
to such deposit) or insofar as Events of Default from bankruptcy or insolvency
events are concerned, at any time in the period ending on the 91st day after
the date of deposit; (v) such Legal Defeasance or Covenant Defeasance will not
result in a breach or violation of, or constitute a default under any material
agreement or instrument (other than the Indenture) to which the Company or any
of its Subsidiaries is a party or by which the Company or any of its
Subsidiaries is bound; (vi) the Company must have delivered to the Trustee an
opinion of counsel to the effect that after the 91st day following the deposit,
the trust funds will not be subject to the effect of Section 547 of
69
the United States Bankruptcy Code or any analogous New York State law provision
to any other applicable federal or New York bankruptcy, insolvency,
reorganization or similar law affecting creditors' rights generally; (vii) the
Company must deliver to the Trustee an Officers' Certificate stating that the
deposit was not made by the Company with the intent of preferring the Holders
of Notes over the other creditors of the Company with the intent of defeating,
hindering, delaying or defrauding creditors of the Company or others; and
(viii) the Company must deliver to the Trustee an Officers' Certificate and an
opinion of counsel (which opinion may be subject to customary assumptions and
exclusions), each stating that all conditions precedent provided for relating
to the Legal Defeasance or the Covenant Defeasance have been complied with.
TRANSFER AND EXCHANGE
A Holder may transfer or exchange Notes in accordance with the Indenture.
The Registrar and the Trustee may require a Holder, among other things, to
furnish appropriate endorsements and transfer documents and the Company may
require a Holder to pay any taxes and fees required by law or permitted by the
Indenture. The Company is not required to transfer or exchange any Note
selected for redemption. Also, the Company is not required to transfer or
exchange any Note for a period of 15 days before a selection of Notes to be
redeemed.
The registered Holder of a Note will be treated as the owner of it for all
purposes.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next two succeeding paragraphs, the Indenture
and the Notes may be amended or supplemented with the consent of the Holders of
at least a majority in principal amount of the Notes then outstanding
(including, without limitation, consents obtained in connection with a purchase
of, or tender offer or exchange offer for, Notes), and any existing default or
compliance with any provision of the Indenture or the Notes may be waived with
the consent of the Holders of a majority in principal amount of the then
outstanding Notes (including consents obtained in connection with a tender
offer or exchange offer for Notes).
Without the consent of each Holder affected, an amendment or waiver may
not (with respect to any Notes held by a non-consenting Holder): (i) reduce the
principal amount of Notes whose Holders must consent to an amendment,
supplement or waiver; (ii) reduce the principal of or change the fixed maturity
of any Note or alter the provisions with respect to the redemption of the Notes
(other than provisions relating to the covenants described above under the
caption "--Repurchase at the Option of Holders"); (iii) reduce the rate of or
change the time for payment of interest on any Note; (iv) waive a Default or
Event of Default in the payment of principal of or premium, if any, or interest
on the Notes (except a rescission of acceleration of the Notes by the Holders
of at least a majority in aggregate principal amount of the Notes and a waiver
of the payment default that resulted from such acceleration); (v) make any Note
payable in money other than that stated in the Notes; (vi) make any change in
the provisions of the Indenture relating to waivers of (a) past Defaults or (b)
the rights of Holders of Notes to receive payments of principal of or premium,
if any, or interest on the Notes; (vii) waive a redemption payment with respect
to any Note (other than a payment required by one of the covenants described
above under the caption "--Repurchase at the Option of Holders") or (viii) make
any change in the foregoing amendment and waiver provisions.
Notwithstanding the foregoing, without the consent of any Holder of Notes,
the Company and the Trustee may amend or supplement the Indenture or the Notes
to cure any ambiguity, defect or inconsistency, to provide for uncertificated
Notes in addition to or in place of certificated Notes, to provide for the
assumption of the Company's obligations to Holders of Notes in the case of a
merger or consolidation or the sale of all or substantially all of the assets
of the Company, to make any change that would provide any additional rights or
benefits to the Holders of Notes or that does not adversely affect the legal
rights under the Indenture of any such Holder, to comply with requirements of
the Commission in order to effect or maintain the qualification of the
Indenture under the Trust Indenture Act or to allow any Subsidiary to guarantee
the Notes.
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CONCERNING THE TRUSTEE
The Indenture contains certain limitations on the rights of the Trustee,
should it become a creditor of the Company, to obtain payment of claims in
certain cases, or to realize on certain property received in respect of any
such claim as security or otherwise. The Trustee will be permitted to engage in
other transactions; however, if it acquires any conflicting interest it must
eliminate such conflict within 90 days, apply to the Commission for permission
to continue or resign.
The Holders of a majority in principal amount of the then outstanding
Notes will have the right to direct the time, method and place of conducting
any proceeding for exercising any remedy available to the Trustee, subject to
certain exceptions. The Indenture provides that in case an Event of Default
shall occur (which shall not be cured), the Trustee will be required, in the
exercise of its power, to use the degree of care of a prudent man in the
conduct of his own affairs. Subject to such provisions, the Trustee will be
under no obligation to exercise any of its rights or powers under the Indenture
at the request of any Holder of Notes, unless such Holder shall have offered to
the Trustee security and indemnity satisfactory to it against any loss,
liability or expense.
ADDITIONAL INFORMATION
Anyone who receives this Prospectus may obtain a copy of the Indenture and
Registration Rights Agreement without charge by writing to AKI, Inc., 1815 East
Main Street, Chattanooga, Tennessee 37404; Attention: Chief Financial Officer.
FORM, DENOMINATION AND BOOK-ENTRY PROCEDURES
The Old Notes were initially sold to qualified institutional buyers in
reliance on Rule 144A under the Securities Act ("Rule 144A Notes"). Old Notes
also were offered and sold in offshore transactions in reliance on Regulation S
("Regulation S Notes"). Rule 144A Notes and Regulation S Notes were each
initially represented by one or more Notes in registered, global form without
interest coupons (the "Old Global Notes"). The Old Global Notes were deposited
upon issuance with the Trustee as custodian for The Depository Trust Company
("DTC"), in New York, New York, and registered in the name of a nominee of DTC,
in each case for credit to an account of a direct or indirect participant as
described below. Regulation S Notes were deposited upon issuance with the
Trustee as custodian for DTC, and registered in the name of a nominee of DTC,
in each case for credit to the accounts of Euroclear System ("Euroclear") and
Cedel Bank, S.A. ("CEDEL").
The New Notes will be represented by one or more new notes in registered,
global form without interest coupons (collectively, the "New Global Notes") and
deposited with the Trustee as custodian and registered in the name of a nominee
of DTC. The Old Global Notes, to the extent directed by holders thereof in
their Letters of Transmittal, will be exchanged through book-entry electronic
transfer for one or more New Global Notes for credit to an account of a direct
or indirect participant as described below. No service charge will be made for
any registration of transfer or exchange of Notes, but the Company may require
payment of a sum sufficient to cover any tax or other governmental charge
payable in connection therewith.
New Notes issued to non-qualified institutional buyers in exchange for Old
Notes held by such investors, if any, will be issued only in certificated,
fully registered, definitive form. The New Global Note will, upon request, be
exchangeable for other New Notes in definitive, fully registered form without
coupons in denominations of $1,000 and integral multiples thereof, but only in
accordance with DTC's customary procedures. The New Global Note will also be
exchangeable in certain other limited circumstances. See "--Exchange of
Book-Entry Notes for Certificated Notes." The Company, the Trustee and any
other agent thereof will be entitled to treat DTC's nominee as the sole owner
and holder of the unexchanged portion of the New Global Note for all purposes.
Depositary Procedures
DTC has advised the Company that DTC is a limited-purpose trust company
created to hold securities for its participating organizations (collectively,
the "Participants") and to facilitate the clearance
71
and settlement of transactions in those securities between the Participants
through electronic book-entry changes in accounts of the Participants. The
Participants include securities brokers and dealers (including the Initial
Purchasers), banks, trust companies, clearing corporations and certain other
organizations. Access to DTC's system is also available to other entities such
as banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a Participant, either directly or indirectly
(collectively, the "Indirect Participants"). Persons who are not Participants
may beneficially own securities held by or on behalf of DTC only through the
Participants or the Indirect Participants. The ownership interest and transfer
of ownership interest of each actual purchaser of each security held by or on
behalf of DTC are recorded on the records of the Participants and the Indirect
Participants.
DTC has also advised the Company that pursuant to procedures established
by it, (i) upon deposit of the New Global Note, DTC will credit the accounts of
Participants designated by the Participants with portions of the principal
amount of the Old Global Notes and (ii) ownership of such interests in the New
Global Note will be shown on, and the transfer of ownership thereof will be
effected only through, records maintained by DTC (with respect to the
Participants) or by the Participants and the Indirect Participants (with
respect to other owners of beneficial interests in the New Global Note).
Investors in the New Global Note may hold their interests therein directly
through DTC, if they are Participants in such system, or indirectly through
organizations (including Euroclear and CEDEL) which are Participants in such
system. All interests in the New Global Note, including those held through
Euroclear or CEDEL, may be subject to the procedures and requirements of DTC.
Those interests held through Euroclear or CEDEL may also be subject to the
procedures and requirements of such system.
The laws of some states require that certain persons take physical
delivery in definitive form of securities that they own. Consequently, the
ability to transfer beneficial interests in the Old Global Notes or the New
Global Note to such persons may be limited to that extent. Because DTC can act
only on behalf of the Participants, which in turn act on behalf of the Indirect
Participants and certain banks, the ability of a person having beneficial
interests in the New Global Note to pledge such interests to persons or
entities that do not participate in the DTC system, or otherwise take actions
in respect of such interests, may be affected by the lack of a physical
certificate evidencing such interests. For certain other restrictions on the
transferability of the Notes, see "--Exchange of Book-Entry Notes for
Certificated Notes."
Except as described below, owners of interests in the New Global Note will
not have New Notes registered in their names, will not receive physical
delivery of New Notes in certificated form and will not be considered the
registered owners or holders thereof under the Indenture for any purpose.
Payments in respect of the principal of (and premium, if any) and interest
on the New Global Note registered in the name of DTC or its nominee will be
payable by the Trustee to DTC or its nominee in its capacity as the registered
holder under the Indenture. Under the terms of the Indenture, the Company and
the Trustee will treat the persons in whose names the New Notes, including the
New Global Note, are registered as the owners thereof for the purpose of
receiving such payments and for any and all other purposes whatsoever.
Consequently, neither the Company, the Trustee or any agent of the Company or
the Trustee has or will have any responsibility or liability for (i) any aspect
or accuracy of DTC's records or any Participant's or Indirect Participant's
records relating to or payments made on account of beneficial ownership
interests in the New Global Note, or for maintaining, supervising or reviewing
any of DTC's records or any Participant's or Indirect Participant's records
relating to the beneficial ownership interests in the New Global Note, or (ii)
any other matter relating to the actions and practices of DTC or any of the
Participants or the Indirect Participants.
DTC has advised the Company that its current practice, upon receipt of any
payment in respect of securities such as the New Notes (including principal and
interest), is to credit the accounts of the relevant Participants with the
payment on the payment date, in amounts proportionate to their respective
holdings in principal amount of beneficial interests in the relevant security
as shown on the records of DTC. Payments by the Participants and the Indirect
Participants to the beneficial owners of New Notes will be governed by standing
instructions and customary practices and will not be the responsibility of DTC,
the Trustee or the Company. Neither the Company nor the Trustee will be liable
for any delay by DTC or any
72
of the Participants in identifying the beneficial owners of the New Notes, and
the Company and the Trustee may conclusively rely on and will be protected in
relying on instructions from DTC or its nominee as the registered owner of the
New Global Note for all purposes.
DTC has advised the Company that it will take any action permitted to be
taken by a holder of Notes only at the direction of one or more Participants to
whose account with DTC interests in the Old Global Notes or the New Global Note
are credited and only in respect of such portion of the aggregate principal
amount of the Notes as to which such Participant or Participants has or have
given such direction. However, if any of the events described under "--
Exchange of Book Entry Notes for Certificated Notes" occurs, DTC reserves the
right to exchange the New Global Note for New Notes in certificate form and to
distribute such New Notes to its Participants.
Although DTC, Euroclear and CEDEL have agreed to the foregoing procedures
to facilitate transfers of interests in the Old Global Notes and the New Global
Note among accountholders in DTC and accountholders of Euroclear and CEDEL,
they are under no obligation to perform or to continue to perform such
procedures, and such procedures may be discontinued at any time. None of the
Company or the Trustee nor any agent of the Company or the Trustee will have
any responsibility for the performance by DTC, Euroclear or CEDEL or their
respective participants, indirect participants or accountholders of their
respective obligations under the rules and procedures governing their
operations.
EXCHANGE OF BOOK-ENTRY NOTES FOR CERTIFICATED NOTES
The New Global Note is exchangeable for definitive New Notes in registered
certificated form if (i) DTC (x) notifies the Company that it is unwilling or
unable to continue as depository for the New Global Note and the Company
thereupon fails to appoint a successor depository or (y) has ceased to be a
clearing agency registered under the Exchange Act, (ii) the Company, at its
option, notifies the Trustee in writing that it elects to cause the issuance of
the New Notes in certificated form or (iii) there shall have occurred and be
continuing a Default or an Event of Default with respect to the New Notes. In
all cases, certificated New Notes delivered in exchange for the New Global Note
or beneficial interests therein will be registered in the names, and issued in
any approved denominations, requested by or on behalf of the depository (in
accordance with its customary procedures). In addition, subject to certain
restrictions on the transferability of the New Notes, New Notes in definitive
form will be issued upon the resale, pledge or other transfer of any New Notes
or interest therein to any person or entity that is not a qualified
institutional buyer or that does not participate in DTC.
The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that the Company believes to be reliable, but
the Company takes no responsibility for the accuracy thereof.
SAME DAY SETTLEMENT AND PAYMENT
The Indenture requires that payments in respect of the Notes represented
by the Global Note (including principal, premium, if any, interest and
Liquidated Damages, if any) be made by wire transfer of immediately available
next day funds to the accounts specified by the Global Note Holder. With
respect to Certificated Notes, the Company will make all payments of principal,
premium, if any, interest and Liquidated Damages, if any, by wire transfer of
immediately available funds to the accounts specified by the Holders thereof
or, if no such account is specified, by mailing a check to each such Holder's
registered address. The Company expects that secondary trading in the
Certificated Notes will also be settled in immediately available funds.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the Indenture. Reference
is made to the Indenture for a full disclosure of all such terms, as well as
any other capitalized terms used herein for which no definition is provided.
"Acquired Debt" means, with respect to any specified Person, (i)
Indebtedness of any other Person existing at the time such other Person is
merged with or into or became a Subsidiary of such specified
73
Person, including, without limitation, Indebtedness incurred in connection
with, or in contemplation of, such other Person merging with or into or
becoming a Subsidiary of such specified Person, and (ii) Indebtedness secured
by a Lien encumbering any asset acquired by such specified Person.
"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as used with respect to any Person, shall
mean the possession, directly or indirectly, of the power to direct or cause
the direction of the management or policies of such Person, whether through the
ownership of voting securities, by agreement or otherwise.
"Asset Sale" means (i) the sale, lease, conveyance or other disposition (a
"Disposition") of any assets or rights (including, without limitation, by way
of a sale and leaseback) provided that the sale, lease, conveyance or other
disposition of all or substantially all of the assets of the (Company and its
Restricted Subsidiaries taken as a whole will be governed by the provisions of
the Indenture described above under the caption "--Repurchase at the Option of
Holders--Change of Control" and/or the provisions described above under the
caption "--Certain Covenants--Merger, Consolidation or Sale of Assets" and not
by the provisions of the Asset Sale covenant), and (ii) the issue or sale by
the Company or any of its Restricted Subsidiaries of Equity Interests of any of
the Company's Restricted Subsidiaries, in the case of either clause (i) or
(ii), whether in a single transaction or a series of related transactions (a)
that have a fair market value in excess of $3.0 million or (b) for net proceeds
in excess of $3.0 million. Notwithstanding the foregoing the following items
shall not be deemed to be Asset Sales: (i) a disposition of assets by the
Company to a Restricted Subsidiary or by a Restricted Subsidiary to the Company
or to another Restricted Subsidiary, (ii) an issuance of Equity Interests by a
Restricted Subsidiary to the Company or to another Restricted Subsidiary, (iii)
a Restricted Payment that is permitted by the covenant described above under
the caption "--Certain Covenants--Restricted Payments"; (iv) a disposition in
the ordinary course of business, (v) the sale and leaseback of any assets
within 90 days of the acquisition thereof, (vi) foreclosures on assets and
(vii) any exchange of property pursuant to Section 1031 on the Internal Revenue
Code of 1986, as amended, for use in a Related Business.
"Attributable Debt" in respect of a sale and leaseback transaction means,
at the time of determination, the present value (discounted at the rate of
interest implicit in such transaction, determined in accordance with GAAP) of
the obligation of the lessee for net rental payments during the remaining term
of the lease included in such sale and leaseback transaction (including any
period for which such lease has been extended or may, at the option of the
lessor, be extended).
"Capital Lease Obligation" means, at the time any determination thereof is
to be made, the amount of the liability in respect of a capital lease that
would at such time be required to be capitalized on a balance sheet in
accordance with GAAP.
"Capital Stock" means (i) in the case of a corporation, corporate stock,
(ii) in the case of an association or business entity, any and all shares,
interests, participations, rights or other equivalents (however designated) of
corporate stock, (iii) in the case of a partnership or limited liability
company, partnership or membership interests (whether general or limited) and
(iv) any other interest or participation that confers on a Person the right to
receive a share of the profits and losses of, or distributions of assets of,
the issuing Person.
"Cash Equivalents" means (i) United States dollars, (ii) Government
Securities having maturities of not more than six months from the date of
acquisition, (iii) certificates of deposit and eurodollar time deposits with
maturities of six months or less from the date of acquisition, bankers'
acceptances with maturities not exceeding six months and overnight bank
deposits, in each case with the lender under the Credit Agreement or with any
domestic commercial bank having capital and surplus in excess of $500 million
and a Thompson Bank Watch Rating of "B" or better, (iv) repurchase obligations
with a term of not more than seven days for underlying securities of the types
described in clauses (ii) and (iii) above entered into with any financial
institution meeting the qualifications specified in clause (iii) above, (v)
commercial paper having the rating of "P-2" (or higher) from Moody's Investors
Service, Inc. or "A-3" (or higher) from Standard & Poor's Corporation and in
each case maturing within six months after the date of acquisition and (vi) any
fund investing exclusively in investments of the type described in clauses (i)
through (v) above.
74
"Change of Control" means the occurrence of any of the following: (i) the
sale, lease, transfer, conveyance or other disposition (other than by way of
merger or consolidation), in one or a series of related transactions, of all or
substantially all of the assets of the Company and its Subsidiaries taken as a
whole to any "person" (as such term is used in Section 13(d)(3) of the Exchange
Act) other than the Principals or their Related Parties (as defined below),
(ii) the adoption of a plan relating to the liquidation or dissolution of the
Company, (iii) the consummation of any transaction (including, without
limitation, any merger or consolidation) the result of which is that any
"person" (as defined above), other than the Principals and their Related
Parties, becomes the "beneficial owner" (as such term is defined in Rule 13d-3
and Rule 13d-5 under the Exchange Act, directly or indirectly, of more than 50%
of the Voting Stock of the Company (measured by voting power rather than number
of shares), or (iv) the first day on which a majority of the members of the
Board of Directors of the Company are not Continuing Directors.
"Consolidated Cash Flow" means, with respect to any Person for any period,
the Consolidated Net Income of such Person for such period plus (i) an amount
equal to any extraordinary loss plus any net loss realized in connection with
an Asset Sale (to the extent such losses were deducted in computing such
Consolidated Net Income), plus (ii) provision for taxes based on income or
profits of such Person and its Subsidiaries for such period, to the extent that
such provision for taxes was included in computing such Consolidated Net
Income, plus (iii) consolidated interest expense of such Person and its
Subsidiaries for such period, whether paid or accrued and whether or not
capitalized (including, without limitation, amortization of debt issuance costs
and original issue discount, non-cash interest payments, the interest component
of any deferred payment obligations, the interest component of all payments
associated with Capital Lease Obligations, commissions, discounts and other
fees and charges incurred in respect of letter of credit or bankers' acceptance
financings, and net payments (if any) pursuant to Hedging Obligations), to the
extent that any such expense was deducted in computing such Consolidated Net
Income, plus (iv) depreciation, amortization (including amortization of
goodwill and other intangibles but excluding amortization of prepaid cash
expenses that were paid in a prior period) and other non-cash charges
(excluding any such non-cash charge to the extent that it represents an accrual
of or reserve for cash expenses in any future period or amortization of a
prepaid cash expense that was paid in a prior period) of such Person and its
Subsidiaries for such period to the extent that such depreciation, amortization
and other non-cash expenses were deducted in computing such Consolidated Net
Income, plus (v) expenses and charges of the Company related to the Refinancing
which are paid, taken or otherwise accounted for within 90 days of the
consummation of the Refinancing, plus (vi) any non-capitalized transaction
costs incurred in connection with actual or proposed financings, acquisitions
or divestitures (including, but not limited to, financing and refinancing fees
and costs incurred in connection with the Refinancing). Notwithstanding the
foregoing, the provision for taxes on the income or profits of, and the
depreciation and amortization and other non-cash charges of, a Subsidiary of
the referent Person shall be added to Consolidated Net Income to compute
Consolidated Cash Flow only to the extent (and in the same proportion) that Net
Income of such Subsidiary was included in calculating Consolidated Net Income
of such Person.
