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, 2002
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, 2002, 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 and sampling systems that utilize various technologies
that engage the senses of touch, sight and olfactory. Our sampling vehicles 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 technologies
that can be incorporated into various advertising media designed to reach the
consumer at home or in-store, such as magazine inserts, catalog inserts,
remittance envelopes, statement enclosures, blow-ins, direct mail, direct sell
and point-of-sale materials and gift-with-purchase/purchase-with-purchase
programs.
We are a fully integrated multi-sensory advertising and sampling company,
conducting our business under the Arcade Marketing name. We believe that we are
well positioned to provide complete, interactive advertising and sampling
programs to our customers, including creative content and product sample systems
and distribution.
We believe 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. We 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 technologies.
In recent years, we have expanded our sampling system business by
developing and acquiring new technologies in the olfactory and beauty sampling
system categories. 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. Many of our
innovative sampling systems are designed to fill the needs of these marketers by
providing a 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
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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, 2002, 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
proprietary, patented and patent-pending sampling systems catering to the
fragrance, cosmetics and personal care industries, as well as microencapsulation
products and processes. Such sampling systems include MicroSilk(TM),
MicroDot(TM) and Aromalacquer(TM). The acquired businesses also include a
creative service division that engages in marketing communications and catalogs.
On December 18, 2001, we acquired, through a newly formed subsidiary, IST,
Corp., the business including certain assets and assumed certain liabilities of
Color Prelude, Inc. (such business referred to hereafter as "CP"). CP
manufactures interactive advertising and sampling products for cosmetic and
consumer products companies. The acquired business offers proprietary, patented
and patent-pending sampling systems including the ShadeSeal(R) family of
products primarily for lipstick and powder sampling, BeautiPak(TM) for sampling
certain lipstick products, LiquiSeal(TM) for sampling skin care and foundation
products, PowdaScent(TM) for the sampling of fragrance products and
SelectaShade(TM) which is a unique beauty tool for shade selection for
foundation.
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.
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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 a
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. In recent years, our products have been used
in many major new fragrance launches that have utilized sampling systems.
o ScentStrip(R): A proprietary technology introduced by our Company in
1979, ScentStrip(R) is 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 and 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 that "snap" open to deliver an
olfactory sample and wearable on-skin trial when "pearls" are touched.
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 not only for fine
fragrances but can deliver a quality aroma for a variety of personal
care products in addition to food and beverage products.
o DiscCover(R)More: This patented sampling system offers all of the
attributes of the original DiscCover(R) technology enhanced to offer a
single, wearable, on-skin trial of the fragrance.
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): This patented technology 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
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with no pre-release and delivers a spill proof trial of any alcohol
formulated fragrance product. The product is available in a single or
dual chamber pressure-sensitive format and has been approved by the
U.S. Postal Service 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 proprietary technology, uses microencapsulated
fragrance oil, delivered in powder form, deposited between two layers
of paper which pull apart to deliver superior on-skin fragrance trial.
The technology is available as a stand alone product, as pressure
sensitive labels or as pressure sensitive labels on perforated sheets.
o PowdaScent(TM): A patented technology in which an encapsulated
fragrance oil, in a powder format, is hygienically sealed between a
board stock and a see-thru layer of transparent film. This transparent
film displays the powder which can be produced in any size, shape and
color. Once peeled open, and the capsules are touched, an aroma
rendition is delivered.
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(TM) 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 strategic 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.
BEAUTY SAMPLING SYSTEMS
Our portfolio also includes non-fragrance sampling system products,
primarily for the beauty industry, 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 and powders. Almost
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, designed to withstand
significant pressure and is approved by the U.S. Postal Service 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
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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 ActiSeal(TM): A patented technology, with characteristics similar to
BeautiSeal(R) , which is peeled open to reveal two adjacent wells,
each well containing a formula component which are blended together by
the consumer upon application.
o LiquiSeal(TM): A patented clear top packette which can be utilized to
sample liquid, cream, lotion or gel products. The patented clear
laminate has unique barrier characteristics which allow it to pass
stringent stability tests. The product sample can contain makeup, hair
care, skin care, fragranced ancillaries and body care, among other
products.
