Filed Pursuant to Rule 424(b)(3)
Registration No. 333-60989
PROSPECTUS SUPPLEMENT DATED SEPTEMBER 18, 2001
To Prospectus dated December 23, 1998
10 1/2% SENIOR NOTES DUE 2008
OF
AKI, INC.
RECENT DEVELOPMENTS
Attached hereto and incorporated by reference herein is the Form 10-K of
AKI, Inc. filed September 18, 2001.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2001
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to _____________
AKI HOLDING CORP.
(Exact name of registrant as specified in its charter)
Commission File Number: 333-60991
Delaware 74-288316
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
AKI, INC.
(Exact name of registrant as specified in its charter)
Commission File Number: 333-60989
Delaware 13-3785856
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1815 East Main Street
Chattanooga, TN 37404
(423) 624-3301
(Address, including zip code and telephone number, including area code,
of principal executive offices)
Securities Registered Pursuant to Section 12(b) of the Act:
None.
Securities Registered Pursuant to Section 12(g) of the Act:
None.
Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) have been subject to such
filing requirements for the past 90 days. (X) Yes ( ) No
As of September 17, 2001, 1,000 shares of common stock of AKI Holding Corp.,
$0.01 par value, were outstanding and 1,000 shares of common stock of AKI, Inc.,
$0.01 par value, were outstanding.
Indicate by check mark if disclosure of delinquent filers is not contained
herein, and will not be contained, to the best of registrants' knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. (X)
AKI, Inc. meets the requirements set forth in General Instruction I 1(a) and (b)
of Form 10-K and is therefore filing this form with reduced disclosure format.
DOCUMENTS INCORPORATED BY REFERENCE:
None.
As used within this report, the term "company" refers to AKI Holding Corp.,
a Delaware corporation, and its subsidiaries, including AKI, Inc., a Delaware
corporation ("AKI"). The term "Holding" refers solely to AKI Holding Corp.
PART I
Part I is presented with respect to both registrants submitting this
filing, Holding and AKI.
ITEM 1. BUSINESS
General
Our Company is a leading global marketer and manufacturer of multi-sensory,
interactive advertising that utilizes sampling systems that engage the senses of
touch, sight, sound and olfactory. Our sampling systems are widely recognized in
the fragrance, cosmetics and personal care industries, as well as the household
products and food and beverage industries. We offer an extensive portfolio of
proprietary, patented and patent-pending sampling systems that can be
incorporated into various advertising media which is designed to reach the
consumer at home or in-store, using vehicles such as magazine inserts, catalog
inserts, remittance envelopes, statement enclosures, blow-ins, direct mail and
point-of-sale handouts and displays.
We are a fully integrated multi-sensory advertising company, conducting our
business under the Arcade Marketing Inc. name. We believe that we are well
positioned to provide complete, interactive advertising programs to our
customers, including creative content and product sample systems and
distribution.
Product sampling is one of the most effective, widely used and fastest
growing forms of promotional activity. Product sampling is particularly crucial
to the fragrance and cosmetics industries where consumers traditionally "try
before they buy" due to the highly personal nature of the products. We believe
that our introduction in 1979 of the ScentStrip(R) Sampler, the first
pull-apart, microencapsulated scent sampling system, transformed the fragrance
sampling industry. By combining advertising with a sampling system, marketers
were afforded the first cost-effective means to reach consumers in their homes
on a mass scale. Though the microencapsulated fragrance sampling system remains
the most widely used product throughout the fragrance industry, we now have a
diverse portfolio of alternative scent sampling systems, all designed for
cost-effective mass distribution, and we continue to be a leading innovator in
sampling system advertising.
In recent years, we have expanded our sampling system business by
developing new technologies, specifically BeautiSeal(R), LipSeal(TM) and
BeautiTouch(R), for the sampling of skincare products, foundation, lipstick and
PowdaTouch(R) for the sampling of cosmetic powders. Although product sampling is
critical to the success of these markets, sampling programs for these products
historically have been too costly for mass production and incapable of
efficiently being incorporated into magazines, catalogs, direct mail and other
printed vehicles. Our innovative sampling systems are designed to fill the needs
of these marketers by providing a
1
cost-effective means of reaching consumers in their homes on a mass scale with
quality renditions of skincare products, foundation, lipstick and cosmetic
powders. Management believes that our innovative sampling systems have altered
the economics and efficiencies of product sampling in the cosmetics market.
In December 1997, DLJ Merchant Banking Partners II, L.P. and other related
investors (collectively, "DLJMBII") and certain members of our prior management
organized AHC I Acquisition Corp., a Delaware corporation ("AHC"), to acquire
all of the outstanding equity interests of AKI. Holding was formed as a holding
company in 1998 and its only significant asset is the capital stock of AKI.
Holding conducts all of its business through AKI. As of August 31, 2001, DLJMBII
owned approximately 98.8% of the outstanding common stock of AHC.
On November 6, 2000, Credit Suisse Group completed the merger of Diamond
Restructuring Corp., an indirect wholly owned subsidiary of Credit Suisse Group,
with and into Donaldson, Lufkin & Jenrette, Inc. ("DLJ"). As a result of the
merger, DLJ is now an indirect subsidiary of Credit Suisse First Boston, Inc.
("CSFB"). All references to DLJ in this annual report on Form 10-K refer to
entities now controlled by or affiliated with CSFB.
On September 15, 1999, we acquired all of the issued and outstanding shares
of capital stock of RetCom Holdings Ltd. ("RetCom"), a Delaware corporation, and
refinanced $4.5 million indebtedness of RetCom and its subsidiaries. The
acquired businesses of RetCom and its subsidiaries include a portfolio of
sampling systems catering to the fragrance, cosmetics and personal care
industries, as well as microencapsulation products and processes. The acquired
businesses also include a creative service division that engages in marketing
communications and catalogs, and a multi-media division focused presently at
merchandising at point-of-sale and through the Internet. The acquired businesses
offer proprietary, patented and patent-pending sampling systems that include
MicroSilk(TM), MicroDot(TM) and Aromalacquer(TM).
Products
We offer a broad and diversified portfolio of innovative, interactive
sampling systems and advertising formats for the fragrance, cosmetics and
personal care markets as well as other consumer products markets and the food
and beverage markets. Our major technologies are described below, including a
description of the patent protection of each product technology. Each of our
sample systems is generally sold to the same category of manufacturers of the
product being advertised.
------------------ ------------ ------------ ------------ ---------------------
Year of Patent
Product Introduction Origin Protection Target Market
------------------ ------------ ------------ ------------ ---------------------
ScentStrip(R) 1979 Internally Proprietary Fragrance, consumer
developed secret products
------------------ ------------ ------------ ------------ ---------------------
ScentStrip(R)Plus mid 1980's Internally Proprietary Fragrance, consumer
developed secret products
------------------ ------------ ------------ ------------ ---------------------
DiscCover(R) 1994 Licensed Patented Fragrance, consumer
products, personal
care, food & beverage
------------------ ------------ ------------ ------------ ---------------------
2
------------------ ------------ ------------ ------------ ---------------------
ScentSeal(R) 1995 Acquired Patented Fragrance and
personal care
------------------ ------------ ------------ ------------ ---------------------
LiquaTouch(R) 1997 Internally Patent Fragrance, skin care
developed pending
------------------ ------------ ------------ ------------ ---------------------
MicroDot(TM) 1993 Acquired Proprietary Fragrance
secret
------------------ ------------ ------------ ------------ ---------------------
Aromalacquer(TM) 1997 Acquired Proprietary Fragrance, food &
secret beverage and
consumer products
------------------ ------------ ------------ ------------ ---------------------
Microfragrance(R) 1978 Acquired Proprietary Fragrance, food &
Scratch `n Sniff secret beverage and
consumer products
------------------ ------------ ------------ ------------ ---------------------
BeautiSeal(R) 1997 Internally Patented Cosmetics, skin care
developed and personal care
------------------ ------------ ------------ ------------ ---------------------
PowdaTouch(R) 1997 Internally Patented Cosmetic powders
developed
------------------ ------------ ------------ ------------ ---------------------
LipSeal(TM) 1998 Internally Patented Lipsticks
developed
------------------ ------------ ------------ ------------ ---------------------
TouchDown(R) 1999 Internally Proprietary Nail Enamel
Nail Color developed secret
Sampler
------------------ ------------ ------------ ------------ ---------------------
BeautiTouch(R) 1999 Internally Patent Cosmetics, skin care
Multi-well developed pending and personal care
Sampler
------------------ ------------ ------------ ------------ ---------------------
Olfactory Sampling Systems
Our diverse portfolio of fragrance sampling systems, which uses a variety
of proprietary chemistries and processes, historically has represented a
significant portion of our annual sales. While ScentStrip(R) continues to be the
most widely used technology for sampling products for the fragrance industry,
management believes that our new and recently acquired sampling systems have
enabled us to maintain a competitive advantage and affirm our position as an
innovator in the sampling industry. Our products have been used in most major
new fragrance launches in recent years that have utilized sampling systems.
o ScentStrip(R): A proprietary technology introduced by our Company in
1979, is a microencapsulated essential oil deposited between two layers of
paper which "snap" open to release a quality fragrance rendition.
ScentStrip(R) can deliver quality aroma renditions of fine fragrance,
personal care, sun care and consumer products. ScentStrip(R) is available
in many formats, including magazine and catalogue inserts, blow-ins,
enclosures, remittance envelopes, among others, all of which can be
customized to include multiple fragrances in ScentStrip(R) form.
o ScentStrip(R) Plus: Combines the traditional ScentStrip(R) format with
perfume "pearls" in a proprietary technology wherein powder is deposited
between two layers of paper.
3
o DiscCover(R): A peel-and-reveal, non-encapsulated patented sampling
system that opens and reseals, delivering a quality aroma rendition up to
25 times. This technology is color-printable, affixable to nearly any
surface, including plastic and glass, and can be die-cut in nearly any
shape and size. This technology keeps fragrance locked-in until "lift off"
with no pre-release and can be utilized for not only fine fragrances but
can deliver a quality aroma for a variety of personal care products in
addition to food and beverage products.
o ScentSeal(R): A patented, pouch-like, pressure sensitive format that
incorporates a product rendition deposited between two layers of foil
laminate. When pulled open, ScentSeal(R) reveals a moist, alcohol-based gel
applicable to skin for wearable-trial. ScentSeal(R) can contain quality
fragrance, fragrance ancillary or personal care product renditions. The
product offers customers the opportunity to deliver moist, on-skin trial
via its "wet delivery system" and is available in many shapes and sizes
compatible with brand image and creative design.
o LiquaTouch(R): Delivers a rendition of finished fragrance product (e.g.,
eau de parfum, eau de toilette or after shave), any liquid treatment or
personal care product and contains an applicator. LiquaTouch(R) is
hermetically sealed with no pre-release and delivers a spill proof trial of
any alcohol formulated fragrance product. Available in a single or dual
chamber pressure-sensitive format designed for U.S. Postal Service approval
for subscription magazine periodical rates, LiquaTouch(R) is also available
in a stand-alone version, which is a cost-effective alternative to
fragrance vials.
o MicroDot(TM): A peel away resealable label, which reveals pressure
sensitive microencapsulated fragrance oil delivered in a Microsilk(TM)
powder. When applied to the skin, the Microsilk(TM) powder delivers a
superior fragrance rendition. MicroDot(TM) is available as a stand-alone
handout or a pressure sensitive label affixable to virtually any media.
o Aromalacquer(TM): Scented varnish that delivers a superior aroma
rendition of nearly any fragrance, personal care, household, food,
beverage, pharmaceutical or novelty product. When rubbed or scratched,
Aromalacquer releases the aroma rendition.
o Microfragrance(R) Scratch `n Sniff: Microfragrance capsules are applied
to paper or stickers which affix to nearly any surface, delivering an
accurate aroma rendition of any product where scent is part of the message
such as flowers, shampoos, etc. When the sampling system is scratched,
capsules release a quality aroma rendition. Through a proprietary
relationship with the 3M Company, the product is also available applied to
the familiar 3M Post-it(R) Notes to deliver an aroma rendition of almost
any scent.
4
Other Sampling Systems
Our portfolio also includes non-fragrance sampling system products, which
represent a growing percentage of our sales. These sampling systems are utilized
to sample cosmetics and beauty care products including foundation, creams and
lotions, lipstick, powders and nail enamel. All of these sampling systems have
been designed to meet U.S. Postal Service approval for subscription magazine
periodical rates.
o BeautiSeal(R): A proprietary, patented technology is a sampling system
for quality renditions of creams, lotion or gel products which are
deposited between the foil layers of a heat-sealed, pressure sensitive
well. BeautiSeal(R) is hermetically sealed and designed to withstand
significant pressure and is designed for US Postal Service approval for
subscription magazine periodical rates. BeautiSeal(R) can contain
renditions of liquid foundation, as well as creams, lotions and gel
treatment and personal care products such as moisturizers, eye treatments,
body, hand and foot lotions and hair gel, among others. BeautiSeal(R) is
ideal for magazine and catalogue inserts, bind-in cards, direct mailers,
brochures and in-store handout and regimen cards.
o PowdaTouch(R): A proprietary, patented technology is a sampling system
wherein cosmetic powder is deposited between two layers of paper, die-cut
with a tab that lifts up to reveal the powder rendition area. PowdaTouch(R)
can contain quality renditions of eye shadow, powder blush, face powder or
bronzer. Applies up to four different powders on a single carrier and is
ideal for trial of a single item shade range or a complete color story.
PowdaTouch(R) is ideal for magazine and catalogue inserts, blow-ins, and
bind-in cards among others and is designed for US Postal Service approval
for subscription magazine periodical rates. Management estimates that
PowdaTouch(R) sampling systems can be produced approximately ten times
faster than currently competing products.
o LipSeal(TM): A proprietary, patented technology, is a sampling system
wherein a lipstick rendition is deposited into the well of a
pressure-sensitive format that easily pulls apart to offer user-friendly,
hygienic trial. LipSeal(TM) offers trial of any lipstick shade, finish and
texture in any lipstick formula, including long-lasting formulas.
o TouchDown(R) Nail Color Sampler: A proprietary technology, is a die-cut,
pressure-sensitive, nail-shaped "chip" printed to match nail enamel shades.
TouchDown(R) can deliver trial of up to 2 nail enamel shades on a single
carrier. TouchDown(R) does not mare the user's manicure and leaves no
residue when trialed by the consumer.
o BeautiTouch(R) Multi-Well Sampler: A proprietary, patent pending
technology, is a sampling system for cream, lotion, lipstick or gel product
renditions which are deposited into individually-sealed, foil laminate
"pouches." Heat-sealed "pouches" which share a common backing easily pull
apart to provide trial of multiple shades or formulas. BeautiTouch(R)
offers ideal, multiple shade demonstration by delivering trial
5
of 8, 10, 12 or more foundation shades on a single carrier with no
cross-contamination.
Other Products & Services
o Arcade Direct: Our Company offers a full range of creative services to
our customers in the cosmetic and fragrance industry, as well as a niche
presence in various industries that include retail and specialty stores,
fashion catalogues, buying offices, direct marketers, hotels and spas. This
dedicated division offers complete turnkey marketing and creative services
up to and including electronic production and final video production.
o Arcade Product Technologies: This division employs proprietary
chemistries to manufacture and market microencapsulated ingredients used in
the formulation of various personal care products. Fragrance oil, whether
customer-supplied or selected from our Company's extensive aroma library,
can be encapsulated using these proprietary systems and supplied in powder
form, resulting in a scent that can be renewed as the capsules are sheared.
In addition, the technologies can be used to encapsulate a wide range of
cosmetic formulation materials which provide consumers with additional,
longer-lasting benefits due to ingredients that re-release over time and
which enhance texture, application and overall product stability.
o Arcade Consumer Communications: This division specializes in electronic,
multi-media, multi-sensory devices primarily for use at point-of-sale.
Formats
We produce a wide and versatile range of formats designed for U.S. Postal
Service approval for subscription magazine periodical rates and which can be
incorporated into almost any print media. The most common formats for our
products are described below.
Magazine Inserts: Magazine inserts are available in half-, full-, two- and
four-page formats, can be die-cut, can contain any of our sampling systems and
are the most commonly produced among our formats.
Catalog Inserts: Full color formats can be produced in a variety of sizes
and inserted into retail or mail order catalogs. Catalog inserts can be produced
with or without an attached envelope, which may be provided to facilitate the
return of merchandise order forms to the store. We have the ability to create
and produce special formats, to custom imprint with store information and to
incorporate most of our sampling systems.
Remittance Envelopes: Remittance envelopes, which are inserted into store
statement mailings, can be customized with a store logo and can accommodate many
of our sampling systems. We believe that we are the only company in the sampling
industry that can produce remittance envelopes in-house. Remittance envelopes
can be produced with or without our
6
sampling systems. Remittance envelope production, which is a highly customized
service business, reinforces our position as a fully integrated enterprise.
Statement Enclosures Statement enclosures are available in various formats
and sizes. Fragrance statement 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 store logo and product pricing information. The
six-inch format is our design and has become the leading industry format.
Blow-ins: Blow-ins, which are available in all formats and sizes, can
accommodate nearly all of our sampling systems and are loosely inserted (blown
in) rather than bound into store catalogues, newspapers and magazines.
Direct Mail: Full color, direct mail formats can be produced in a variety
of sizes, weights and designs, including single, double and triple folds, as
well as standard and oversized postcards. Direct mailers can be customized with
store or manufacturer logo and can accommodate virtually all of our sampling
technologies.
In-Store Handouts: We have made significant advances in replacing and
expanding current methods of in-store cosmetic and fragrance sampling. Due to
the lower cost and design flexibility of our products, marketers have expanded
the number and type of in-store vehicles. Working in partnership with our
customers, new and creative formats have been developed. These formats
incorporate many of our sampling systems and items such as postcards, stickers,
wristbands, bookmarks and CD inserts. Our other technologies, including
LiquaTouch(R), BeautiSeal(R) and PowdaTouch(R) are becoming more widely accepted
for in-store handouts and an alternative to more traditional sampling methods.
Intellectual Property
We currently hold patents covering the proprietary processes used to
produce many of our products in both the U.S. and abroad and have submitted
applications for many of our manufacturing processes. We have trademarks
registered in the United States and we have also filed and registered trademarks
in over 15 countries around the world, including countries in the European
Union, Australia, Japan and Brazil.
We have ongoing research efforts and expect to seek additional patents in
the future covering results of our research. We cannot assure you that any
pending patent applications filed by our company:
o will result in patents being issued or that any patents now or hereafter
owned by our Company will afford protection against competitors with
similar technology;
o will not be infringed upon or designed around by others; or
o will not be challenged by others or held to be invalid or unenforceable.
7
o In addition, many of our manufacturing processes are not covered by any
patent or patent application. As a result, our business may be adversely
affected by competitors who independently develop technologies
substantially equivalent to those employed by our Company.