"Consolidated Interest Expense" means, with respect to any Person for any
period, the sum of, without duplication, (a) the interest expense of such
Person and its Restricted Subsidiaries for such period, on a consolidated
basis, determined in accordance with GAAP (including amortization of original
issue discount, non-cash interest payments, the interest component of all
payments associated with Capital Lease Obligations, imputed interest with
respect to Attributable Debt, commissions, discounts and other fees and charges
incurred in respect of letter of credit or bankers' acceptance financings, and
net payments, if any, pursuant to Hedging Obligations; provided that in no
event shall any amortization of deferred financing costs be included in
Consolidated Interest Expense); and (b) the consolidated capitalized interest
of such Person and its Restricted Subsidiaries for such period, whether paid or
accrued. Notwithstanding the foregoing, the Consolidated Interest Expense with
respect to any Restricted Subsidiary that is not a Wholly Owned Restricted
Subsidiary shall be included only to the extent (and in the same proportion)
that the net income of such Restricted Subsidiary was included in calculating
Consolidated Net Income.
"Consolidated Net Income" means, with respect to any Person for any
period, the aggregate of the Net Income of such Person and its Restricted
Subsidiaries for such period, on a consolidated basis,
75
determined in accordance with GAAP; provided that (i) the Net Income (but not
loss) of any Person that is not a Restricted Subsidiary or that is accounted
for by the equity method of accounting shall be included only to the extent of
the amount of dividends or distributions paid in cash to the referent Person or
a Restricted Subsidiary thereof, (ii) the Net Income of any Restricted
Subsidiary shall be excluded to the extent that the declaration or payment of
dividends or similar distributions by that Restricted Subsidiary of that Net
Income is not at the date of determination permitted without any prior
governmental approval (that has not been obtained) or, directly or indirectly,
by operation of the terms of its charter or any agreement, instrument,
judgment, decree, order, statute, rule or governmental regulation applicable to
that Subsidiary or its stockholders, (iii) the Net Income of any Person
acquired in a pooling of interests transaction for any period prior to the date
of such acquisition shall be excluded, (iv) the cumulative effect of a change
in accounting principles shall be excluded and (v) the Net Income of any
Unrestricted Subsidiary shall be excluded, whether or not distributed to the
Company or one of its Restricted Subsidiaries for purposes of the covenant
described under the caption "Incurrence of Indebtedness and Issuance of
Preferred Stock" and shall be included for purposes of the covenant described
under the caption "Restricted Payments" only to the extent of the amount of
dividends or distributions paid in cash to the Company or one of its Restricted
Subsidiaries.
"Continuing Directors" means, as of any date of determination, any member
of the Board of Directors of the Company who (i) was a member of such Board of
Directors on the date of the Indenture or (ii) was nominated for election or
elected to such Board of Directors with the approval of a majority of the
Continuing Directors who were members of such Board at the time of such
nomination or election.
"Credit Agreement" means that certain Credit Agreement, dated as of April
30, 1996, as amended on December 12, 1997, between the Company and Heller
Financial, Inc., providing for revolving credit borrowings, including any
related notes, guarantees, collateral documents, instruments and agreements
executed in connection therewith, and in each case as amended, modified,
renewed, refunded, replaced or refinanced from time to time.
"Default" means any event that is or with the passage of time or the
giving of notice or both would be an Event of Default.
"Disqualified Stock" means any Capital Stock that, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event, matures or is mandatorily
redeemable, pursuant to a sinking fund obligation or otherwise, or redeemable
at the option of the Holder thereof, in whole or in part, on or prior to the
date that is 91 days after the date on which the Notes mature; provided,
however, that any Capital Stock that would not qualify as Disqualified Stock
but for change of control provisions shall not constitute Disqualified Stock if
the provisions are not more favorable to the holders of such Capital Stock than
the provisions described under "--Change of Control" applicable to the Holders
of the Notes.
"Equity Interests" means Capital Stock and all warrants, options or other
rights to acquire Capital Stock (but excluding any debt security that is
convertible into, or exchangeable for, Capital Stock).
"Existing Indebtedness" means Indebtedness of the Company and its
Subsidiaries (other than Indebtedness under the Credit Agreement) in existence
on the date of the Indenture, until such amounts are repaid.
"Fixed Charges" means, with respect to any Person for any period, the sum,
without duplication, of (i) the Consolidated Interest Expense of such Person
for such period, (ii) any interest expense on Indebtedness of another Person
that is Guaranteed by such Person or one of its Restricted Subsidiaries or
secured by a Lien on assets of such Person or one of its Restricted
Subsidiaries (whether or not such Guarantee or Lien is called upon) and (iii)
the product of (a) all dividend payments, whether or not in cash, on any series
of preferred stock of such Person or any of its Restricted Subsidiaries, other
than dividend payments on Equity Interests payable solely in Equity Interests
of the Company, times (b) a fraction, the numerator of which is one and the
denominator of which is one minus the then current combined federal, state and
local statutory tax rate of such Person, expressed as a decimal, in each case,
on a consolidated basis and in accordance with GAAP.
76
"Fixed Charge Coverage Ratio" means with respect to any Person for any
period, the ratio of the Consolidated Cash Flow of such Person for such period
to the Fixed Charges of such Person for such period. In the event that the
Company or any of its Restricted Subsidiaries incurs, assumes, Guarantees or
redeems any Indebtedness (other than revolving credit borrowings) or issues
preferred stock subsequent to the commencement of the period for which the
Fixed Charge Coverage Ratio is being calculated but prior to the date on which
the event for which the calculation of the Fixed Charge Coverage Ratio is made
(the "Calculation Date"), then the Fixed Charge Coverage Ratio shall be
calculated giving pro forma effect to such incurrence, assumption, Guarantee or
redemption of Indebtedness, or such issuance or redemption of preferred stock,
as if the same had occurred at the beginning of the applicable four-quarter
reference period. In addition, for purposes of making the computation referred
to above, (i) acquisitions that have been made by the Company or any of its
Restricted Subsidiaries, including through mergers or consolidations and
including any related financing transactions, during the four-quarter reference
period or subsequent to such reference period and on or prior to the
Calculation Date shall be calculated to include the Consolidated Cash Flow of
the acquired entities on a pro forma basis after giving effect to cost savings
resulting from employee terminations, facilities consolidations and closings,
standardization of employee benefits and compensation policies, consolidation
of property, casualty and other insurance coverage and policies,
standardization of sales and distribution methods, reductions in taxes other
than income taxes and other cost savings reasonably expected to be realized
from such acquisition, shall be deemed to have occurred on the first day of the
four-quarter reference period and Consolidated Cash Flow for such reference
period shall be calculated without giving effect to clause (iii) of the proviso
set forth in the definition of Consolidated Net Income, (ii) the Consolidated
Cash Flow attributable to discontinued operations, as determined in accordance
with GAAP, and operations or businesses disposed of prior to the Calculation
Date, shall be excluded, and (iii) the Fixed Charges attributable to
discontinued operations, as determined in accordance with GAAP, and operations
or businesses disposed of prior to the Calculation Date, shall be excluded, but
only to the extent that the obligations giving rise to such Fixed Charges will
not be obligations of the referent Person or any of its Restricted Subsidiaries
following the Calculation Date.
"Foreign Subsidiary" means any Subsidiary of the Company that is not
organized under the laws of a state or territory of the United States or the
District of Columbia.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as have been approved by a significant segment of the accounting
profession, which are in effect on the date of the Indenture.
"Government Securities" means direct obligations of, or obligations
guaranteed by, the United States of America for the payment of which guarantee
or obligations the full faith and credit of the United States is pledged.
"Guarantee" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including, without limitation, letters of credit and
reimbursement agreements in respect thereof), of all or any part of any
Indebtedness.
"Hedging Obligations" means, with respect to any Person, the obligations
of such Person under (i) interest rate swap agreements, interest rate cap
agreements and interest rate collar agreements and (ii) other agreements or
arrangements designed to protect such Person against fluctuations in interest
rates or currency exchange rates.
"Indebtedness" means, with respect to any Person, any indebtedness of such
Person, in respect of borrowed money or evidenced by bonds, notes, debentures
or similar instruments or letters of credit (or reimbursement agreements in
respect thereof) or bankers' acceptances or representing Capital Lease
Obligations or the balance deferred and unpaid of the purchase price of any
property or representing any Hedging Obligations, except any such balance that
constitutes an accrued expense or trade payable, if and to the extent any of
the foregoing indebtedness (other than letters of credit and Hedging
Obligations) would appear as a liability upon a balance sheet of such Person
prepared in accordance with GAAP, as
77
well as all indebtedness of others secured by a Lien on any asset of such
Person (whether or not such Indebtedness is assumed by such Person) and, to the
extent not otherwise included, the Guarantee by such Person of any indebtedness
of any other Person; provided that Indebtedness shall not include the pledge by
the Company of the Capital Stock of an Unrestricted Subsidiary of the Company
to secure Non-Recourse Debt of such Unrestricted Subsidiary. The amount of any
Indebtedness outstanding as of any date shall be (i) the accreted value
thereof, in the case of any Indebtedness that does not require current payments
of interest, and (ii) the principal amount thereof, together with any interest
thereon that is more than 30 days past due, in the case of any other
Indebtedness.
"Investments" means, with respect to any Person, all investments by such
Person in other Persons (including Affiliates) in the forms of direct or
indirect loans (including guarantees of Indebtedness or other obligations),
advances or capital contributions (excluding commission, travel and similar
advances to officers and employees made in the ordinary course of business),
purchases or other acquisitions for consideration of Indebtedness, Equity
Interests or other securities, together with all items that are or would be
classified as investments on a balance sheet prepared in accordance with GAAP.
If the Company or any Restricted Subsidiary of the Company sells or otherwise
disposes of any Equity Interests of any direct or indirect Restricted
Subsidiary of the Company such that, after giving effect to any such sale or
disposition, such Person is no longer a Restricted Subsidiary of the Company,
the Company shall be deemed to have made an Investment on the date of any such
sale or disposition equal to the fair market value of the Equity Interests of
such Restricted Subsidiary not sold or disposed of in an amount determined as
provided in the final paragraph of the covenant described above under the
caption "--Restricted Payments."
"Lien" means, with respect to any asset, any mortgage, lien, pledge,
charge, security interest or encumbrance of any kind in respect of such asset,
whether or not filed, recorded or otherwise perfected under applicable law
(including any conditional sale or other title retention agreement, any lease
in the nature thereof, any option or other agreement to sell or give a security
interest in and any filing of or agreement to give any financing statement
under the Uniform Commercial Code (or equivalent statutes) of any
jurisdiction).
"Net Income" means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP and before any reduction in
respect of preferred stock dividends, excluding, however, (i) any gain (but not
loss), together with any related provision for taxes on such gain (but not
loss), realized in connection with (a) any Asset Sale (including, without
limitation, dispositions pursuant to sale and leaseback transactions) or (b)
the disposition of any securities by such Person or any of its Restricted
Subsidiaries or the extinguishment of any Indebtedness of such Person or any of
its Restricted Subsidiaries and (ii) any extraordinary or nonrecurring gain
(but not loss), together with any related provision for taxes on such
extraordinary or nonrecurring gain (but not loss).
"Net Proceeds" means the aggregate cash proceeds received by the Company
or any of its Restricted Subsidiaries in respect of any Asset Sale (including,
without limitation, any cash received upon the sale or other disposition of any
non-cash consideration received in any Asset Sale), net of the direct costs
relating to such Asset Sale (including, without limitation, legal, accounting
and investment banking fees, and sales commissions) and any relocation expenses
incurred as a result thereof, taxes paid or payable as a result thereof (after
taking into account any available tax credits or deductions and any tax sharing
arrangements), the amounts required to be applied to the payment of
Indebtedness (other than Indebtedness incurred pursuant to the Credit
Agreement), secured by a Lien on the asset or assets that were the subject of
the Asset Sale, and any reserve for adjustment in respect of the sale price of
such asset or assets established in accordance with GAAP.
"Non-Recourse Debt" means Indebtedness (i) as to which neither the Company
nor any of its Restricted Subsidiaries (a) provides credit support of any kind
(including any undertaking, agreement or instrument that would constitute
Indebtedness), (b) is directly or indirectly liable (as a guarantor or
otherwise), or (c) constitutes the lender; (ii) no default with respect to
which (including any rights that the holders thereof may have to take
enforcement action against an Unrestricted Subsidiary) would permit (upon
notice, lapse of time or both) any holder of any other Indebtedness (other than
the Notes being
78
offered hereby) of the Company or any of its Restricted Subsidiaries to declare
a default on such other Indebtedness or cause the payment thereof to be
accelerated or payable prior to its stated maturity; and (iii) as to which the
lenders have been notified in writing that they will not have any recourse to
the stock (other than stock of an Unrestricted Subsidiary pledged by the
Company to secure debt of such Unrestricted Subsidiary) or assets of the
Company or any of its Restricted Subsidiaries.
"Obligations" means any principal, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.
"Permitted Business" means any business in which the Company and its
Restricted Subsidiaries are engaged on the date of the Indenture or any
business reasonably related, incidental or ancillary thereto.
"Permitted Investments" means (a) any Investment in the Company or in a
Restricted Subsidiary of the Company that is engaged in a Permitted Business;
(b) any Investment in Cash Equivalents; (c) any Investment by the Company or
any Restricted Subsidiary of the Company in a Person, if as a result of such
Investment (i) such Person becomes a Restricted Subsidiary of the Company that
is engaged in a Permitted Business or (ii) such Person is merged, consolidated
or amalgamated with or into, or transfers or conveys substantially all of its
assets to, or is liquidated into, the Company or a Restricted Subsidiary of the
Company that is engaged in a Permitted Business; (d) any Restricted Investment
made as a result of the receipt of non-cash consideration from an Asset Sale
that was made pursuant to and in compliance with the covenant described above
under the caption "--Repurchase at the Option of Holders--Asset Sales"; (e) any
acquisition of assets solely in exchange for the issuance of Equity Interests
(other than Disqualified Stock) of the Company; and (f) other Investments made
after the date of the Indenture in any Person having an aggregate fair market
value (measured on the date each such Investment was made and without giving
effect to subsequent changes in value), when taken together with all other
Investments made pursuant to this clause (f) that are at the time outstanding,
not to exceed $10.0 million.
"Permitted Liens" means (i) Liens securing Indebtedness under the Credit
Agreement that was permitted by the terms of the Indenture to be incurred or
other Indebtedness allowed to be incurred under clause (i) of the covenant
described above under the caption "--Incurrence of Indebtedness and Issuance of
Preferred Stock"; (ii) Liens in favor of the Company; (iii) Liens on property
of a Person existing at the time such Person is merged into or consolidated
with the Company or any Restricted Subsidiary of the Company, provided that
such Liens were not incurred in contemplation of such merger or consolidation
and do not extend to any assets other than those of the Person merged into or
consolidated with the Company or any Restricted Subsidiary; (iv) Liens on
property existing at the time of acquisition thereof by the Company or any
Restricted Subsidiary of the Company, provided that such Liens were not
incurred in contemplation of such acquisition; (v) Liens to secure the
performance of statutory obligations, surety or appeal bonds, performance bonds
or other obligations of a like nature incurred in the ordinary course of
business; (vi) Liens existing on the date of the Indenture; (vii) Liens for
taxes, assessments or governmental charges or claims that are not yet
delinquent or that are being contested in good faith by appropriate proceedings
promptly instituted and diligently concluded, provided that any reserve or
other appropriate provision as shall be required in conformity with GAAP shall
have been made therefor; (viii) Liens to secure Indebtedness (including Capital
Lease Obligations) permitted by clause (iv) of the second paragraph of the
covenant entitled "Incurrence of Indebtedness and Issuance of Preferred Stock";
(ix) Liens securing Permitted Refinancing Indebtedness where the Liens securing
the Permitted Refinancing Indebtedness were permitted under the Indenture; (x)
Liens incurred in the ordinary course of business of the Company or any
Restricted Subsidiary of the Company with respect to obligations that do not
exceed $5.0 million at any one time outstanding and that (a) are not incurred
in connection with the borrowing of money or the obtaining of advances or
credit (other than trade credit in the ordinary course of business) and (b) do
not in the aggregate materially detract from the value of the property or
materially impair the use thereof in the operation of business by the Company
or such Restricted Subsidiary; and (xi) Liens on assets of Unrestricted
Subsidiaries that secure Non-Recourse Debt of Unrestricted Subsidiaries.
"Permitted Refinancing Indebtedness" means any Indebtedness of the Company
or any of its Restricted Subsidiaries issued in exchange for, or the net
proceeds of which are used to extend, refinance,
79
renew, replace, defease or refund other Indebtedness of the Company or any of
its Restricted Subsidiaries; provided that: (i) the principal amount (or
accreted value, if applicable) of such Permitted Refinancing Indebtedness does
not exceed the principal amount of (or accreted value, if applicable), plus
accrued interest on, the Indebtedness so extended, refinanced, renewed,
replaced, defeased or refunded (plus the amount of reasonable expenses incurred
in connection therewith); (ii) such Permitted Refinancing Indebtedness has a
final maturity date no earlier than the final maturity date of, and has a
Weighted Average Life to Maturity equal to or greater than the Weighted Average
Life to Maturity of, the Indebtedness being extended, refinanced, renewed,
replaced, defeased or refunded; and (iii) if the Indebtedness being extended,
refinanced, renewed, replaced, defeased or refunded is subordinated in right of
payment to the Notes, such Permitted Refinancing Indebtedness has a final
maturity date later than the final maturity date of, and is subordinated in
right of payment to, the Notes on terms at least as favorable to the Holders of
Notes as those contained in the documentation governing the Indebtedness being
extended, refinanced, renewed, replaced, defeased or refunded.
"Principals" means Roger L. Barnett, DLJ Merchant Banking Partners II,
L.P., DLJ Merchant Banking Partners II-A, L.P., DLJ Offshore Partners II, L.P.,
DLJ Offshore Partners II, C.V., DLJ Diversified Partners, L.P., DLJ Diversified
Partners-A, L.P., DLJMB Funding II, Inc., DLJ Millennium Partners, L.P., DLJ
Millennium Partners-A, L.P., DLJ EAB Partners, L.P., UK Investment Plan 1997
Partners and DLJ First ESC L.P.
"Public Equity Offering" means a public offering of Equity Interests
(other than Disqualified Stock) of (i) the Company or (ii) Acquisition Corp. or
Holding to the extent the net proceeds thereof are contributed to the Company
as a capital contribution, that, in each case, results in net proceeds to the
Company of at least $25.0 million.
"Related Party" with respect to any Principal means (A) any controlling
stockholder or partner, 80% (or more) owned Subsidiary, or spouse or immediate
family member (in the case of an individual) of such Principal or (B) any
trust, corporation, partnership or other entity, the beneficiaries,
stockholders, partners, owners or Persons beneficially holding (directly or
through one or more Subsidiaries) a 51% or more controlling interest of which
consist of the Principals and/or such other Persons referred to in the
immediately preceding clause (A).
"Restricted Investment" means an Investment other than a Permitted
Investment.
"Restricted Subsidiary" of a Person means any Subsidiary of the referent
Person that is not an Unrestricted Subsidiary.
"Rule 144A" means Rule 144A promulgated under the Securities Act.
"Significant Subsidiary" means any Subsidiary that would be a "significant
subsidiary" as defined in Article 1, Rule 1-02 of Regulation S-X, promulgated
pursuant to the Act, as such Regulation is in effect on the date hereof.
"Stated Maturity" means, with respect to any installment of interest or
principal on any series of Indebtedness, the date on which such payment of
interest or principal was scheduled to be paid in the original documentation
governing such Indebtedness, and shall not include any contingent obligations
to repay, redeem or repurchase any such interest or principal prior to the date
originally scheduled for the payment thereof.
"Subsidiary" means, with respect to any Person, (i) any corporation,
association or other business entity of which more than 50% of the total voting
power of shares of Capital Stock entitled (without regard to the occurrence of
any contingency) to vote in the election of directors, managers or trustees
thereof is at the time owned or controlled, directly or indirectly, by such
Person or one or more of the other Subsidiaries of that Person (or a
combination thereof) and (ii) any partnership or limited liability company (a)
the sole general partner or the managing general partner or managing member of
which is such Person or a Subsidiary of such Person or (b) the only general
partners of which are such Person or of one or more Subsidiaries of such Person
(or any combination thereof).
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"Subsidiary Guarantor" means any Restricted Subsidiary that executes a
supplemental indenture providing for the Guarantee of the payment of the Notes
by such Restricted Subsidiary.