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. PowdaTouch(R) is ideal for magazine and
catalogue inserts, blow-ins, and bind-in cards among others and is
approved by the Postal Service for subscription magazine periodical
rates.
o ShadeSeal(R): This patented technology is used to sample renditions of
cosmetic powders or lip products. The product rendition is deposited
between two substrates which pull apart to offer a trial sample while
a transparent "window" displays the shade. This product can be
utilized in many different formats to accommodate either multiple
shades or a variety of cosmetic products including both long-lasting
and conventional lipsticks.
o LipSeal(R): A patented technology with characteristics similar to
BeautiSeal(R) this product provides 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(R) offers trial of any lipstick shade, finish and texture in
any lipstick formula, including long-lasting formulas.
o BeautiPak(TM): A proprietary "windowed" sampling system for a variety
of lipstick formulations. Product is sealed into one well of a
thermoformed "tray" while a second well contains a flocked lipstick
applicator.
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 of 8, 10, 12 or more foundation shades on a single
carrier with no cross-contamination.
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o SelectaShade(TM): A proprietary beauty tool used to determine
foundation shades that precisely match consumers' skin tones. This
transparent strip of polyester film is printed with special inks that
replicate foundation shades exactly. When SelectaShade(TM) is placed
against face or hand, the shade that best matches the users own skin
will become invisible on the chart to give each consumer an accurate
shade match.
OTHER PRODUCTS & SERVICES
o Arcade Direct: This full service division of our Company offers a full
range of creative services to our customers in the cosmetic and
fragrance industry, and has established a niche presence in various
industries including 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.
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.
FORMATS
Mail Formats
We produce a wide and versatile range of formats approved by the U.S.
Postal Service 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 nearly all of our sampling
systems and are the most commonly produced among our sampling 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, 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 be produced with
or without sampling
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systems. We believe that we are the only company in the sampling industry that
can produce remittance envelopes in-house. 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.
Other Formats
Direct Sell: Many of our Company's sampling systems are widely used in
direct sales campaigns. Beauty companies, whose treatment, cosmetic and
fragrance products are sold directly to the consumer by representatives, use our
sampling technologies to promote their product offerings.
Point-of-Sale Materials: 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. Many of our other technologies, including
LiquaTouch(R), BeautiSeal(R), BeautiPak(TM), MicroDot(TM), LiquiSeal(TM) and
PowdaTouch(R) are becoming more widely accepted for point-of-sale handouts as an
alternative to more traditional sampling methods and for salable unit doses.
Gift-with-Purchase/Purchase-with-Purchase Programs: Many of our fragrance
and cosmetic customers promote new product offerings with our sampling systems.
LiquaTouch(R) stand alones and DiscCover(R)More offer single, long-lasting
wearable fragrance trial samples. BeautiPak(TM) gives the consumer a full
application of a lipstick formula or shade and LiquiSeal(TM) can be used to
offer a full application of up to four foundation or treatment product samples.
INTELLECTUAL PROPERTY
We currently hold patents covering the proprietary processes used to
produce many of our products in both the United States and abroad and have
submitted applications for many of our manufacturing processes. We have
trademarks registered in the United States and we have
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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.
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 and 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, Estee Lauder,
Inc., Mary Kay, Victoria's Secret Beauty and The Procter & Gamble Company. Our
top ten customers accounted for approximately 69% of sales in fiscal 2002. Estee
Lauder and Mary Kay were the only customers that accounted for 10% or more of
net sales in fiscal 2002. 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, Mexico 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, Baltimore, Maryland 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 and
extensive joint marketing programs with magazines, retailers and oil houses. We
also provide press coverage in industry trade
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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.
Management believes that as the pressure for creativity increases with each
new product introduction, cosmetic and fragrance marketers are increasingly
looking for their vendors to contribute to the overall strategy-building effort
to introduce a new product. 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 know-how, as well as our
complete product line of sampling technologies 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 in-house
laboratories;
o printing advertising pages and other media;
o manufacturing the sampling product, 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 three of the Company's manufacturing facilities 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
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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 strive to replicate the fragrance of a product in a bottle
containing an alcohol solution. 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 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 is typically furnished by
the customer or its advertising agency. Our digital prepress department utilizes
state-of-the-art technology to receive customer-supplied computer disks and
transfers this material directly 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 in Chattanooga, Tennessee in
a continuous in-line operation. Our formulated letterpress or flexo label
samplers (DiscCover(R), BeautiSeal(R), LipSeal(R), LiquaTouch(R)) are produced
on specially modified label and finishing equipment in our second Chattanooga
facility while the Microfragrance(R) Scratch `n Sniff operation is conducted in
a third facility in Chattanooga, Tennessee. Our specialized screen printing
manufacturing process which produces our ShadeSeal(R) and PowdaScent(TM)
technologies takes place in our facility in Baltimore, Maryland. In addition
BeautiPak(TM) our proprietary thermoformed technology for sampling lipstick is
produced in our Baltimore, Maryland facility. At each facility, 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. 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, that 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.