Customers
We sell our products to prestige and mass cosmetic, fragrance, consumer
products companies, department stores, home shopping retailers and specialty
retailers including Avon Products, Inc., Calvin Klein Cosmetics (Unilever plc),
Chanel, Inc., Coty, Inc., Cosmair/L'Oreal S.A., Elizabeth Arden (French
Fragrances Inc.), Estee Lauder, Inc., Giorgio Beverly Hills, Colgate-Palmolive,
Victoria Secret Beauty and The Procter & Gamble Company. Our top ten customers
accounted for approximately 62% of sales in fiscal 2001. Estee Lauder was the
only customer that accounted for 10% or more of net sales in fiscal 2001. We
believe that our technical expertise, manufacturing reliability and customer
support capabilities have enabled us to develop strong relationships with our
customers. We employ sales and marketing personnel who possess the requisite
technical backgrounds to communicate effectively with both prospective customers
and our manufacturing personnel. Historically, we have had long-term
relationships with our major customers.
Sales and Marketing
Our sales and marketing efforts are organized geographically. The U.S.
sales group is supervised by our Senior Vice President of U.S. Sales, while our
European sales executives are based in Paris, France and London, England and are
managed by an executive based in Paris, France. We also have representatives in
Australia, Brazil, Canada and Japan. Each sales executive is dedicated to a
certain number of identified customers. In addition, these sales efforts are
supported by production managers/customer service representatives, which are
based in Chattanooga, Tennessee and Paris, France. A portion of the compensation
for sales executives is commission-based.
Our 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. We also
provide press coverage in industry trade publications, attend industry seminars,
advertise in trade publications and sponsor promotional pieces. In addition, we
focus our sales efforts toward three principal groups within our customers'
organizations that management believes influence our customers' purchasing
decisions:
o marketing, which selects the sampling system technology and typically
controls the promotional budget;
o product development, which approves our sampling system rendition and
conducts stability testing; and
o purchasing, which buys the sampling system pieces and controls quality.
8
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 to introduce a new
fragrance. Our executives routinely introduce new sampling system formats and
ideas based on our technologies to the marketing departments of our customers.
Our in-house creative and marketing expertise, as well as our complete product
line provides customers with maximum flexibility in designing promotional
programs.
Manufacturing
Our manufacturing processes are highly technical and largely proprietary.
Our sampling systems must meet demanding performance specifications regarding
fidelity to the product being sampled, shelf life, resistance to pressure and
temperature variations and various other requirements. Our manufacturing
processes are composed of one or more of the following:
o formulating cosmetic and fragrance product renditions in our slurry
laboratories;
o printing advertising pages and other media;
o manufacturing the sampler, which consists of either applying an
encapsulated slurry onto paper or producing sampling labels that contain
fragrance or other cosmetic product renditions; and
o affixing our label products onto a preprinted advertising carrier.
ISO 9001 Registration: During 2001 the International Organization for
Standardization awarded our Company's three manufacturing facilities in
Chattanooga, Tennessee with ISO 9001 registration. These facilities produce many
of the Company's proprietary, patented and patent pending products, as well as
several of our other sampling systems. The registration was awarded following an
extensive examination incorporating 20 elements that outline the requirements
for documenting and implementing our Company's overall philosophy as it pertains
to quality, its policies, systems and procedures. The ISO standards serve as
guidelines for businesses interested in assuring that their processes result in
products that reflect the highest level of quality. The ISO 9001 section of the
series applies to organizations that design, develop, produce, install and
service products.
Management believes that our formulation capabilities are the best in the
cosmetics and fragrance sampling industry. The formulation process is highly
complex because we try to replicate the fragrance of a product in a bottle
containing an alcohol solution using primarily essential oils and paper.
Formulation approval is an interactive process between our Company and our
customers. We have more than 125 different, proprietary formulations that we
utilize in replicating different characteristics of over 500 fragrances to
obtain a customer-approved rendition. A number of these formulations are
patented and the majority of the formulation process is based on unique and
proprietary methods. Formulation of the fragrance and cosmetic product rendition
is performed under very strict tolerances and in complete conformity to the
9
formula that the customer has pre-approved. Formulation is conducted in our
specially designed formulation laboratories by trained specialists.
The artwork for substantially all printed pieces has typically been
furnished by the customer or its advertising agency. Our digital prepress
department utilizes state-of-the-art technology in receipt of customer-supplied
computer disks and produces this material directly on to our printing plates. We
have the capability to produce high quality printed materials, including the
covers of major fashion magazines, in connection with fragrance sampling
systems.
Our formulated offset paper samplers (ScentStrip(R), ScentStrip(R) Plus,
PowdaTouch(R)) are produced in our primary facility where we carefully apply
microencapsulated slurry onto the paper during the printing process and, in a
continuous in-line operation, fold, cut and trim the samplers for packing. A
24-hour quality control function and hourly accountability provide significant
value to our customers' product development personnel, who are typically
responsible for sample system quality. Our formulated letterpress or flexo label
samplers (DiscCover(R), BeautiSeal(R), LipSeal(TM), LiquaTouch(R)) are produced
on specially modified label and finishing equipment in our second facility. In
addition to the patents pending on a number of our manufacturing processes, we
use a number of proprietary techniques in producing label samplers. Similar to
the formulated paper operation, sampling quality control personnel evaluate all
sample systems by roll and provide full accountability for our production.
We also have agreements with North American, European and Australian
printers and labelers, which we contract with to produce some materials for our
customers. These arrangements are typically utilized when foreign distribution
is required or demand exceeds our internal capacity. Each of these arrangements
is protected by non-competition agreements.
We have been awarded The Procter & Gamble Pinnacle Award, which is
presented to companies as recognition for having met certain quality
requirements and having demonstrated outstanding quality assurance. We are also
registered with the Food and Drug Administration for the packaging of regulated
cosmetic products.
Sources and Availability of Raw Materials
Generally, the raw materials used by our Company in the manufacturing of
our products have been readily available from numerous suppliers and have been
purchased by our Company at prices that we believe are competitive. Our
encapsulated paper products utilize specific grades of paper that are subject to
comprehensive evaluation and certification by us for quality, consistency and
fit. We have not experienced any material supply shortages in the past, nor are
any anticipated.
Competition
Our competitors, some of whom have substantially greater capital resources
than us, are actively engaged in manufacturing products similar to, or in
competition with, our products. Competition in our markets is based upon product
quality, product technologies, customer relationships, price and customer
service. Our principal competitors in the printed fragrance and
10
cosmetic samplers market are Webcraft, a subsidiary of Vertis, Inc., Orlandi,
Inc., Delta Graphics, Inc., Nord'est, Marietta Corp., Klocke, Color Prelude,
Rotocon, Ascent and Appliquesence. We also compete with numerous manufacturers
of miniatures, vials, packets, sachets, blister packs and scratch and sniff
products. In addition, some cosmetics companies produce sampling products for
their own cosmetic products. We also compete with numerous other marketing and
advertising venues for marketing dollars our customers allocate to various types
of advertising, marketing and promotional efforts such as print, television and
in-store promotions.
Environmental and Safety Regulation
Our 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. Our
policy is to comply with all legal requirements of applicable environmental,
health and safety laws and regulations. We believe that we are in general
compliance with such requirements and have adequate professional staff and
systems in place to remain in compliance, although there can be no assurances
that this is the case. We consider costs for environmental compliance to be a
normal cost of doing business and include such costs in pricing decisions.
Employees
As of August 31, 2001, we employed 433 persons, which included 260 hourly
and 173 salaried and management personnel. Substantially all of our hourly
employees are represented by the Graphics Communications International Union
(GCIU) local 197-M. Management considers our relations with the union to be
good. The current union contract was signed in April 1999 and will be in effect
through March 31, 2003.
11
RISK FACTORS
Our substantial indebtedness and restrictive covenants imposed by the terms of
our indebtedness could adversely affect our cash flow and prevent us from
fulfilling our obligations under our notes and debentures.
We have substantial indebtedness and debt service obligations. As of June
30, 2001, Holding and AKI had total consolidated indebtedness of approximately
$127.9 million and $104.0 million, respectively. As of August 31, 2001, AKI had
outstanding borrowings of $4.9 million under its revolving credit agreement with
Heller Financial, Inc. and $0.4 million under a promissory note with AHC. In
addition, as of such date, borrowings of up to approximately $15.1 million were
available under the credit agreement, subject to specified conditions. The
indenture governing Holding's 13 1/2% Senior Discount Debentures due 2009 and
the indenture governing AKI's 10 1/2% Senior Notes due 2008 and the credit
agreement permit our Company and its restricted subsidiaries, as defined in the
indentures, in each case, to incur additional indebtedness if we meet specified
requirements.
The level of our indebtedness could have negative consequences to holders
of the notes and the debentures, including, but not limited to, the following:
o a substantial portion of cash flow from operations must be dedicated to
debt service and will not be available for other purposes;
o additional debt financing in the future for working capital, capital
expenditures or acquisitions may be limited;
o our level of indebtedness could limit flexibility in reacting to changes
in the operating environment and economic conditions generally;
o our level of indebtedness could restrict our ability to increase
manufacturing capacity;
o we may face difficulties in satisfying our obligations with respect to
our indebtedness; and
o a portion of our 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 indentures and the credit agreement contain covenants that, among other
things, limit the ability of our Company and its restricted subsidiaries to:
o pay dividends or make certain restricted payments;
o incur additional indebtedness and issue preferred stock;
o create liens;
o incur dividend and other payment restrictions affecting subsidiaries;
12
o enter into mergers, consolidations or sales of all or substantially all
of the assets of our Company;
o enter into certain transactions with affiliates; and
o sell certain assets.
In addition, the credit agreement requires us to maintain specified financial
ratios and satisfy specified financial condition tests. Our ability to meet
those financial ratios and tests can be affected by events beyond our control,
and there can be no assurance that we will meet those tests.
To service our indebtedness we will require a significant amount of cash. Our
ability to generate cash depends on many factors beyond our control.
The ability of our Company to pay principal and interest on the notes or
principal on the debentures and to satisfy our other debt obligations will
depend upon AKI's future operating performance. AKI's future operating
performance will be affected by prevailing economic conditions and financial,
business and other factors, which factors may be beyond our control. We
anticipate that our operating cash flow, together with available borrowings
under the credit agreement, will be sufficient to meet our operating expenses
and to service our debt requirements as they become due. However, if we are
unable to service our indebtedness, we may be required to take action such as
reducing or delaying capital expenditures, selling assets, restructuring or
refinancing our 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. If we are unable to maintain the specified financial ratios or
generate sufficient cash flow or otherwise obtain funds necessary to make
required payments, we would be in default under the terms of our indebtedness,
which would permit the holders of such indebtedness to accelerate the maturity
of the indebtedness.
Holding Company Structure - Holding's debentures are structurally subordinated
to indebtedness of its subsidiaries.
Holding is a holding company and does not have any material operations or
assets other than ownership of all of the capital stock of AKI. Accordingly, its
debentures are effectively subordinated to all existing and future liabilities
of Holding's subsidiaries, including indebtedness under the credit agreement and
AKI's notes. As of June 30, 2001, Holding's subsidiaries had $104.0 million of
indebtedness and $23.7 million of other outstanding liabilities (including trade
payables, accrued liabilities and deferred taxes). As of August 31, 2001, AKI
had outstanding borrowings of $4.9 million under the credit agreement and $0.4
million under a promissory note with AHC. In addition, as of August 31, 2001,
borrowings of up to approximately $15.1 million were available under the credit
agreement, subject to specified conditions. All such indebtedness effectively
ranks senior to Holding's debentures. At June 30, 2001, Holding had $0.1 million
of accrued liabilities and no outstanding indebtedness other than the
debentures. Holding and its subsidiaries may incur additional indebtedness in
the future, subject to the limitations contained in the instruments governing
their indebtedness.
13
Any right of Holding to participate in any distribution of assets of its
subsidiaries upon the liquidation, reorganization or insolvency of any such
subsidiary (and the consequent right of the holders of the debentures to
participate in the distribution of those assets) will be subject to the prior
claims of the respective subsidiary's creditors.
Holding's ability to repay its debentures may depend on its ability to raise
cash other than through its subsidiaries.
Holding's cash flow, and consequently its ability to service debt,
including its obligations under its debentures, is dependent upon the cash flows
of its subsidiaries and the payment of funds by such subsidiaries to Holding in
the form of loans, dividends or otherwise. Holding's subsidiaries have no
obligations, contingent or otherwise, to pay any amounts due pursuant to the
debentures or to make any funds available for payment of the debentures. In
addition, AKI's credit agreement and its note indenture impose, and agreements
entered into in the future may impose, significant restrictions on the payment
of dividends and the making of loans by AKI and its subsidiaries to Holding.
Accordingly, repayment of the debentures may depend upon the ability of Holding
to affect an equity offering or to refinance the debentures.
Your right to receive payments on the notes and debentures is junior to our
existing and future secured indebtedness.
Under the terms of our credit agreement, Heller Financial, Inc., the lender
under the credit agreement, has a security interest in substantially all of the
current and future assets of AKI. In the event of 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, the lender will have a prior secured
claim on the capital stock of AKI and the encumbered assets of our Company. As a
result, the encumbered assets of our Company would be available to pay
obligations on the notes and the debentures 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 its collateral, our financial
condition and the value of the debentures and the notes will be materially
adversely affected and could be eliminated. As of August 31, 2001, AKI had
outstanding borrowings of $4.9 million under the credit agreement and could
borrow up to approximately $15.1 million under the credit agreement, subject to
specified conditions.
Our results of operations could be adversely affected if the U.S. Postal Service
reclassifies our sampling systems or the sampling products of our competitors.
Our sampling systems are approved by the U.S. Postal Service for inclusion
in subscription magazines mailed at periodical postage rates. Our sampling
systems have a significant cost advantage over other competing sampling
products, such as miniatures, vials, packettes, sachets and blister packs,
because these 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 28% of our net sales in fiscal 2001.
There can be no assurance that the U.S. Postal Service will not approve other
competing types of sampling systems for use in subscription magazines without
requiring a postal surcharge, or that the U.S. Postal Service will
14
not reclassify our sampling systems such that they would incur a postal
surcharge. Any such action by the U.S. Postal Service could have a material
adverse effect on our results of operations and financial condition.
We rely on a small number of customers for a large portion of our revenues.
Our top ten customers by sales revenue accounted for approximately 62% of
our net sales in fiscal 2001. None of our customers, other than Estee Lauder,
accounted for 10% or more of net sales in fiscal 2001. Although we have
long-established relationships with most of our major customers, we do not have
long-term contracts with any of our customers. We may be required by some
customers to qualify our manufacturing operations under specified supplier
standards. There can be no assurance that we will be able to qualify under any
supplier standards or that our customers will continue to purchase sampling
systems from us if our manufacturing operations are not so qualified. An adverse
change in our relationship with significant customers, including Estee Lauder,
would have a material adverse effect on our results of operations and financial
condition.
Our ability to compete with other companies depends, in part, on our ability to
meet customer needs on a cost-effective and timely basis.
Our competitors, some of whom have substantially greater financial
resources than our Company, are actively engaged in manufacturing products
similar to those of our Company. Our principal competitors in the cosmetic
sampling market are Webcraft, a subsidiary of Vertis, Inc., Orlandi Inc.,
Nord'est, Marietta Corp., Klocke, Color Prelude, Rotocon, Ascent and
Appliquesence. We also compete with numerous manufacturers of miniatures, vials,
packettes, sachets, blister packs, and scratch and sniff products. In addition,
certain cosmetic companies produce sampling products for their own cosmetic
products. Competition in our market is primarily based upon product quality,
product technologies, customer relationships, price and customer service. The
future success of our business will depend in large part upon our ability to
market and manufacture products and 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 we will be successful in generating sales
on commercially favorable terms, if at all.
We must protect our intellectual property to be successful.
Our success, competitive position and revenues will depend, in part, upon
our ability to protect our proprietary technologies and to operate without
infringing on the proprietary rights of others. Although we have certain patents
and have filed, and expect to continue to file, other patent applications, there
can be no assurance that our issued patents are enforceable or that our 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 our Company.
A portion of our manufacturing processes are not covered by any patent or patent
application. As a result, our business may be adversely affected by competitors
who independently develop technologies substantially equivalent to those
employed by us.
15
Our business is affected by the advertising budgets of our customers and is
seasonal in nature.
The advertising budgets of our customers, and therefore our revenues, are
susceptible to prevailing economic and market conditions that affect advertising
expenditures, the performance of the products of our customers in the
marketplace and other related factors. As of August 31, 2001, we have
experienced a 10% decline in sales in the first quarter of fiscal 2002, and we
cannot predict if this trend will continue or worsen in the remainder of the
quarter or fiscal year. There can be no assurance that reductions in advertising
spending will not occur, which could have a material adverse effect on our
results of operations and financial condition.
In addition, our sales and operating results have historically reflected
seasonal variations. These seasonal variations are based on the timing of our
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 our first and third fiscal quarters ending September
30 and March 31, respectively, when sales from such advertising campaigns are
principally recognized while our fourth fiscal quarter ending June 30 typically
reflects the lowest sales level of the fiscal year. These seasonal fluctuations
require us to accurately allocate our resources to manage our manufacturing
capacity, which often operates at full capacity during peak seasonal demand
periods.
Our results of operations and financial condition may be adversely affected by
an increase in raw material prices or a decrease in raw material supply.
Paper is the primary raw material utilized by our Company in producing our
sampling systems. Paper costs represented approximately 28% of our cost of goods
sold in each of fiscal 1999, 2000 and 2001. Significant increases in paper costs
could have a material adverse effect on our results of operations and financial
condition to the extent that we are unable to price our products to reflect such
increases. There can be no assurance that our customers would accept such price
increases or the extent to which such price increases would impact their
decision to utilize our sampling systems.
Substantially all of our encapsulated sampling systems, which accounted for
approximately 52% of our net sales in fiscal 2001, utilize specific grades of
paper that are subject to comprehensive evaluation and certification by us for
quality, consistency and fit. These grades of paper are produced exclusively for
us by one domestic supplier. We do not have a purchase agreement with the
supplier and are not aware of any other suppliers of these specific grades of
paper. Although our products can be manufactured using other grades of paper, we
believe that the specific grades currently used provide us with an advantage
over our competitors. We continue to research methods of replicating the
advantages of these specific grades of paper with other available grades of
paper. Until alternative methods are developed, a loss of such supply of paper
and the resulting competitive advantage could have a material adverse effect on
our results of operations and financial condition to the extent that we are
unable to obtain such paper elsewhere.
16
Certain of our label sampling systems, which accounted for approximately 34% of
our net sales in fiscal 2001, utilize component materials that are sourced from
one qualified vendor in Europe. Although alternative sources are being sought
for the component materials, there can be no assurance that we will be
successful in locating another vendor. A loss of supply of materials could have
a material adverse effect on our results of operations and financial condition
to the extent we are unable to obtain materials elsewhere.