"Unrestricted Subsidiary" means any Subsidiary that is designated by the
Board of Directors as an Unrestricted Subsidiary pursuant to a Board
Resolution; but only to the extent that such Subsidiary: (a) has no
Indebtedness other than Non-Recourse Debt; (b) is not party to any agreement,
contract, arrangement or understanding with the Company or any Restricted
Subsidiary of the Company unless the terms of any such agreement, contract,
arrangement or understanding are no less favorable to the Company or such
Restricted Subsidiary than those that might be obtained at the time from
Persons who are not Affiliates of the Company; (c) is a Person with respect to
which neither the Company nor any of its Restricted Subsidiaries has any direct
or indirect obligation (x) to subscribe for additional Equity Interests or (y)
to maintain or preserve such Person's financial condition or to cause such
Person to achieve any specified levels of operating results; and (d) has not
guaranteed or otherwise directly or indirectly provided credit support for any
Indebtedness of the Company or any of its Restricted Subsidiaries. Any such
designation by the Board of Directors shall be evidenced to the Trustee by
filing with the Trustee a certified copy of the Board Resolution giving effect
to such designation and an Officers' Certificate certifying that such
designation complied with the foregoing conditions and was permitted by the
covenant described above under the caption "Certain Covenants--Restricted
Payments." If, at any time, any Unrestricted Subsidiary would fail to meet the
foregoing requirements as an Unrestricted Subsidiary, it shall thereafter cease
to be an Unrestricted Subsidiary for purposes of the Indenture and any
Indebtedness of such Subsidiary shall be deemed to be incurred by a Restricted
Subsidiary of the Company as of such date (and, if such Indebtedness is not
permitted to be incurred as of such date under the covenant described under the
caption "Incurrence of Indebtedness and Issuance of Preferred Stock," the
Company shall be in default of such covenant). The Board of Directors of the
Company may at any time designate any Unrestricted Subsidiary to be a
Restricted Subsidiary; provided that such designation shall be deemed to be an
incurrence of Indebtedness by a Restricted Subsidiary of the Company of any
outstanding Indebtedness of such Unrestricted Subsidiary and such designation
shall be permitted only if (i) such Indebtedness is permitted under the
covenant described under the caption "Certain Covenants--Incurrence of
Indebtedness and Issuance of Preferred Stock," and (ii) no Default or Event of
Default would be in existence following such designation.
"Voting Stock" of any Person as of any date means the Capital Stock of
such Person that is at the time entitled to vote in the election of the Board
of Directors of such Person.
"Weighted Average Life to Maturity" means, when applied to any
Indebtedness at any date, the number of years obtained by dividing (i) the sum
of the products obtained by multiplying (a) the amount of each then remaining
installment, sinking fund, serial maturity or other required payments of
principal, including payment at final maturity, in respect thereof, by (b) the
number of years (calculated to the nearest one- twelfth) that will elapse
between such date and the making of such payment, by (ii) the then outstanding
principal amount of such Indebtedness.
"Wholly Owned Subsidiary" of any Person means a Subsidiary of such Person
all of the outstanding Capital Stock or other ownership interests of which
(other than directors' qualifying shares) shall at the time be owned by such
Person or by one or more Wholly Owned Subsidiaries of such Person and one or
more Wholly Owned Subsidiaries of such Person.
81
U.S. FEDERAL INCOME TAX CONSEQUENCES
Subject to the qualifications set forth below, the opinion of Akin, Gump,
Strauss, Hauer & Feld, L.L.P., tax counsel to the Company, with respect to the
anticipated material U.S. federal income tax consequences applicable to the
exchange of Old Notes for New Notes and the ownership and disposition of the
New Notes by Holders who acquire the New Notes pursuant to the Exchange Offer
is as follows. The discussion does not address the federal income tax
consequences of ownership of Notes not held as capital assets within the
meaning of Section 1221 of the Internal Revenue Code of 1986, as amended (the
"Code"), or the federal income tax consequences to Holders subject to special
treatment under the federal income tax laws, such as dealers in securities or
foreign currency, tax-exempt investors, real estate investment trusts,
regulated investment companies, banks, thrifts, insurance companies or other
financial institutions, persons that hold the Notes as a position in a
"straddle", or as part of a "synthetic security" or "hedge", "conversion
transaction" or other integrated investment, persons that have a "functional
currency" other than the U.S. dollar, or investors in pass-through entities.
Moreover, this discussion does not address the effect of any applicable state,
local or foreign tax laws or the applicability of U.S. federal estate and gift
taxation.
This discussion is based upon the Code, existing and proposed regulations
thereunder ("Treasury Regulations"), and current administrative rulings and
court decisions. All of the foregoing are subject to change, possibly on a
retroactive basis, and any such change could affect the continuing validity of
this discussion.
EACH PERSON CONSIDERING AN INVESTMENT IN THE NOTES IS URGED TO CONSULT ITS
OWN TAX ADVISOR AS TO PARTICULAR TAX CONSEQUENCES TO IT OF PURCHASING, HOLDING
AND DISPOSING OF NOTES OF HOLDING AS WELL AS THE EXCHANGE OF NOTES FOR NEW
DEBENTURES PURSUANT TO THE EXCHANGE OFFER, INCLUDING THE APPLICABILITY AND
EFFECT OF ANY STATE, LOCAL OR FOREIGN TAX LAWS, AND OF ANY PROPOSED CHANGES IN
APPLICABLE LAWS.
EXCHANGE
The exchange of Old Notes for New Notes pursuant to the Exchange Offer
will not be treated as an exchange or other tax event for federal income tax
purposes because the New Notes will not be considered to differ materially in
kind or extent from the Old Notes. A Holder will have the same adjusted tax
basis and holding period in the New Notes as it had in the Old Notes
immediately before the exchange.
INTEREST
A Holder of New Notes will be required to report interest income for
federal income tax purposes for any interest earned on the Notes in accordance
with such Holder's method of tax accounting.
ORIGINAL ISSUE DISCOUNT
The Old Notes do not have original issue discount ("OID") for federal
income tax purposes. Accordingly, the New Notes also will not have OID since
the New Notes should be treated as a continuation of the Old Notes for federal
income tax purposes.
MARKET DISCOUNT
Under the market discount rules of the Code, an exchanging Holder (other
than a Holder who made the election described below) who purchased an Old Note
with "market discount" (generally defined as the amount by which the stated
redemption price of the Old Note on the Holder's date of purchase exceeded the
Holder's purchase price) will be required to treat any gain recognized on the
redemption, sale or other disposition of the New Note received in the exchange
as ordinary income to the extent of the market discount that accrued during the
Holder's holding period for such New Note (which period will include such
holder's holding period for the Old Note). In addition, a Holder of a Note
acquired at market discount may be required to defer the deduction of all or a
portion of the interest expense on any
82
indebtedness incurred or continued to purchase or carry such Note. A Holder who
has elected under applicable Code provisions to include market discount in
income annually as such discount accrues will not be required to treat any gain
recognized as ordinary income (or defer interest deductions) under the market
discount rules described above. Holders should consult their tax advisors as to
the portion of any gain that would be taxable as ordinary income under these
provisions.
AMORTIZABLE BOND PREMIUM
If a Holder's initial tax basis in the Old Notes at acquisition exceeded
the amount payable at maturity, the excess will be treated as "amortizable bond
premium" (including after the exchange of such Old Notes for New Notes). In
such case, the Holder may elect under section 171 of the Code to amortize the
bond premium annually under a constant yield method. The Holder's adjusted tax
basis in the Note is decreased by the amount of the allowable amortization.
Because the Notes have early call provisions, Holders must take such call
provisions into account to determine the amount of amortizable bond premium.
Amortizable bond premium is treated as an offset to interest received on the
obligation rather than as an interest deduction, except as may be provided in
Treasury regulations. An election to amortize bond premium would apply to
amortizable bond premium on all taxable bonds held on or acquired after the
beginning of the Holder's taxable year for which the election is made, and may
be revoked only with the consent of the IRS. Holders who acquire their Notes
with amortizable bond premium should consult their own tax advisors.
SALE, EXCHANGE, REDEMPTION OR OTHER DISPOSITION OF NOTES
On sale, exchange, redemption or other disposition of the Notes, and
except to the extent that the cash received is attributable to accrued interest
(which generally represents ordinary interest income) or market discount (the
tax consequences of which are described above), a Holder generally will
recognize capital gain or loss measured by the difference between the amount
realized and such Holder's adjusted tax basis in the Notes redeemed, and any
applicable capital gain generally would be taxed at a reduced rate of 20
percent for a Holder that is not a corporation and who holds the Notes for more
than one year.
BACKUP WITHHOLDING
Federal income tax backup withholding at a rate of 31 percent on
dividends, interest payments, and proceeds from a sale, exchange, or redemption
of New Notes will apply unless the Holder (i) is a corporation or comes within
certain other exempt categories (and, when required, demonstrates this fact) or
(ii) provides a taxpayer identification number, certifies as to no loss of
exemption from backup withholding, and otherwise complies with applicable
requirements of the backup withholding rules. The amount of any backup
withholding from a payment to a Holder will be allowed as a credit against the
Holder's federal income tax liability and may entitle such Holder to a refund,
provided that the required information is furnished to the IRS. A Holder of
Notes who does not provide the Company with his correct taxpayer identification
number may be subject to penalties imposed by the IRS. The Company will report
to the Holders of the Notes and the IRS the amount of any "reportable payments"
and any amount withheld with respect to the Notes during the calendar year.
PLAN OF DISTRIBUTION
Subject to the terms and conditions set forth in the Purchase Agreement
dated June 22, 1998, the Company sold the Old Notes to the Initial Purchaser.
The Initial Purchaser received a 3.0% discount and commissions totalling
$3,450,000 in connection with the Offering.
The Initial Purchaser received customary advisory fees and was reimbursed
for its expenses in connection with advice rendered regarding the Acquisition.
In addition, the Company has retained the Initial Purchaser as its financial
advisor until December 31, 2002. An affiliate of the Initial Purchaser provided
the Bridge Financing for the Acquisition for which it was paid customary fees
and reimbursed its expenses. A portion of the proceeds from the Offering was
used to repay the Bridge Notes. Other
83
affiliates of the Initial Purchaser own significant amounts of Acquisition
Corp. Common Stock. See "Use or Proceeds," "Security Ownership of Certain
Beneficial Owners and Management" and "Certain Relationships and Related
Transactions--Transactions with DLJMBII and their Affiliates."
Each broker-dealer that receives New Notes for its own account pursuant to
the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes. This Prospectus, as it may be
amended or supplemented from time to time, may be used by a broker-dealer in
connection with resales of New Notes received in exchange for Old Notes where
such Old Notes were acquired as a result of market-making activities or other
trading activities. The Company has agreed that it will make this Prospectus,
as amended or supplemented, available to any broker-dealer for use in
connection with any such resale for a period until 180 days after the Exchange
Offer Registration Statement has been declared effective, or such shorter
period as will terminate when all Old Notes acquired by broker-dealers for
their own accounts as a result of market-making activities or other trading
activities have been exchanged for New Notes and resold by such broker-dealers.
The Company will not receive any proceeds from any sale of New Notes by
broker-dealers. New Notes received by broker-dealers for their own account
pursuant to the Exchange Offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions,
through the writing of options on the New Notes or a combination of such
methods of resale, at market prices prevailing at the time of resale, at prices
related to such prevailing market prices or negotiated prices. Any such resale
may be made directly to purchasers or to or through brokers or dealers who may
receive compensation in the form of commissions or concessions from any such
broker-dealer and/or the purchasers of any such New Notes. Any broker-dealer
that resells New Notes that were received by it for its own account pursuant to
the Exchange Offer and any broker or dealer that participates in a distribution
of such New Notes may be deemed to be an "underwriter" within the meaning of
the Securities Act and any profit on any such resale of New Notes and any
commissions or concessions received by any such persons may be deemed to be
underwriting compensation under the Securities Act. The Letter of Transmittal
states that by acknowledging that it will deliver and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
For a period until 180 days after the Exchange Offer Registration
Statement has been declared effective, or such shorter period as will terminate
when all Old Notes acquired by broker-dealers for their own accounts as a
result of market-making activities or other trading activities have been
exchanged for New Notes and resold by such broker-dealers, the Company will
promptly send additional copies of this Prospectus and any amendment or
supplement to this Prospectus to any broker-dealer that requests such documents
in the Letter of Transmittal. The Company has agreed to pay all expenses
incident to the Exchange Offer, other than commissions or concessions of any
brokers or dealers and the fees of any counsel or other advisors or experts
retained by the Holders of the Notes, except as expressly set forth in the
Registration Rights Agreement and will indemnify the Holders of the Notes
(including any broker-dealers) against certain liabilities, including
liabilities under the Securities Act.
NOTICE TO HOLDERS
The New Notes may not be sold or transferred to, and each Holder of Old
Notes, by its exchange of Old Notes for New Notes shall be deemed to have
represented and covenanted that it is not acquiring the New Notes for or on
behalf of, and will not transfer the New Notes to, any pension or welfare plan
(as defined in Section 3 of the Employee Retirement Income Security Act of
1974, "ERISA") except that such a purchase for or on behalf of a pension or
welfare plan shall be permitted:
(1) to the extent such purchase is made by or on behalf of a bank
collective investment fund maintained by the Holder in which no plan
(together with any other plans maintained by the same employer or
employee organization) has an interest in excess of 10% of the total
assets in such collective investment fund and the conditions of Section
III of Prohibit Transaction Class Exemption 91-38 issued by the
Department of Labor are satisfied;
84
(2) to the extent such purchase is made by or on behalf of an insurance
company pooled separate account maintained by the Holder in which, at any
time while the New Notes are outstanding, no plan (together with any other
plans maintained by the same employer or employee organization) has an
interest in excees of 10% of the total of all assets in such pooled
separate account and the conditions of Section III of Prohibit Transaction
Class Exemption 90-1 issued by the Department of Labor are satisfied;
(3) to the extent such purchase is made on behalf of a plan by (i) an
investment advisor registered under the Investment Advisers Act of 1940
that had as of the last day of its most recent fiscal year total assets
under its management and control in excess of $50,000,000 and had
stockholders' or partners' equity in excess of $750,000, as shown in its
most recent balance sheet prepared in accordance with generally accepted
accounting principles, or (ii) a bank as defined in Section 202(a)(2) of
the Investment Advisers Act of 1940 with equity capital in excess of
$1,000,000 as of the last day of its most recent fiscal year, or (iii) an
insurance company which is qualified under the laws of more than one state
to manage, acquire or dispose of any assets of a plan, which insurance
company has as of the last day of its most recent fiscal year, net worth
in excess of $1,000,000 and which is subject to supervision and
examination by state authority having supervision over insurance companies
and, in any case, such investment adviser, bank or insurance company is
otherwise a qualified professional asset manager, as such term is used in
Prohibited Transaction Class Exemption 84-14 issued by the Department of
Labor, and the assets of such plan when combined with the assets of other
plans established or maintained by the same employer (or affiliate
thereof) or employee organization and managed by such investment advisor,
bank or insurance company, do not represent more than 20% of the total
client assets managed by such investment advisor, bank or insurance
company, and the conditions of Section I of such exemption are otherwise
satisfied;
(4) to the extent such purchase is made with funds from an insurance
company general account, the conditions of Sections I and IV of Prohibited
Transactions Class Exemption 95-60 issued by the Department of Labor are
satisfied;
(5) to the extent such plan is a governmental plan (as defined in Section
3 of ERISA) which is not subject to the provisions of Title I of ERISA of
Section 401 of the Internal Revenue Code; or
(6) to the extent such purchase is on behalf of a plan by an in-house
asset manager and the conditions of Part I of Prohibited Transactions
Class Exemptions 96-23 issued by the Department of Labor are satisfied.
LEGAL MATTERS
Certain legal matters with respect to the validity of the New Notes will
be passed upon for the Company by Akin, Gump, Strauss, Hauer & Feld, L.L.P.,
New York, New York.
EXPERTS
The consolidated financial statements of AKI, Inc. and Subsidiaries as of
June 30, 1997 and 1998 and for each of the two years in the period ended June
30, 1998, the period from July 1, 1997 through December 15, 1997 and the period
from December 16, 1997 through June 30, 1998 included in this Prospectus have
been so included in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
As of March 23, 1998, the Company dismissed Coopers & Lybrand L.L.P. (the
"Former Independent Accountants") and appointed Price Waterhouse LLP ("Price
Waterhouse") as the Company's independent accountants retained to audit the
Company's financial statements. The dismissal of the Former lndependent
Accountants was approved by the Company's Board of Directors. As of July 1,
1998, Price Waterhouse LLP and Coopers & Lybrand L.L.P. merged their practices
into PricewaterhouseCoopers LLP ("PwC"). As a result, PwC is the Company's
current independent accountants.
The Former Independent Accountant's reports on the Company's financial
statements for the past two fiscal years did not contain any adverse opinion or
disclaimer of opinion and were not qualified or modified as to uncertainty,
audit scope or accounting principles.
85
After the consummation of the Acquisition, a review of the Company's
accounting practices was undertaken by Price Waterhouse at the request of
Acquisition Corp. Price Waterhouse was engaged by Acquisition Corp. to
undertake such review subsequent to the Acquisition. In connection with such
review, Price Waterhouse informed Acquisition Corp. that certain equipment
leases of the Company historically accounted for as operating leases should
have been accounted for as capital leases in accordance with GAAP. The Former
Independent Accountants, after receiving authorization from the Company,
consulted with officers of Acquisition Corp. and Price Waterhouse. The Former
Independent Accountants advised Acquisition Corp. that they did not believe
that the Company's financial statements should be restated for this issue.
Following such disagreement, the Company decided to dismiss the Former
Independent Accountants.
Other than the matter discussed above, in connection with its audits for
the two fiscal years ended June 30, 1997 and through March 23, 1998, there have
been no disagreements with the Former Independent Accountants on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure, which disagreements if not resolved to the satisfaction of
the Former Independent Accountants, would have caused them to make reference
thereto in their report on the financial statements for such years.
Subsequent to the dismissal of the Former Independent Accountants, PwC
audited the Company's financial statements presented in this Prospectus as
referenced in their report set forth herein. Such financial statements account
for the subject equipment leases as capital leases.
86
INDEX TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS
PAGE
----
Introduction to Unaudited Pro Forma Condensed Consolidated Statements of Operations.. P-2
Unaudited Pro Forma Condensed Consolidated Statement of Operations for the Three
Months Ended September 30, 1997 .................................................... P-4
Unaudited Pro Forma Condensed Consolidated Statement of Operations for the Year Ended
June 30, 1998 ...................................................................... P-5
Notes to Unaudited Pro Forma Condensed Consolidated Statements of Operations ........ P-6
P-1
AKI, INC. AND SUBSIDIARIES
INTRODUCTION TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands)
DLJ Merchant Banking Partners II, L.P. and certain related investors
(collectively, "DLJMBII") and certain members of Arcade Holding Corporation
(the "Predecessor") organized ACH I Acquisition Corp. ("Acquisition Corp.") and
AHC I Merger Corp. ("Merger Corp."), for purposes of acquiring the Predecessor.
Merger Corp. was capitalized by an equity contribution from Acquisition Corp.
and the issuance of senior increasing rate notes (the "Bridge Loans"). On
December 15, 1997, Merger Corp. acquired all of the equity interests of the
Predecessor (the "Acquisition"), merged with and into the Predecessor and the
combined entity assumed the name AKI, Inc. (the "Company"). Subsequent to the
Acquisition, Acquisition Corp. contributed all of its equity interest in the
Company to AKI Holding Corp. ("Holding").
On June 22, 1998, the Company acquired the fragrance sampling business,
including certain fixed assets totaling $143, of the Industrial and Consumer
Products division of the Minnesota Mining and Manufacturing Company ("3M") for
approximately $7,250 in cash and the assumption of certain liabilities totaling
$182 (the "3M Acquisition").
The following unaudited pro forma condensed consolidated statements of
operations of the Company is based upon the historical consolidated statements
of operations of the Company or the Predecessor as adjusted to give effect to
the Acquisition, the 3M Acquisition and the issuance by the Company of the
Senior Notes, together with a capital contribution (the "Equity Contribution")
to the Company of the net proceeds from the concurrent issuance by Holding of
Senior Discount Debentures and the application of the net proceeds therefrom to
repay the Bridge Loans and certain other indebtedness (collectively, the
"Refinancing"), as if each event had occurred as of the beginning of the period
presented. The historical consolidated balance sheet of the Company as of June
30, 1998 includes the effects of the Acquisition, the 3M Acquisition and the
Refinancing as such events occurred prior to June 30, 1998.