Both our Chattanooga and Baltimore operations have been awarded The Procter
& Gamble Triple Pinnacle Award, which is presented to companies as recognition
for having met certain quality requirements and having demonstrated outstanding
quality assurance. Both operations are also registered with the Food and Drug
Administration for the packaging of
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regulated cosmetic products and we maintain environmentally controlled cGMP
(current good manufacturing practice) compliant facilities.
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. However, our
encapsulated paper products utilize specific grades of paper which we purchase
primarily from one manufacturer. These paper products are subject to
comprehensive evaluation and certification by us for quality, consistency and
fit. Some of our laminates are purchased from single sources under certain
specifications. 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 our Company, 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
cosmetic samplers market are the fragrance division of Vertis, Inc., Orlandi,
Inc., Delta Graphics, Inc., Nord'est, Marietta Corp., Klocke, Rotakan, Manka
Creations 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, 2002, we employed 497 persons, which included 287 hourly
and 210 salaried and management personnel. A substantial number 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, 2002, Holding and AKI had total consolidated indebtedness of approximately
$131.7 million and $115.8 million, respectively. As of August 31, 2002, AKI had
outstanding borrowings of $9.5 million under its term loan with Heller
Financial, Inc., $6.3 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, additional borrowings of up to approximately $13.5 million were
available under the revolving loan commitment of 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;
12
o incur dividend and other payment restrictions affecting subsidiaries;
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 in the
future.
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, 2002, Holding's subsidiaries had $115.8 million of
indebtedness and $26.0 million of other outstanding liabilities (including trade
payables, accrued liabilities and deferred taxes). As of August 31, 2002, AKI
had outstanding borrowings of $9.5 million under its term loan, $6.3 million
under the revolving loan commitment of the credit agreement and $0.4 million
under a promissory note with AHC. In addition, as of August 31, 2002, additional
borrowings of up to approximately $13.5 million were available under the
revolving loan commitment of the credit agreement, subject to specified
conditions. All such indebtedness effectively ranks senior to Holding's
debentures. At June 30, 2002, Holding had no accrued liabilities and no
outstanding indebtedness other than the
13
debentures. Holding and its subsidiaries may incur additional indebtedness in
the future, subject to the limitations contained in the instruments governing
their indebtedness.
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 the 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 our encumbered assets. As a result, our
encumbered assets 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 would be materially
adversely affected and the value of the debentures and the notes could be
eliminated. As of August 31, 2002, AKI had outstanding borrowings under the
credit agreement consisting of a $9.5 million term loan and a $6.3 million
revolving loan and could borrow an additional $13.5 million under the revolving
loan commitment of 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.
Most of our sampling systems are approved by the U.S. Postal Service
("USPS") for inclusion in subscription magazines mailed at periodical postage
rates. The USPS approved 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
14
entire circulation. Subscription magazine sampling inserts delivered to
consumers through the USPS accounted for approximately 20% of our net sales in
fiscal 2002. There can be no assurance that the USPS will not approve other
competing types of sampling systems for use in subscription magazines without
requiring a postal surcharge, or that the USPS will not reclassify our sampling
systems such that they would incur a postal surcharge. Any such action by the
USPS 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 69% of
our net sales in fiscal 2002. None of our customers, other than Estee Lauder and
Mary Kay, accounted for 10% or more of net sales in fiscal 2002. 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 or
Mary Kay, 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 the fragrance division of Vertis, Inc., Orlandi Inc., Delta
Graphics, Nord'est, Marietta Corp., Klocke, 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. 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.
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 and patented 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
15
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 we cannot estimate any future
expense. 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.
Our business is affected by the advertising budgets of our customers and is
seasonal in nature.