We receive a portion of our revenue from foreign countries which is subject to
foreign laws and regulations and political and economic events.
Approximately 21% of our net sales in fiscal 2001 was generated outside the
United States. Foreign operations are subject to 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 our control. We have
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.
We are controlled by DLJMBII whose interests may conflict with the interests of
the holders of the notes and debentures.
DLJMBII has the power to elect a majority of the directors of AHC and
generally exercises significant control over the business, policies and affairs
of AHC, Holding, AKI and its subsidiaries through its ownership of AHC. DLJMBII
currently owns approximately 98.8% of AHC's outstanding common stock. DLJMBII
may have interests that could be in conflict with those of the holders of the
notes or the debentures and may take actions that adversely affect the interests
of the holders of the notes or debentures.
Our business may be adversely affected by a labor dispute.
As of August 31, 2001, approximately 60% of our employees worked under a
collective bargaining agreement that expires on March 31, 2003. While we believe
that our relations with our employees are good, there can be no assurance that
our 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 our business, financial condition and results of operations.
ITEM 2. PROPERTIES
We own land and buildings in Chattanooga, Tennessee, that are used for
production, administration and warehousing. Our 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. We also
lease a third facility at 3501 St. Elmo Avenue in Chattanooga, Tennessee, which
is used for production and warehousing. This facility is located on 1.875 acres
and encloses
17
approximately 29,500 square feet. The lease for this building expires in
November 2001, at which time we intend to exercise our purchase option.
We currently have a number of web printing presses with multi-color
capability as well as envelope-converting machines and other ancillary
equipment. We operate a fully equipped production lab for the manufacture of
microcapsules and slurry and separate laboratories for the manufacture of Arcade
Product Technologies and our research and development facility. We also have a
fully staffed and equipped label manufacturing facility, which includes
state-of-the-art label manufacturing machines that have been specially modified
to produce our products and a complete label attaching operation. We also lease
sales offices in New York, New York, Paris, France and London, England.
ITEM 3. LEGAL PROCEEDINGS
We do not believe that there are any pending legal proceedings that, if
adversely determined, would have a material adverse effect on our financial
condition or results of operations, taken as a whole.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 18, 2001, by unanimous written consent, each of Holding and AKI
held its respective annual meeting of stockholders to vote upon the election of
directors. The stockholder in each case voted to elect the previously disclosed
directors to serve until the next annual meeting or until their successors are
elected and duly qualified.
18
PART II
ITEM 5. MARKET FOR REGISTRANT COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for Holding's or AKI's common
stock. As of August 31, 2001, AHC was the sole holder of record of Holding's
common stock and Holding was the sole holder of record of AKI's common stock.
Generally, neither Holding nor AKI pays dividends on its shares of common stock
and neither expects to pay dividends on its shares of common stock in the
foreseeable future. The debentures contain restrictions on Holding's ability to
pay dividends on its common stock. The notes and the credit agreement contain
restrictions on AKI's ability to pay dividends on its common stock.
ITEM 6. SELECTED FINANCIAL DATA
The selected historical consolidated financial data presented below as of
June 30, 2001, 2000, 1999 and 1998 and the years ended June 30, 2001, 2000 and
1999 and for the period from December 16, 1997 to June 30, 1998 have been
derived from the historical consolidated financial statements of our company.
The selected historical consolidated financial data presented below as of
December 15, 1997 and June 30, 1997 and for the period from July 1, 1997 to
December 15, 1997 and the fiscal year ended June 30, 1997 have been derived from
the historical consolidated financial statements of Arcade Holding Corporation,
our predecessor. The information contained in this table should be read in
conjunction with "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations," and our Consolidated Financial Statements
and the notes thereto included elsewhere in this report.
19
Holding Predecessor
--------------------------------------------------------- --------------------------
December 16, July 1, 1997
1997 to to
June 30, June 30, June 30, June 30, December 15, June 30,
(dollars in thousands) 2001 2000 1999 1998 1997 1997
---- ---- ---- ---- ---- ----
Statement of Operations Data:
Net sales (1) $ 115,395 $ 99,811 $ 87,169 $ 36,694 $ 36,003 $ 79,584
Cost of goods sold (1) 71,336 61,552 56,401 25,146 23,626 51,328
--------- --------- --------- --------- --------- ---------
Gross profit 44,059 38,259 30,768 11,548 12,377 28,256
Selling, general and
administrative expenses 18,199 16,980 14,500 5,587 5,703 13,333
Amortization of goodwill 5,757 5,336 4,606 2,101 568 1,234
Gain from settlement, net - (858) - - - -
--------- --------- --------- --------- --------- ----------
Income from operations 20,103 16,801 11,662 3,860 6,106 13,689
Interest expense, net 16,911 17,401 16,740 11,327 2,646 6,203
Management fees 250 250 250 125 215 470
Other, net - - 128 (47) 11 (101)
Income tax expense (benefit) 3,449 1,596 (340) (2,052) 1,441 3,135
--------- --------- --------- --------- --------- ----------
Income (loss) before
extraordinary item (507) (2,446) (5,116) (5,493) 1,793 3,982
Extraordinary gain, net 2,016 1,089 - - - -
--------- --------- --------- --------- --------- ----------
Net income (loss) $ 1,509 $ (1,357) $ (5,116) $ (5,493) $ 1,793 $ 3,982
========= ========= ========= ========= ========= ==========
Balance Sheet Data (at end
of period):
Cash and cash equivalents $ 4,654 $ 1,158 $ 7,015 $ 3,842 $ 4,481 $ 303
Working capital (deficit) 10,169 13,759 14,853 15,046 (4,959) (36,957)
Total assets 214,184 223,274 210,386 214,521 77,399 77,142
Total debt and redeemable
preferred stock 127,939 145,722 146,688 144,448 55,408 54,964
Total stockholder's equity 64,769 58,834 49,797 57,084 12,716 11,225
Other Data:
Capital expenditures $ 3,015 $ 2,782 $ 2,856 $ 514 $ 807 $ 2,462
Ratio of earnings to fixed
charges (2) 1.2x --- --- --- 2.2x 2.1x
------------
(1) Net sales and cost of goods sold have been restated to conform with current
year presentation.
(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. Earnings were not sufficient to cover fixed
charges by $851, $5,456 and $7,545 for the years ended June 30, 2000 and
1999 and the period from December 16, 1997 to June 30, 1998, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
Our sales are primarily derived from the sale of sampling systems to
cosmetics, fragrance and consumer products companies. Substantially all of our
sales are made directly to our 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 our Company and our
customers generally do not enter into long-term contracts, we have had
long-standing relationships with the majority of our customer base.
20
The Acquisition
DLJMBII and certain members of our prior management organized AHC I Merger
Corp. for purposes of acquiring Arcade Holding Corporation, our predecessor. On
December 15, 1997, the merger corporation acquired all of the equity interests
of the predecessor corporation (the "Acquisition") for $205.7 million (including
related fees, expenses and cash for working capital). Included in the total cost
of the Acquisition were approximately $6.2 million in non-cash costs comprised
of (1) the assumption of a promissory note issued by the predecessor corporation
in connection with the 1995 acquisition of Scent Seal, Inc., and certain capital
lease obligations and (2) the exchange of stock options to acquire common stock
in the predecessor corporation by the predecessor corporation's chief executive
officer for an option to acquire preferred stock in AHC.
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 predecessor corporation not assumed,
(1) the merger corporation issued $123.5 million of its Senior Increasing Rate
Notes to Scratch & Sniff Funding, Inc., an affiliate of DLJMBII, and (2) AHC
received $76.0 million from debt and equity (common and preferred) financings,
including equity investments by certain stockholders of the predecessor
corporation, which was contributed to the merger corporation. Immediately
following the Acquisition, the merger corporation merged with and into the
predecessor corporation and the combined entity assumed the name AKI, Inc. AHC
then contributed $1 of cash and all of its ownership interest in AKI to Holding
for 1,000 shares of Holding's common stock.
The merger corporation's senior increasing rate notes were subsequently
repaid on June 25, 1998 from the proceeds of AKI's issuance of $115.0 million of
AKI's notes and from a capital contribution from Holding. On June 25, 1998,
Holding issued and sold its debentures totaling $50.0 million in aggregate
principal amount at maturity for gross proceeds of $26.0 million, the majority
of which were used to fund Holding's equity contribution to AKI.
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.
3M Acquisition
On June 22, 1998, we acquired 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. We financed the 3M acquisition
with borrowings under the credit agreement. These borrowings were subsequently
repaid.
RetCom Acquisition
On September 15, 1999, we acquired all of the issued and outstanding shares
of capital stock of RetCom at a purchase price of approximately $12.5 million
and refinanced working
21
capital indebtedness of approximately $4.5 million of RetCom and its
subsidiaries. The purchase price and refinancing of indebtedness were initially
financed by borrowings under the credit agreement.
Results of Operations
Fiscal Year Ended June 30, 2001 Compared to Fiscal Year Ended June 30, 2000
Net Sales. Net sales for the fiscal year ended June 30, 2001 increased
$15.6 million, or 15.6%, to $115.4 million as compared to $99.8 million for the
fiscal year ended June 30, 2000. The increase was primarily attributable to
volume and favorable pricing mix in sales of sampling technologies for
advertising and marketing of fragrance products, and domestic cosmetic products,
partially offset by a decrease in the sales of sampling technologies for
advertising and marketing of consumer products and the unfavorable effect of a
stronger U.S. dollar against foreign currencies, primarily the French Franc.
Gross Profit. Gross profit for the fiscal year ended June 30, 2001
increased $5.8 million, or 15.1%, to $44.1 million as compared to $38.3 million
for fiscal year ended June 30, 2000. The increase in gross profit is primarily
attributable to the increase in net sales discussed above and changes in product
mix, offset by increased raw material costs, additional premium labor costs,
increased overhead costs and foreign exchange rates. Gross profit as a
percentage of net sales decreased to 38.2% in the fiscal year ended June 30,
2001, from 38.4% in the fiscal year ended June 30, 2000.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2001 increased $1.2
million, or 7.1% to $18.2 million as compared to $17.0 million for the fiscal
year ended June 30, 2000. The increase in selling, general and administrative
expenses was primarily due to increased staffing levels and compensation,
including increased sales commissions and incentive bonuses as a result of the
increase in sales volume and other quantitative incentive measures. Selling,
general and administrative expenses as a percent of net sales decreased to 15.8%
in the fiscal year ended June 30, 2001 from 17.0% in the fiscal year ended June
30, 2000.
Income from Operations. Income from operations for the fiscal year ended
June 30, 2001 increased $3.3 million, or 19.6%, to $20.1 million as compared to
$16.8 million for the fiscal year ended June 30, 2000. Income from operations
for 2000 included a net gain of $0.9 million resulting from a favorable
litigation settlement with the sellers of Arcade Holding Corp. Income from
operations as a percentage of net sales increased to 17.4% in the fiscal year
ended June 30, 2001 from 16.8% in the fiscal year ended June 30, 2000,
principally as a result of the factors described above.
Interest Expense. Interest expense for the fiscal year ended June 30, 2001
decreased $0.5 million, or 2.9% to $16.9 million, as compared to $17.4 million
for the fiscal year ended June 30, 2000. Interest expense as a percentage of net
sales decreased to 14.6% in the fiscal year ended June 30, 2001 from 17.4% in
the fiscal year ended June 30, 2000. The decrease in interest expense, including
the amortization of deferred financing costs, is primarily due to a decrease in
22
interest expense related to the repurchased and retired Senior Discount
Debentures and Senior Notes, partially offset by an increase in interest expense
related to use of the credit line and the promissory note to AHC for working
capital and the RetCom acquisition.
Interest expense for AKI for the fiscal year ended June 30, 2001 decreased
$0.5 million, or 3.7%, to $13.2 million, as compared to $13.7 million for the
fiscal year ended June 30, 2000. Interest expense as a percentage of net sales
decreased to 11.4% in the fiscal year ended June 30, 2001 from 13.7% in the
fiscal year ended June 30, 2000. The decrease in interest expense, including the
amortization of deferred financing costs, is primarily due to a decrease in
interest expense related to the repurchased and retired Senior Notes, partially
offset by use of the revolving credit line and the promissory note to AHC for
working capital and the RetCom acquisition.
Income Tax Expense. The income tax expense for the fiscal year ended June
30, 2001 increased $1.8 million to $3.4 million as compared to $1.6 million for
the fiscal year ended June 30, 2000. The increase is due to the increase in
income before income taxes and extraordinary gain.
Income tax expense for AKI for the fiscal year ended June 30, 2001
increased $1.9 million to $4.7 million as compared to $2.8 million for the
fiscal year ended June 30, 2000. The increase is due to the increase in income
before income taxes and extraordinary gain.
Extraordinary gain from early retirement of debt. An extraordinary gain
from early retirement of debt of $2.0 million for the fiscal year ended June 30,
2001 and $1.1 million for the fiscal year ended June 30, 2000 resulted from the
purchase and subsequent contribution in fiscal 2001 of Senior Discount
Debentures by AHC, and the purchase of Senior Notes and the purchase and
subsequent contribution in fiscal year 2000 of Senior Notes and Senior Discount
Debentures by AHC. The purchased and contributed securities were subsequently
retired.
An extraordinary gain from early retirement of debt for AKI of $0.5 million
for the fiscal year ended June 30, 2001 and $0.4 million for the fiscal year
ended June 30, 2000 resulted from the purchase in fiscal year 2001 of Senior
Notes and the purchase in fiscal year 2000 of Senior Notes by AHC and subsequent
contribution by Holding. The purchased and contributed securities were
subsequently retired.
EBITDA. EBITDA for the fiscal year ended June 30, 2001, increased $4.5
million, or 17.5%, to $30.2 million as compared to $25.7 million for the fiscal
year ended June 30, 2000. The increase in EBITDA principally reflects the
increase in gross profit partially offset by the increase in selling, general
and administrative expenses discussed above. EBITDA as a percentage of net sales
was 26.2% and 25.8% for the fiscal year ended June 30, 2001 and 2000,
respectively. EBITDA is income from operations plus depreciation and
amortization of goodwill and other intangibles less net gain from settlement of
litigation.
23
Fiscal Year Ended June 30, 2000 Compared to Fiscal Year Ended June 30, 1999
Net Sales. Net sales for the fiscal year ended June 30, 2000 increased
$12.6 million, or 14.5%, to $99.8 million as compared to $87.2 million for the
fiscal year ended June 30, 1999. The increase was primarily attributable to
increases in domestic sales of sampling technologies for advertising and
marketing of cosmetics and consumer products, due partially to the timing of
completion and delivery of certain substantial orders which remained in process
at June 30, 1999, increases in international sales of sampling technologies for
advertising and marketing of fragrances and sales from the RetCom acquired
business, offset by changes in foreign exchange rates.
Gross Profit. Gross profit for the fiscal year ended June 30, 2000
increased $7.5 million, or 24.4%, to $38.3 million as compared to $30.8 million
for fiscal year ended June 30, 1999. Gross profit as a percentage of net sales
increased to 38.4% in the fiscal year ended June 30, 2000, from 35.3% in the
fiscal year ended June 30, 1999. The increase in gross profit and gross profit
as a percentage of net sales was primarily attributable to the increase in net
sales discussed above, changes in product mix and more efficient production
levels, offset partially by changes in foreign exchange rates.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2000 increased $2.5
million, or 17.2% to $17.0 million as compared to $14.5 million for the fiscal
year ended June 30, 1999. The increase in selling, general and administrative
expenses was primarily due to increased staffing levels and compensation and
additional expenses associated with the acquisition and operation of RetCom. As
a result of these factors, selling, general and administrative expenses as a
percent of net sales increased to 17.0% in the fiscal year ended June 30, 2000
from 16.6% in the fiscal year ended June 30, 1999.
Income from Operations. Income from operations for the fiscal year ended
June 30, 2000 increased $5.1 million, or 43.6%, to $16.8 million as compared to
$11.7 million for the fiscal year ended June 30, 1999. Income from operations as
a percentage of net sales increased to 16.8% in the fiscal year ended June 30,
2000 from 13.4% in the fiscal year ended June 30, 1999, principally as a result
of the factors described above and an $0.8 million net gain from settlement of
litigation involving the acquisition purchase price.
Interest Expense. Interest expense for the fiscal year ended June 30, 2000
increased $0.7 million, or 4.2% to $17.4 million, as compared to $16.7 million
for the fiscal year ended June 30, 1999. Interest expense as a percentage of net
sales decreased to 17.4% in the fiscal year ended June 30, 2000 from 19.2% in
the fiscal year ended June 30, 1999. The increase in interest expense, including
the amortization of deferred financing costs, is primarily due to use of draw
downs under the credit agreement for working capital and the RetCom acquisition,
offset partially by a decrease in interest expense related to the repurchased
and retired Senior Discount Debentures and Senior Notes.
Interest expense for AKI for the fiscal year ended June 30, 2000
increased $0.7 million, or 5.4%, to $13.7 million, as compared to $13.0 million
for the fiscal year ended June 30, 1999.
24
Interest expense as a percentage of net sales decreased to 13.7% in the fiscal
year ended June 30, 2000 from 14.9% in the fiscal year ended June 30, 1999. The
increase in interest expense, including the amortization of deferred financing
costs, is primarily due to use of the credit line for working capital and the
RetCom acquisition, offset partially by a decrease in interest expense related
to the repurchased and retired Senior Notes.
Income Tax Expense. The income tax expense for the fiscal year ended June
30, 2000 increased $1.9 million to $1.6 million as compared to a benefit of $0.3
million for the fiscal year ended June 30, 1999. The increase is due to the
increase in income before income taxes and extraordinary gain.
Income tax expense for AKI for the fiscal year ended June 30, 2000
increased $2.0 million to $2.8 million as compared to $0.8 million for the
fiscal year ended June 30, 1999. The increase is due to the increase in income
before income taxes and extraordinary gain.
Extraordinary gain from early retirement of debt. An extraordinary gain
from early retirement of debt of $1.1 million for the fiscal year ended June 30,
2000 resulted from the purchase and subsequent contribution of Senior Notes and
Senior Discount Debentures by AHC. The contributed securities were subsequently
retired.
An extraordinary gain from early retirement of debt for AKI of $0.4 million
for the fiscal year ended June 30, 2000 resulted from the purchase of Senior
Notes by AHC and subsequent contribution by Holding. The contributed securities
were subsequently retired.
EBITDA. EBITDA for the fiscal year ended June 30, 2000, increased $5.6
million, or 27.9%, to $25.7 million as compared to $20.1 million for the fiscal
year ended June 30, 1999. The increase principally reflects the increase in
income from operations discussed above. EBITDA as a percentage of net sales was
25.8% and 23.1% for the fiscal year ended June 30, 2000 and 1999, respectively.