Pro forma adjustments are described in the accompanying notes and are
applied to the historical consolidated statements of operations of the Company
and the Predecessor to account for the Acquisition and the 3M Acquisition under
the purchase method of accounting and the Refinancing. In accordance with the
consensus reached by the Emerging Issues Task Force of the Financial Accounting
Standards Board in Issue 88-16, "Basis in Leveraged Buyout Transactions," the
purchase price allocation required an adjustment for the continuing interest
attributable to management's ownership interest in Predecessor carried over in
connection with the Acquisition. As a result, a reduction in stockholder's
equity was recorded which represents the difference between the fair value of
the Company's assets and the related book value attributable to the interest of
the continuing shareholders' investment in the Predecessor. The remaining
purchase price has been allocated to asset and liabilities based upon estimates
of their respective fair value as determined by management and a third-party
appraisal with respect to property, plant and equipment. For the 3M
Acquisition, the purchase price has been allocated to assets purchased and
liabilities assumed based upon estimates of their respective fair values as
determined by management.
The Company has preliminarily analyzed the savings it expects to realize
from reductions in management fees, total depreciation expense, salaries,
benefits, material costs and other operating expenses as a result of the
Acquisition. To the extent that the Company has agreed prospectively to
reductions in management fees (which represent the difference between the
Predecessor's management fees and the new financial advisory fees to which the
Company is contractually obligated through the Acquisition agreement) and has
quantified the expected reduction in total depreciation expense (useful lives
of certain property, plant and equipment were extended based upon the
third-party appraisal), these reductions have been reflected in the unaudited
pro forma condensed consolidated statements of operations. Other potential cost
savings have not been included in the unaudited pro forma condensed
consolidated statements of operations.
P-2
AKI, INC. AND SUBSIDIARIES
INTRODUCTION TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS--(CONTINUED)
(dollars in thousands)
As noted above, the Company has acquired the fragrance sampling business
of 3M. 3M's fragrance sampling business was predominantly a sales and
distribution business as it outsourced the production of the majority of the
products it sold. The Company did not assume such outsourcing arrangements and
relocated such operations to its Chattanooga facilities as the Company has
excess manufacturing capacity at such facilities. In addition, except for
several sales and technical employees, the Company did not extend employment to
any employees from 3M; the Company's management has determined that additional
personnel will be required at its Chattanooga facilities in the selling and
technical functions in order to serve the incremental sales volume. As
described in the notes to the unaudited pro forma condensed consolidated
statement of operations, the Company has adjusted the historical operating
results of this business to reflect the cost of producing and selling such
products by the Company. The adjustments to 3M's historical results are based
on the Company's historical production and selling, general and administrative
cost structure, modified as described to account for the sales volume
attributable to the 3M Acquisition.
The pro forma adjustments are based on estimates, available information
and certain assumptions and may be revised as additional information becomes
available. The unaudited pro forma condensed consolidated statements of
operations do not purport to represent what the Company's results of operations
would have actually been if the Acquisition, the 3M Acquisition or the
Refinancing had occurred on the date indicated and are not necessarily
representative of the Company's results of operations for any future period.
The unaudited pro forma condensed consolidated statements of operations should
be read in conjunction with the Consolidated Financial Statements and the notes
thereto, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the other financial information appearing elsewhere
in this Registration Statement.
P-3
AKI, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997
(dollars in thousands)
PRO FORMA
ACQUISITION FOR
AKI, INC. ADJUSTMENTS ACQUISITION
--------- ----------- -----------
Net sales ........................ $ 21,928 $ -- $ 21,928
Cost of goods sold ............... 13,622 (201)(a) 13,421
-------- ---------- --------
Gross profit ................... 8,306 201 8,507
Selling, general and
administrative expenses ......... 3,322 15 (a) 3,337
Amortization of goodwill ......... 304 659 (b) 963
-------- ---------- --------
Income (loss) from
operations .................... 4,680 (473) 4,207
Other expenses (income):
Interest expense, net ........... 1,451 2,916 (c) 4,367
Management fees to
stockholders and affiliate 118 (55)(d) 63
Other, net ...................... 28 -- 28
-------- ---------- --------
Income (loss) before
income taxes .................. 3,083 (3,334) (251)
Income tax expense (benefit) ..... 1,287 (1,007)(e) 280
-------- ---------- --------
Net income (loss) .............. $ 1,796 $ (2,327) $ (531)
======== ========== ========
STATEMENT OF CASH FLOW DATA:
Net cash provided by (used
in) operating activities ....... $ (2,237) $ (1,003) $ (3,240)
Net cash used in investing
activities ..................... (448) -- (448)
Net cash provided by (used
in) financing activities ....... 3,896 (4,056) (160)
PRO FORMA
FOR 3M
REFINANCING ACQUISITION AND ACQUISITION
ADJUSTMENTS REFINANCING ADJUSTMENTS(H) PRO FORMA
----------- ----------- -------------- ---------
Net sales ........................ $ -- $ 21,928 $ 2,788 $ 24,716
Cost of goods sold ............... -- 13,421 1,380 14,801
---------- -------- ------- --------
Gross profit ................... -- 8,507 1,408 9,915
Selling, general and
administrative expenses ......... -- 3,337 265 3,602
Amortization of goodwill ......... -- 963 45 1,008
---------- -------- ------- --------
Income (loss) from
operations .................... -- 4,207 1,098 5,305
Other expenses (income):
Interest expense, net ........... (1,118)(f) 3,249 -- 3,249
Management fees to
stockholders and affiliate -- 63 -- 63
Other, net ...................... -- 28 -- 28
---------- -------- ------- --------
Income (loss) before
income taxes .................. 1,118 867 1,098 1,965
Income tax expense (benefit) ..... 421 (g) 701 413 1,114
---------- -------- ------- --------
Net income (loss) .............. $ 697 $ 166 $ 685 $ 851
========== ======== ======= ========
STATEMENT OF CASH FLOW DATA:
Net cash provided by (used
in) operating activities ....... $ 160 $ (3,080) $ 739 $ (2,341)
Net cash used in investing
activities ..................... -- (448) -- (448)
Net cash provided by (used
in) financing activities ....... -- (160) -- (160)
See notes to unaudited pro forma consolidated statements of operations.
P-4
AKI, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED JUNE 30, 1998
(dollars in thousands)
PRO FORMA
ACQUISITION FOR
AKI, INC. ADJUSTMENTS ACQUISITION
--------- ----------- -----------
Net sales ........................ $ 71,252 $ -- $ 71,252
Cost of goods sold ............... 47,327 (437)(a) 46,890
---------- ---------- ---------
Gross profit ................... 23,925 437 24,362
Selling, general and
administrative expenses ......... 11,313 32 (a) 11,345
Amortization of goodwill ......... 2,646 1,202 (b) 3,848
---------- ---------- ---------
Income (loss) from
operations .................... 9,966 (797) 9,169
Other expenses (income):
Interest expense, net ........... 13,915 3,616 (c) 17,531
Management fees to
stockholders and affiliate 340 (90)(d) 250
Other, net ...................... (36) -- (36)
---------- ---------- ---------
Income (loss) before
income taxes .................. (4,253) (4,323) (8,576)
Income tax expense (benefit) ..... (592) (1,175)(e) (1,767)
---------- ---------- ---------
Net income (loss) .............. $ (3,661) $ (3,148) $ (6,809)
========== ========== =========
STATEMENT OF CASH FLOW DATA:
Net cash provided by (used
in) operating activities ....... $ (3,893) $ 3,481 $ (412)
Net cash provided by (used
in) investing activities ....... (142,724) 134,153 (8,571)
Net cash provided by (used
in) financing activities ....... 152,436 (143,936) 8,500
PRO FORMA
FOR 3M
REFINANCING ACQUISITION AND ACQUISITION
ADJUSTMENTS REFINANCING ADJUSTMENTS(H) PRO FORMA
----------- ----------- -------------- ---------
Net sales ........................ $ -- $ 71,252 $ 10,579 $ 81,831
Cost of goods sold ............... -- 46,890 5,237 52,127
---------- --------- -------- ---------
Gross profit ................... -- 24,362 5,342 29,704
Selling, general and
administrative expenses ......... -- 11,345 1,005 12,350
Amortization of goodwill ......... -- 3,848 182 4,030
---------- --------- -------- ---------
Income (loss) from
operations .................... -- 9,169 4,155 13,324
Other expenses (income):
Interest expense, net ........... (4,482)(f) 13,049 -- 13,049
Management fees to
stockholders and affiliate -- 250 -- 250
Other, net ...................... -- (36) -- (36)
---------- --------- -------- ---------
Income (loss) before
income taxes .................. 4,482 (4,094) 4,155 61
Income tax expense (benefit) ..... 1,687 (g) (80) 1,564 1,484
---------- --------- -------- ---------
Net income (loss) .............. $ 2,795 $ (4,014) $ 2,591 $ (1,423)
========== ========= ======== =========
STATEMENT OF CASH FLOW DATA:
Net cash provided by (used
in) operating activities ....... $ 749 $ 337 $ 2,810 $ 3,146
Net cash provided by (used
in) investing activities ....... -- (8,571) 7,250 (1,321)
Net cash provided by (used
in) financing activities ....... (9,157) (657) -- (657)
See notes to unaudited pro forma consolidated statements of operations.
P-5
AKI, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands)
ACQUISITION ADJUSTMENTS
(a) Represents the net reduction in depreciation expense ($186 for the
three months ended September 30, 1997 and $405 for the year ended June 30,
1998) as a result of the fair values assigned to property, plant and equipment
and estimated useful lives which were extended as determined from appraisals
commissioned by the Company in connection with the application of purchase
accounting associated with the Acquisition.
(b) Adjusts goodwill amortization to $963 for the three months ended
September 30, 1997 and $3,848 for the year ended June 30, 1998 based upon
goodwill of $153,929 amortized using straight-line method over 40 years.
(c) Reflects incremental interest expense and amortization of deferred
charges ($2,916 for the three months ended September 30, 1997 and $3,616 for
the year ended June 30, 1998) on the Bridge Loans issued in connection with the
Acquisition as though such issuance had occurred at the beginning of the
period.
(d) Reflects the elimination of management fees and expenses paid to
former stockholders, net of financial advisory fees agreed to on a prospective
basis through the Acquisition agreement ($55 for the three months ended
September 30, 1998 and $90 for the year ended June 30, 1998).
(e) Reflects incremental income tax benefit ($1,007 for the three months
ended September 30, 1997 and $1,175 for the year ended June 30, 1998) relating
to pro forma consolidated statement of operations' adjustments in (c) and (d)
above. Goodwill is not tax deductible.
REFINANCING ADJUSTMENTS
(f) Reflects incremental reduction in interest expense and amortization of
deferred charges ($1,182 for the three months ended September 30, 1997 and
$4,482 for the year ended June 30, 1998) associated with the Refinancing as
though such Refinancing had occurred at the beginning of the period.
(g) Reflects the incremental provision for income taxes ($421 for the
three months ended September 30, 1997 and $1,687 for the year ended June 30,
1998) on the incremental reduction in interest expense associated with the
Refinancing.
3M ACQUISITION ADJUSTMENTS
(h) Reflects the incremental impact of the Company's acquisition of 3M's
fragrance sampling business' historical statements of operations conformed to
the periods indicated as well as the adjustments to these historical results
for not assuming outsourcing arrangements on a prospective basis and to reflect
the costs of producing and selling such products by the Company.
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997
3M 3M
HISTORICAL ADJUSTMENTS ADJUSTED
---------- ----------- --------
Net sales ............................................ $4,075 $ (1,287)(i) $ 2,788
Cost of goods sold ................................... 3,085 (1,705)(ii) 1,380
------ ----------- -------
Gross profit ........................................ 990 418 1,408
Selling, general and administrative expenses ......... 1,356 (1,091) (iii) 265
Amortization of goodwill ............................. -- 45 (iv) 45
------ ----------- -------
Income (loss) before income taxes ................... (366) 1,464 1,098
Income tax expense (benefit) ......................... (132) 545 (v) 413
------ ----------- -------
Net income (loss) ................................... $ (234) $ 919 $ 685
====== =========== =======
P-6
AKI, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS--(CONTINUED)
(dollars in thousands)
FOR THE YEAR ENDED JUNE 30, 1998
3M 3M
HISTORICAL ADJUSTMENTS ADJUSTED
---------- ----------- --------
Net sales ............................................ $ 15,679 $ (5,100)(i) $ 10,579
Cost of goods sold ................................... 12,037 (6,800)(ii) 5,237
-------- ----------- --------
Gross profit ........................................ 3,642 1,700 5,342
Selling, general and administrative expenses ......... 5,059 (4,054) (iii) 1,005
Amortization of goodwill ............................. -- 182 (iv) 182
-------- ----------- --------
Income (loss) before income taxes ................... (1,417) 5,572 4,155
Income tax expense (benefit) ......................... (510) 2,074 (v) 1,564
-------- ----------- --------
Net income (loss) ................................... $ (907) $ 3,498 $ 2,591
======== =========== ========
- --------------
(i) Reflects the decrease in net sales resulting from the loss of a
significant customer prior to the 3M Acquisition.
(ii) Reflects the decrease in production costs ($988 for the three months
ended September 30, 1997 and $3,915 for the year ended June 30, 1998)
resulting from the loss of a significant customer prior to the 3M
Acquisition noted in (i) above and reflects the decrease in production
costs ($717 for the three months ended September 30, 1997 and $2,885 for
the year ended June 30, 1998) from the Company not assuming 3M's
outsourcing arrangements and consolidating production into the Company's
Chattanooga facilities. The decrease in production costs from
consolidating production into the Company's Chattanooga facilities takes
into account the Company's available manufacturing capacity at such
facilities as well as the variable costs (primarily materials and direct
labor) of such incremental sales based upon the Company's historical
results. Due to the Company's existing capacity, fixed costs (primarily
depreciation and overhead) will not be affected by such incremental
sales.
(iii) Reflects the net decrease in selling, general and administrative expenses
due to the consolidation of these activities into the Company. Subsequent
to the consummation of the 3M Acquisition, the Company added several
additional sales and technical employees as well as certain additional
administrative employees. The salaries, benefits and commissions, if
applicable, of these employees have been accounted for in the adjustment.
The Company believes that due to the similarity of its existing customers
and 3M's fragrance sampling customers, no other additional employees will
be required. The adjustment also reflects the elimination of corporate
expense allocations that have been discontinued as a result of the
transfer of the 3M fragrance sampling business to the Company.
(iv) Represents amortization expense based upon goodwill of $7,289 arising
from the 3M Acquisition amortized over 40 years using the straight-line
method.
(v) Reflects incremental income tax expense relating to the 3M adjustments in
(i) through (iv) above.
P-7
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants ........................................................ F-2
Report of Independent Accountants ........................................................ F-3
Consolidated Balance Sheet at June 30, 1997 and 1998, and Unaudited Consolidated Balance
Sheet at September 30, 1998 ............................................................. F-4
Consolidated Statements of Operations for the Two Years Ended June 30, 1997 and for the
period from July 1, 1997 through December 15, 1997 and for the period from
December 16, 1997 through June 30, 1998, and Unaudited Consolidated Statements of
Operations for the Three Months Ended September 30, 1997 and 1998 ....................... F-5
Consolidated Statements of Changes in Stockholder(s) Equity for the Two Years Ended
June 30, 1997 and for the period from July 1, 1997 through December 15, 1997 and for the
period from December 16, 1997 through June 30, 1998, and Unaudited Consolidated
Statement of Changes in Stockholder Equity for the Three Months Ended September 30,
1998 .................................................................................... F-6
Consolidated Statements of Cash Flows for the Two Years Ended June 30, 1997 and for the
period from July 1, 1997 through December 15, 1997 and for the period from
December 16, 1997 through June 30, 1998, and Unaudited Consolidated Statements of Cash
Flows for the Three Months Ended September 30, 1997 and 1998 ............................ F-7
Notes to Consolidated Financial Statements ............................................... F-8
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
AKI, Inc. and Subsidiaries
In our opinion, the accompanying consolidated balance sheet and the
related consolidated statements of operations, of changes in stockholder's
equity and of cash flows present fairly, in all material respects, the
financial position of AKI, Inc. and Subsidiaries (a wholly-owned subsidiary of
AKI Holding Corp.), formerly known as Arcade Holding Corporation (the
"Predecessor") at June 30, 1998, and the results of their operations and their
cash flows for the period from December 16, 1997 through June 30, 1998 in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of management; our responsibility is to
express an opinion on these financial statements based on our audit. We
conducted our audit of these statements in accordance with generally accepted
auditing standards which 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, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1998
F-2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
AKI, Inc. and Subsidiaries
In our opinion, the accompanying consolidated balance sheet and the
related consolidated statements of operations, of changes in stockholders'
equity and of cash flows present fairly, in all material respects, the
financial position of Arcade Holding Corporation and Subsidiaries at June 30,
1997, and the results of their operations and their cash flows for each of the
two years in the period ended June 30, 1997 and the period from July 1, 1997
through December 15, 1997 in conformity with generally accepted accounting
principles. These financial statements are the responsibility of management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1998
F-3
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
CONSOLIDATED BALANCE SHEET
(dollars in thousands, except share information)
PREDECESSOR SUCCESSOR
--------------- -------------------------------------
JUNE 30, 1997 JUNE 30, 1998 SEPTEMBER 30, 1998
--------------- --------------- -------------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents ................................. $ 303 $ 1,641 $ 1,341
Accounts receivable, net .................................. 10,200 13,577 21,449
Inventory ................................................. 2,786 2,078 3,948
Income tax refund receivable .............................. -- 5,155 132
Prepaid expenses .......................................... 221 378 326
Deferred income taxes ..................................... 424 827 827
-------- --------- ---------
TOTAL CURRENT ASSETS ................................... 13,934 23,656 28,059
Property, plant and equipment, net ........................ 18,156 18,936 18,579
Goodwill, net ............................................. 44,293 159,131 158,123
Deferred charges .......................................... 555 5,272 5,229
Deferred income taxes ..................................... -- 3,869 3,532
Other assets .............................................. 204 200 203
-------- --------- ---------
TOTAL ASSETS ........................................... $ 77,142 $ 211,064 $ 213,725
======== ========= =========
LIABILITIES AND STOCKHOLDER(S) EQUITY
CURRENT LIABILITIES
Current portion of loans payable to stockholder ........... $ 37,892 $ -- $ --
Current portion of capital lease obligation ............... 557 609 623
Current portion of other notes payable .................... 100 1,330 --
Revolving line of credit .................................. 4,338 -- --
Accounts payable, trade ................................... 3,435 4,140 5,934
Accrued income taxes ...................................... 26 100 1,088
Accrued bonuses ........................................... 1,396 650 319
Accrued interest .......................................... -- 168 3,196
Accrued expenses .......................................... 3,147 3,814 2,455
-------- --------- ---------
TOTAL CURRENT LIABILITIES .............................. 50,891 10,811 13,615
Long-term portion of capital lease obligation ............. 2,098 1,489 1,328
Senior notes .............................................. 115,000 115,000
Other notes payable, net .................................. 1,301 -- --
Deferred income taxes ..................................... 2,949 4,143 3,692
-------- --------- ---------
57,239 131,443 133,635
Commitments and contingencies (see Note 13)
Redeemable preferred stock ................................ 8,678
STOCKHOLDER(S) EQUITY
Common stock, $0.01 par, 100,000 shares authorized;
48,000 shares issued and outstanding at June 30,
1997 ..................................................... 1
Preferred stock, $0.01 par, 8,700 shares authorized;
no shares issued or outstanding at June 30, 1998 ......... -- --
Common stock, $0.01 par, 100,000 shares authorized;
1,000 shares issued and outstanding at June 30,
1998 ..................................................... -- --
Additional paid-in capital ................................ 4,889 100,862 100,862
Stock purchase warrants ................................... 1,923
Retained earnings (deficit) ............................... 4,565 (5,454) (5,097)
Accumulated other comprehensive income .................... (153) (57) 55
Carryover basis adjustment ................................ -- (15,730) (15,730)
-------- --------- ---------
TOTAL STOCKHOLDER(S) EQUITY ............................ 11,225 79,621 80,090
-------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDER(S) EQUITY ............ $ 77,142 $ 211,064 $ 213,725
======== ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands)
PREDECESSOR SUCCESSOR
---------------------------------------------------------- -----------------------------
JULY 1, 1997 THREE MONTHS DECEMBER 16, THREE MONTHS
YEAR ENDED JUNE 30, THROUGH ENDED 1997 ENDED
----------------------- DECEMBER 15, SEPTEMBER 30, THROUGH SEPTEMBER 30,
1996 1997 1997 1997 JUNE 30, 1998 1998
---------- ---------- -------------- --------------- -------------- --------------
(UNAUDITED) (UNAUDITED)
Net sales ........................ $73,486 $77,723 $35,186 $21,928 $ 36,066 $24,024
Cost of goods sold ............... 49,862 49,467 22,809 13,622 24,518 15,421
------- ------- ------- ------- --------- -------
Gross profit .................. 23,624 28,256 12,377 8,306 11,548 8,603
Selling, general and
administrative expenses ......... 10,655 13,353 5,712 3,322 5,601 3,121
Amortization of goodwill ......... 1,214 1,214 559 304 2,087 1,008
------- ------- ------- ------- --------- -------
Income from operations 11,755 13,689 6,106 4,680 3,860 4,474
Other expenses (income):
Interest expense to
stockholder(s) and
affiliate ..................... 6,164 5,196 2,143 1,230 10,785 --
Interest expense, net ........... 598 1,007 503 221 484 3,210
Management fees to
stockholders and affiliate 470 470 215 118 125 63
Other, net ...................... 244 (101) 11 28 (47) --
------- ------- ------- ------- --------- -------
Income (loss) before
income taxes ................. 4,279 7,117 3,234 3,083 (7,487) 1,201
Income tax expense (benefit) 2,101 3,135 1,441 1,287 (2,033) 844
------- ------- ------- ------- --------- -------
Net income (loss) ............. $ 2,178 $ 3,982 $ 1,793 $ 1,796 $ (5,454) $ 357
======= ======= ======= ======= ========= =======
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER(S) EQUITY
(dollars in thousands, except share information)
ADDITIONAL STOCK
COMMON STOCK PAID-IN PURCHASE
SHARES DOLLARS CAPITAL WARRANTS
-------- --------- ------------ ----------
PREDECESSOR
------------------------------------------
Balances, June 30, 1995 ........... 48,000 $ 1 $ 4,889 $1,923
Net income ........................ -- -- -- --
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment ...................... -- -- -- --
Comprehensive income ..............