The advertising and marketing budgets of our customers, and therefore our
revenues, are susceptible to prevailing economic and market conditions that
affect advertising and marketing expenditures, the performance of the products
of our customers in the marketplace and other related factors. 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 and marketing 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. The severity of our seasonal sales variations have
decreased over time as we have developed and acquired other sampling
technologies for advertising and marketing of cosmetic and consumer products.
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 18% of our cost of goods
sold in fiscal 2002 and 28% of our cost of goods sold in each of fiscal 2001 and
2000. 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 39% of our net sales in fiscal 2002, 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
16
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 our 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.
Certain of our label sampling systems, which accounted for approximately
26% of our net sales in fiscal 2002, utilize component materials that are
sourced from one qualified vendor. 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 2002 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, 2002, approximately 46% 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.
17
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 have
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 approximately 29,500 square feet.
We lease buildings in Baltimore, Maryland, that are used for production and
warehousing. The production facility at 7600 Energy Parkway encloses
approximately 50,000 square feet and its lease expires in August, 2004. The
warehouse facility at 7525 Perryman Court encloses approximately 13,000 square
feet and its lease expires in May, 2003 with options to renew the lease for two
additional one year periods.
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
None.
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, 2002, 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.
19
ITEM 6. SELECTED FINANCIAL DATA
The selected historical consolidated financial data presented below as of
June 30, 2002, 2001, 2000, 1999 and 1998 and the years ended June 30, 2002,
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 for the period from July 1, 1997 to December 15, 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.
Holding Predecessor
------------------------------------------------------------------------- -----------
December 16, July 1, 1997
1997 to to
June 30, June 30, June 30, June 30, June 30, December 15,
(dollars in thousands) 2002 2001 2000 1999 1998 1997
---- ---- ---- ---- ---- ----
Statement of Operations Data:
Net sales (1) $ 120,893 $ 115,395 $ 99,811 $ 87,169 $ 36,694 $ 36,003
Cost of goods sold (1) 73,888 71,336 61,552 56,401 25,146 23,626
--------- --------- --------- --------- --------- ---------
Gross profit 47,005 44,059 38,259 30,768 11,548 12,377
Selling, general and
administrative expenses 18,943 18,199 16,980 14,500 5,587 5,703
Amortization of goodwill 6,451 5,757 5,336 4,606 2,101 568
Gain from settlement, net (992) - (858) - - -
---------- --------- --------- --------- --------- ---------
Income from operations 22,603 20,103 16,801 11,662 3,860 6,106
Interest expense, net 15,633 16,911 17,401 16,740 11,327 2,646
Management fees 250 250 250 250 125 215
Other, net - - - 128 (47) 11
Income tax expense (benefit) 4,658 3,449 1,596 (340) (2,052) 1,441
--------- --------- --------- --------- --------- ---------
Income (loss) before
extraordinary item 2,062 (507) (2,446) (5,116) (5,493) 1,793
Extraordinary gain, net 2,675 2,016 1,089 - - -
--------- --------- --------- --------- --------- ---------
Net income (loss) $ 4,737 $ 1,509 $ (1,357) $ (5,116) $ (5,493) $ 1,793
========= ========= ========= ========= ========= =========
Balance Sheet Data (at end
of period):
Cash and cash equivalents $ 1,875 $ 4,654 $ 1,158 $ 7,015 $ 3,842 $ 4,481
Working capital (deficit) 11,571 10,169 13,759 14,853 15,046 (4,959)
Total assets 226,279 214,184 223,274 210,386 214,521 77,399
Total debt and redeemable
preferred stock 131,661 127,939 145,722 146,688 144,448 55,408
Total stockholder's equity 69,897 64,769 58,834 49,797 57,084 12,716
Other Data:
Capital expenditures $ 1,338 $ 3,015 $ 2,782 $ 2,856 $ 514 $ 807
Ratio of earnings to fixed
charges (2) 1.4x 1.2x --- --- --- 2.2x
- ------------
(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 $850, $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.
20
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.
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.
21
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 $7.3 million in cash and the assumption of a liability of $0.2
million 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 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.
COLOR PRELUDE ACQUISITION
On December 18, 2001, we acquired the CP business for $19.4 million. We
financed the CP acquisition with borrowings under our credit agreement.