EBITDA is income from operations plus depreciation and amortization of goodwill
and other intangibles less net gain from settlement of litigation.
Liquidity and Capital Resources
We have substantial indebtedness and significant debt service obligations.
As of June 30, 2001, we had consolidated indebtedness in an aggregate amount of
$127.9 million (excluding trade payables, accrued liabilities and deferred
taxes), of which (1) approximately $23.9 million is a direct obligation of
Holding relating to its debentures and (2) approximately $103.5 million is a
direct obligation of AKI relating to its notes, revolving credit line and
capital leases. At June 30, 2001, Holding had $21.5 million of accrued
liabilities and AKI had $23.7 million in accrued liabilities (including trade
payables, accrued liabilities and deferred taxes). As of August 31, 2001, AKI
had outstanding borrowings of $4.9 million under the credit agreement.
Borrowings under the credit agreement are limited to a maximum amount equal
to $20.0 million. At June 30, 2001 and August 31, 2001, AKI had borrowing
availability of approximately $20.0 million and $15.1 million, respectively,
subject to a borrowing base calculation and the achievement of specified
financial ratios and compliance with specified
25
conditions. The interest rate for borrowings under the credit agreement are
determined from time to time based on our choice of formulas, plus a margin. The
credit agreement will mature on December 31, 2002.
The indentures and the credit agreement permit Holding and its subsidiaries
to incur additional indebtedness, subject to specified limitations. In addition,
the indentures contain restrictive covenants that, among other things, limit the
ability of Holding and its 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 our company; (vi) enter into certain
transactions with affiliates; and (vii) sell certain assets.
Payment of Holding's debentures is not guaranteed by AKI or any of its
subsidiaries. Because Holding is a holding company with no substantive
operations, it is dependent upon the cash flows of AKI and its subsidiaries and
the payment of funds by AKI and its subsidiaries to Holding in the form of
loans, dividends or otherwise to pay its obligations.
Holding's principal liquidity requirements are for debt service
requirements under the debentures. AKI's principal liquidity requirements are
for debt service requirements and fees under the notes and the credit agreement.
Historically, we have funded our capital, debt service and operating
requirements with a combination of net cash provided by operating activities,
which was $19.6 million and $4.9 million for fiscal 2001 and 2000, respectively,
together with borrowings under revolving credit facilities. Net cash provided by
operating activities during fiscal 2001 resulted primarily from net income
before depreciation and amortization, a decrease in accounts receivable and
inventory levels and an increase in accounts payable and accrued expenses.
In fiscal 2001 and fiscal 2000, we had capital expenditures of
approximately $3.0 million and $2.8 million, respectively. These capital
expenditures consisted primarily of the purchase and maintenance of
manufacturing equipment and furniture and fixtures and maintaining and upgrading
our computer systems.
On September 15, 1999, we acquired all of the issued and outstanding shares
of capital stock of RetCom at a purchase price of approximately $12.5 million
and refinanced working capital indebtedness of approximately $4.5 million of
RetCom and its subsidiaries. The purchase price and refinancing of indebtedness
were financed by borrowings under the credit agreement.
We may from time to time evaluate additional potential acquisitions. There
can be no assurance that additional capital sources will be available to us to
fund additional acquisitions on terms that we find acceptable, or at all.
At June 30, 2001, AHC had outstanding $45.0 million of Notes which bear
interest at approximately 16% per annum and mature on December 15, 2009, and
approximately $85.5 million of Senior Preferred Stock which accrue dividends at
15% per annum and must be redeemed by December 15, 2012. Interest on the notes
and dividends on the senior preferred stock may be settled through the issuance
of additional floating rate notes and senior preferred
26
stock through maturity or redemption, respectively. The floating rate notes are
general, unsecured obligations of AHC and are not obligations of, or guaranteed
by Holding, AKI or any of its subsidiaries. AHC is a holding company and is
dependent upon the cash flows of its subsidiaries and the payment to it of funds
by its subsidiaries. The indenture relating to the debentures restricts the
payment of dividends or the making of other restricted payments by Holding to
AHC.
In September 1999, AHC consummated a private placement to DLJMBII of
15,000,000 shares of its common stock at a purchase price of $1.00 per share. A
portion of the proceeds were used in fiscal 2000 to reduce outstanding
indebtedness of Holding and AKI. The balance of the proceeds may become
available to us to reduce outstanding indebtedness of Holding or AKI or for
working capital or other general corporate purposes, but there is no obligation
on the part of AHC to make any of these funds available.
Capital expenditures for the fiscal year ending June 30, 2002 are budgeted
to be approximately $3.0 million. Based on borrowings outstanding (other than
pursuant to the credit agreement) as of June 30, 2001 and borrowings outstanding
under the credit agreement as of August 31, 2001, we expect total cash payments
for debt service in fiscal 2002 to be approximately $11.1 million, consisting of
$10.9 million in interest payments on the notes and $0.2 million in interest and
fees under the credit agreement. We also expect to make royalty payments of
approximately $1.1 million during fiscal 2002.
We believe that, in the absence of future acquisitions, cash flows from
existing operations and available borrowings will be sufficient to fund budgeted
capital expenditures, working capital requirements and interest and principal
payments on our indebtedness, including the debentures and the notes for fiscal
2002. In the event we consummate any additional acquisitions, we may seek
additional debt or equity financings subject to compliance with the terms of the
indentures.
At June 30, 2001, Holding's cash and cash equivalents and net working
capital were $4.7 million and $10.2 million, respectively, representing an
increase in cash and cash equivalents of $3.5 million and a decrease in net
working capital of $3.6 million from June 30, 2000. Account receivables, net, at
June 30, 2001 decreased 16.3% or $3.5 million over the June 30, 2000 amount,
primarily due to a reduction in the days sales outstanding and a comparative
decrease in fourth quarter sales.
Seasonality
Our sales and operating results have historically reflected seasonal
variations. Such seasonal variations are based on the timing of our 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 our first and third fiscal quarters ended September 30 and March 31
when sales from such advertising campaigns are principally recognized. These
seasonal fluctuations require us to allocate our resources to manage our
manufacturing capacity, which often operates at full capacity during peak
seasonal demand periods.
27
Recently Issued Accounting Standards
In September 2000, the Emerging Issues Task Force reached a consensus on
Issue 00-10, "Accounting for Shipping and Handling Fees and Costs" ("Issue
00-10"). Issue 00-10 requires that all amounts billed to customers related to
shipping and handling should be classified as revenues. Issue 00-10 was
effective for the Company no later than the fourth quarter of the fiscal year
ending June 30, 2001, and, accordingly, amounts billed to customers related to
shipping and handling have been reclassified from cost of goods sold to net
sales.
FASB Statement of Financial Accounting Standards No. 141 "Business
Combinations" ("SFAS 141) was issued in June 2001. SFAS 141 changes the
accounting and reporting for business combinations. SFAS 141 is effective for
all business combinations initiated after June 30, 2001.
FASB Statement of Financial Accounting Standards No. 142 "Goodwill and
Other Intangible Assets" ("SFAS 142") was issued in June 2001. SFAS 142 changes
the accounting and reporting for acquired goodwill and other intangible assets.
SFAS 142 is effective for fiscal years beginning after December 15, 2001 and
must be applied at the beginning of an entity's fiscal year. The Company is
currently assessing the effect, if any, on its financial statements of
implementing SFAS 142.
Forward-Looking Statements
The information provided in this document contains forward-looking
statements that involve a number of risks and uncertainties. A number of factors
could cause actual results, performance, achievements of our 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: (i) the competitive environment in the
sampling industry in general and in our specific market areas; (ii) changes in
prevailing interest rates; (iii) inflation; (iv) changes in cost of goods and
services; (v) economic conditions in general and in our specific market areas;
(vi) changes in or failure to comply with postal regulations or other federal,
state and/or local government regulations; (vii) liability and other claims
asserted against us; (viii) changes in operating strategy or development plans;
(ix) the ability to attract and retain qualified personnel; (x) the significant
indebtedness of our company; (xi) labor disturbances; (xii) changes in our
capital expenditure plans; (xiii) and other factors.
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 risk, 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," "should," "seeks," "pro
forma," "anticipates," "intends" or the negative of any such word, or other
variations or comparable terminology, or by discussions of strategy or
intentions. Given these uncertainties, readers are cautioned not place undue
reliance on any forward-looking statements. We disclaim any obligations to
update any factors or to publicly announce the results of any revisions to any
28
of the forward-looking statements contained in this document to reflect future
events or developments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
In fiscal 2001, we generated approximately 21% of our sales from customers
outside the United States, principally in Europe. International sales are made
mostly from our foreign subsidiary located in France and are primarily
denominated in the local currency. Our foreign subsidiary also incurs the
majority of its expenses in the local currency and uses the local currency as
its functional currency.
Our major principal cash balances are held in U.S. dollars. Cash balances
in foreign currencies are held to minimum balances for working capital purposes
and therefore have a minimum risk to currency fluctuations.
We periodically enter into forward foreign currency exchange contracts to
hedge certain exposures related to selected transactions that are relatively
certain as to both timing and amount and to hedge a portion of the production
costs expected to be denominated in foreign currencies. The purpose of entering
into these hedge transactions is to minimize the impact of foreign currency
fluctuations on the results of operations and cash flows. Gains and losses on
the hedging activities are recognized concurrently with the gains and losses
from the underlying transactions. At June 30, 2001, there were no forward
exchange contracts outstanding.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Consolidated Financial Statements of each of
Holding and AKI, the related notes and the Report of Independent Accountants for
each of Holding and AKI commencing at page F-1 of this report, which financial
statements, notes and reports are incorporated by reference into this report.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
29
PART III
ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS OF REGISTRANT
The following table sets forth certain information with respect to the
directors and executive officers of Holding as of September 1, 2001.
Name Age Position
---- --- --------
Thompson Dean 43 Chairman of the Board and Director
William J. Fox 45 President, Chief Executive Officer and Director
Kenneth A. Budde 52 Senior Vice President, Chief Financial Officer and
Secretary
A. Bruce Prashker 39 Senior Vice President and Assistant Secretary
Hugh R. Kirkpatrick 64 Director
David M. Wittels 37 Director
James A. Quella 51 Director
Thompson Dean has served as Chairman of the Board and a Director of Holding
since December 1997. Mr. Dean has been Head of Leveraged Corporate Private
Equity for Credit Suisse First Boston since November 2000. He has also been
Investment Committee Co-Chairman and Managing Partner of DLJ Merchant Banking
Partners since 1995. Previously, Mr. Dean was a Managing Director of DLJ
Merchant Banking and its predecessor since 1991. Mr. Dean also serves as
Chairman of the Board of DeCrane Aircraft Holdings, Inc. and Von Hoffmann Press,
Inc., and as a director of Charles River Laboratories, Inc. Formica Corporation,
Insilco Holding Company, Manufactures' Services Ltd. and Mueller Holdings
(N.A.), Inc.
William J. Fox has served as President, Chief Executive Officer and a
Director of Holding and as Chairman, President and Chief Executive Officer and a
Director of AKI, Inc. since February 1999. Mr. Fox was President, Strategic and
Corporate Development of Revlon Worldwide, Senior Executive Vice President of
Revlon, Inc. and Revlon Consumer Products Corporation ("RCPC") (collectively,
"Revlon") and Chief Executive Officer, Revlon Technologies, a division of
Revlon, from January 1998 through January 1999. He was Executive Vice President
from 1991 through January 1997 and Senior Executive Vice President from January
1997 through January 1999 and Chief Financial Officer of Revlon from 1991 to
1997. Mr. Fox served as a director from November 1995 of Revlon, Inc. and from
September 1994 of RCPC, until April 1999. He was Senior Vice President of
MacAndrews and Forbes Holding Inc., the indirect majority shareholder of Revlon,
from August 1990 through January 1999. Mr. Fox also serves as Director and
Co-Chairman of the Board of Loehmann's Holdings, Inc.
Kenneth A. Budde has served as Chief Financial Officer of Holding 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.
30
A. Bruce Prashker has served as Senior Vice President of Holding since
April 2000. Prior to joining the Company, Mr. Prashker was Managing Principal of
the Capital Markets Company N.V. from April 1999 through April 2000. Mr.
Prashker served as Vice President & Controller of the International Division of
RCPC from January 1996 through April 1999, Vice President and Chief Financial
Officer of the Licensing Division of RCPC from August 1994 through January 1996
and held various other executive positions at RCPC and MacAndrews and Forbes
Holding Inc. from April 1990 through August 1994.
Hugh R. Kirkpatrick has served as a director of Holding 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.
David M. Wittels has served as a director of Holding since December 1997.
Mr. Wittels has been a Managing Director of DLJ Merchant Banking since January
2001. For the past five years, Mr. Wittels has served in various capacities with
DLJ Merchant Banking. Mr. Wittels also serves as a director of Mueller Holdings
(N.A.), Inc., Ziff Davis Holdings, Inc., Ziff Davis Media Inc., Advanstar, Inc.,
Advanstar Communications, Inc. and Wilson Greatbatch Technologies, Inc.
James A. Quella has served as a director of Holding since September 2000.
Mr. Quella has been a Managing Director and Operating Partner of DLJ Merchant
Banking since July 2000. From January 2000 to July 2000 Mr. Quella served as the
Managing Director of GH Venture Partners. Mr. Quella served as the
Vice-Chairman: Market Development and Director of the Executive Committee of
Mercer Management Consulting from 1996 to 2000. Mr. Quella was a Senior
Consultant for Mercer Management Consulting from 1990 to 1996. Mr. Quella serves
on the boards of directors of Advanstar, Inc. Merrill Corporation, Formica,
Inc., and Von Hoffman Press, Inc.
Compensation of Directors
Except for Mr. Kirkpatrick, who receives an annual fee of $20,000,
directors of Holding will not receive compensation for services rendered 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 of the
board. Mr. Kirkpatrick also received a grant of 5,000 stock options in fiscal
2000.
31
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information for the three most
recently completed fiscal years with respect to the compensation of our chief
executive officer and our other most highly compensated executive officers whose
total annual compensation exceeded $100,000. We refer to these individuals as
our named executive officers.
Summary Compensation Table
Long Term
Annual Compensation Compensation
------------------- ------------
Fiscal Securities All Other
Name and Principal Position Year Salary Bonus Underlying Options Compensation(1)
--------------------------- ---- ------ ----- ------------------ ---------------
William J. Fox 2001 $ 700,000 $ 1,125,000 -- 6,800
President, Chief Executive Officer 2000 650,000 1,214,000 888,000(2) 6,400
And Director 1999 242,308 250,000 -- --
Kenneth A. Budde 2001 190,000 135,000 -- 6,800
Chief Financial Officer 2000 175,000 102,500 160,000 7,090
1999 154,327 80,625 -- 9,077
A. Bruce Prashker 2001 190,000 90,000 -- 4,787
Senior Vice President 2000 34,346 -- 50,000 --
1999 - -- -- --
(1) Represents amounts contributed on behalf of the named executive to our
company's 401(k) retirement savings plan.
(2) Pursuant to the terms of his employment agreement, Mr. Fox is entitled to
receive options to acquire 5% of AHC's issued and outstanding common stock
on a fully diluted basis. As of June 30, 2000, 888,000 shares of common
stock represented 5% of AHC's issued and outstanding common stock on a
fully diluted basis.
32
Option Grants in Last Fiscal Year
There were no stock options granted during fiscal 2001 to any of the named
executive officers.
Fiscal Year End Option Values
The following table sets forth information about the number and value of
options held by the named executive officers as of June 30, 2001. The values of
the in-the-money options have been calculated on the basis of $1.00 per share
fair market value of our common stock as of that date less the applicable
exercise price.
Year End Option Values
Number of securities
underlying unexercised Value of unexercised in-the-
options at June 30, 2001 money options at June 30, 2001
--------------------------------- ---------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
William J. Fox 444,000 444,000 -- --
President, Chief Executive Officer
And Director
Kenneth A. Budde 83,334 76,666 -- --
Chief Financial Officer
A. Bruce Prashker 8,333 41,667 -- --
Senior Vice President
Equity-Based Compensation
AHC adopted the 1998 Stock Option Plan for employees and directors of AHC
and any parent or subsidiary corporation of AHC. The objectives of the option
plan are (1) to retain the services of persons holding key positions and to
secure the services of persons capable of filling such positions and (2) to
provide persons responsible for the future growth of AHC an opportunity to
acquire a proprietary interest in our Company and thus create in such key
employees an increased interest in and a greater concern for the welfare of our
Company.
The option plan authorizes the issuance of options to acquire up to
1,650,000 shares of common stock of AHC. The option plan will be administered by
the board of directors or a compensation committee to be designated by the board
of directors. Pursuant to the option plan, AHC may grant options, including
options that become exercisable as performance standards determined by the
committee are met, to key employees and directors of AHC and any parent or
subsidiary corporation. The terms of any grant will be determined by the
committee and set
33
forth in a separate grant agreement. The exercise price will be at least equal
to the fair market value per share of AHC 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 in the option plan) of AHC, each option may, at the
discretion of the committee, be terminated upon notice to the holder and each
such holder will receive, in respect of each share of AHC 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 AHC common stock over the per share exercise
price.
AHC granted 35,500 options for shares of capital stock in fiscal 2001 and
no options for shares of capital stock of AHC were exercised in fiscal 2001.
These options vest over periods ranging from one to five years. Certain options
are eligible for accelerated vesting based on targeted EBITDA.
Employment Agreements
Fox Agreement
On January 27, 1999, William J. Fox entered into an employment agreement
with our company effective February 1, 1999 and as amended effective July 1,
2001. The agreement initially ended on February 1, 2002, the third anniversary
of the effective date, subject to extension for one additional day each day
after February 1, 2000, unless either party provides notice not to extend.
Accordingly, as of September 1, 2001 the agreement ends on September 1, 2003.
Mr. Fox's base salary is $775,000 and he is eligible to receive a
performance-based bonus of between 50% to 100% or between 100% to 200% of his
base salary upon achievement of targeted goals, and other incentive payments.
Pursuant to the terms of his employment agreement, Mr. Fox is entitled to
receive options to acquire 5% of AHC's issued and outstanding common stock on a
fully diluted basis, subject to anti-dilution protection. Once granted, these
options will vest at specified dates and upon the occurrence of specified
conditions. In addition, upon a change in control (as defined in the employment
agreement), all time vested options vest and all performance vested options vest
if the DLJ Entities (as defined in the employment agreement) achieve certain
levels of return on their equity investments.
If Mr. Fox's employment is terminated by us without cause or by Mr. Fox for
good reason, we will pay Mr. Fox two times his base salary, 50% of such amount
on termination of employment and 50% paid in equal monthly installments over a
six-month period following the date of termination. However, in the event Mr.