Preferred stock dividend .......... -- -- -- --
------ --- -------- ------
Balances, June 30, 1996 ........... 48,000 1 4,889 1,923
Net income ........................ -- -- -- --
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment ...................... -- -- -- --
Comprehensive income ..............
Preferred stock dividend .......... -- -- -- --
------ --- -------- ------
Balances, June 30, 1997 ........... 48,000 1 4,889 1,923
Net income ........................ -- -- -- --
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment ...................... -- -- -- --
Comprehensive income ..............
Preferred stock dividend .......... -- -- -- --
------ --- -------- ------
Balances, December 15, 1997 ....... 48,000 $ 1 $ 4,889 $1,923
====== === ======== ======
SUCCESSOR
Balances, December 16, 1997 ....... -- $-- $ -- $ --
Initial capitalization ............ 1,000 -- 78,363 --
Carryover basis adjustment ........ -- -- -- --
Equity contribution by Holding .... -- -- 22,499 --
Net loss .......................... -- -- -- --
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment ...................... -- -- -- --
Comprehensive income ..............
Balances, June 30, 1998 ........... 1,000 -- 100,862 --
Net income (unaudited) ............ -- -- -- --
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment (unaudited) .......... -- -- -- --
Comprehensive income
(unaudited) ......................
Balances (unaudited) .............. 1,000 $-- $100,862 $ --
====== === ======== ======
ACCUMULATED
OTHER CARRYOVER
RETAINED COMPREHENSIVE BASIS
EARNINGS INCOME ADJUSTMENT TOTAL
------------ --------------- ------------- ------------
PREDECESSOR
-------------------------------------------------------
Balances, June 30, 1995 ........... $ (361) $ 120 $ $ 6,572
--
Net income ........................ 2,178 -- -- 2,178
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment ...................... -- (200) -- (200)
----------
Comprehensive income .............. 1,978
Preferred stock dividend .......... (618) -- -- (618)
-------- ------ ----------- ----------
Balances, June 30, 1996 ........... 1,199 (80) -- 7,932
Net income ........................ 3,982 -- -- 3,982
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment ...................... -- (73) -- (73)
----------
Comprehensive income .............. 3,909
Preferred stock dividend .......... (616) -- -- (616)
-------- ------ ----------- ----------
Balances, June 30, 1997 ........... 4,565 (153) -- 11,225
Net income ........................ 1,793 -- -- 1,793
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment ...................... -- (19) -- (19)
----------
Comprehensive income .............. 1,774
Preferred stock dividend .......... (283) -- -- (283)
-------- ------ ----------- ----------
Balances, December 15, 1997 ....... $ 6,075 $ (172) $ -- $ 12,716
======== ====== =========== ==========
Balances, December 16, 1997 ....... $ -- $ -- -- $ --
Initial capitalization ............ -- -- -- 78,363
Carryover basis adjustment ........ -- -- (15,730) (15,730)
Equity contribution by Holding .... -- -- -- 22,499
Net loss .......................... (5,454) -- -- (5,454)
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment ...................... -- (57) -- (57)
Comprehensive income .............. (5,511)
----------
Balances, June 30, 1998 ........... (5,454) (57) (15,730) 79,621
Net income (unaudited) ............ 357 -- -- 357
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment (unaudited) .......... -- 112 -- 112
----------
Comprehensive income
(unaudited) ...................... 469
----------
Balances (unaudited) .............. $ (5,097) $ 55 $ (15,730) $ 80,090
======== ====== =========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
PREDECESSOR
------------------------------------------------------
JULY 1, 1997 THREE MONTHS
YEAR ENDED JUNE 30, THROUGH ENDED
----------------------- DECEMBER 15, SEPTEMBER 30,
1996 1997 1997 1997
----------- ----------- -------------- ---------------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ................................ $ 2,178 $ 3,982 $ 1,793 $ 1,796
Adjustment to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization of goodwill
and other intangibles .......................... 4,422 5,084 2,456 1,401
Amortization of debt discount ................... 642 560 233 127
Amortization of loan closing costs .............. 231 258 101 54
Deferred income taxes ........................... (483) (297) (460) (90)
Other ........................................... 239 (138) (18) (6)
Changes in operating assets and liabilities:
Accounts receivable ............................ (1,268) 2,546 1,153 (5,421)
Inventory ...................................... (304) (550) 69 (642)
Prepaid expenses, deferred charges and
other assets .................................. (168) (101) (62) (109)
Income taxes ................................... 75 (1,163) 699 1,028
Accounts payable and accrued expenses (227) (1,239) (1,036) (375)
-------- -------- -------- ----------
Net cash provided by (used in)
operating activities .......................... 5,337 8,942 4,928 (2,237)
-------- -------- -------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment ........................... (2,051) (2,462) (807) (448)
Proceeds from sale of equipment .................. 55 38 -- --
Refundable deposit on equipment .................. 1,984 -- -- --
Payments for acquisitions, net of cash
acquired ........................................ -- -- -- --
-------- -------- -------- ----------
Net cash used in investing activities .......... (12) (2,424) (807) (448)
-------- -------- -------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments under capital leases for equipment (646) (2,359) (249) (135)
Proceeds on line of credit with stockholder ...... 7,500 -- -- --
Repayments on line of credit with
stockholder ..................................... (7,500) -- -- --
Net proceeds (repayments) on line of credit -- 4,338 2,362 6,062
Proceeds from issuance of senior increasing
rate notes, net of offering costs ............... -- -- -- --
Payments on senior increasing rate notes ......... -- -- -- --
Proceeds from issuance of senior notes, net
of offering costs ............................... -- -- -- --
Proceeds from issuance of common stock ........... -- -- -- --
Redemption of preferred stock .................... -- -- -- --
Repayment of loans payable to stockholder ........ (6,004) (7,004) (1,851) (1,851)
Repayment of other notes payable ................. (1,627) (1,200) (50) (25)
Dividends paid on preferred stock ................ (618) (616) (155) (155)
-------- -------- -------- ----------
Net cash provided by (used in) financing
activities .................................... (8,895) (6,841) 57 3,896
-------- -------- -------- ----------
Net increase (decrease) in cash and cash
equivalents ...................................... (3,570) (323) 4,178 1,211
Cash and cash equivalents, beginning of period 4,196 626 303 303
-------- -------- -------- ----------
Cash and cash equivalents, end of period .......... $ 626 $ 303 $ 4,481 $ 1,514
======== ======== ======== ==========
SUPPLEMENTAL INFORMATION:
Cash paid during the period for:
Interest to stockholder(s) ...................... $ 5,573 $ 4,559 $ 1,146 $ 1,140
Interest, other ................................. 604 917 459 130
Income taxes .................................... 2,834 4,594 1,222 349
SIGNIFICANT NON-CASH ACTIVITIES:
Assets acquired under capital lease .............. $ 3,555 $ -- $ -- $ --
SUCCESSOR
---------------------------------------
DECEMBER 16, 1997 THREE MONTHS
THROUGH ENDED
JUNE 30, 1998 SEPTEMBER 30, 1998
------------------- -------------------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ................................ $ (5,454) $ (357)
Adjustment to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization of goodwill
and other intangibles .......................... 3,954 2,049
Amortization of debt discount ................... 81 --
Amortization of loan closing costs .............. 3,808 143
Deferred income taxes ........................... (2,016) (114)
Other ........................................... (57) 112
Changes in operating assets and liabilities:
Accounts receivable ............................ (4,589) (7,872)
Inventory ...................................... 543 (1,906)
Prepaid expenses, deferred charges and
other assets .................................. (452) (57)
Income taxes ................................... 767 6,011
Accounts payable and accrued expenses (5,406) 3,132
----------- ---------
Net cash provided by (used in)
operating activities .......................... (8,821) 1,855
----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment ........................... (514) (678)
Proceeds from sale of equipment .................. -- --
Refundable deposit on equipment .................. -- --
Payments for acquisitions, net of cash
acquired ........................................ (141,403) --
----------- ---------
Net cash used in investing activities .......... (141,917) (678)
----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments under capital leases for equipment (308) (147)
Proceeds on line of credit with stockholder ...... -- --
Repayments on line of credit with
stockholder ..................................... -- --
Net proceeds (repayments) on line of credit (6,700) --
Proceeds from issuance of senior increasing
rate notes, net of offering costs ............... 119,735 --
Payments on senior increasing rate notes ......... (123,500) --
Proceeds from issuance of senior notes, net
of offering costs ............................... 110,158 --
Proceeds from issuance of common stock ........... 98,499 --
Redemption of preferred stock .................... (8,678) --
Repayment of loans payable to stockholder ........ (36,649) --
Repayment of other notes payable ................. (50) (1,330)
Dividends paid on preferred stock ................ (128) --
----------- ---------
Net cash provided by (used in) financing
activities .................................... 152,379 (1,477)
----------- ---------
Net increase (decrease) in cash and cash
equivalents ...................................... 1,641 (300)
Cash and cash equivalents, beginning of period -- 1,641
----------- ---------
Cash and cash equivalents, end of period .......... $ 1,641 $ 1,341
=========== =========
SUPPLEMENTAL INFORMATION:
Cash paid during the period for:
Interest to stockholder(s) ...................... $ 11,503 $ --
Interest, other ................................. 214 39
Income taxes .................................... (784) (5,053)
SIGNIFICANT NON-CASH ACTIVITIES:
Assets acquired under capital lease .............. $ -- $ --
The accompanying notes are an integral part of these consolidated
financial statements.
F-7
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
1. ORGANIZATION, BUSINESS AND ACQUISITIONS
On November 4, 1993, Arcade Holding Corporation (the "Predecessor") was
organized for the purpose of acquiring all the issued and outstanding capital
stock of Arcade, Inc. ("A, Inc."). A, Inc. manufactures and distributes
cosmetics sampling products from its Chattanooga, Tennessee facilities, and
distributes its products in Europe through its French subsidiary, Arcade Europe
S.A.R.L. On June 9, 1995, the Predecessor acquired all of the issued and
outstanding stock of Scent Seal Inc. ("Scent Seal") (see Note 10). The
acquisition of Scent Seal did not have a material impact on the financial
position or results of operations of the Predecessor. These acquisitions were
accounted for as purchase transactions whereby the purchase cost was allocated
to the fair value of the net assets acquired.
As more fully described in Note 3, DLJ Merchant Banking Partners II, L.P.
and certain related investors (collectively, "DLJMBII") and certain members of
the Predecessor organized AHC I Acquisition Corp. ("Acquisition Corp.") and AHC
I Merger Corp. ("Merger Corp.") for purposes of acquiring the Predecessor.
Merger Corp. was a wholly-owned subsidiary of Acquisition Corp. and was
initially capitalized by Acquisition Corp. with an equity contribution of
$78,363, comprised of $76,000 of cash (see Note 12) and $2,363 of non-cash
consideration in the form of an option to purchase Senior Preferred Stock of
Acquisition Corp. (see Note 16). Immediately following this equity
contribution, Merger Corp. issued $123,500 of senior increasing rate notes (the
"Bridge Loans") to an entity with a partial ownership interest in Acquisition
Corp. On December 15, 1997, Merger Corp. acquired all of the equity interests
of the Predecessor (the "Acquisition") for a total cost of $197,730, which
consisted of $138,634 cash paid for equity interests and related expenses,
$2,363 in non-cash consideration in the form of an option to purchase Senior
Preferred Stock of Acquisition Corp. (see Note 16) and the assumption of
$56,733 in debt, preferred stock and related interest and dividends, including
capital lease obligations. Merger Corp. then merged with and into the
Predecessor and the combined entity assumed the name AKI, Inc. ("AKI," the
"Successor" or the "Company"). The Acquisition was accounted for using the
purchase method of accounting. Subsequent to the Acquisition, Acquisition Corp.
contributed all of its ownership interest in AKI to AKI Holding Corp.
("Holding"). Since all companies are under common control and since Holding and
Acquisition Corp. have no operations other than those related to the Company,
the contribution was accounted for as if it were a pooling of interests. As
also discussed in Note 3, the Company acquired the fragrance sampling business
of the Industrial and Consumer Products Division of Minnesota Mining and
Manufacturing Company ("3M") on June 22, 1998 (the "3M Acquisition") for
approximately $7,250 in cash and the assumption of $182 of liabilities.
Unless otherwise indicated, all references to years refer to the
Predecessor's and AKI's fiscal year, June 30.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Interim Financial Information
The interim consolidated balance sheet at September 30, 1998, the interim
consolidated statements of operations and of cash flows for the three months
ended September 30, 1997 and 1998, respectively, and the interim consolidated
statement of changes in stockholder(s) equity for the three months ended
September 30, 1998 period are unaudited, and certain information and footnote
disclosure related thereto, normally included in financial statements prepared
in accordance with generally accepted accounting principles, have been omitted.
In the opinion of management, the unaudited interim consolidated financial
statements were prepared following the same policies and procedures used in the
preparation of the audited financial statements and all adjustments, consisting
only of normal recurring adjustments necessary to fairly present the financial
position, results of operations and cash flows with respect to the interim
consolidated financial statements, have been included. The results of
operations for the interim periods are not necessarily indicative of the
results for the entire year.
F-8
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The accompanying unaudited interim consolidated financial statements as of
September 30, 1998 and for the three months then ended, present the financial
position and results of operations of the Company on the basis of accounting
described in Note 3 and, accordingly, are not comparable with the audited
Predecessor consolidated financial statements as of June 30, 1997 and for each
of the two years ended June 30, 1997 and the period from July 1, 1997 through
December 15, 1997, nor with the unaudited interim consolidated financial
statements for the three months ended September 30, 1997.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
transactions have been eliminated.
Reclassification
Certain prior year amounts have been reclassified to conform with the
current year presentation.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid investments with an original maturity of three
months or less at the time of purchase to be cash equivalents.
Concentration of Credit Risk
The Company maintains its cash in bank deposit accounts which, at times,
may exceed federally insured limits. The Company has not experienced any losses
in such accounts; in addition, the Company believes it is not exposed to any
significant credit risk on cash and cash equivalents. The Company grants credit
terms in the normal course of business to its customers and as part of its
ongoing procedures, the Company monitors the credit worthiness of its
customers. The Company does not believe that it is subject to any unusual
credit risk beyond the normal credit risk attendant in its business.
A single customer accounted for approximately 12.9% of the Predecessor's
net sales in 1996. In 1997, two customers accounted for 12.1% and 11.4% of the
Predecessor's net sales, respectively. In the period from July 1, 1997 through
December 15, 1997, two customers accounted for 24.2% and 11.1% of the
Predecessor's net sales, respectively. In the period from December 16, 1997
through June 30, 1998, one customer accounted for 13.3% of the Company's net
sales.
Concentration of Purchasing
Products accounting for a majority of the Company's net sales utilize
specific grades of paper that are produced exclusively for the Company by one
domestic supplier. The Company does not have a purchase agreement with the
supplier and is not aware of any other suppliers of these specific grades of
paper. These products can be manufactured using other grades of paper; however,
the Company believes these specific grades of paper provide the Company with an
advantage over its competitors. The Company is currently researching methods of
replicating the advantages of these specific grades of paper with other less
costly grades of paper available from multiple suppliers. Until such methods
are developed, a loss of supply of these specific grades of paper and the
resulting competitive advantage could cause a possible loss of sales which
could adversely affect operating results.
Revenue Recognition and Accounts Receivable
Product sales are recognized upon shipment, net of estimated discounts.
Accounts receivable are accounted for net of allowances for doubtful accounts.
F-9
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Inventory
Paper inventory is stated at the lower of cost or market using the
last-in, first-out (LIFO) method; all other inventories are stated at the lower
of cost or market using the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Expenditures that extend
the economic lives or improve the efficiency of equipment are capitalized. The
costs of maintenance and repairs are expensed as incurred. Upon retirement or
disposal, the related cost and accumulated depreciation are removed from the
respective accounts and any gain or loss is recorded.
Depreciation is computed using the straight-line method based on the
estimated useful lives of the assets as indicated in Note 6 for financial
reporting purposes and accelerated methods for tax purposes.
Goodwill
The aggregate purchase price of business acquisitions was allocated to the
assets and liabilities of the acquired companies based on their respective fair
values as of the acquisition dates. Goodwill represents the excess purchase
price paid over the fair value of net identifiable assets acquired and is
amortized over forty years using the straight-line method. Accumulated
amortization was $4,300 and $2,087 at June 30, 1997 and 1998, respectively.
Management periodically reviews the value of its goodwill to determine if
an impairment has occurred. The potential impairment of recorded goodwill is
measured by the undiscounted value of expected future operating cash flows in
relation to its net capital investment. Based on its review, management does
not believe that an impairment of its goodwill has occurred.
Fair Value of Financial Instruments
SFAS No. 107, "Disclosures About Fair Values of Financial Instruments,"
requires the disclosure of the fair value of financial instruments, for assets
and liabilities recognized and not recognized on the balance sheet, for which
it is practicable to estimate fair value. The carrying value of financial
instruments approximates fair value.
Foreign Currency Transactions
Gains and losses on foreign currency transactions with third parties have
been included in the determination of net income in accordance with SFAS No.
52, "Foreign Currency Translation." Foreign currency losses and (gains)
amounted to $(99), $387, $44 and $52 for each of the two years ended June 30,
1997, the period from July 1, 1997 through December 15, 1997 and the period
from December 16, 1997 through June 30, 1998, respectively.
Research and Development Expenses
Research and development expenditures are charged to selling, general and
administrative expenses in the period incurred. Research and development
expenses totaled $1,012, $1,263, $664 and $717 for each of the two years ended
June 30, 1997, the period from July 1, 1997 through December 15, 1997 and the
period from December 16, 1997 through June 30, 1998, respectively.
Debt Issuance Costs
Debt issuance costs are being amortized using the effective interest
method over the terms of the related debt. Such costs are included in the
accompanying consolidated balance sheets, net of accumulated amortization.
F-10
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income Taxes
Income taxes are provided in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." Accordingly,
deferred tax assets and liabilities are recognized at the applicable income tax
rates based upon future tax consequences of temporary differences between the
tax basis and financial reporting basis of assets and liabilities using enacted
tax rates in effect in the years in which the differences are expected to
reverse. The measurement of deferred tax assets is reduced, if necessary, by
the amount of any tax benefits that, based on available evidence, are not
expected to be realized.
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 reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Comprehensive Income
The Company adopted the provision of Statement of Financial Accounting
Standards No. 130 ("SFAS No. 130") on July 1, 1998. This Statement establishes
standards for reporting and displaying comprehensive income and its components
in the financial statements. This Statement also requires that comparative
information for earlier periods be reclassified. As the Company only has two
items of comprehensive income, net income and foreign currency translations,
adoption of this statement did not have a material effect upon the Company's
financial position or results of operations.
3. SIGNIFICANT ACQUISITIONS
DLJMBII and certain members of the Predecessor organized Acquisition Corp.
and Merger Corp. for purposes of acquiring the Predecessor. Merger Corp. was a
wholly-owned subsidiary of Acquisition Corp. and was initially capitalized by
Acquisition Corp. with an equity contribution of $78,363, comprised of $76,000
of cash and $2,363 of non-cash consideration in the form of an option to
purchase Senior Preferred Stock of Acquisition Corp. (see Note 16). Immediately
following this equity contribution, Merger Corp. issued $123,500 of Bridge
Loans to an entity that has a partial ownership interest in Acquisition Corp.
The Bridge Loans had a stated maturity of December 15, 1998 and had an interest
equal to the greater of (i) a rate of 10.0% per annum and (ii) a daily floating
rate of prime plus 2.25% plus an additional percentage amount equal to (a) 1.0%
from and including the interest payment date on June 15, 1998 or (b) 1.5% from
and including the interest payment date on September 15, 1998. Merger Corp.
received cash proceeds from the issuance of the Bridge Loans of $119,735, net
of $3,765 of associated debt issuance costs. On June 25, 1998, the Bridge Loans
were repaid, without penalty, with the proceeds from the Senior Note offering
(see Note 9) and the equity contribution from Holding (see Note 12)
(collectively, the "Refinancing"). Contemporaneous with the repayment of the
Bridge Loans, the Company wrote-off the unamortized balance of debt issuance
costs associated with the Bridge Loans of $1,795 to interest expense.