RESULTS OF OPERATIONS
Fiscal Year Ended June 30, 2002 Compared to Fiscal Year Ended June 30, 2001
Net Sales. Net sales for the fiscal year ended June 30, 2002 increased $5.5
million, or 4.8%, to $120.9 million as compared to $115.4 million for the fiscal
year ended June 30, 2001. The increase was attributable to sales of sampling
technologies for advertising and marketing of cosmetics by CP, partially offset
by decreases in volume of core product sales of sampling technologies for
advertising and marketing of fragrance, cosmetic and consumer products. We
believe the decline in core product sales is predominately attributable to the
weak economic conditions in the United States, particularly in the advertising
industry. We cannot predict if this trend will worsen or when sales may increase
in the future. Sales of the CP products in the fiscal year ended June 30, 2002
totaled $24.0 million, a significant increase compared to CP's historical levels
due to sales related to a new sampling technology and the major introduction of
new products by Mary Kay. We do not believe that sales increases of this
magnitude will continue long-term.
Gross Profit. Gross profit for the fiscal year ended June 30, 2002
increased $2.9 million, or 6.6%, to $47.0 million as compared to $44.1 million
for fiscal year ended June 30, 2001. Gross profit as a percentage of net sales
increased to 38.9% in the fiscal year ended June 30, 2002, from 38.2% in the
fiscal year ended June 30, 2001. The increase in gross profit and gross profit
as a percentage of net sales is primarily due to the increase in sales volume
and to a lessor extent manufacturing scheduling efficiencies, reduced premium
labor and certain material costs.
22
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2002 increased $0.7
million, or 3.9% to $18.9 million as compared to $18.2 million for the fiscal
year ended June 30, 2001. The increase in selling, general and administrative
expenses was primarily due to increased expenses related to the CP operation and
acquisition, an increase in legal fees related to a patent infringement lawsuit
brought by AKI, an estimated loss on office lease abandonment and an estimated
loss to settle a foreign value added tax audit partially offset by a decrease in
personnel in fiscal year 2002, a decrease in sales commissions and incentive
bonuses and foreign exchange transaction gains. Selling, general and
administrative expenses as a percent of net sales decreased to 15.6% in the
fiscal year ended June 30, 2002 from 15.8% in the fiscal year ended June 30,
2001.
Income from Operations. Income from operations for the fiscal year ended
June 30, 2002 increased $2.5 million, or 12.4%, to $22.6 million as compared to
$20.1 million for the fiscal year ended June 30, 2001. Income from operations as
a percentage of net sales increased to 18.7% in the fiscal year ended June 30,
2002 from 17.4% in the fiscal year ended June 30, 2001, principally as a result
of the factors described above and the net settlement of the RCC purchase price
dispute.
Interest Expense. Interest expense for the fiscal year ended June 30, 2002
decreased $1.3 million, or 7.7% to $15.6 million, as compared to $16.9 million
for the fiscal year ended June 30, 2001. Interest expense as a percentage of net
sales decreased to 12.9% in the fiscal year ended June 30, 2002 from 14.6% in
the fiscal year ended June 30, 2001. 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 Discount
Debentures and Senior Notes and reduced average borrowings and lower interest
rates under the revolving loan and the promissory note to a stockholder
partially offset by the additional term loan incurred in connection with the CP
acquisition.
Interest expense for AKI for the fiscal year ended June 30, 2002 decreased
$0.7 million, or 5.3%, to $12.5 million, as compared to $13.2 million for the
fiscal year ended June 30, 2001. Interest expense as a percentage of net sales
decreased to 10.3% in the fiscal year ended June 30, 2002 from 11.4% in the
fiscal year ended June 30, 2001. 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 and reduced
average borrowings and lower interest rates under the revolving loan and the
promissory note to an affiliate partially offset by the additional term loan
incurred in connection with the CP acquisition.
Income Tax Expense. The income tax expense for the fiscal year ended June
30, 2002 increased $1.3 million to $4.7 million as compared to $3.4 million for
the fiscal year ended June 30, 2001. 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, 2002
increased $1.0 million to $5.7 million as compared to $4.7 million for the
fiscal year ended June 30, 2001. The increase is due to the increase in income
before income taxes and extraordinary gain.