Fox's employment is terminated by us without cause or by Mr. Fox for good
reason, within sixteen months following a Change of Control, Mr. Fox is entitled
to an amount equal to two times the highest aggregate base salary and
performance-based bonus amount paid to him in any of the three calendar years
prior to the effective date of any Change of Control, 50% of such amount on
termination of employment and 50% paid in equal monthly installments over a
six-month period following the date of termination. In addition, Mr. Fox will
receive a pro-rata bonus for the year of termination if he would have been
entitled to such a bonus had he remained employed during the year of
termination.
34
If such termination occurs within 6 months of a time where a tranche of
time-vested options would otherwise become exercisable, then a pro-rata portion
of such tranche will become exercisable.
The employment agreement contains confidentiality, noncompetition and
nonsolicitation provisions. The restricted period for the noncompetition
provisions upon termination of employment is two years if Mr. Fox's employment
is terminated by us without cause or by us for good reason, and one year if Mr.
Fox's employment is terminated for any other reason.
Budde Agreement
Mr. Budde is presently retained as chief financial officer pursuant to an
employment agreement that provides for an annual base salary of $210,000 and he
is eligible to receive a performance-based bonus of 60% of his base salary upon
achievement of targeted goals and up to 100% of his base salary for higher
performance. The term of the employment agreement with Mr. Budde, which expires
on June 30, 2002, automatically renews for additional twelve-month terms, unless
either party elects otherwise. If Mr. Budde is terminated by us without cause or
if we elect not to renew Mr. Budde's employment, we will pay Mr. Budde an amount
equal to his base salary over a twelve-month period following the date of
termination.
Compensation Committee Interlocks and Insider Participation
None of AHC, Holding or AKI had a compensation committee during fiscal
2001. Certain members of our board of directors, other than Mr. Fox,
participated in deliberations regarding compensation to be paid to Mr. Fox. Mr.
Fox determined the compensation to be paid to other executive officers.
35
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
All of AKI's issued and outstanding capital stock is owned by Holding. All
of Holding's issued and outstanding capital stock is owned by AHC. The following
table sets forth certain information as of August 31, 2001 with respect to the
beneficial ownership of AHC common stock by (1) owners of more than 5% of such
AHC common stock, (2) each director and named executive officer of Holding and
(3) all directors and executive officers of Holding, as a group.
Shares Percentage of
Beneficially Outstanding AHC
Beneficial Owner Owned Common Stock
---------------- ----- ------------
DLJ Merchant Banking Partners, II, L.P. 15,921,111 98.8%
and affiliated entities (1)
William J. Fox (2) 666,000 4.0%
Thompson Dean (3) --- ---
Hugh R. Kirpatrick (2) 2,778 *
James Quella (3) --- ---
David M. Wittels (3) --- ---
Kenneth A. Budde (2) 126,667 *
A. Bruce Prashker (2) 33,333 *
All directors and executive officers 828,778 4.9%
as a group (2)
-------------
* Less than one percent.
(1) Consists of shares held directly by the following affiliated
investors: DLJ Merchant Banking Partners II, L.P; DLJ Merchant Banking
Partners II-A, LP ("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");
DLJ First ESC L.P ("First ESC"); and Scratch & Sniff Funding, Inc.
("Scratch & Sniff")." The address of each of DLJMBII, DLJMBII-A,
Diversified Partners, Diversified Partners-A, DLJ Funding II, Scratch
& Sniff, Millennium Partners, Millennium Partners-A, EAB Partners and
First ESC is Eleven Madison Avenue, New York, New York 10010. The
address of Offshore Partners 11 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 AHC Common Stock held
directly by the Scratch & Sniff Funding, Inc., an affiliate of
DLJMBII.
(2) Includes shares of common stock issuable upon the exercise of stock
options exercisable within 60 days of August 31, 2001.
36
(3) Messrs. Dean, Quella and Wittels are officers of DLJ Merchant Banking,
an affiliate of DLJMBII. 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,
Quella and Wittels is Eleven Madison Avenue, New York, New York 10010.
ITEM 13. RELATED PARTY TRANSACTIONS
Transactions with DLJMBII and their Affiliates
Messrs. Dean and Wittels, who are directors of AKI and officers and
directors of Holding and AHC, are officers of DLJ Merchant Banking. DLJ Merchant
Banking, together with DLJMBII, beneficially own, in the aggregate,
approximately 98.8% of the outstanding common stock of AHC.
Pursuant to an agreement between Donaldson, Lufkin & Jenrette Securities
Corporation ("DLJ") and AHC, DLJ receives an annual fee of $250,000 for acting
as the exclusive financial and investment banking advisor until December 31,
2002. Our Company has agreed to indemnify DLJ in connection with its actions as
our financial advisor.
Stockholders Agreement
In connection with the acquisition of our Company, AHC, DLJMBII and certain
investors in our Company prior to the acquisition entered into a stockholders
agreement, dated as of December 15, 1997, that sets forth certain rights and
restrictions relating to the ownership of the capital stock of AHC (including
securities exercisable for or convertible or exchangeable into capital stock of
AHC) and agreements among the parties thereto as to the governance of AHC and,
indirectly, Holding and AKI.
Pursuant to the stockholders agreement, the board of directors of AHC
consists of six members, of which four may currently be nominated by DLJMBII.
The Chief Executive Officer of our Company is also to be a member of the board.
The stockholders agreement contains (1) certain restrictions on the ability
of each holder of capital stock of AHC to transfer any capital stock of AHC, (2)
certain preemptive rights to the holders of capital stock of AHC, (3) "drag
along" rights to DLJMBII to require the remaining holders of capital stock of
AHC to sell a percentage of their ownership and (4) "tag along" rights to the
holders of capital stock of AHC, other than DLJMBII, with respect to sales of
capital stock of AHC by DLJMBII.
DLJMBII is entitled to demand and piggy back registration rights with
regard to its shares of our common stock.
37
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The financial statements listed on the accompanying
index to such financial statements are filed as part
of this report.
2. Financial Statement Schedule
None.
3. Exhibits and Exhibit Index.
3.1 Certificate of Incorporation of Holding.*
3.2 Certificate of Incorporation of AKI.**
3.3 Bylaws of Holding.*
3.4 Bylaws of AKI.**
4.1 Indenture dated as of June 25, 1998 between Holding and State Street Bank
and Trust Company, as Trustee.*
4.2 Indenture dated as of June 25, 1998 between AKI and IBJ Schroder Trust
Company, as Trustee.**
4.3 Form of 13 1/2% Senior Discount Debentures due July 1, 2009 (included
in Exhibit 4.1).
4.4 Form of 10 1/2% Senior Discount Notes due July 1, 2008 (included in
Exhibit 4.2).
10.1 Registration Rights Agreement of Holding, dated as of June 25, 1998
between Holding and DLJMBII.*
10.2 Registration Rights Agreement of AKI, dated as of June 25, 1998, between
AKI and DLJMBII.**
10.3 AHC Stock Option Plan.*
10.4 Employment Agreement dated as of February 1, 1999 between Holding and
William J. Fox.***
10.5 Amendment to Employment Agreement dated as of September 17, 2001 between
Holding and William J. Fox. +
10.6 Credit Agreement, dated as of April 30, 1996, as amended by Amendment
No. 1, dated December 12, 1997, and as further amended by Amendment
No. 2, dated October 30, 1998, between the Company and Heller Financial,
Inc. (the "Credit Agreement").*
38
10.7 Amendment No. 3 to the Credit Agreement, dated August 30, 1999, between
the Company and Heller Financial.****
10.8 Amendment No. 4 to the Credit Agreement, dated September 21, 1999,
between the Company and Heller Financial, Inc.****
10.9 Amendment No. 5 to the Credit Agreement dated as of May 17, 2000, between
the Company and Heller Financial, Inc. |_|
10.10 Amendment No. 6 to the Credit Agreement dated as of December 1, 2000,
between the Company and Heller Financial, Inc. |_|
10.11 Securities Purchase Agreement dated as of December 15, 1997 between
Holding and Scratch & Sniff Funding, Inc.*
10.12 Asset Purchase Agreement dated as of May 28, 1998 between AKI and
Minnesota, Mining and Manufacturing Company.*
10.13 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
related investors.*
10.14 Financial Advisory Agreement dated as of December 12, 1997 between AHC
and DLJ.*
10.15 Stock Purchase Agreement, by and among AKI and each of Michael Berman,
Paul Pearl, Stuart Fleischer, Jay Gartlan, Retail TCA Corporation, a New
York corporation, Retail TCB Corporation, a New York corporation, and
Sleepeck Printing Company, an Illinois corporation, dated as of September
2, 1999.*****
10.16 Employment Agreement dated as of July 1, 2000, between Holding and
Kenneth A. Budde .*****
12.1 Computation of Ratio of Earnings to Fixed Charges.+
21.1 Subsidiaries of Holding.+
--------------
* Incorporated by reference from Registrant's Registration Statement on
Form S-4, File No. 333-60991 filed with the Securities and Exchange
Commission on August 7, 1998.
** Incorporated by reference from Registrant's Registration Statement on
Form S-4, File No. 333-60989 filed with the Securities and Exchange
Commission on August 7, 1998.
*** Incorporated by reference from Registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on February 4, 1999.
**** Incorporated by reference from Registrant's Annual Report on Form 10-K
filed with the Securities and Exchange Commission on September 28, 1999.
***** Incorporated by reference from Registrant's Annual Report on Form 10-K
filed with the Securities and Exchange Commission on September 28, 2000.
|_| Incorporated by reference from Registrant's Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on November 14, 2000.
+ Filed herewith.
39
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the three months
ended June 30, 2001.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, AKI Holding Corp. has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on the 18th day of
September, 2001.
AKI HOLDING CORP.
(Registrant)
By: /S/ William J. Fox
--------------------------------------
William J. Fox
President and Chief Executive Officer
Each person whose signature appears below hereby appoints William J. Fox
and Kenneth Budde, or any of them, as such person's true and lawful
attorney-in-fact, with full power of substitution or resubstitution for such
person and in such person's name, place and stead, in any and all capacities, to
sign on such person's behalf, individually and in each capacity stated below,
any and all amendments to this Report on Form 10-K, with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact, full power and authority to do
and perform each and every act and thing requisite or necessary to be done in
and about the premises, as fully to all intents and purposes as such person
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact, or their substitute or substitutes, may lawfully do or cause
to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities indicated on
the 18th day of September, 2001.
SIGNATURE TITLE
--------- -----
/S/ Thompson Dean Chairman and Director
---------------------------
Thompson Dean
/S/ William J. Fox President, Chief Executive Officer and
--------------------------- Director (Principal Executive Officer)
William J. Fox
/S/ Kenneth Budde Senior Vice President, Chief Financial Officer
--------------------------- and Secretary (Principal Financial and
Kenneth Budde Accounting Officer)
/S/ Hugh Kirkpatrick Director
---------------------------
Hugh Kirkpatrick
41
/S/ James A. Quella Director
----------------------------
James A. Quella
/S/ David Wittels Director
----------------------------
David Wittels
42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, AKI, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized on the 18th day of
September, 2001.
AKI, INC.
(Registrant)
By: /S/ William J. Fox
--------------------------------------
William J. Fox
President, Chief Executive Officer and
Chairman
Each person whose signature appears below hereby appoints William J. Fox
and Kenneth Budde, or any of them, as such person's true and lawful
attorney-in-fact, with full power of substitution or resubstitution for such
person and in such person's name, place and stead, in any and all capacities, to
sign on such person's behalf, individually and in each capacity stated below,
any and all amendments to this Report on Form 10-K, with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact, full power and authority to do
and perform each and every act and thing requisite or necessary to be done in
and about the premises, as fully to all intents and purposes as such person
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact, or their substitute or substitutes, may lawfully do or cause
to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities indicated on
the 18th day of September, 2001.
SIGNATURE TITLE
/S/ William J. Fox President, Chief Executive Officer, Chairman
--------------------------- and Director (Principal Executive Officer)
William J. Fox
/S/ Kenneth Budde Senior Vice President, Chief Financial Officer
--------------------------- and Secretary (Principal Financial and
Kenneth Budde Accounting Officer)
/S/ Thompson Dean Director
---------------------------
Thompson Dean
/S/ Hugh Kirkpatrick Director
---------------------------
Hugh Kirkpatrick
43
/S/ James A. Quella Director
---------------------------
James A. Quella
/S/ David Wittels Director
---------------------------
David Wittels
44
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO
SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES
PURSUANT TO SECTION 12 OF THE ACT.
No annual report or proxy material has been or is expected to be sent to
security holders of the registrants.
45
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS OF AKI HOLDING CORP.:
Report of Independent Accountants.................................... F-2
Consolidated Balance Sheets at June 30, 2001 and 2000................ F-3
Consolidated Statements of Operations for the years ended
June 30, 2001, 2000 and 1999 .................................... F-4
Consolidated Statements of Stockholder's Equity
for the years ended June 30, 2001, 2000 and 1999 ................ F-5
Consolidated Statements of Cash Flows for the years ended
June 30, 2001, 2000 and 1999 .................................... F-6
Notes to Consolidated Financial Statements........................... F-7
CONSOLIDATED FINANCIAL STATEMENTS OF AKI, INC.:
Report of Independent Accountants.................................... F-23
Consolidated Balance Sheets at June 30, 2001 and 2000 ............... F-24
Consolidated Statements of Operations for the years ended
June 30, 2001, 2000 and 1999 .................................... F-25
Consolidated Statements of Stockholder's Equity
for the years ended June 30, 2001, 2000 and 1999 ................ F-26
Consolidated Statements of Cash Flows for the years ended
June 30, 2001, 2000 and 1999 .................................... F-27
Notes to Consolidated Financial Statements........................... F-28
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
AKI Holding Corp. and Subsidiaries
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholder's equity and cash
flows present fairly, in all material respects, the financial position of AKI
Holding Corp. and Subsidiaries at June 30, 2001 and 2000, and the results of
their operations and their cash flows for each of the three years in the period
ended June 30, 2001 in conformity with generally accepted accounting principles
in the United States of America. 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 auditing standards generally accepted in the
United States of America, 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 our opinion.
PricewaterhouseCoopers LLP
Knoxville, Tennessee
August 3, 2001
F-2
AKI HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share information)
June 30,
----------------------
2001 2000
---- ----
ASSETS
Current assets
Cash and cash equivalents.............................................. $ 4,654 $ 1,158
Accounts receivable, net............................................... 18,020 21,522
Inventory.............................................................. 6,330 7,757
Prepaid expenses....................................................... 492 92
Deferred income taxes.................................................. 770 396
----------- -----------
Total current assets............................................. 30,266 30,925
Property, plant and equipment, net..................................... 15,778 17,097
Goodwill, net ......................................................... 157,334 162,472
Other intangible assets, net........................................... 6,337 7,174
Deferred charges, net.................................................. 4,381 5,461
Deferred income taxes.................................................. - 57
Other assets........................................................... 88 88
----------- -----------
Total assets..................................................... $ 214,184 $ 223,274
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligations........................... $ 503 $ 847
Accounts payable, trade................................................ 3,886 3,565
Accrued income taxes................................................... 1,642 724
Accrued compensation................................................... 4,715 3,965
Accrued interest....................................................... 5,443 5,695
Accrued expenses....................................................... 3,908 2,370
----------- -----------
Total current liabilities........................................ 20,097 17,166
Long-term portion of capital lease obligations......................... - 502
Revolving credit line.................................................. - 9,000
Senior notes........................................................... 103,510 107,510
Senior discount debentures............................................. 23,926 27,863
Deferred income taxes.................................................. 19 -
Other non-current liabilities.......................................... 1,863 2,399
----------- -----------
Total liabilities................................................ 149,415 164,440
Commitments and contingencies
Stockholder's equity
Common stock, $0.01 par, 1,000 shares authorized; 1,000
shares issued and outstanding...................................... - -
Additional paid-in capital............................................. 93,656 88,935
Accumulated deficit.................................................... (12,320) (13,829)
Accumulated other comprehensive loss................................... (837) (542)
Carryover basis adjustment............................................. (15,730) (15,730)
----------- -----------
Total stockholder's equity....................................... 64,769 58,834
----------- -----------
Total liabilities and stockholder's equity....................... $ 214,184 $ 223,274
=========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
AKI HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
Year Ended June 30,
----------------------------------
2001 2000 1999
---- ---- ----
Net sales..................................................... $ 115,395 $ 99,811 $ 87,169
Cost of goods sold............................................ 71,336 61,552 56,401
--------- --------- ---------
Gross profit............................................. 44,059 38,259 30,768
Selling, general and administrative expenses ................. 18,199 16,980 14,500
Amortization of goodwill and other intangible assets.......... 5,757 5,336 4,606
Gain from settlement of litigation, net....................... - (858) -
--------- --------- ---------
Income from operations................................... 20,103 16,801 11,662
Other expenses (income):
Interest expense to stockholder(s) and affiliate........... 320 22 -
Interest expense, other.................................... 16,591 17,379 16,740
Management fees to stockholders and affiliate.............. 250 250 250
Other, net................................................. - - 128
--------- --------- ---------
Income (loss) before income taxes and extraordinary gain. 2,942 (850) (5,456)
Income tax expense (benefit).................................. 3,449 1,596 (340)
--------- --------- ---------
Loss before extraordinary gain........................... (507) (2,446) (5,116)
Extraordinary gain from early retirement of debt, net of tax.. 2,016 1,089 -
--------- --------- ---------
Net income (loss).......................................... $ 1,509 $ (1,357) $ (5,116)
========= ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
AKI HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(in thousands, except share information)
Accumulated
Additional Other Carryover
Common Stock Paid-in Accumulated Comprehensive Basis
Shares Amount Capital Deficit Loss Adjustment Total
------ ------ ------- ------- ---- ---------- -----
Balances, June 30, 1998......... 1,000 $ - $ 78,364 $ (5,493) $ (57) $ (15,730) $ 57,084
Net loss........................ - - - (5,116) - - (5,116)
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment................. - - - - (308) - (308)
--------
Comprehensive loss.............. (5,424)
Dividend to AHC I Acquisition
Corp.......................... - - - (1,863) - - (1,863)
----- ------- --------- --------- --------- --------- --------
Balances, June 30, 1999......... 1,000 - 78,364 (12,472) (365) (15,730) 49,797
Equity contribution by AHC I
Acquisition Corp.............. - - 10,571 - - - 10,571
Net loss........................ - - - (1,357) - - (1,357)
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment................. - - - - (177) - (177)
--------
Comprehensive loss.............. (1,534)
----- ------- --------- ---------- --------- --------- --------
Balances, June 30, 2000......... 1,000 - 88,935 (13,829) (542) (15,730) 58,834
Equity contribution by AHC I
Acquisition Corp.............. - - 4,721 - - - 4,721
Net income...................... - - - 1,509 - - 1,509
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment................. - - - - (295) - (295)
--------
Comprehensive income............ 1,214
----- ------- --------- ---------- --------- --------- --------
Balances, June 30, 2001......... 1,000 $ - $ 93,656 $ (12,320) $ (837) $ (15,730) $ 64,769
===== ======= ========= ========== ========= ========= ========
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
AKI HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended June 30,
---------------------------------------
2001 2000 1999
---- ---- ----
Cash flows from operating activities:
Net income (loss).......................................... $ 1,509 $ (1,357) $ (5,116)
Adjustment to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization of goodwill and other
intangibles............................................ 10,119 9,738 8,487
Amortization of debt discount............................ 3,610 3,638 3,631
Amortization of loan closing costs....................... 664 1,309 727
Deferred income taxes.................................... (1,597) 945 (544)
Gain on sale of equipment................................ - - (50)
Gain from early retirement of debt....................... (2,016) (2,345) -
Other.................................................... (84) (1) (308)
Changes in operating assets and liabilities:
Accounts receivable.................................... 3,502 (2,576) (2,737)
Inventory.............................................. 1,427 (2,496) (3,031)
Prepaid expenses, deferred charges and other assets.... (400) 450 (975)
Accounts payable and accrued expenses.................. 1,939 (2,637) 4,511
Income taxes........................................... 931 259 5,238
--------- --------- ---------
Net cash provided by operating activities.............. 19,604 4,927 9,833
--------- --------- ---------
Cash flows from investing activities:
Purchases of equipment..................................... (3,015) (2,782) (2,856)
Proceeds from sale of equipment............................ - - 50
Payments for acquisitions, net of cash acquired............ - (16,164) -
Patents.................................................... (137) (150) -
--------- --------- ---------
Net cash used in investing activities.................. (3,152) (19,096) (2,806)
--------- --------- ---------
Cash flows from financing activities:
Payments under capital leases for equipment................ (846) (688) (661)
Repayments of long-term debt............................... (3,110) - -
Net proceeds (repayments) on line of credit................ (9,000) 9,000 -
Repayment of other notes payable........................... - - (1,330)
Dividend paid to AHC I Acquisition Corp.................... - - (1,863)
--------- --------- ---------
Net cash provided by (used in) financing activities.... (12,956) 8,312 (3,854)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents.......... 3,496 (5,857) 3,173
Cash and cash equivalents, beginning of period................ 1,158 7,015 3,842
--------- --------- ---------
Cash and cash equivalents, end of period...................... $ 4,654 $ 1,158 $ 7,015
========= ========= =========
Supplemental information:
Cash paid (received) during the period for:
Interest to stockholder(s) and affiliate............. $ 320 $ 22 $ -
Interest, other...................................... 12,233 13,188 6,512
Income taxes......................................... 4,115 1,264 (5,123)
Significant non-cash activities:
Assets acquired under capital lease........................ $ - $ - $ 600
Contribution of equity and retirement of senior discount
debentures and senior notes.............................. 4,721 10,571 -
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
1. ORGANIZATION AND BUSINESS
Arcade Holding Corporation (the "Predecessor") was organized for the
purpose of acquiring all the issued and outstanding capital stock of
Arcade, Inc. ("Arcade") on November 4, 1993. 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. ("AHC") and AHC I Merger Corp. ("Merger
Corp.") for purposes of acquiring the Predecessor (the "Acquisition"). On
December 15, 1997, Merger Corp. acquired all of the equity interests of the
Predecessor and then merged with and into the Predecessor and the combined
entity assumed the name AKI, Inc. and Subsidiaries ("AKI"). Subsequent to
the Acquisition, AHC contributed $1 and all of its ownership interest in
AKI to AKI Holding Corp. ("Holding," the "Successor" or the "Company") for
all of the outstanding equity of Holding. AKI is engaged in interactive
advertising for consumer products companies and has a specialty in the
design, production and distribution of sampling systems from its
Chattanooga, Tennessee facilities and distributes its products in Europe
through its French subsidiary, Arcade Europe S.A.R.L.