On December 15, 1997, Merger Corp. acquired all of the equity interests of
the Predecessor (the "Acquisition") for a total cost of $197,730 which
consisted of $138,634 cash paid for equity interests and related expenses,
$2,363 in non-cash consideration in the form of an option to purchase Senior
Preferred Stock of Acquisition Corp. (see Note 16) and the assumption of
$56,733 in debt, preferred stock and
F-11
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
3. SIGNIFICANT ACQUISITIONS (CONTINUED)
related interest and dividends, including capital lease obligations. Merger
Corp. then merged with and into the Predecessor and the combined entity assumed
the name AKI. Subsequent to the Acquisition, Acquisition Corp. contributed $1
of cash all of its ownership interest in AKI to Holding.
The Acquisition was accounted for using the purchase method of accounting.
In accordance with the consensus reached by the Emerging Issues Task Force of
the Financial Accounting Standards Board in Issue 88-16, "Basis in Leveraged
Buyout Transactions," the purchase price allocation required an adjustment for
the continuing interest attributable to management's ownership interest in the
Predecessor carried over in connection with the Acquisition. As a result, a
reduction in stockholders' equity of $15,730 was recorded which represents the
difference between the fair value of the Company's assets and the related book
value attributable to the interest of the continuing shareholders' investment
in the Predecessor. The remaining purchase price has been allocated to assets
and liabilities based upon estimates of their respective fair value as
determined by management and third-party appraisals with respect to property,
plant and equipment.
In connection with the Acquisition, the Company repaid the outstanding
balance and related interest of the Predecessor's loans payable to a
shareholder of $37,374, the outstanding balance and related interest of the
Predecessor's line of credit of $6,278 and the outstanding balance and related
dividends on the Predecessor's preferred stock of $8,806.
The following shows the acquisition costs and the allocation of the
purchase price:
Acquisition costs
Cash paid for stock ..................................................... $ 134,403
Direct acquisition costs ................................................ 4,231
---------
138,634
Non-cash consideration for stock in the form of an option to purchase
Senior Preferred Stock of Acquisition Corp. (see Note 16) .............. 2,363
---------
Total ................................................................... 140,997
Less--Carryover basis adjustment ........................................ (15,730)
---------
Purchase price to be allocated .......................................... $ 125,267
=========
Summary allocation of purchase price
Cash .................................................................... $ 4,481
Other current assets .................................................... 17,782
Property, plant and equipment ........................................... 20,132
Deferred income taxes ................................................... 2,953
Other assets ............................................................ 329
Goodwill ................................................................ 153,929
---------
Total allocation to assets .............................................. $ 199,606
=========
Current liabilities ..................................................... $ 13,190
Long-term debt (including current portion) and related interest ......... 47,927
Deferred income taxes ................................................... 4,416
Preferred stock and related dividends ................................... 8,806
---------
Total liabilities assumed ............................................... $ 74,339
=========
F-12
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
3. SIGNIFICANT ACQUISITIONS (CONTINUED)
On June 22, 1998, the Company acquired (the "3M Acquisition") the
fragrance sampling business of the Industrial and Consumer Products division of
Minnesota Mining and Manufacturing Company ("3M") for approximately $7,250 in
cash and the assumption of liabilities of approximately $182. The only assets
acquired were approximately $143 of equipment. The acquisition was accounted
for using the purchase method of accounting and resulted in goodwill of
approximately $7,289 which is being amortized on a straight line basis over a
period of 40 years.
Unaudited pro forma results for the Company assuming the Acquisition, the
3M Acquisition and the Refinancing had occurred as of the beginning of each
applicable fiscal year are presented below:
UNAUDITED PRO FORMA RESULTS
FOR THE YEAR ENDED
----------------------------
JUNE 30, 1997 JUNE 30, 1998
------------- -------------
Revenue ........................ $87,771 $ 81,831
Income from operations ......... 15,247 13,324
Interest expense ............... 12,961 13,049
Net loss ....................... (121) (1,423)
4. ACCOUNTS RECEIVABLE
The following table details the components of accounts receivable:
JUNE 30, JUNE 30,
1997 1998
-------- --------
Trade accounts receivable .................................... $ 10,362 $ 13,782
Allowance for doubtful accounts .............................. (319) (277)
-------- --------
10,043 13,505
Employee and other related party accounts receivable ......... 121 28
Other accounts receivable .................................... 36 44
-------- --------
$ 10,200 $ 13,577
======== ========
5. INVENTORY
The following table details the components of inventory:
JUNE 30, JUNE 30,
1997 1998
------ ------
Raw materials
Paper ....................... $ 915 $ 556
Other raw materials ......... 956 786
------ ------
Net raw materials ........... 1,871 1,342
Work in process .............. 915 736
------ ------
Net inventory ................ $2,786 $2,078
====== ======
Inventory would have been greater by $45 at June 30, 1997, had it been
stated using the FIFO method. There was an insignificant difference between
inventory stated using the FIFO or LIFO methods at June 30, 1998.
F-13
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
6. PROPERTY, PLANT AND EQUIPMENT
The following table details the components of property, plant and
equipment as well as their estimated useful lives:
ESTIMATED JUNE 30, JUNE 30,
USEFUL LIVES 1997 1998
------------ ---- ----
Land .............................. $ 243 $ 256
Building and improvements ......... 15 - 30 years 2,741 1,201
Machinery and equipment ........... 5 - 7 years 23,250 17,146
Furniture and fixtures ............ 3 - 5 years 2,359 1,634
Construction in progress .......... 424 552
--------- --------
29,017 20,789
Accumulated depreciation .......... (10,861) (1,853)
--------- --------
$ 18,156 $ 18,936
========= ========
Depreciation expense amounted to $3,188, $3,850, $1,888 and $1,853 for
each of the two years ended June 30, 1997, the period from July 1, 1997 through
December 15, 1997 and the period from December 16, 1997 through June 30, 1998,
respectively.
Property held under capital lease was included in the respective property,
plant and equipment account on the balance sheet as follows:
JUNE 30, JUNE 30,
1997 1998
------ ------
Machinery and equipment ............... $3,555 $3,000
Less accumulated depreciation ......... (762) (275)
------ ------
$2,793 $2,725
====== ======
Depreciation of the capital lease totaled $421, $633, $232 and $275 for
each of the two years ended June 30, 1997, the period from July 1, 1997 through
December 15, 1997 and the period from December 16, 1997 through June 30, 1998,
respectively. Future minimum lease payments under the remaining lease are as
follows:
PAYMENT INTEREST
------- --------
1999 ......... $ 774 $165
2000 ......... 774 107
2001 ......... 839 17
------ ----
$2,387 $289
====== ====
7. LINE OF CREDIT
Prior to March 31, 1996, the Predecessor had a line of credit with a
stockholder that provided a revolving loan commitment up to a maximum of
$5,000. Interest on amounts borrowed accrued at a floating rate based upon
prime. The weighted average interest rate on the outstanding balance of this
line of credit was 10.10% for the year ended June 30, 1996. The Predecessor was
required to pay commitment fees on the unused portion of the revolving loan
commitment at a rate of approximately 0.5% per annum. Such fees totaled $16 for
the year ended June 30, 1996.
F-14
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
7. LINE OF CREDIT (CONTINUED)
On April 30, 1996, the Predecessor entered into a line of credit
agreement, which was amended on December 12, 1997, in connection with the
Acquisition (the "Credit Agreement"). The Credit Agreement provides for a
revolving loan commitment up to a maximum of $20,000 and expires on December
31, 2002. Borrowings are limited to a borrowing base consisting of accounts
receivable, inventory and property, plant and equipment which serve as
collateral for the borrowings. Interest on amounts borrowed accrue at a
floating rate based upon either prime or LIBOR (9.50% and 9.25% at June 30,
1997 and 1998, respectively). The Company is required to pay commitment fees on
the unused portion of the revolving loan commitment at a rate of approximately
0.5% per annum. In addition, the Company is required to pay fees equal to 2.5%
of the average daily outstanding amount of lender guarantees. Such fees totaled
$16, $109, $30 and $59 for each of the two years ended June 30, 1997, the
period from July 1, 1997 through December 15, 1997 and the period from December
16, 1997 through June 30, 1998, respectively.
The Credit Agreement contains certain financial covenants and other
restrictions including restrictions on additional indebtedness and restrictions
on the payment of dividends. The Predecessor was not in compliance with all
applicable covenants at June 30, 1997; therefore, all amounts outstanding under
the Credit Agreement were classified as short-term liabilities. The weighted
average interest rate on the outstanding balance under the Credit Agreement was
9.31%, 9.50% and 9.25% for the year ended June 30, 1997, the period from July
1, 1997 through December 15, 1997 and from December 16, 1997 through June 30,
1998, respectively. The Company did not draw on the Credit Agreement during the
year ended June 30, 1996. All amounts outstanding at June 30, 1997 were repaid
in connection with the Acquisition. The Company was also not in compliance with
a covenant at June 30, 1998. The Company has received a waiver for this
covenant violation effective through September 30, 1998. There was no
outstanding balance on the Credit Agreement at June 30, 1998.
8. LOANS PAYABLE TO STOCKHOLDER
Loans payable to stockholder consists of the following:
JUNE 30,
1997
------------
Senior Loan ............................. $ 7,906
Senior Subordinated Loans ............... 30,594
Less unamortized debt discounts ......... (608)
---------
37,892
Less current portion .................... (37,892)
---------
$ --
=========
The Predecessor entered into a Senior Loan Agreement and two Subordinated
Loan Agreements (collectively, the "Loan Agreements") with a party that had
owned the Predecessor's preferred stock and a significant portion of its common
stock. The Loan Agreements were collateralized by substantially all the assets
of the Predecessor. The Loan Agreements limited the Predecessor's ability to
incur additional indebtedness, pay dividends and purchase fixed assets.
Additionally, the Loan Agreements required that certain financial covenants be
maintained. The Predecessor was not in compliance with all such covenants at
June 30, 1997. Therefore, all amounts outstanding under the Loan Agreement at
June 30, 1997 were classified as short-term liabilities. However, this debt was
subsequently retired upon the acquisition of the Predecessor as discussed in
Note 3. All amounts borrowed under the Senior Loan Agreement bore interest at
prime plus 1.50% (10.0% at June 30, 1997).
F-15
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
8. LOANS PAYABLE TO STOCKHOLDER (CONTINUED)
The Predecessor borrowed $30,000 under the Subordinated Loan Agreements,
of which $23,000 was designated as Loan I and $7,000 was designated as Loan II.
Loan I bore interest, payable quarterly, at 12% until November 4, 1998, and
then would have converted to prime plus 4%. Loan II bore interest, payable
quarterly, at 7%. The outstanding amount of the subordinated loans was net of
unamortized debt discounts, which were being amortized over the term of the
related loan.
In connection with Loan II, the Predecessor issued a warrant to purchase
19,233 shares of common stock at $0.05 per share. The warrant was exercisable
until November 4, 2003. The Predecessor valued the warrants at $100 each based
on the fair market value of a share of the underlying common stock resulting
from a sale with a third party. In connection with the warrant issued, the
Predecessor recorded debt discount of $1,923. In connection with the sale of
the Predecessor on December 15, 1997 (see Note 3), all outstanding warrants
were purchased from the holder by the buyer of the Predecessor and retired.
9. SENIOR LOANS
On June 25, 1998, the Company completed a private placement of $115,000 of
Senior Notes (the "Senior Notes"). The Senior Notes are general unsecured
obligations of the Company and bear interest at 10.5% per annum, payable
semi-annually on January 1 and July 1. The Senior Notes mature on July 1, 2008
and may be redeemed at the option of the Company, in whole or in part, at any
time on or after July 1, 2003 at a price equal to 105.25% of the outstanding
principal balance plus accrued and unpaid interest. The placement of the Senior
Notes yielded the Company net proceeds of $110,158 after deducting offering
expenses of $4,842, including $3,450 of underwriting fees paid to an affiliate
of the stockholder. The Senior Notes contain certain customary covenants
including restrictions on the declaration and payment of dividends and
limitations on the incurrence of additional indebtedness.
10. OTHER NOTES PAYABLE
In connection with the acquisition of Scent Seal, the Predecessor issued
$3,627 in noninterest bearing promissory notes (the "Notes") to an employee of
the Predecessor who was previously a Scent Seal stockholder. The Predecessor
recorded a debt discount of $649 in connection with the issuance of the Notes
to reflect an effective interest rate of 10%. The discount was being amortized
over the term of the Notes.
Under certain provisions of the Scent Seal acquisition agreement, the
Company is permitted to reduce the outstanding principal balance of the Notes
based upon the ultimate realization of assets acquired and settlement of
liabilities assumed. In June 1998, the Company reached a settlement with the
holder of the Notes under these provisions which resulted in the reduction of
the outstanding principal balance of the Notes of $120. The remaining principal
balance of the Notes of $1,330 was repaid in July 1998 in accordance with the
terms of the Notes.
11. REDEEMABLE PREFERRED STOCK
In connection with the 1993 acquisition of Arcade, the Predecessor
authorized and issued 8,000 shares of 7% cumulative, $1 par value preferred
stock at $1,000 per share. The preferred stock prohibited the Predecessor from
acquiring its common stock as long as the preferred stock was outstanding and
restricted the payment of common stock dividends. Accrued and unpaid dividends
of $678 accrued through December 31, 1994, were added to the outstanding
balance. The preferred stock would have been redeemable on December 31, 2001,
at liquidation value of $1,000 per share plus accrued and unpaid dividends. In
conjunction with the sale of Predecessor on December 15, 1997 (see Note 3), all
outstanding preferred stock was redeemed at $1,000 per share plus accrued and
unpaid dividends.
F-16
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
12. INITIAL CAPITALIZATION
In conjunction with the Acquisition, Acquisition Corp. issued $30,000 of
Floating Rate Notes, $50,278 of Senior Preferred Stock and $1,111 of its Common
Stock. The Floating Rate Notes were issued with an original issuance discount
of $5,389, bear interest at 15% per annum and mature on December 15, 2009. The
Senior Preferred Stock accrues dividends at 15% per annum and must be redeemed
by December 15, 2012. Interest on the Floating Rate Notes and dividends on
Senior Preferred Stock can be settled through the issuance of additional
Floating Rate Notes and Senior Preferred Stock, respectively, through maturity.
The Floating Rate Notes and Senior Preferred Stock are general, unsecured
obligations of Acquisition Corp.
The cash proceeds from the issuance of the Floating Rate Notes, Senior
Preferred Stock and Common Stock of $76,000 and a Senior Preferred Stock option
of $2,363 (see Note 16) were contributed by Acquisition Corp. to the Company in
exchange for 1,000 shares of the Company's Common Stock. Subsequent to the
initial capitalization of the Company, Acquisition Corp. contributed $1 of cash
all of its ownership interest in the Company to Holding.
On June 25, 1998, Holding completed a private offering of $50,000 Senior
Discount Debentures (the "Debentures"). The Debentures do not accrue or pay
interest until July 1, 2003 and were issued with an original issuance discount
of $24,038. The original issue discount is being accreted from issuance through
July 1, 2003 at an effective rate of 13.5% per annum. After July 1, 2003, the
Debentures will accrue interest at a rate of 13.5% per annum, payable
semi-annually, commencing January 1, 2004. The Debentures are general,
unsecured obligations of Holding. With the proceeds of the Debenture offering,
Holding contributed $22,499 of cash to the Company. No additional shares were
issued to Holding as a result of this contribution.
Acquisition Corp. and Holding have no other operations other than the
Company. Absent additional financing by Acquisition Corp. or Holding, the
Company's operations represent the only current source of funds available to
service the Floating Rate Notes, Senior Preferred Stock and Debentures.
13. COMMITMENTS AND CONTINGENCIES
Operating Leases
Equipment and office, warehouse and production space under operating
leases expire at various dates. Rent expense was $355, $443, $192 and $198 for
each of the two years ended June 30, 1997, the period from July 1, 1997 through
December 15, 1997 and the period from December 16, 1997 through June 30, 1998,
respectively. Future minimum lease payments under these leases are as follows:
1999 ............ $ 243
2000 ............ 162
2001 ............ 138
-----
$ 543
=====
Licensing Agreements
Licensing agreements are maintained for certain technologies used in the
manufacture of certain products. Under the terms of one licensing agreement,
royalty payments are required based on a percentage of net sales of those
products manufactured with the specific technology, or a minimum of $500 per
year. This agreement expires in 2003 or when a total of $12,500 in cumulative
royalty payments has been paid. The Company expensed $893, $761, $437 and $516
under this licensing agreement for each of
F-17
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
the two years ended June 30, 1997, the period from July 1, 1997 through
December 15, 1997 and from December 16, 1997 through June 30, 1998,
respectively, and has paid $3,123 and $4,076 in cumulative royalty payments
under this licensing agreement through June 30, 1997 and June 30, 1998,
respectively.
Under the terms of another licensing agreement, royalty payments are
required based on the number of products sold that were manufactured with the
specific licensed technology, or a minimum payment per year. These minimum
payments are $575 for fiscal 1999 and $625 thereafter through the expiration of
the agreement in 2012. The Company expensed $388, $4,475, $241 and $284 under
this licensing agreement for each of the two years ended June 30, 1997, the
period from July 1, 1997 through December 15, 1997 and the period from December
16, 1997 through June 30, 1998, respectively.
Employment Agreements
The Company has employment agreements with certain executive officers
through June 30, 2001. Such agreements provide for base salaries totaling $770
per year and incentive bonuses of up to 100% of base salaries which are payable
if certain management goals are attained. The employment agreements also
provide severance benefits of up to one year's base salary if the executives'
services are terminated under certain conditions.
Litigation
The Company is a party to litigation arising in the ordinary course of
business which, in the opinion of management, will not have a material adverse
effect on the Company's financial condition, results of operations or cash
flows.
Year 2000/European Monetary Unit
The Company is in the process of implementing a strategy to be fully
compliant with Year 2000 issues related to its computer systems. Management
does not believe that the costs related to completing this process will be
material to the results of operations of the Company. The Company has not
implemented a similar strategy to address European monetary unit issues related
to its computer systems. Management does not expect that the costs related to
such a strategy will require material expenditures on the part of the Company.
14. RETIREMENT PLANS
A 401(k) defined contribution plan (the "Plan") is maintained for
substantially all full-time salaried employees. Applicable employees who have
six months of service and have attained age 21 are eligible to participate in
the Plan. Employees may elect to contribute a percentage of their earnings to
the Plan in accordance with limits prescribed by law. Contributions to the Plan
are determined annually by the Company and generally are a matching percentage
of employee contributions. Costs associated with the Plan totaled $154, $180,
$95 and $113 for each of the two years ended June 30, 1997, the period from
July 1, 1997 through December 15, 1997 and the period from December 16, 1997
through June 30, 1998, respectively.
Certain hourly employees are covered under a multiemployer defined benefit
plan administered under a collective bargaining agreement. Costs (determined by
union contract) under the defined benefit plan were $127, $143, $80 and $81 for
each of the two years ended June 30, 1997, the period from July 1, 1997 through
December 15, 1997 and from December 16, 1997 through June 30, 1998,
respectively.
F-18
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
15. INCOME TAXES
The Company was included in the consolidated federal income tax return
filed by Acquisition Corp. for the period from December 16, 1997 through June
30, 1998. Income taxes related to the Company for this period were determined
on a separate entity basis. The Company files separate state income tax returns
and calculates its state tax provision on a separate company basis. Any income
taxes payable or receivable by the consolidated group are settled or received
by the Company. The Predecessor was not part of a consolidated group.