23
Extraordinary gain from early retirement of debt. An extraordinary gain
from early retirement of debt of $2.7 million for the fiscal year ended June 30,
2002 and $2.0 million for the fiscal year ended June 30, 2001 resulted from the
purchase of Senior Discount Debentures in fiscal year 2002 and from the purchase
and subsequent contribution in fiscal 2001 of Senior Discount Debentures by AHC,
and the purchase of Senior Notes in fiscal 2001. The purchased and contributed
securities were subsequently retired.
An extraordinary gain from early retirement of debt for AKI of $0.5 for the
fiscal year ended June 30, 2001 resulted from the purchase in fiscal year 2001
of Senior Notes. The purchased securities were subsequently retired.
EBITDA. EBITDA for the fiscal year ended June 30, 2002, increased $3.5
million, or 11.6%, to $33.7 million as compared to $30.2 million for the fiscal
year ended June 30, 2001. 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 27.9% and 26.2% for the fiscal year ended June 30, 2002 and 2001,
respectively. EBITDA is income from operations plus depreciation and
amortization of goodwill and other intangibles less net gain from settlement of
purchase price dispute.
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.
24
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
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
25
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.
COMMITMENTS AND CONTINGENCIES
The following table summarizes our contractural obligations and other
contingencies as of June 30, 2002:
Payments due by fiscal year
---------------------------------------------------------------------------------------
2003 2004 2005 2006 2007 Thereafter
---- ---- ---- ---- ---- ----------
Debt obligations:
Principal................ $ 1,375 $ 1,875 $ 2,125 $ 2,625 $ 4,250 $ 121,630
Interest*................ 11,694 14,041 13,919 13,780 13,483 15,762
Standby letter of credit..... - - 87 - - 291
Operating leases............. 1,212 1,281 1,001 728 557 2,100
Minimum royalties............ 1,125 1,125 1,125 1,125 1,125 7,049
Unconditional raw material
purchase obligations......... 5,211 1,062 - - - -
Other long-term obligations.. 750 750 750 - - -
* Interest for floating rate obligations has been calculated using the
rates in effect as of June 30, 2002.
LIQUIDITY AND CAPITAL RESOURCES
We have substantial indebtedness and significant debt service obligations.
As of June 30, 2002, we had consolidated indebtedness in an aggregate amount of
$131.7 million (excluding trade payables, accrued liabilities and deferred
taxes), of which (1) approximately $15.9 million is a direct obligation of
Holding relating to its debentures and (2) approximately $115.8 million is a
direct obligation of AKI relating to its notes, term loan and revolving credit
line. At June 30, 2002, Holding had $24.7 million of accrued liabilities and AKI
had $26.0 million in accrued liabilities (including trade payables, accrued
liabilities, deferred taxes and other liabilities). As of August 31, 2002, AKI
had outstanding borrowings of $9.5 million under the term loan of the credit
agreement, $6.3 million under the revolving loan commitment of the credit
agreement and $0.4 million under a promissory note with AHC.
26
Borrowings under the revolving credit line are limited to a maximum amount
equal to $20.0 million. At June 30, 2002 and August 31, 2002, AKI had borrowing
availability of approximately $17.0 million and $13.5 million, respectively,
subject to a borrowing base calculation and the achievement of specified
financial ratios and compliance with specified 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, 2006.
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 operating working capital, 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 $13.8 million and $19.6 million for fiscal 2002
and 2001, respectively, together with borrowings under revolving credit
facilities. Net cash provided by operating activities during fiscal 2002
resulted primarily from net income before depreciation and amortization and a
decrease in inventory levels, net of CP acquisition, partially offset by
increased accounts receivable and a decrease in accounts payable and accrued
expenses.
In fiscal 2002 and fiscal 2001, we had capital expenditures of
approximately $1.3 million and $3.0 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. In fiscal 2002 we
received $1.0 million as a result of the purchase price reduction from the
sellers of RetCom.
On December 18, 2001, we acquired the CP business for $19.4 million. We
financed the CP acquisition with borrowings under our credit agreement.
27
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, 2002, AHC had outstanding $53.6 million of Notes which bear
interest at approximately 16% per annum and mature on December 15, 2009, and
approximately $98.4 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 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 limits 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.