Unless otherwise indicated, all references to years refer to AKI's and
Holding's fiscal year, June 30.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
F-7
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
One customer accounted for 14.9% of net sales during the year ended
June 30, 2001. One customer accounted for 15.3% of net sales during the
year ended June 30, 2000. Two customers accounted for 26.8% of net sales
during the year ended June 30, 1999.
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 the specific grades of paper utilized
by the Company 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 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 at the time ownership transfers, net of
estimated discounts. Accounts receivable is accounted for net of allowances
for doubtful accounts. Under arrangements with certain customers, custom
product which is stored for future delivery is recognized as revenue when
title has passed to the customer.
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. Leasehold
improvements are depreciated over the shorter of their estimated useful
lives or the lease term.
F-8
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 a period of up to forty years using the
straight-line method. Accumulated amortization was $15,353 and $10,546 at
June 30, 2001 and June 30, 2000, respectively.
Management periodically reviews the value of its goodwill and other
long-lived assets to determine if an impairment has occurred. The potential
impairment of recorded goodwill and other long-lived assets 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 or its other long-lived assets
has occurred.
Deferred Charges
Deferred charges are primarily comprised of debt issuance costs which
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.
Other Intangible Assets
Other intangible assets include covenants not to compete, patents and
other intangible assets and are being amortized over their estimated lives
using the straight-line method. Accumulated amortization related to these
intangibles assets was $2,442 and $1,479 at June 30, 2001 and June 30,
2000, respectively.
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
fair value of the Company's Senior Notes and Senior Discount Debentures, as
determined from quoted market prices, was $99,370 and $12,110 at June 30,
2001 compared to a carrying value of $103,510 and $23,926, respectively.
The carrying value of all other financial instruments approximated fair
value at June 30, 2001.
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
amounted to $403, $51 and $91 for the years ended June 30, 2001, 2000 and
1999, respectively.
F-9
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 $1,591, $1,309 and $1,136 for the years ended
June 30, 2001, 2000 and 1999, respectively.
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 bases and financial reporting bases of assets and
liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse. Deferred tax assets are 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.
Recently Issued Accounting Standards
In September 2000, the Emerging Issues Task Force reached a consensus
on Issue 00-10, "Accounting for Shipping and Handling Fees and Costs"
("Issue 00-10"). Issue 00-10 requires that all amounts billed to customers
related to shipping and handling should be classified as revenues. Issue
00-10 was effective for the Company no later than the fourth quarter of the
fiscal year ending June 30, 2001, and, accordingly, amounts billed to
customers related to shipping and handling have been reclassified from cost
of goods sold to net sales.
FASB Statement of Financial Accounting Standards No. 141 "Business
Combinations" ("SFAS 141) was issued in June 2001. SFAS 141 changes the
accounting and reporting for business combinations. SFAS 141 is effective
for all business combinations initiated after June 30, 2001.
FASB Statement of Financial Accounting Standards No. 142 "Goodwill and
Other Intangible Assets" ("SFAS 142") was issued in June 2001. SFAS 142
changes the accounting and reporting for acquired goodwill and other
intangible assets. SFAS 142 is effective for fiscal years beginning after
December 15, 2001 and must be applied at the beginning of an entity's
fiscal year. The Company is currently assessing the effect, if any, on its
financial statements of implementing SFAS 142.
F-10
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
3. SIGNIFICANT ACQUISITIONS
On September 15, 1999, the Company acquired all of the equity
interests in RetCom Holdings Ltd. and its subsidiaries ("RetCom") for
approximately $12,500 and refinanced working capital indebtedness of
approximately $4,500 of RetCom. The acquisition was accounted for using the
purchase method of accounting. The purchase price has been allocated to the
assets and liabilities acquired using estimated fair values at the date of
acquisition and resulted in assigning value to goodwill totaling
approximately $19,100 which is being amortized on a straight line basis
over a period of twenty years. The fair values assigned are preliminary and
may be revalued at a later date but the change is not expected to be
material. The results of the acquired operations are included in the
financial statements since the date of acquisition. Pro forma results had
RetCom been acquired at the beginning of fiscal 1999 and 2000 are not
determinable.
In December, 1999 the Company settled a dispute with the former owners
of the Predecessor. In connection with the settlement the Company received
approximately $1.2 million and has included the settlement amount net of
related expenses in income from operations.
4. ACCOUNTS RECEIVABLE
The following table details the components of accounts receivable:
June 30,
--------------------
2001 2000
---- ----
Trade accounts receivable............... $ 18,487 $ 22,314
Allowance for doubtful accounts......... (836) (963)
---------- ----------
17,651 21,351
Other accounts receivable............... 369 171
---------- ----------
$ 18,020 $ 21,522
========== ==========
5. INVENTORY
The following table details the components of inventory:
June 30,
--------------------
2001 2000
---- ----
Raw materials
Paper................................. $ 1,796 $ 3,944
Other raw materials................... 2,697 2,541
--------- ----------
Total raw materials................ 4,493 6,485
Work in process......................... 1,837 1,272
--------- ----------
Total inventory......................... $ 6,330 $ 7,757
========= ==========
The difference between the carrying value of paper inventory using the
FIFO method as compared to the LIFO method was not significant at June 30,
2001 or June 30, 2000. During the year ended June 30, 2001, certain
inventory quantity reductions caused a liquidation of LIFO inventory values
which were immaterial.
F-11
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per 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:
June 30,
Estimated ------------------
Useful Lives 2001 2000
------------ ---- ----
Land....................... $ 258 $ 258
Building................... 7 - 15 years 1,851 1,719
Leasehold improvements..... 1 - 3 years 651 635
Machinery and equipment.... 5 - 7 years 23,622 21,348
Furniture and fixtures..... 3 - 5 years 3,370 3,081
Construction in progress... 405 101
--------- --------
30,157 27,142
Accumulated depreciation... (14,379) (10,045)
--------- --------
$ 15,778 $ 17,097
========= ========
Depreciation expense amounted to $4,334, $4,381 and $3,881 for the
years ended June 30, 2001, 2000 and 1999, respectively.
Property held under capital lease is included in the respective
property, plant and equipment category as follows:
June 30,
-------------------
2001 2000
---- ----
Machinery and equipment................... $ - $ 3,000
Building.................................. 600 600
--------- --------
600 3,600
Less accumulated depreciation............. (500) (1,390)
--------- --------
$ 100 $ 2,210
========= ========
Depreciation of assets under capital lease totaled $200, $600 and $515
for the years ended June 30, 2001, 2000 and 1999, respectively. Future
minimum lease payments under the remaining lease are as follows:
Payment Interest
--------- --------
2002................. $ 529 $ 26
7. LINE OF CREDIT
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.
As of June 30, 2001, the Company's borrowing base was approximately
$19,551. Interest on amounts borrowed accrue at a floating rate based upon
either prime or LIBOR (7.75% and 10.25% at June 30, 2001 and 2000,
respectively). The weighted average interest rate on the outstanding
balance under the Credit Agreement was 9.58%, 9.12% and 8.51% for the years
ended June 30, 2001, 2000 and 1999, respectively.
F-12
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
7. LINE OF CREDIT (Continued)
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. The Company did not
have any lender guarantees outstanding at June 30, 2001. These fees totaled
$59, $69 and $111 for the years ended June 30, 2001, 2000 and 1999,
respectively. The Credit Agreement contains certain financial covenants and
other restrictions including restrictions on additional indebtedness and
restrictions on the payment of dividends. As of June 30, 2001, the Company
was in compliance with all debt covenants.
8. LOANS PAYABLE TO STOCKHOLDER
In May 2000, the Company signed a promissory note payable to AHC which
allows the Company to borrow up to $10 million at such interest rates and
due as agreed upon by the Company and AHC. At June 30, 2001 no amount was
outstanding under the promissory note.
9. SENIOR NOTES
On June 25, 1998, AKI completed a private placement of $115,000 of
Senior Notes (the "Senior Notes") which mature on July 1, 2008. The Senior
Notes are general unsecured obligations of AKI and bear interest at 10.5%
per annum, payable semi-annually on January 1 and July 1. The placement of
the Senior Notes yielded AKI 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 are redeemable at the
option of the Company, in whole or part, at any time after July 1, 2003 at
a price of up to 105.25% of the outstanding principal balance plus accrued
and unpaid interest. Prior to July 1, 2003, AKI is permitted to repurchase
up to 35% of the Senior Notes at a redemption price equal to 110.5% of the
aggregate principal amount plus accrued and unpaid interest with the net
proceeds of one or more public equity offerings. The Senior Notes contain
certain covenants including restrictions on the declaration and payment of
dividends by AKI to Holding and limitations on the incurrence of additional
indebtedness. On December 22, 1998, AKI completed the registration of its
Senior Notes with the Securities and Exchange Commission. During fiscal
2001, AKI purchased $4,000 of the Senior Notes for $3,110 and recognized a
gain, net of income taxes, of approximately $457. During fiscal 2000, AHC
purchased $7,490 of the Senior Notes for $6,486 and recognized a gain, net
of income taxes, of approximately $429, respectively. The notes were
contributed to Holding and Holding contributed the notes to AKI. The notes
were subsequently retired.
10. SENIOR DISCOUNT DEBENTURES
On June 25, 1998, Holding completed a private placement of Senior
Discount Debentures (the "Debentures") with a stated value of $50,000. The
Debentures are general unsecured obligations of Holding and mature on July
1, 2009. The Debentures do not accrue or pay interest until July 1, 2003
and were issued with an original issuance discount of $24,038. The
placement of the Debentures yielded the Company net proceeds of $24,699
after deducting offering expenses of $1,263, including $1,038 of
underwriting fees paid to an affiliate of the stockholder. The original
issuance discount of $24,038 on the Debentures is being accreted from
issuance through July 1, 2003 at an effective rate of 13.5% per annum. The
unamortized balance of the original issuance discount was $7,124 and
$13,368 at June 30, 2001 and 2000, respectively. After July 1, 2003,
F-13
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
10. SENIOR DISCOUNT DEBENTURES (Continued)
the Debentures will accrue interest at a rate of 13.5% per annum, payable
semi-annually, 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 at a price up to 106.75% of the outstanding principal balance plus
accrued and unpaid interest. Prior to July 1, 2003, Holding is permitted to
repurchase up to 35% of the aggregate principal amount at maturity of the
Debentures originally issued at a redemption price equal to 113.5% of the
accreted value of the Debentures with the net proceeds of one or more
public equity offerings. The Debentures contain certain covenants including
restrictions on the declaration and payment of dividends and limitations on
the incurrence of additional indebtedness. On December 22, 1998, the
Company completed the registration of its Senior Discount Debentures with
the Securities and Exchange Commission. During fiscal 2001, AHC purchased
Senior Discount Debentures with a carrying value of $7,547 for $4,721 and
recognized a gain, net of income taxes, of approximately $1,559. During
fiscal 2000, AHC purchased Senior Discount Debentures with a carrying value
of $5,426 for $4,084 and recognized a gain, net of income taxes, of
approximately $660. The debentures were contributed to Holding and
subsequently retired.
11. INITIAL CAPITALIZATION
In conjunction with the Acquisition, AHC issued $30,000 of Floating
Rate Notes, $50,279 of Mandatorily Redeemable Senior Preferred Stock (the
"Senior Preferred Stock") and $1,111 of its Common Stock. The Floating Rate
Notes were issued with an original issuance discount of $5,389. Interest
was payable quarterly and could be settled through the issuance of
additional Floating Rate Notes through December 15, 2009, the maturity
date, at the discretion of AHC. The original issuance discount of $5,389
was being amortized using the effective interest method over the life of
the Floating Rate Notes. On November 1, 1999 AHC issued Amended and
Restated Notes totaling $35,500 in exchange for the Floating Rate Notes.
The Amended and Restated Notes bear a fixed interest rate of approximately
16% per annum and mature on December 15, 2009 and provide for the payment
of stipulated early redemption premiums. In connection with the exchange
the unamortized original issue discount was expensed by AHC. The Senior
Preferred Stock accretes in value at 15% per annum and must be redeemed by
December 15, 2012. The Amended and Restated Notes and Senior Preferred
Stock are general unsecured obligations of AHC.
The cash proceeds from the issuance of the Floating Rate Notes, Senior
Preferred Stock and Common Stock of approximately $76,000 and a Mandatorily
Redeemable Senior Preferred Stock Option of $2,363 were contributed by AHC
to AKI in exchange for 1,000 shares of AKI's Common Stock. Subsequent to
the capitalization of AKI, AHC contributed $1 of cash and all of its
ownership interest in AKI to Holding for all of the outstanding equity of
Holding.
AHC has no other operations other than the Company. Absent additional
financing by AHC, the Company's operations represent the only current
source of funds available to service the Floating Rate Notes and
Mandatorily Redeemable Senior Preferred Stock; however, the Company is not
obligated to pay or otherwise guarantee the Floating Rate Notes and
Mandatorily Redeemable Senior Preferred Stock.
F-14
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
12. COMMITMENTS AND CONTINGENCIES
Operating Leases
Equipment and office, warehouse and production space under operating
leases expire at various dates. Rent expense was $538, $589 and $338 for
the years ended June 30, 2001, 2000 and 1999, respectively. Future minimum
lease payments under the leases are as follows.
2002 $ 353
2003 431
2004 377
2005 356
2006 365
2007 157
--------
$ 2,039
========
Royalty Agreements
Royalty agreements are maintained for certain technologies used in the
manufacture of certain products. Under the terms of one royalty agreement,
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 $500 under this
agreement for each of the three years ended June 30, 2001. The Company has
paid $5,576 in cumulative royalty payments under this agreement through
June 30, 2001.
Under the terms of another 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 for years after fiscal 1999 are $625 through the expiration of the
agreement in 2012. The Company expensed $625, $625 and $575 under this
agreement for the years ended June 30, 2001, 2000 and 1999, respectively.
Employment Agreements
The Company has employment agreements with certain executive officers
with terms through June 30, 2002 and 2003. Such agreements provide for base
salaries totaling $985 per year. One officer has an incentive bonus of up
to 200% of base salary which is payable if certain financial and management
goals are attained and certain other incentive payments. The employment
agreements also provide severance benefits of up to two years of base
salary if the officers' 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.
F-15
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
12. COMMITMENTS AND CONTINGENCIES (Continued)
Printing Services Agreement
In connection with the RetCom acquisition, AKI entered into a five
year Printing Services Agreement with a former shareholder of RetCom. The
Printing Services Agreement requires annual purchases of printing services
totaling $5,000 and a 15% charge on the amount of any shortfall. The
present value of the costs related to the estimated shortfall over the life
of the Printing Services Agreement was recorded as a liability in the
RetCom purchase accounting.
13. 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. The
Company makes contributions to the Plan by matching a percentage of
employee contributions. Costs associated with the Plan totaled $294, $251
and $201 for the years ended June 30, 2001, 2000 and 1999, 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 $233,
$215 and $204 for the years ended June 30, 2001, 2000 and 1999,
respectively.
14. INCOME TAXES
The Company is included in the consolidated federal income tax return
filed by AHC. Income taxes related to the Company are 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 AKI.