For financial reporting purposes, income (loss) before income taxes
includes the following components:
JULY 1, 1997 DECEMBER 16, 1997
JUNE 30, THROUGH THROUGH
--------------------- DECEMBER 15, JUNE 30,
1996 1997 1997 1998
--------- --------- -------------- ------------------
Income (loss) before income taxes:
United States ................... $4,100 $7,609 $3,298 $ (8,169)
Foreign ......................... 179 (492) (64) 682
------ ------ ------ --------
$4,279 $7,117 $3,234 $ (7,487)
====== ====== ====== ========
Significant components of the provision (benefit) for income taxes are as
follows:
JULY 1, 1997 DECEMBER 16, 1997
JUNE 30, THROUGH THROUGH
----------------------- DECEMBER 15, JUNE 30,
1996 1997 1997 1998
--------- ----------- -------------- ------------------
Current expense (benefit):
Federal .................. $2,158 $ 2,880 $1,623 $ --
Foreign .................. 67 -- -- 104
State .................... 359 552 278 (121)
------ ------- ------ -------
2,584 3,432 1,901 (17)
------ ------- ------ -------
Deferred expense (benefit):
Federal .................. (431) (90) (376) (1,900)
Foreign .................. 13 (165) (25) 162
State .................... (65) (42) (59) (278)
------ ------- ------ ---------
(483) (297) (460) (2,016)
------ ------- ------ ---------
$2,101 $ 3,135 $1,441 $ (2,033)
====== ======= ====== ===========
F-19
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
15. INCOME TAXES (CONTINUED)
The significant components of deferred tax assets and deferred tax
liabilities at June 30, 1997 and 1998, were as follows:
JUNE 30, 1997 JUNE 30, 1998
------------------------ -----------------------
CURRENT NONCURRENT CURRENT NONCURRENT
--------- ------------ --------- -----------
Deferred income tax assets:
Accrued expenses ......................... $300 $ -- $719 $ --
Allowance for doubtful accounts .......... 124 -- 108 --
Net operating loss carryforwards ......... -- -- -- 2,947
Preferred stock option ................... -- -- -- 922
---- ---------- ---- --------
424 -- 827 3,869
Deferred income tax liability:
Property, plant and equipment ............ -- 2,949 -- 4,143
---- ---------- ---- --------
$424 $ (2,949) $827 $ (274)
==== ========== ==== =========
The income tax provision recognized by the Predecessor for the years ended
June 30, 1996 and 1997 and the period from July 1, 1997 through December 15,
1997 and by the Company for the period from December 16, 1997 through June 30,
1998 , differs from the amount determined by applying the applicable U.S.
statutory federal income tax rate to pretax income as a result of the
following:
JULY 1, 1997 DECEMBER 16, 1997
JUNE 30, THROUGH THROUGH
--------------------- DECEMBER 15, JUNE 30,
1996 1997 1997 1998
--------- --------- -------------- ------------------
Computed tax provision (benefit) at
statutory rates ...................... $1,455 $2,420 $1,100 $ (2,546)
State income tax provision, net of
Federal effect ....................... 194 335 145 (263)
Nondeductible expenses, primarily
the amortization of goodwill ......... 427 455 193 720
Other, net ............................ 25 (75) 3 56
------ ------ ------ --------
$2,101 $3,135 $1,441 $ (2,033)
====== ====== ====== ========
In conjunction with the Acquisition, the Company recognized an income tax
benefit of $7,327 related to the excess of the redemption price over the strike
price of certain non-qualified options of the Predecessor redeemed and retired
by the Company. This benefit was recorded as a reduction to goodwill.
Due to the Company's current year losses and certain transactions made in
conjunction with the Acquisition, the Company has recorded a deferred tax asset
of $2,947 reflecting cumulative net operating loss carryforwards available to
offset future federal taxable income of $6,500 and future state taxable income
of $14,500. These cumulative net operating loss carryforwards expire in varying
amounts through 2013. Realization is dependent on generating sufficient taxable
income prior to expiration of the loss carryforwards. Although realization is
not assured, management believes that it is more likely than not that all of
the deferred tax asset will be realized. The amount of the deferred tax asset
considered realizable, however, could be reduced in the near term if estimates
of future taxable income during the carryforward period are reduced.
F-20
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
16. STOCK OPTIONS
The Predecessor sponsored a key employee stock option plan under which a
maximum of 12,571 shares of the Predecessor's common stock could be reserved
for nonqualified options; all stock options were granted with an exercise price
equal to the fair market value of $100 per share. All options vest ratably over
five years and would have expired ten years from the grant date.
The Predecessor accounted for its employee stock options under Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB
25"). Under APB 25, because the exercise price of the Predecessor's employee
stock options equaled the market value of the underlying stock on the date of
grant, no compensation expense was recognized.
A summary of the Predecessor's stock option activity and related
information follows:
JUNE 30, 1996 JUNE 30, 1997
----------------------- ----------------------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
--------- ----------- --------- ----------
Outstanding, beginning of year ...................... 12,571 $100 12,571 $100
Granted ............................................ -- -- -- --
Exercised .......................................... -- -- -- --
Forfeited .......................................... -- -- -- --
------ ---- ------ ----
Outstanding, end of year ............................ 12,571 $100 12,571 $100
====== ==== ====== ====
Exercisable, at end of year ......................... 3,352 $100 5,866 $100
====== ==== ====== ====
Weighted average remaining contractual life ......... 8.3 years 7.3 years
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("SFAS 123"), requires disclosure of pro forma
information regarding net income for option grants subsequent to December 15,
1995. Because all of the Predecessor's options were granted prior to that date,
no pro forma adjustments to net income or disclosure of information would apply
under SFAS 123.
As a result of the sale of the Predecessor on December 15, 1997 (see Note
3), all outstanding options became immediately vested and exercisable under the
individual stock option agreements. In connection with the Acquisition, the
Company purchased and retired 11,201 of the outstanding options of the
Predecessor. The remaining 1,370 options, held by an officer of the Company,
were exchanged at their fair value for an option to purchase 100,000 shares of
Acquisition Corp.'s Senior Preferred Stock (the "Preferred Stock Option") with
a stated value of $2,500. The Preferred Stock Option has an exercise price of
$137, which represents the cumulative exercise price of the 1,370 options
surrendered in exchange for the Preferred Stock Option. The Preferred Stock
Option was issued with a Put and Call Option (the "Put and Call Option") which
granted the officer the right to compel DLJMBII to purchase the 100,000 shares
of Senior Preferred Stock obtainable under the Preferred Stock Option, together
with certain common equity interests in Acquisition Corp. held by the officer,
for $2,590. The Put and Call Option also granted DLJMBII the right to purchase
the equity interests, both common and preferred, of the officer for the same
amount. The Put and Call Option had a stated termination of June 30, 1998. The
officer agreed to terminate the Put and Call Option and enter into a new put
option (the "Put Option") dated June 17, 1998. The Put Option granted the
officer an irrevocable option to require Acquisition Corp. to purchase 80,000
shares of the Senior Preferred Stock obtainable under the Preferred Stock
Option for $2,000 in
F-21
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
16. STOCK OPTIONS (CONTINUED)
cash. As the terms of the Put Option were generally more restrictive than the
Put and Call Option, no compensation expense was recognized as a result of the
transaction. On July 30, 1998, the officer exercised the Preferred Stock Option
and Put Option. To provide Acquisition Corp. the funds to redeem the 80,000
shares of Senior Preferred Stock, Holding issued Acquisition Corp. a dividend
of $1,863 in cash on such date.
Subsequent to the Acquisition, Acquisition Corp. adopted the 1998 Stock
Option Plan ("Option Plan") for certain key employees and directors of
Acquisition Corp. and any parent or subsidiary of Acquisition Corp. The Option
Plan authorizes the issuance of options to acquire up to 80,000 shares of
Acquisition Corp. Common Stock. The terms of each individual options grant are
determined by the Board of Directors. The exercise price for each grant is
required to be set at least equal to the fair market value per share of
Acquisition Corp. provided that the exercise price shall not be less than $1.00
per share. Options may be exercisable for up to ten years.
On June 17, 1998, Acquisition Corp. granted an officer of the Company
options to purchase 32,500 shares of Acquisition Corp. Common Stock. All
options have an exercise price of $1.00 per share and a term of 10 years. Under
the terms of the option agreement, 16,250 of the options granted to the officer
are subject to time vesting. One-third of these options become exercisable on
June 30, 1999 and are thereafter exercisable as to an additional one-third of
such options on June 30, 2000 and June 30, 2001. The remaining 16,250 of
options become exercisable at various percentages on June 30, 1999 and on June
30, 2000 and on June 30, 2001, based on the achievement of certain financial
performance targets for the years then ended.
The Company has elected to account for its stock based compensation with
employees under the intrinsic value method as permitted under FAS 123. Under
the intrinsic value method, because the stock price of the Company's employee
stock options equaled the fair value of the underlying stock on the date of
grant, no compensation expense was recognized. If the Company had elected to
recognize compensation expense based on the fair value of the options at grant
date as prescribed by FAS 123, the net loss for the period from December 16,
1997 through June 30, 1998 would have been $(5,455). In making this
determination, fair value was estimated on the date of grant using the minimum
value method and a risk-free interest rate of 5.4%. The weighted average fair
value at date of grant of options granted during 1998 was approximately $0.41
per option.
17. RELATED PARTY TRANSACTIONS
The Predecessor made payments to a company controlled by a stockholder of
the Predecessor of $692 and $612 for the years ended June 30, 1996 and 1997 and
$160 for the period from July 1, 1997 through December 15, 1997, for management
fees, bonuses and expense reimbursements.
The Predecessor made payments to another stockholder of $120 for each of
the years ended June 30, 1996 and 1997 and $55 for the period from July 1, 1997
through December 15, 1997, for management fees.
The Successor made payments to an affiliate of DLJMBII of $125 for the
period from December 16, 1997 through June 30, 1998, for financial advisory
fees. In addition, the Successor had approximately $200 of cash on deposit with
a financial institution affiliated with DLJMBII.
F-22
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
18. GEOGRAPHIC INFORMATION
The following table illustrates geographic information for revenues and
long-lived assets. Revenues are attributed to countries based on origin of
shipment, and long-lived assets are based upon the country of domicile.
UNITED STATES FRANCE TOTAL
------------- ------ -----
PREDECESSOR
NET SALES:
Year ended June 30, 1996 .................................... $ 64,708 $ 8,778 $ 73,486
Year ended June 30, 1997 .................................... 70,660 7,063 77,723
Period from July 1, 1997 through
December 15, 1997 .......................................... 32,600 2,586 35,186
LONG-LIVED ASSETS:
June 30, 1997 ............................................... 63,004 204 63,208
- ---------------------------------------------------------------------------------------------------------------
SUCCESSOR
NET SALES:
Period from December 16, 1997 through June 30, 1998 ......... $ 29,162 $ 6,904 $ 36,066
LONG-LIVED ASSETS:
June 30, 1998 ............................................... 187,250 158 187,408
F-23
AKI, INC. AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF AKI HOLDING CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except share information)
19. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following is a summary of the unaudited quarterly results of
operations for Fiscal 1997 and Fiscal 1998.
PREDECESSOR
-------------------------------------------------------------------------------
QUARTER ENDED QUARTER ENDED QUARTER ENDED QUARTER ENDED FULL
SEPTEMBER 30, 1996 DECEMBER 31, 1996 MARCH 31, 1997 JUNE 30, 1997 YEAR
-------------------- ------------------- ---------------- --------------- -------
FISCAL 1997
Net sales ................ 22,315 20,306 19,746 15,356 77,723
Gross profit ............. 8,367 7,287 7,184 5,418 28,256
Income from
operations .............. 4,875 3,307 3,275 2,232 13,689
Interest expense ......... 1,619 1,593 1,481 1,510 6,203
Net income ............... 1,844 1,006 973 159 3,982
PREDECESSOR SUCCESSOR
---------------------------------------- ----------------------------------------------------
OCTOBER 1, 1997 DECEMBER 16, 1997
QUARTER ENDED THROUGH THROUGH QUARTER ENDED QUARTER ENDED FULL
SEPTEMBER 30, 1997 DECEMBER 15, 1997 DECEMBER 31, 1997 MARCH 31, 1998 JUNE 30, 1998 YEAR
-------------------- ------------------- ------------------- ---------------- --------------- -----------
FISCAL 1998
Net sales ............ 21,928 13,258 2,791 19,191 14,084 71,252
Gross profit ......... 8,306 4,071 813 7,256 3,479 23,925
Income from
operations .......... 4,680 1,426 153 3,603 104 9,966
Interest expense ..... 1,451 1,195 759 4,404 6,106 13,915
Net income (loss) 1,796 (3) (443) (887) (4,124) (3,661)
F-24
===============================================================================
NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS EXCHANGE
OFFER OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES, NOR DOES IT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION
OF AN OFFER TO BUY SUCH SECURITIES IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS
NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY
IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE
THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY
TIME SUBSEQUENT TO ITS DATE.
--------------------------
TABLE OF CONTENTS
PAGE
----
Available Information ......................... iii
Prospectus Summary ............................ 1
Risk Factors .................................. 13
Use of Proceeds ............................... 18
The Exchange Offer ............................ 19
Capitalization ................................ 26
Selected Historical Consolidated Financial
Data ....................................... 27
Management's Discussion and Analysis of
Financial Condition and Results of
Operations ................................. 28
Business ...................................... 37
The Transactions .............................. 47
Management .................................... 48
Security Ownership of Certain Beneficial
Owners and Management ...................... 52
Certain Relationships and Related
Transactions ............................... 53
Description of Certain Indebtedness ........... 55
Description of New Notes ...................... 57
U.S. Federal Income Tax Consequences .......... 82
Plan of Distribution .......................... 83
Notice to Holders ............................. 84
Legal Matters ................................. 85
Experts ....................................... 85
Index to Unaudited Pro Forma
Condensed Consolidated Statements of
Operations ................................. P-1
Index to Consolidated Financial
Statements ................................. F-1
===============================================================================
===============================================================================
OFFER TO EXCHANGE
NEW 10 1/2% SENIOR NOTES DUE 2008 FOR UP TO $115,000,000
IN PRINCIPAL
AMOUNT OUTSTANDING
10 1/2% SENIOR NOTES DUE 2008
AKI, INC.
----------------
PROSPECTUS
----------------
, 1998
===============================================================================
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF ANY OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO ANY REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY STATE.
[ALTERNATE COVER FOR MARKET-MAKING PROSPECTUS]
PROSPECTUS
AKI, INC.
NEW 10 1/2% SENIOR NOTES DUE 2008
----------------
The New 10 1/2% Senior Notes due 2008 (the "New Notes") were issued in
exchange for the 10 1/2% Senior Notes due 2008 (the "Old Notes") by AKI, Inc.,
a Delaware corporation (the "Company"). The New Notes are obligations of the
Company. Prior to the Exchange Offer there was no public trading market for the
Old Notes or the New Notes.
The New Notes will mature on July 1, 2008. The New Notes bear interest
from June 25, 1997, the date of issuance of the Old Notes tendered in exchange
for the New Notes. Interest on the New Notes will be payable semi-annually on
January 1 and July 1 of each year, commencing on January 1, 1999, at a rate of
10 1/2% per annum. The New Notes are redeemable at the option of the Company,
in whole or in part, at anytime on or after July 1, 2003, in cash at the
redemption prices set forth herein, plus accrued and unpaid interest and
Liquidated Damages (as defined herein), if any, thereon to the date of
redemption. In addition, at any time prior to July 1, 2001, the Company may on
any one or more occasions redeem up to 35% of the aggregate principal amount of
New Notes originally issued at a redemption price equal to 110.5% of the
principal amount thereof, plus accrued and unpaid interest and Liquidated
Damages, if any, thereon to the redemption date, with the net cash proceeds of
one or more Public Equity Offerings (as defined herein); provided that at least
65% of the aggregate principal amount of New Notes originally issued remains
outstanding immediately after the occurrence of any such redemption. See
"Description of New Notes--Optional Redemption." In addition, upon the
occurrence of a Change of Control (as defined herein), each holder of Notes
will have the right to require the Company to repurchase all or any part of
such holder's Notes at an offer price in cash equal to 101% of the aggregate
principal amount thereof, plus accrued and unpaid interest and Liquidated
Damages, if any, thereon to the date of repurchase. See "Description of New
Notes--Repurchase at the Option of Holders--Change of Control." There can be no
assurance that, in the event of a Change of Control, the Company would have
sufficient funds to purchase all Notes tendered. See "Risk Factors--Limitations
on Ability to Make Change of Control Payment."
The New Notes are general unsecured obligations of the Company, and rank
pari passu in right of payment to all existing and future senior unsecured
indebtedness of the Company and rank senior in right of payment to all existing
and future subordinated indebtedness of the Company. As of September 30, 1998,
the Company had $16.7 million in other unsecured obligations (including trade
payables, accrued liabilities and deferred taxes), all of which ranks pari
passu in right of payment with the Notes. The New Notes, however, are
effectively subordinated to all secured obligations of the Company, including
borrowings under the Credit Agreement (as defined herein), to the extent of the
assets securing such obligations. As of September 30, 1998, the Company had no
outstanding secured obligations, other than outstanding letters of credit in
the amount of $0.6 million under the Credit Agreement and $1.9 million
outstanding under a capitalized lease. In addition, as of such date, borrowings
of up to approximately $19.4 million were available under the Credit Agreement,
subject to certain conditions.
(Continued on next page)
----------------
SEE "RISK FACTORS" BEGINNING ON PAGE 13 OF THIS PROSPECTUS FOR A
DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION WITH AN
INVESTMENT IN THE NEW NOTES.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THE PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
This Prospectus is to be used by Donaldson, Lufkin & Jenrette Securities
Corporation ("DLJ") in connection with the offers and sales in market-making
transactions at negotiated prices related to prevailing market prices at the
time of sale. The Company does not intend to list the New Notes on a national
securities exchange or to apply for quotation of the New Notes through the
National Association of Securities Dealers Automated Quotation System. DLJ has
advised the Company that it intends to make a market in the New Notes. However
DLJ is not obligated to do so and any market-making activities with respect to
the New Notes may be discontinued at any time without notice. The Company will
receive no portion of the proceeds of the sale of the New Notes and will bear
expenses incident to the registration thereof.
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
The date of this Prospectus is , 1998
A-1
[ALTERNATE SECTION FOR MARKET-MAKING PROSPECTUS]
NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS. IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR DLJ. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY OF THE
NEW NOTES IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO
MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR
IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
The New Notes are general unsecured obligations of the Company, and rank
pari passu in right of payment to all existing and future senior unsecured
indebtedness of the Company and rank senior in right of payment to all existing
and future subordinated indebtedness of the Company. The New Notes, however,
are effectively subordinated to all secured obligations of the Company,
including borrowings under the Credit Agreement (as defined herein), to the
extent of the assets securing such obligations. As of June 30, 1998, the
Company had no outstanding secured obligations (other than outstanding letters
of credit in the amount of $0.6 million) under the Credit Agreement. In
addition, as of such date borrowings of up to approximately $19.4 million were
available under the Credit Agreement, subject to certain conditions.
A-2
[ALTERNATE SECTION FOR MARKET-MAKING PROSPECTUS]
----------------
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 (the "Exchange Offer Registration Statement") under the Securities Act with
respect to the New Notes being offered by this Prospectus. This Prospectus does
not contain all of the information set forth in the Exchange Offer Registration
Statement and the exhibits and schedules thereto, certain portions of which
have been omitted pursuant to the rules and regulations of the Commission.
Statements made in this Prospectus as to the contents of any contract,
agreement or other document are not necessarily complete. With respect to each
such contract, agreement or other document filed or incorporated by reference
as an exhibit to the Exchange Offer Registration Statement, reference is made
to such exhibit for a more complete description of the matter involved, and
each such statement is qualified in its entirety by such reference.
Upon the effectiveness of the Exchange Offer Registration Statement, the
Company became subject to the information requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith will file reports and other information with the Commission. The
Exchange Offer Registration Statement and the exhibits and schedules thereto as
well as any reports and other information filed by the Company may be inspected
and copied at the public reference facilities maintained by the Commission at
Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and
will also be available for inspection and copying at the regional offices of
the Commission located at 7 World Trade Center, New York, New York 10048 and at
500 West Madison Street (Suite 1400), Chicago, Illinois 60661. Copies of such
material may also be obtained from the Public Reference Section of the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed
rates. The Commission maintains a web site (http://www.sec.gov) that contains
reports, proxy statements and other information regarding registrants that file
electronically with the Commission. Under the terms of the Indenture pursuant
to which the New Notes were issued, the Company has agreed that, whether or not
it is required to do so by the rules and regulations of the Commission, for so
long as any of the Notes remain outstanding, it will furnish to the Trustee and
Holders of the Notes and file with the Commission (unless the Commission will
not accept such a filing) (i) all quarterly and annual financial information
that would be required to be contained in such a filing with the Commission on
Forms 10-Q and 10-K if the Company was required to file such forms, including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and, with respect to the annual information only, a report thereon
by the Company's certified independent public accountants and (ii) all reports
that would be required to be filed with the Commission on Form 8-K if the
Company was required to file such reports. The Company has agreed to make such
information available to the Trustee, securities analysts and prospective
investors upon request. In addition, for so long as any of the Notes remain
outstanding, the Company has agreed to make available to any prospective
purchaser of the Notes or Holder of the Notes in connection with any sale
thereof, the information required by Rule 144A(d)(4) under the Securities Act.
A-3
[ALTERNATE SECTION FOR MARKET-MAKING PROSPECTUS]
TRADING MARKET FOR THE NEW NOTES
There is no existing trading market for the New Notes, and there can be no
assurance regarding the future development of a market for the New Notes or the
ability of the Holders of the New Notes to sell their New Notes or the price at
which such Holders may be able to sell their New Notes. If such market were to
develop, the New Notes could trade at prices that may be higher or lower than
their initial offering price depending on many factors, including prevailing
interest rates, the Company's operating results and the market for similar
securities. Although it is not obligated to do so, DLJ intends to make a market
in the New Notes. Any such market-making activity may be discontinued at any
time, for any reason, without notice at the sole discretion of DLJ. No
assurance can be given as to the liquidity of or the trading market for the New
Notes.
DLJ is an affiliate of the Company and, as such, is required to deliver a
prospectus in connection with its market-making activities in the New Notes.
Pursuant to the Registration Rights Agreement, the Company agreed to use its
respective best efforts to file and maintain a registration statement that
would allow DLJ to engage in market-making transactions in the New Notes. The
Company has agreed to bear substantially all the costs and expenses related to
such registration statement.
A-4
[ATLERNATE SECTION FOR MARKET-MAKING PROSPECTUS]
USE OF PROCEEDS
This Prospectus is delivered in connection with the sale of the New Notes
by DLJ in market-making transactions. The Company will not receive any of the
proceeds from such transactions.
A-5
[ALTERNATE SECTION FOR MARKET-MAKING PROSPECTUS]
PLAN OF DISTRIBUTION
This Prospectus is to be used by DLJ (the "Initial Purchaser") in
connection with offers and sales of the New Notes in market-making transactions
effected from time to time. The Initial Purchaser may act as a principal or
agent in such transactions, including as agent for the counterparty when acting
as principal or as agent for both counterparties, and may receive compensation
in the form of discounts and commissions, including from both counterparties
when it acts as agent for both. Such sales will be made at prevailing market
prices at the time of sale, at prices related thereto or at negotiated prices.
DLJ has informed the Company that it does not intend to confirm sales of the
New Notes to any accounts over which it exercises discretionary authority
without the prior specific written approval of such transactions by the
customer.
DLJMBII, an affiliate of DLJ, and certain of its affiliates beneficially
own approximately 81.3% of the outstanding Acquisition Corp. Common Stock.
Messrs. Dean, Michael and Wittels, who are directors of the Company and
officers and directors of Holding and Acquisition Corp., are officers of DLJ
Merchant Banking. The Initial Purchaser is also an affiliate of DLJ Merchant
Banking and DLJMBII and has acted as financial advisor to the Company in
connection with the structuring of the Acquisition. For these financial
advisory services, the Initial Purchaser received a customary fee and was
reimbursed for its out-of-pocket expenses. In addition, pursuant to an
agreement between the Initial Purchaser and Acquisition Corp., the Initial
Purchaser will receive a customary annual fee for acting as the exclusive
financial and investment banking advisor to the Company ending December 31,
2002. DLJ acted as a purchaser in connection with the initial sale of the Old
Notes and received an underwriting discount of $3.45 million in connection
therewith. See "Certain Relationships and Related Party Transactions."
The Company has been advised by the Initial Purchaser that, subject to
applicable laws and regulations, the Initial Purchaser currently intends to
make a market in the New Notes following completion of the Exchange Offer.
However, the Initial Purchaser is not obligated to do so and any such
market-making may be interrupted or discontinued at any time without notice. In
addition, such market-making activity will be subject to the limits imposed by
the Securities Act and the Exchange Act. There can be no assurance that an
active trading market will develop or be sustained. See "Risk Factors --Trading
Market for the New Notes."
The Initial Purchaser and the Company have entered into the Registration
Rights Agreement with respect to the use by the Initial Purchaser of this
Prospectus. Pursuant to such agreement, the Company agreed to bear all
registration expenses incurred under such agreement, and the Company agreed to
indemnify the Initial Purchaser in connection with its acting as Initial
Purchaser and as financial advisor.
A-6
[ALTERNATE SECTION FOR MARKET-MAKING PROSPECTUS]
U.S. FEDERAL TAX CONSIDERATIONS FOR NON-U.S. HOLDERS
Subject to the qualifications set forth below, the opinion of Akin, Gump,
Strauss, Hauer & Feld, L.L.P., tax counsel to the Company, with respect to the
anticipated material U.S. federal income tax consequences of the acquisition,
ownership and disposition of Notes by an initial beneficial owner of Notes
that, for U.S. federal income tax purposes, is not a "U.S. person" (a "Non-U.S.
Holder") is as follows. This discussion is based upon the U.S. federal tax law
now in effect, which is subject to change, possibly retroactively. For purposes
of this discussion, a "U.S. person" means a citizen or resident of the U.S., a
corporation created or organized in the U.S. or under the laws of the U.S., or
of any political subdivision thereof, an estate whose income is includable in
gross income for U.S. federal income tax purposes regardless of its source or a
trust, if a U.S. court is able to exercise primary supervision over the
administration of the trust and one or more U.S. persons have the authority to
control all substantial decisions of the trust. For purposes of the withholding
tax on interest, a non-resident alien or other non-resident fiduciary of an
estate or trust will be considered to be a Non-U.S. Holder. The tax treatment
of the holders of the Notes may vary depending upon their particular
situations. U.S. persons acquiring the Notes are subject to different rules
than those discussed below. This discussion does not address the U.S. federal
income tax consequences to investors in pass-through entities that hold a Note.
HOLDERS ARE URGED TO CONSULT THEIR TAX ADVISORS REGARDING THE U.S. FEDERAL TAX
CONSEQUENCES OF ACQUIRING, HOLDING AND DISPOSING OF NOTES, AS WELL AS ANY TAX
CONSEQUENCES THAT MAY ARISE UNDER THE LAWS OF ANY FOREIGN, STATE, LOCAL OR
OTHER TAXING JURISDICTION.
For purposes of the discussion below, interest and gain on the sale,
exchange or other disposition of Notes will be considered to be "U.S. trade or
business income" if such income or gain is (i) effectively connected with the
conduct of a U.S. trade or business or (ii) in the case of a treaty resident,
attributable to a permanent establishment (or, in the case of an individual, a
fixed base) in the U.S.
INTEREST
Interest paid by the Company to a Non-U.S. Holder will not be subject to
U.S. federal income or withholding tax if such interest is not U.S. trade or
business income and is "portfolio interest." Interest will be portfolio
interest if (i) the Non-U.S. Holder does not actually or constructively own 10%
or more of the total combined voting power of all classes of stock of the
Company and is not a controlled foreign corporation with respect to which the
Company is a "related person" within the meaning of the U.S. Internal Revenue
Code of 1986, as amended (the "Code"), and (ii) the beneficial owner (a)
certifies, under penalties of perjury, that such holder is not a U.S. person
and provides such holder's name and address and (b) is not a bank receiving
interest on an extension of credit made pursuant to a loan agreement made in
the ordinary course of its trade or business.
The gross amount of payments of interest that do not qualify for the
portfolio interest exception and that are not U.S. trade or business income
will be subject to U.S. withholding tax at a rate of 30% unless a treaty
applies to reduce or eliminate withholding. U.S. trade or business income will
be taxes at regular graduated U.S. rates rather than the 30% gross rate. In the
case of a Non-U.S. Holder that is a corporation, such U.S. trade or business
income may also be subject to the branch profits tax (which is generally
imposed on a foreign corporation on the actual or deemed repatriation from the
United States of earnings and profits attributable to U.S. trade or business
income) at a rate of 30%. The branch profits tax may not apply (or may apply at
a reduced rate) if the recipient is a qualified resident of certain countries
with which the United States has an income tax treaty. To claim exemption from
withholding or to claim the benefits of a treaty, a Non-U.S. Holder must
provide properly executed Form 1001 or 4224 (or such successor form as the
Internal Revenue Service (the "IRS") designates), as applicable prior to the
payment of interest. These forms must be periodically updated. Under new final
regulations effective, subject to certain transition rules, for payments after
December 31, 1999, the Forms 1001 and 4224 will be replaced by a Form W-8. Also
under these regulations, a Non-U.S. Holder who is claiming the benefits of a
treaty may be required in certain instances to obtain a U.S. taxpayer
identification number and to
A-7
provide certain documentary evidence issued by the appropriate foreign
governmental authority to prove residence in the foreign country. Certain
special procedures are provided in the final regulations for payments through
qualified intermediaries. PROSPECTIVE PURCHASERS ARE URGED TO CONSULT THEIR TAX
ADVISORS REGARDING THE FINAL REGULATIONS.
GAIN ON DISPOSITION
A Non-U.S. Holder will generally not be subject to U.S. federal income tax
on gain recognized on a sale, redemption or other disposition of a Note unless
(i) the gain is effectively connected with the conduct of a trade or business
within the U.S. by the Non-U.S. Holder; (ii) in the case of a Non-U.S. Holder
who is a nonresident alien individual and holds the Notes as a capital asset,
such holder is present in the U.S. for 183 or more days in the taxable year and
certain other requirements are met; or (iii) the Non-U.S. Holder is subject to
the special rules applicable to certain former citizens and residents of the
U.S.
FEDERAL ESTATE TAXES
Notes held (or treated as held) by an individual who is not a citizen or
resident of the United States (for federal estate tax purposes) at the time of
his or her death will not be subject to the U.S. federal estate tax, provided
that (i) the individual does not actually or constructively own 10% or more of
the total voting power of all voting stock of the Company and (ii) income on
the Notes was not U.S. trade or business income.
INFORMATION REPORTING AND BACKUP WITHHOLDING
The Company must report annually to the IRS and to each Non-U.S. Holder
any interest paid to the Non-U.S. Holder. Copies of these information returns
may also be made available under the provisions of a specific treaty or other
agreement to the tax authorities of the country in which the Non-U.S. Holder
resides.
In the case of a payments of interest to Non-U.S. Holders, Treasury
regulations provide that the 31% backup withholding tax and certain information
reporting will not apply to such payments with respect to which either the
requisite certification, as described above, has been received or an exemption
has otherwise been established, provided that neither the Company nor its
payment agent has actual knowledge that the holder is a U.S. person or that the
conditions of any other exemption are not in fact satisfied. The payment of the
proceeds from the disposition of Notes to or through the U.S. office of any
broker, U.S. or foreign, will be subject to information reporting and possible
backup withholding unless the owner certifies as to its non-U.S. status under
penalty of perjury or otherwise establishes an exemption, provided that the
broker does not have actual knowledge that the Holder is a U.S. person or that
the conditions of any other exemption are not, in fact, satisfied. The payment
of the proceeds from the disposition of Notes to or through a non-U.S. office
of a non-U.S. broker will not be subject to information reporting or backup
withholding unless the non-U.S. broker has certain types of relationships with
the U.S.
In the case of the payment of proceeds from the disposition of Notes to or
through a non-U.S. office of a broker that is either a U.S. person or a U.S.
related person, the regulations require information reporting (but not backup
withholding) on the payment unless the broker has documentary evidence in its
files that the owner is a Non-U.S. Holder and the broker has no knowledge to
the contrary.
The Treasury Department recently promulgated final regulations regarding
the withholding and information reporting rules discussed above. In general,
the final regulations do not significantly alter the substantive withholding
and information reporting requirements but rather unify current certification
procedures and forms and clarify reliance standards. The final regulations are
generally effective for payments made after December 31, 1999, subject to
certain transition rules. NON-U.S. HOLDERS SHOULD CONSULT THEIR OWN TAX
ADVISORS WITH RESPECT TO THE IMPACT, IF ANY, OF THE NEW FINAL REGULATIONS.
Backup withholding is not an additional tax. Any amounts withheld under
the backup withholding rules may be refunded or credited against the Non-U.S.
Holder's U.S. federal income tax liability, provided that the required
information is furnished to the IRS.
A-8
[ALTERNATE COVER FOR MARKET-MAKING PROSPECTUS]
===============================================================================
NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES, NOR DOES IT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION
OF AN OFFER TO BUY SUCH SECURITIES IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS
NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY
IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE
THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY
TIME SUBSEQUENT TO ITS DATE.
--------------------------
TABLE OF CONTENTS
PAGE
----
Available Information ......................... iii
Prospectus Summary ............................ 1
Risk Factors .................................. 13
Use of Proceeds ............................... 18
Capitalization ................................ 26
Selected Historical Consolidated Financial
Data ....................................... 27
Management's Discussion and Analysis of
Financial Condition and Results of
Operations ................................. 28
Business ...................................... 37
The Transactions .............................. 47
Management .................................... 48
Security Ownership of Certain Beneficial
Owners and Management ...................... 52
Certain Relationships and Related
Transactions ............................... 53
Description of Certain Indebtedness ........... 55
Description of New Notes ...................... 57
U.S. Federal Income Tax Consequences .......... 82
Plan of Distribution .......................... 83
Notice to Holders ............................. 84
Legal Matters ................................. 85
Experts ....................................... 85
Index to Unaudited Pro Forma
Condensed Consolidated Statements of
Operations ................................. P-1
Index to Consolidated Financial
Statements ................................. F-1
===============================================================================
===============================================================================
NEW 10 1/2% SENIOR NOTES
DUE 2008
AKI, INC.
----------------
PROSPECTUS
----------------
, 1998
===============================================================================
A-9
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Pursuant to Section 102(b)(7) of the Delaware General Corporation Law (the
"DGCL"), Article Eighth of the Company's Certificate of Incorporation, (the
"Certificate of Incorporation") (incorporated by reference as Exhibit 3.1 to
this Registration Statement), eliminates the liability of the Company's
directors to the Company or its stockholders, except for liabilities related to
breach of duty of loyalty, actions not in good faith and certain other
liabilities.
Section 145 of the DGCL provides, in substance, that Delaware corporations
shall have the power, under specified circumstances, to indemnify their
directors, officers, employees and agents in connection with actions, suits or
proceedings brought against them by a third party or in the right of the
corporation, by reason of the fact that they were or are such directors,
officers, employees or agents, against expenses incurred in any such action,
suit or proceeding. The DGCL also provides that Delaware corporations may
purchase insurance on behalf of any such director, officer, employee or agent.
Article Eighth of the Certificate of Incorporation provides that the
Company shall indemnify any director to the fullest extent permitted by the
DGCL. The Company also maintains officers' and directors' liability insurance
which insures against liabilities that officers and directors of the Company
may incur in such capacities.
Reference is made to Section 8 of the Registration Rights Agreement filed
as Exhibit 4.3 to this Exchange Offer Registration Statement which provides for
indemnification for the officers and directors of the Company and certain
control persons of the Company against certain liabilities, including
liabilities caused by any untrue statement of material fact or omission in any
registration statement, draft prospectus, prospectus or any amendments thereto.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits
1.1. Purchase Agreement dated June 22, 1998 between DLJ and the Company.+
3.1. Certificate of Incorporation of the Company.*
3.2. Bylaws of the Company.+
4.1. Indenture dated as of June 25, 1998 between the Company and IBJ Schroder Bank &
Trust Company, as Trustee.+
4.2. Form of 10 1/2% Senior Notes due July 1, 2008 (included as an exhibit to Exhibit 4.1).+
4.3. Registration Rights Agreement, dated as of June 25, 1998 between the Company and
DLJ.+
5.1. Legal opinion of Akin, Gump, Strauss, Hauer & Feld, L.L.P. concerning the legality of the
Notes.*
8.1. Legal opinion of Akin, Gump, Strauss, Hauer & Feld, L.L.P. concerning certain tax
matters.*
10.1. Acquisition Corp. Stock Option Plan.+
10.2. Option Letter Agreement relating to the Time Vesting Options dated as of June 17, 1998
between Acquisition Corp. and Roger L. Barnett.+
10.3. Option Letter Agreement relating to the Standard Options dated as of June 17, 1998
between Acquisition Corp. and Roger L. Barnett.+
10.4. Employment Agreement dated as of June 17, 1998 between the Company and Roger L.
Barnett.+
II-1
10.5. Employment Agreement dated as of May 12, 1998 between the Company and Barry W.
Miller.+
10.6. Stockholders Agreement dated as of December 15, 1997 between Acquisition Corp.,
DLJMBII and certain other investors including Roger L. Barnett.+
10.7. Credit Agreement dated as of April 30, 1996, as amended on December 12, 1997 and
October 30, 1998, between the Company and Heller Financial, Inc.*
10.8. Securities Purchase Agreement dated as of December 15, 1997 between the Company and
the Bridge Lender.*
10.9. Asset Purchase Agreement dated as of June 22, 1998 between Arcade Marketing, Inc. and
Minnesota, Mining and Manufacturing Company.+
10.10. Stock Purchase Agreement dated as of November 14, 1997, as amended on December 2,
1997 and December 12, 1997, among the Company and DLJMBII and certain related
investors.*
10.11. Financial Advisory Agreement dated as of December 12, 1997 between Acquisition Corp.
and DLJ.*
10.12. Indenture dated as of June 25, 1998 between the Company and State Street Bank and
Trust Company.+
10.13. Replacement Stock Option Agreement dated as of December 15, 1997 between
Acquisition Corp. and Roger L. Barnett.*
10.14. Option Substitution Agreement dated as of December 15, 1997 among the Company,
Acquisition Corp., and Roger L. Barnett.*
10.15. Put and Call Agreement dated as of December 15, 1997, as amended on February 2, 1997
and April 1, 1997, among Roger L. Barnett, Acquisition Corp., and DLJMBII.*
10.16. Termination of Put and Call Agreement dated June 17, 1997 among DLJMBII, Roger L.
Barnett, and Acquisition Corp.*
12.1. Computation of Earnings to Fixed Charges.*
16.1. Letter from PricewaterhouseCoopers LLP dated as of November 13, 1998 regarding Change
in Certifying Accountant.*
23.1. Consent of PricewaterhouseCoopers LLP.*
23.2. Consent of Akin, Gump, Strauss, Hauer & Feld, L.L.P. (included in Exhibit 5.1).*
24.1. Powers of Attorney.+
25.1. Form T-1 Statement of Eligibility of Trustee and Qualification under the Trust Indenture
Act of 1939 of IBJ Schroder Bank & Trust Company, as Trustee under the Indenture.*
27.1. Financial Data Schedule for the year ended June 30, 1996.*
27.2. Financial Data Schedule for the year ended June 30, 1997.*
27.3. Financial Data Schedule for the year ended June 30, 1998.*
27.4. Financial Data Schedule for the three months ended September 30, 1997.*
27.5. Financial Data Schedule for the three months ended September 30, 1998.*
99.1. Form of Letter of Transmittal.*
99.2 Form of Notice of Guaranteed Delivery.*
(b) Financial Statement Schedules
Schedule II -- Allowance for Doubtful Accounts*
- ----------
* Filed herewith.
+ Previously filed.
II-2
ITEM 22. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the DGCL, the Certificate of Incorporation and Bylaws,
or otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in such Securities Act, and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than payment by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in the successful defense of
any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in such Securities Act and will be governed by the final adjudication
of such issue.
The undersigned Registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the Prospectus pursuant to
items 4.10(b), 11 or 13 of this Form, within one business day receipt of such
request, and to send the incorporated documents by first class mail or other
equally prompt means. This includes information contained in documents filed
subsequent to the effective date of the Registration Statement through the date
of responding to the request.
The undersigned Registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the Registration Statement when it became effective.
This undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the Registration Statement (or the most
recent post-effective amendment thereof) which, individually or in
the aggregate, represent a fundamental change in the information set
forth in the Registration Statement. Notwithstanding the foregoing,
any increase or decrease in volume of securities offered (if the
total dollar value of securities offered would not exceed that which
was registered) and any deviation from the low or high and of the
estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) if, in
the aggregate, the changes in volume and price represent no more than
20 percent change in the maximum aggregate offering price set forth
in the "Calculation of Registration Fee" table in the effective
Registration Statement.
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in the Registration
Statement or any material change to such information in the
Registration Statement;
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new Registration Statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
II-3
SIGNATURES
Pursuant to the requirements of the Securities Act, the registrant has
duly caused this amendment to the Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of New York,
State of New York, on the 13th day of October 1998.
AKI, INC.
By: /s/ Kenneth A. Budde
-----------------------------------
Kenneth A. Budde
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, this amendment
to the Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Roger L. Barnett President, Chief Executive Officer November 13, 1998
- ------------------------- (principal executive officer)
Roger L. Barnett and Director
* Chairman of the Board and Director November 13, 1998
- -------------------------
Thompson Dean
* Chief Operating Officer November 13, 1998
- -------------------------
Barry W. Miller
* Chief Financial Officer (principal November 13, 1998
- ------------------------- financial officer and principal
Kenneth A. Budde accounting officer)
* Director November 13, 1998
- -------------------------
Hugh R. Kirkpatrick
Director November 13, 1998
- -------------------------
Mark Michaels
* Director November 13, 1998
- -------------------------
David M. Wittels
* /s/ Roger L. Barnett
- -------------------------
Roger L. Barnett
Attorney-in-Fact
II-4
SCHEDULE II
AKI, INC. AND SUBSIDIARIES
ALLOWANCE FOR DOUBTFUL ACCOUNTS
(dollars in thousands)
BALANCE AT BALANCE AT
YEAR BEGINNING END OF
ENDED OF PERIOD ADDITIONS(1) DEDUCTIONS(2,3) PERIOD
----- --------- ------------ --------------- ------
1996 379 337 (249) 467
1997 467 120 (268) 319
1998 319 0 (42) 277
- ----------
(1) Additions represent amounts charged to expense during the respective
periods.
(2) Deductions represent net writeoffs and recoveries recorded by the Company
during the respective periods.
(3) Net deductions for the year ended June 30, 1998 were comprised of net
recoveries of $58 for the period from July 1, 1997 through December 15,
1997 and net deductions of $100 for the period from December 16, 1997
through June 30, 1998.