For financial reporting purposes, income (loss) before income taxes
and extraordinary gain includes the following components:
Year Ended June 30,
---------------------------------------
2001 2000 1999
---- ---- ----
Income (loss) before income taxes and
extraordinary gain:
United States.................................. $ 1,481 $ (1,305) $ (5,978)
Foreign........................................ 1,461 455 522
--------- --------- ---------
$ 2,942 $ (850) $ (5,456)
========= ========= =========
F-16
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
14. INCOME TAXES (Continued)
Significant components of the provision (benefit) for income taxes are
as follows:
Year Ended June 30,
---------------------------------------
2001 2000 1999
---- ---- ----
Current expense (benefit):
Federal........................................ $ 4,288 $ 480 $ -
Foreign........................................ 526 171 204
State.......................................... 232 - -
--------- --------- ---------
5,046 651 204
--------- --------- ---------
Deferred expense (benefit):
Federal........................................ (1,931) 519 (481)
Foreign........................................ - - -
State.......................................... 334 426 (63)
--------- --------- ---------
(1,597) 945 (544)
--------- --------- ---------
$ 3,449 $ 1,596 $ (340)
========= ========= =========
The significant components of deferred tax assets (liabilities) at
June 30, 2001 and 2000, were as follows:
June 30,
-------------------------------------------------------
2001 2000
---------------------- ----------------------
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------
Deferred income tax assets:
Accrued expenses........................ $ 474 $ 2,338 $ 215 $ 2,427
Allowance for doubtful accounts......... 296 - 181 -
Net operating loss carryforwards........ - 78 - 412
Other non-current liabilities........... - 343 - 308
--------- -------- --------- ---------
770 2,759 396 3,147
Deferred income tax liability:
Property, plant and equipment......... - (2,778) - (3,090)
--------- --------- --------- ----------
Deferred tax assets (liabilities).. $ 770 $ (19) $ 396 $ 57
========= ======== ========= =========
The income tax provision recognized by the Company for the years ended
June 30, 2001, 2000 and 1999 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:
Year Ended June 30,
---------------------------------------
2001 2000 1999
---- ---- ----
Computed tax provision (benefit) at the
statutory rate................................. $ 1,030 $ (289) $ (1,855)
State income tax provision (benefit),
net of federal effect.......................... 368 281 (42)
Nondeductible expenses........................... 2,036 1,588 1,530
Other, net....................................... 15 16 27
--------- --------- ---------
$ 3,449 $ 1,596 $ (340)
========= ========= =========
F-17
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
14. INCOME TAXES (Continued)
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 losses in prior years the Company has recorded a
long-term deferred tax asset of $78 reflecting cumulative net operating
loss carryforwards available to offset future state taxable income of
approximately $1,297 at June 30, 2001. These cumulative net operating loss
carryforwards expire in varying amounts through 2019. Realization is
dependent on generating sufficient state 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.
15. STOCK OPTIONS
Subsequent to the Acquisition, AHC adopted the 1998 Stock Option Plan
("Option Plan") for certain employees and directors of AHC and any parent
or subsidiary of AHC. The Option Plan authorizes the issuance of options to
acquire up to 1,650,000 shares of AHC Common Stock. The Board of Directors
determines the terms of each individual options grant. The exercise price
for each grant is required to be set at least equal to the fair market
value per share of AHC provided that the exercise price shall not be less
than $1.00 per share. Options vest over periods ranging from one to eight
years. Certain options are eligible for accelerated vesting based on
targeted EBITDA. Options may be exercisable for up to ten years.
A summary of AHC stock option activity and related information for the
years ended June 30, 2001 and 2000 follows:
2001 2000
------------------------ ------------------------
Weighted Weighted
Average Average
Exercise Exercise
Options Price Options Price
------- ----- ------- -----
Outstanding, beginning of year.......... 1,509,450 $ 1.00 - $ -
Granted............................ 35,500 1.00 1,519,917 1.00
Exercised.......................... - - - -
Forfeited.......................... (90,567) 1.00 (10,467) 1.00
--------- ------- --------- --------
Outstanding, end of year................ 1,454,383 $ 1.00 1,509,450 $ 1.00
========= ======= ========= ========
Exercisable, end of year................ 640,793 $ 1.00 273,668 $ 1.00
========= ======= ========= ========
Weighted average remaining
contractual life................... 8.5 years 9.5 years
F-18
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
15. STOCK OPTIONS (Continued)
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 income (loss)
for the years ended June 30, 2001 and 2000 would have been $1,404 and
$(1,408), respectively. In making this determination, fair value was
estimated on the date of grant using the minimum value method and a
risk-free interest rate ranging from 6.3% to 6.9%, estimated life of five
years and dividend rate of 0.0%. The weighted average fair value at date of
grant of options granted during 2001 and 2000 was approximately $0.27 per
option.
16. RELATED PARTY TRANSACTIONS
The Company made payments to an affiliate of DLJMBII for management
fees of $250 for each of the three years ended June 30, 2001.
17. GEOGRAPHIC INFORMATION
The following table illustrates geographic information for revenues
and long-lived assets. Revenues are attributed to countries based on the
receipt of sales orders and long-lived assets are based upon the country of
domicile.
United
Net sales: States France Total
Year ended June 30, 1999.................... $ 72,016 $ 15,153 $ 87,169
Year ended June 30, 2000.................... 85,418 14,393 99,811
Year ended June 30, 2001.................... 96,845 18,550 115,395
Long-lived assets:
June 30, 1999............................... 180,984 107 181,091
June 30, 2000............................... 192,262 87 192,349
June 30, 2001............................... 183,848 70 183,918
F-19
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
18. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following condensed balance sheet at June 30, 2001 and June 30,
2000 and condensed statement of operations, stockholder's equity and cash
flows for the years ended June 30, 2001 and June 30, 2000 for Holding
should be read in conjunction with the consolidated financial statements
and notes thereto.
BALANCE SHEETS
June 30,
---------------------
2001 2000
---- ----
Assets
Investment in subsidiaries........................................ $ 102,237 $ 99,798
Deferred charges.................................................. 806 1,167
Deferred income taxes............................................. 2,338 2,013
---------- -----------
Total assets.................................................... $ 105,381 $ 102,978
========== ===========
Liabilities
Accrued Income Taxes.............................................. $ 119 $ 9
Senior Discount Debentures........................................ 23,926 27,863
---------- -----------
Total liabilities............................................... 24,045 27,872
---------- -----------
Stockholder's equity
Common Stock, $0.01 par value, 1,000 shares authorized;
1,000 shares issued and outstanding............................. - -
Additional paid-in capital........................................ 93,656 88,935
Accumulated deficit............................................... (12,320) (13,829)
---------- -----------
Total stockholder's equity...................................... 81,336 75,106
---------- -----------
Total liabilities and stockholder's equity...................... $ 105,381 $ 102,978
========== ===========
STATEMENT OF OPERATIONS
Year Ended June 30,
----------------------
2001 2000
---- ----
Equity in net income of subsidiaries.............................. $ 2,439 $ 495
Interest expense, net............................................. (3,699) (3,733)
---------- -----------
Loss before income taxes and extraordinary gain................. (1,260) (3,238)
Income tax benefit................................................ (1,210) (1,221)
---------- -----------
Loss before extraordinary gain.................................. (50) (2,017)
Extraordinary gain from early retirement of debt, net of tax...... 1,559 660
---------- -----------
Net income (loss)............................................... $ 1,509 $ (1,357)
========== ===========
F-20
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
18. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)
STATEMENT OF STOCKHOLDER'S EQUITY
Additional
Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----
Balances, June 30, 1999.......... 1,000 $ - $ 78,364 $ (12,472) $ 65,892
Equity contribution by AHC I
Acquisition Corp............... - - 10,571 - 10,571
Net loss......................... - - - (1,357) (1,357)
------- ------- ----------- ---------- -----------
Balances, June 30, 2000.......... 1,000 - 88,935 (13,829) 75,106
Equity contribution by AHC I
Acquisition Corp............... - - 4,721 - 4,721
Net income....................... - - - 1,509 1,509
------- ------- ----------- ---------- -----------
Balances, June 30, 2001.......... 1,000 $ - $ 93,656 $ (12,320) $ 81,336
======= ======= =========== ========== ===========
STATEMENT OF CASH FLOWS
Year Ended June 30,
-------------------
2001 2000
---- ----
Cash flows from operating activities:
Net income (loss)................................................... $ 1,509 $ (1,357)
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Net change in investment in subsidiaries.......................... (2,439) (495)
Amortization of original issuance discount and loan closing costs. 3,699 3,733
Deferred income taxes............................................. (1,210) (1,221)
Gain from early retirement of debt................................ (1,559) (660)
---------- -----------
Net cash provided by (used in) operating activities............. - -
---------- -----------
Net increase (decrease) in cash and cash equivalents.............. - -
Cash and cash equivalents, beginning of period.................... - -
---------- -----------
Cash and cash equivalents, end of period.......................... $ - $ -
========== ===========
F-21
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
19. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following is a summary of the unaudited quarterly results of
operations for Fiscal 2001 and Fiscal 2000.
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2001 2000 2000 2001 2001 Total
---- ---- ---- ---- -----
Net sales............... $ 32,353 $ 26,180 $ 33,094 $ 23,768 $ 115,395
Gross profit............ 12,805 8,487 13,765 9,002 44,059
Income from operations.. 6,868 2,626 7,298 3,311 20,103
Interest expense, net... 4,404 4,244 4,269 3,994 16,911
Net income (loss)....... 937 (621) 1,712 (519) 1,509
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2000 1999 1999 2000 2000 Total
---- ---- ---- ---- -----
Net sales............... $ 28,673 $ 20,843 $ 25,783 $ 24,512 $ 99,811
Gross profit............ 12,587 7,220 9,941 8,511 38,259
Income from operations.. 7,265 2,202 4,926 2,408 16,801
Interest expense, net... 4,372 4,295 4,382 4,352 17,401
Net income (loss)....... 1,281 (664) (230) (1,744) (1,357)
F-22
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
AKI, Inc. and Subsidiaries
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholder's equity and cash
flows present fairly, in all material respects, the financial position of AKI,
Inc. and Subsidiaries at June 30, 2001 and 2000 and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 2001 in conformity with generally accepted accounting principles in the
United States of America. 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 auditing standards generally accepted in the United States of
America, 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 our opinion.
PricewaterhouseCoopers LLP
Knoxville, Tennessee
August 3, 2001
F-23
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share information)
June 30,
------------------------
2001 2000
---- ----
ASSETS
Current assets
Cash and cash equivalents.............................................. $ 4,654 $ 1,158
Accounts receivable, net............................................... 18,020 21,522
Inventory.............................................................. 6,330 7,757
Prepaid expenses....................................................... 492 92
Deferred income taxes.................................................. 770 396
---------- -----------
Total current assets............................................. 30,266 30,925
Property, plant and equipment, net..................................... 15,778 17,097
Goodwill, net ......................................................... 157,334 162,472
Other intangible assets, net........................................... 6,337 7,174
Deferred charges, net.................................................. 3,575 4,294
Other assets........................................................... 88 88
---------- -----------
Total assets..................................................... $ 213,378 $ 222,050
========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligation............................ $ 503 $ 847
Accounts payable, trade................................................ 3,886 3,565
Accrued income taxes................................................... 1,523 301
Accrued compensation................................................... 4,715 3,965
Accrued interest....................................................... 5,443 5,695
Accrued expenses....................................................... 3,908 2,370
---------- -----------
Total current liabilities........................................ 19,978 16,743
Long-term portion of capital lease obligation.......................... - 502
Revolving credit line.................................................. - 9,000
Senior notes........................................................... 103,510 107,510
Deferred income taxes.................................................. 2,357 2,370
Other non-current liabilities.......................................... 1,863 2,399
---------- -----------
Total liabilities................................................ 127,708 138,524
Commitments and contingencies
Stockholder's equity
Common stock, $0.01 par, 100,000 shares authorized; 1,000
shares issued and outstanding...................................... - -
Additional paid-in capital............................................. 107,348 107,348
Accumulated deficit.................................................... (5,111) (7,550)
Accumulated other comprehensive loss................................... (837) (542)
Carryover basis adjustment............................................. (15,730) (15,730)
---------- -----------
Total stockholder's equity....................................... 85,670 83,526
---------- -----------
Total liabilities and stockholder's equity....................... $ 213,378 $ 222,050
========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-24
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
Year Ended June 30,
----------------------------------
2001 2000 1999
---- ---- ----
Net sales..................................................... $ 115,395 $ 99,811 $ 87,169
Cost of goods sold............................................ 71,336 61,552 56,401
--------- --------- ---------
Gross profit............................................... 44,059 38,259 30,768
Selling, general and administrative expenses.................. 18,199 16,980 14,500
Amortization of goodwill and other intangible assets.......... 5,757 5,336 4,606
Gain from settlement of litigation, net....................... - (858) -
--------- ---------- ---------
Income from operations..................................... 20,103 16,801 11,662
Other expenses (income):
Interest expense to stockholder(s) and affiliate........... 320 22 -
Interest expense, other.................................... 12,892 13,646 13,028
Management fees to stockholders and affiliate.............. 250 250 250
Other, net................................................. - - 128
--------- --------- ---------
Income (loss) before income taxes and
extraordinary gain....................................... 6,641 2,883 (1,744)
Income tax expense ........................................... 4,659 2,817 847
--------- --------- ---------
Income (loss) before extraordinary gain.................. 1,982 66 (2,591)
Extraordinary gain from early retirement of debt, net
of tax ..................................................... 457 429 -
--------- --------- ---------
Net income (loss)............................................. $ 2,439 $ 495 $ (2,591)
========= ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-25
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(in thousands, except share information)
Accumulated
Additional Other Carryover
Common Stock Paid-in Accumulated Comprehensive Basis
Shares Amount Capital Deficit Loss Adjustment Total
------ ------ ------- ------- ---- ---------- -----
Balances, June 30, 1998......... 1,000 $ - $ 100,862 $ (5,454) $ (57) $ (15,730) $ 79,621
Net loss........................ - - - (2,591) - - (2,591)
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment................. - - - - (308) - (308)
--------
Comprehensive loss.............. (2,899)
------ ------- --------- -------- --------- --------- --------
Balances, June 30, 1999......... 1,000 - 100,862 (8,045) (365) (15,730) 76,722
Equity contribution by AKI
Holding Corp.................. - - 6,486 - - - 6,486
Net income...................... - - - 495 - - 495
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment................. - - - - (177) - (177)
--------
Comprehensive income............ 318
------ ------- --------- -------- --------- --------- --------
Balances, June 30, 2000......... 1,000 - 107,348 (7,550) (542) (15,730) 83,526
Equity contribution by AKI
Holding Corp.................. - - - - - - -
Net income...................... - - - 2,439 - - 2,439
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment................. - - - - (295) - (295)
--------
Comprehensive income............ 2,144
------ ------- --------- -------- --------- --------- --------
Balances, June 30, 2001......... 1,000 $ - $ 107,348 $ (5,111) $ (837) $ (15,730) $ 85,670
====== ======= ========= ======== ========= ========= ========
The accompanying notes are an integral part of these consolidated
financial statements.
F-26
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended June 30,
---------------------------------------
2001 2000 1999
---- ---- ----
Cash flows from operating activities:
Net income (loss)........................................ $ 2,439 $ 495 $ (2,591)
Adjustment to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization of goodwill and other
intangibles 10,119 9,738 8,487
Amortization of loan closing costs................... 575 656 636
Deferred income taxes................................ (387) 2,166 643
Gain on sale of equipment............................ - - (50)
Gain from early retirement of debt................... (457) (429) -
Other................................................ (84) (1) (308)
Changes in operating assets and liabilities:.........
Accounts receivable................................ 3,502 (2,576) (2,737)
Inventory.......................................... 1,427 (2,496) (3,031)
Prepaid expenses, deferred charges and other assets (400) 450 (627)
Accounts payable and accrued expenses.............. 1,939 (2,637) 4,511
Income taxes....................................... 931 (439) 5,238
--------- --------- ---------
Net cash provided by operating activities............ 19,604 4,927 10,171
--------- --------- ---------
Cash flows from investing activities:
Purchases of equipment................................... (3,015) (2,782) (2,856)
Proceeds from sale of equipment.......................... - - 50
Payments for acquisitions, net of cash acquired.......... - (16,164) -
Patents.................................................. (137) (150) -
--------- --------- ---------
Net cash used in investing activities................ (3,152) (19,096) (2,806)
--------- --------- ---------
Cash flows from financing activities:
Payments under capital leases for equipment.............. (846) (688) (661)
Repayments of long-term debt............................. (3,110) - -
Net proceeds (repayments) on line of credit.............. (9,000) 9,000 -
Repayment of other notes payable......................... - - (1,330)
--------- --------- --------
Net cash provided by (used in) financing activities.. (12,956) 8,312 (1,991)
--------- --------- --------
Net increase (decrease) in cash and cash equivalents....... 3,496 (5,857) 5,374
Cash and cash equivalents, beginning of period............. 1,158 7,015 1,641
--------- --------- --------
Cash and cash equivalents, end of period................... $ 4,654 $ 1,158 $ 7.015
========= ========= ========
Supplemental information:
Cash paid (received) during the period for:
Interest to stockholder(s)............................. $ 320 $ 22 $ -
Interest, other........................................ 12,233 13,188 6,512
Income taxes........................................... 4,115 1,264 (5,123)
Significant non-cash activities:
Assets acquired under capital lease...................... $ - $ - $ 600
Contribution of equity and retirement of senior notes.... - 6,486 -
The accompanying notes are an integral part of these consolidated
financial statements.
F-27
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
1. ORGANIZATION AND BUSINESS
Arcade Holding Corporation (the "Predecessor") was organized for the
purpose of acquiring all the issued and outstanding capital stock of
Arcade, Inc. ("Arcade") on November 4, 1993. 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. ("AHC") and AHC I Merger Corp. ("Merger
Corp.") for purposes of acquiring the Predecessor (the "Acquisition"). On
December 15, 1997, Merger Corp. acquired all of the equity interests of the
Predecessor and then merged with and into the Predecessor and the combined
entity assumed the name AKI, Inc. and Subsidiaries ("AKI," the "Successor"
or the "Company"). Subsequent to the Acquisition, AHC contributed $1 of
cash and all of its ownership interest in AKI to AKI Holding Corporation
("Holding") for all of the outstanding equity of Holding. AKI is engaged in
interactive advertising for consumer products companies and has a specialty
in the design, production and distribution of sampling systems from its
Chattanooga, Tennessee facilities and distributes its products in Europe
through its French subsidiary, Arcade Europe S.A.R.L.
Unless otherwise indicated, all references to years refer to AKI's
fiscal year, June 30.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
F-28
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
One customer accounted for 14.9% of net sales during the year ended
June 30, 2001. One customer accounted for 15.3% of net sales during the
year ended June 30, 2000. Two customers accounted for 26.8% of net sales
during the year ended June 30, 1999.
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 the specific grades of paper utilized
by the Company 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 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 at the time ownership transfers, net of
estimated discounts. Accounts receivable is accounted for net of allowances
for doubtful accounts. Under arrangements with certain customers, custom
product which is stored for future delivery is recognized as revenue when
title has passed to the customer.
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. Leasehold
improvements are depreciated over the shorter of their estimated useful
lives or the lease term.
F-29
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 a period of up to forty years using the
straight-line method. Accumulated amortization was $15,353 and $10,546 at
June 30, 2001 and June 30, 2000, respectively.
Management periodically reviews the value of its goodwill and other
long-lived assets to determine if an impairment has occurred. The potential
impairment of recorded goodwill and other long-lived assets 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 or other long-lived assets has
occurred.
Deferred Charges
Deferred charges are primarily comprised of debt issuance costs, which
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.
Other Intangible Assets
Other intangible assets include covenants not to compete, patents and
other intangible assets and are being amortized over their estimated lives
using the straight-line method. Accumulated amortization related to these
intangible assets was $2,442 and $1,479 at June 30, 2001 and June 30, 2000,
respectively.
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
fair value of the Company's Senior Notes, as determined from quoted market
prices, was $99,370 at June 30, 2001, compared to a carrying value of
$103,510. The carrying value of all other financial instruments
approximates fair value at June 30, 2001.
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
amounted to $403, $51 and $91 for the years ended June 30, 2001, 2000 and
1999, respectively.
F-30
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 $1,591, $1,309 and $1,136 for the years ended
June 30, 2001, 2000 and 1999, respectively.
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 bases and financial reporting bases of assets and
liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse. Deferred tax assets are 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.
Recently Issued Accounting Standards
In September 2000, the Emerging Issues Task Force reached a consensus
on Issue 00-10, "Accounting for Shipping and Handling Fees and Costs"
("Issue 00-10"). Issue 00-10 requires that all amounts billed to customers
related to shipping and handling should be classified as revenues. Issue
00-10 was effective for the Company no later than the fourth quarter of the
fiscal year ending June 30, 2001, and, accordingly, amounts billed to
customers related to shipping and handling have been reclassified from cost
of goods sold to net sales.
FASB Statement of Financial Accounting Standards No. 141 "Business
Combinations" ("SFAS 141) was issued in June 2001. SFAS 141 changes the
accounting and reporting for business combinations. SFAS 141 is effective
for all business combinations initiated after June 30, 2001.
FASB Statement of Financial Accounting Standards No. 142 "Goodwill and
Other Intangible Assets" ("SFAS 142") was issued in June 2001. SFAS 142
changes the accounting and reporting for acquired goodwill and other
intangible assets. SFAS 142 is effective for fiscal years beginning after
December 15, 2001 and must be applied at the beginning of an entity's
fiscal year. The Company is currently assessing the effect, if any, on its
financial statements of implementing SFAS 142.
F-31
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
3. SIGNIFICANT ACQUISITIONS
On September 15, 1999, the Company acquired all of the equity
interests in RetCom Holdings Ltd. and its subsidiaries ("RetCom") for
approximately $12,500 and refinanced working capital indebtedness of
approximately $4,500 of RetCom. The acquisition was accounted for using the
purchase method of accounting. The purchase price has been allocated to the
assets and liabilities acquired using estimated fair values at the date of
acquisition and resulted in assigning value to goodwill totaling
approximately $19,100 which is being amortized on a straight line basis
over a period of twenty years. The fair values assigned are preliminary and
may be revalued at a later date but the change is not expected to be
material. The results of the acquired operations are included in the
financial statements since the date of acquisition. Pro forma results had
RetCom been acquired at the beginning of fiscal 1999 and 2000 are not
determinable.
In December 1999 the Company settled a dispute with the former owners
of the Predecessor. In connection with the settlement the Company received
approximately $1.2 million and has included the settlement amount net of
related expenses in income from operations.
4. ACCOUNTS RECEIVABLE
The following table details the components of accounts receivable:
June 30,
-------------------
2001 2000
---- ----
Trade accounts receivable.............. $ 18,487 $ 22,314
Allowance for doubtful accounts........ (836) (963)
---------- ---------
17,651 21,351
Other accounts receivable.............. 369 171
---------- ---------
$ 18,020 $ 21,522
========== =========
5. INVENTORY
The following table details the components of inventory:
June 30,
-------------------
2001 2000
---- ----
Raw materials
Paper............................... $ 1,796 $ 3,944
Other raw materials................. 2,697 2,541
---------- ---------
Total raw materials.............. 4,493 6,485
Work in process....................... 1,837 1,272
---------- ---------
Total inventory....................... $ 6,330 $ 7,757
========== =========
The difference between the carrying value of paper inventory using the
FIFO method as compared to the LIFO method was not significant at June 30,
2001 or June 30, 2000. During the year ended June 30, 2001, certain
inventory quantity reductions caused a liquidation of LIFO inventory
values, which were immaterial.
F-32
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per 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:
June 30,
Estimated ------------------
Useful Lives 2001 2000
------------ ---- ----
Land....................... $ 258 $ 258
Buildings.................. 7 - 15 years 1,851 1,719
Leasehold improvements..... 1 - 3 years 651 635
Machinery and equipment.... 5 - 7 years 23,622 21,348
Furniture and fixtures..... 3 - 5 years 3,370 3,081
Construction in progress... 405 101
-------- --------
30,157 27,142
Accumulated depreciation... (14,379) (10,045)
-------- --------
$ 15,778 $ 17,097
======== ========
Depreciation expense amounted to $4,341, $4,381 and $3,881 for the
years ended June 30, 2001, 2000 and 1999, respectively.
Property held under capital lease is included in the respective
property, plant and equipment category as follows:
June 30,
--------------------
2001 2000
---- ----
Machinery and equipment................... $ - $ 3,000
Building.................................. 600 600
-------- --------
600 3,600
Less accumulated depreciation............. (500) (1,390)
-------- --------
$ 100 $ 2,210
======== ========
Depreciation of the assets under capital lease totaled $200, $600 and
$515 for the years ended June 30, 2001, 2000 and 1999, respectively. Future
minimum lease payments under the remaining leases are as follows:
Payment Interest
------- --------
2002.............. $ 529 $ 26
F-33
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
7. LINE OF CREDIT
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.
As of June 30, 2001, the Company's borrowing base was approximately
$19,551. Interest on amounts borrowed accrue at a floating rate based upon
either prime or LIBOR (7.75% and 10.25% at June 30, 2001 and 2000,
respectively). The weighted average interest rate on the outstanding
balance under the Credit Agreement was 9.58%, 9.12% and 8.51% for the years
ended June 30, 2001, 2000 and 1999, 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. The Company did not
have any lender guarantees outstanding at June 30, 2001. These fees totaled
$59, $69 and $111 for the years ended June 30, 2001, 2000 and 1999,
respectively. The Credit Agreement contains certain financial covenants and
other restrictions including restrictions on additional indebtedness and
restrictions on the payment of dividends. As of June 30, 2001, the Company
was in compliance with all debt covenants.
8. LOANS PAYABLE TO STOCKHOLDER
In May 2000, the Company signed a promissory note payable to AHC which
allows the Company to borrow up to $10 million at such interest rates and
due as agreed upon by the Company and AHC. At June 30, 2001, no amount was
outstanding under the promissory note.
9. SENIOR NOTES
On June 25, 1998, the Company completed a private placement of
$115,000 of Senior Notes (the "Senior Notes"), which mature on July 1,
2008. 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 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 are redeemable at the option of the Company, in whole or part, at any
time after July 1, 2003 at a price of up to 105.25% of the outstanding
principal balance plus accrued and unpaid interest. Prior to July 1, 2003,
the Company is permitted to repurchase up to 35% of the Senior Notes at a
redemption price of up to 110.5% of the aggregate principal amount plus
accrued and unpaid interest with the net proceeds of one or more public
equity offerings. The Senior Notes contain certain covenants including
restrictions on the declaration and payment of dividends by the Company to
Holding and limitations on the incurrence of additional indebtedness. On
December 22, 1998, the Company completed the registration of its Senior
Notes with the Securities and Exchange Commission. During fiscal 2001, the
Company purchased $4,000 of the Senior Notes for $3,110 and recognized a
gain, net of income taxes of approximately $457. During fiscal 2000, AHC
purchased $7,490 of the Senior Notes for $6,486 and recognized a gain, net
of income taxes, of approximately $429. The notes were contributed to
Holding and Holding contributed the notes to AKI. The purchased and
contributed notes were subsequently retired.
F-34
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
10. INITIAL CAPITALIZATION
In conjunction with the Acquisition, AHC issued $30,000 of Floating
Rate Notes, $50,279 of Mandatorily Redeemable Senior Preferred Stock (the
"Senior Preferred Stock") and $1,111 of its Common Stock. The Floating Rate
Notes were issued with an original issuance discount of $5,389. Interest
was payable quarterly and could be settled through the issuance of
additional Floating Rate Notes through December 15, 2009, the maturity
date, at the discretion of AHC. The original issuance discount of $5,389
was being amortized using the effective interest method over the life of
the Floating Rate Notes. On November 1, 1999 AHC issued Amended and
Restated Notes totaling $35,500 in exchange for the Floating Rate Notes.
The Amended and Restated Notes bear a fixed interest rate of approximately
16% per annum and mature on December 15, 2009 and provide for the payment
of stipulated early redemption premiums. In connection with the exchange
the unamortized original issue discount was expensed by AHC. The Senior
Preferred Stock accretes in value at 15% per annum and must be redeemed by
December 15, 2012. The Amended and Restated Notes and Senior Preferred
Stock are general unsecured obligations of AHC.
The cash proceeds from the issuance of the Floating Rate Notes, Senior
Preferred Stock and Common Stock of approximately $76,000 and a Senior
Preferred Stock option of $2,363 were contributed by AHC to the Company in
exchange for 1,000 shares of the Company's Common Stock. Subsequent to the
initial capitalization of the Company, AHC contributed $1 and all of its
ownership interest in the Company to Holding for all of the outstanding
equity of Holding.
AHC and Holding have no other operations other than the Company.
Absent additional financing by AHC 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; however, the
Company is not obligated to pay or otherwise guarantee the Floating Rate
Notes, Senior Preferred Stock and Debentures.
11. COMMITMENTS AND CONTINGENCIES
Operating Leases
Equipment and office, warehouse and production space under operating
leases expire at various dates. Rent expense was $538, $589 and $338 for
the years ended June 30, 2001, 2000 and 1999, respectively. Future minimum
lease payments under the leases are as follows:
2002 $ 353
2003 431
2004 377
2005 356
2006 365
2007 157
--------
$ 2,039
========
F-35
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
11. COMMITMENTS AND CONTINGENCIES (Continued)
Royalty Agreements
Royalty agreements are maintained for certain technologies used in the
manufacture of certain products. Under the terms of one royalty agreement,
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 $500, under this
agreement for each of the three years ended June 30, 2001. The Company has
paid $5,576 in cumulative royalty payments under this agreement through
June 30, 2001.
Under the terms of another 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 for years after fiscal 1999 are $625 per year through the
expiration of the agreement in 2012. The Company expensed $625, $625 and
$575 under this agreement for the years ended June 30, 2001, 2000 and 1999,
respectively.
Employment Agreements
The Company has employment agreements with certain executive officers
with terms through June 30, 2002 and 2003. Such agreements provide for base
salaries totaling $985 per year. One officer has an incentive bonus of up
to 200% of base salary which is payable if certain financial and management
goals are attained and certain other incentive payments. The employment
agreements also provide severance benefits of up to two years of base
salary if the officers' 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.
Printing Services Agreement
In connection with the RetCom acquisition, AKI entered into a five
year Printing Services Agreement with a former shareholder of RetCom. The
Printing Services Agreement requires annual purchases of printing services
totaling $5,000 and a 15% charge on the amount of any shortfall. The
present value of the costs related to the estimated shortfall over the life
of the Printing Services Agreement was recorded as a liability in the
RetCom purchase accounting.
F-36
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
12. 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. The
Company makes contributions to the Plan by matching a percentage of
employee contributions. Costs associated with the Plan totaled $294, $251
and $201 for the years ended June 30, 2001, 2000 and 1999, 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 $233,
$215 and $204 for the years ended June 30, 2001, 2000 and 1999,
respectively.
13. INCOME TAXES
The Company is included in the consolidated federal income tax return
filed by AHC. Income taxes related to the Company are 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.
For financial reporting purposes, income (loss) before income taxes
and extraordinary gain includes the following components:
Year Ended June 30,
---------------------------------------
2001 2000 1999
---- ---- ----
Income (loss) before income taxes and
extraordinary gain:
United States.................................. $ 5,180 $ 2,428 $ (2,266)
Foreign........................................ 1,461 455 522
--------- --------- ---------
$ 6,641 $ 2,883 $ (1,744)
========= ========= =========
Significant components of the provision (benefit) for income taxes are
as follows:
Year Ended June 30,
---------------------------------------
2001 2000 1999
---- ---- ----
Current expense (benefit):
Federal........................................ $ 4,288 $ 480 $ -
Foreign........................................ 526 171 204
State.......................................... 232 - -
--------- --------- ---------
5,046 651 204
--------- --------- ---------
Deferred expense (benefit):
Federal........................................ (721) 1,740 569
Foreign........................................ - - -
State.......................................... 334 426 74
--------- --------- ---------
(387) 2,166 643
--------- --------- ---------
$ 4,659 $ 2,817 $ 847
========= ========= =========
F-37
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
13. INCOME TAXES (Continued)
The significant components of deferred tax assets and (liabilities) at
June 30, 2001 and 2000, were as follows:
June 30,
-----------------------------------------------------------
2001 2000
--------------------------- --------------------------
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------
Deferred income tax assets:
Accrued expenses..................... $ 474 $ - $ 215 $ -
Allowance for doubtful accounts...... 296 - 181 -
Net operating loss carry forwards.... - 78 - 412
Other non-current liabilities........ - 343 - 308
--------- -------- --------- ---------
770 421 396 720
Deferred income tax liability:
Property, plant and equipment........ - (2,778) - (3,090)
--------- -------- --------- ---------
Deferred tax assets (liabilities). $ 770 $ (2,357) $ 396 $ (2,370)
========= ======== ========= =========
The income tax provision recognized by the Company for the years ended
June 30, 2001, 2000 and 1999 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:
Year Ended June 30,
---------------------------------------
2001 2000 1999
---- ---- ----
Computed tax provision (benefit)
at the statutory rate.......................... $ 2,324 $ 980 $ (593)
State income tax provision, net of
federal effect................................. 368 281 49
Nondeductible expenses........................... 1,952 1,540 1,364
Other, net....................................... 15 16 27
--------- --------- --------
$ 4,659 $ 2,817 $ 847
========= ========= ========
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 losses in prior years the Company has recorded a
long-term deferred tax asset of $78 reflecting cumulative net operating
loss carryforwards available to offset future state taxable income of
approximately $1,297 at June 30, 2001. These cumulative net operating loss
carryforwards expire in varying amounts through 2019. Realization is
dependent on generating sufficient state 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-38
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
14. STOCK OPTIONS
Subsequent to the Acquisition, AHC adopted the 1998 Stock Option Plan
("Option Plan") for certain employees and directors of AHC and any parent
or subsidiary of AHC. The Option Plan authorizes the issuance of options to
acquire up to 1,650,000 shares of AHC Common Stock. The Board of Directors
determines the terms of each individual options grant. The exercise price
for each grant is required to be set at least equal to the fair market
value per share of AHC provided that the exercise price shall not be less
than $1.00 per share. Options vest over periods ranging from one to eight
years. Certain options are eligible for accelerated vesting based on
targeted EBITDA. Options may be exercisable for up to ten years.
A summary of AHC stock option activity and related information for the
years ended June 30, 2001 and 2000 follows:
2001 2000
------------------------ ------------------------
Weighted Weighted
Average Average
Exercise Exercise
Options Price Options Price
------- ----- ------- -----
Outstanding, beginning of year.......... 1,509,450 $ 1.00 - $ -
Granted............................ 35,500 1.00 1,519,917 1.00
Exercised.......................... - - - -
Forfeited.......................... (90,567) 1.00 (10,467) 1.00
--------- ------- --------- -------
Outstanding, end of year................ 1,454,383 $ 1.00 1,509,450 $ 1.00
========= ======= ========= =======
Exercisable, end of year................ 640,793 $ 1.00 273,668 $ 1.00
========= ======= ========= =======
Weighted average remaining
contractual life................... 8.5 years 9.5 years
The Company has elected to account for its stock based compensation
with employees under the intrinsic value method as permitted under SFAS
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 SFAS 123, the net
income (loss) for the years ended June 30, 2001 and 2000 would have been
$2,334 and $444, respectively. In making this determination, fair value was
estimated on the date of grant using the minimum value method and a
risk-free interest rate ranging from 6.3% to 6.9%, estimated life of five
years and dividend rate of 0.0%. The weighted average fair value at date of
grant of options granted during 2001 was approximately $0.27 per option.
15. RELATED PARTY TRANSACTIONS
The Company made payments to an affiliate of DLJMBII for management
fees of $250 for each of the three years ended June 30, 2001.
F-39
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
16. GEOGRAPHIC INFORMATION
The following table illustrates geographic information for revenues
and long-lived assets. Revenues are attributed to countries based on the
receipt of sales orders and long-lived assets are based upon the country of
domicile.
United
Net sales: States France Total
Year ended June 30, 1999.................... $ 72,016 $ 15,153 $ 87,169
Year ended June 30, 2000.................... 85,418 14,393 99,811
Year ended June 30, 2001.................... 96,845 18,550 115,395
Long-lived assets:
June 30, 1999............................... 179,464 107 179,571
June 30, 2000............................... 191,038 87 191,125
June 30, 2001............................... 183,042 70 183,112
17. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following is a summary of the unaudited quarterly results of
operations for Fiscal 2001 and Fiscal 2000.
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2001 2000 2000 2001 2001 Total
---- ---- ---- ---- -----
Net sales............... $ 32,353 $ 26,180 $ 33,094 $ 23,768 $ 115,395
Gross profit............ 12,805 8,487 13,765 9,002 44,059
Income from operations.. 6,868 2,626 7,298 3,311 20,103
Interest expense, net... 3,442 3,344 3,331 3,095 13,212
Net income (loss)....... 1,584 (509) 1,932 (568) 2,439
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2000 1999 1999 2000 2000 Total
---- ---- ---- ---- -----
Net sales............... $ 28,673 $ 20,843 $ 25,783 $ 24,512 $ 99,811
Gross profit............ 12,587 7,220 9,941 8,511 38,259
Income from operations.. 7,265 2,202 4,925 2,409 16,801
Interest expense, net... 3,348 3,393 3,479 3,448 13,668
Net income (loss)....... 1,969 (713) 376 (1,137) 495