Substantially all of the proceeds were used in fiscal 2001 and 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, 2003 are budgeted
to be approximately $4.0 million. Based on borrowings outstanding (other than
pursuant to the revolving credit agreement) as of June 30, 2002 and borrowings
outstanding under the revolving credit agreement as of August 31, 2002, we
expect total cash payments for debt service in fiscal 2003 to be approximately
$13.4 million, consisting of $1.4 million in term loan principal payments, $10.9
million in interest payments on the notes and $1.1 million in interest and fees
under the credit agreement. We also expect to make royalty payments of
approximately $1.1 million during fiscal 2003.
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
2003. 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, 2002, Holding's consolidated cash and cash equivalents and net
working capital were $1.9 million and $11.6 million, respectively, representing
a decrease in cash and cash equivalents of $2.8 million and an increase in net
working capital of $1.4 million from June 30, 2001. Account receivables, net, at
June 30, 2002 increased 32.1% or $5.8 million over the June 30, 2001 amount, due
to a comparative increase in fourth quarter sales primarily resulting from the
CP acquisition.
28
SEASONALITY
Our sales of sampling technologies for advertising and marketing of
fragrance products 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 generally
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. The severity of our seasonal sales variations has
decreased over time as we have developed and acquired other sampling
technologies for advertising and marketing of cosmetic and consumer products.
RECENTLY ISSUED ACCOUNTING STANDARDS
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, and accordingly, the CP
acquisition has been accounted for and reported in accordance with SFAS 141.
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 adoption of
SFAS 142 in future financial statements will eliminate the amortization of
goodwill, approximately $4.8 million in fiscal 2002, while requiring annual
tests for impairment of goodwill.
FASB Statement of Financial Accounting Standards No. 144 "Accounting for
the Impairment of Disposal of Long-Lived Assets" ("SFAS 144") was issued in
August 2001. SFAS 144 requires that long-lived assets that are to be disposed of
by sale be measured at the lower of book value or fair value less cost to sell.
SFAS 144 is effective for financial statements issued for fiscal years beginning
after December 15, 2001. The Company does not expect a material impact in
implementing SFAS 144 on its future financial statements.
FASB Statement of Financial Accounting Standards No. 145 "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" ("SFAS 145") was issued in April 2002. The most
significant aspects of this pronouncement, with respect to the Company, is the
elimination of SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt". As a result of the elimination of SFAS No. 4, gains and losses from
extinguishment of debt should be classified as extraordinary items only if they
meet the criteria in APB No. 30, "Reporting the Results of Operations -
Discontinued Events and Extraordinary Items". The implementation of SFAS No. 145
will require future early retirements of debt to be included in income from
continuing operations which could materially
29
affect our income from continuing operations. In fiscal 2002 the Company
reported an approximate $2.7 million extraordinary gain from early retirement of
debt, net of tax.
FASB Statement of Financial Accounting Standards No. 146 "Accounting for
Costs Associated with Exit or Disposal Activities" ("SFAS 146") was issued in
June 2002. SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities. SFAS 146 is effective for exit or
disposal activities that are initiated after December 31, 2002. The Company
adopted SFAS 146 in fiscal 2002 and did not consider the impact to be material.
CRITICAL ACCOUNTING POLICIES
We have chosen accounting policies that we believe are appropriate to
accurately and fairly report our operating results and financial position, and
we apply those accounting policies in a consistent manner. The significant
accounting policies are summarized in Note 2 to the consolidated financial
statements.
The preparation of financial statements in conformity with generally
accepted accounting principles requires that we make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and expenses.
These estimates and assumptions are based on historical and other factors
believed to be reasonable under the circumstances. We evaluate these estimates
and assumptions on an ongoing basis and may retain outside professional advisors
to assist in our evaluation. We believe the following accounting policies are
the most critical because they involve the most significant judgments and
estimates used in preparation of our consolidated financial statements:
o Allowance for doubtful accounts. We maintain an allowance for doubtful
receivables for estimated losses resulting from the inability of our
trade customers to make required payments. We provide an allowance for
specific customer accounts where collection is doubtful and also
provide a general allowance for other accounts based on historical
collection and write-off experience. Judgment is necessary and if the
financial condition of our customers were to worsen, additional
allowances may be required.
o Inventories. Our inventories, which consist of raw materials and
work-in-process, are valued at the lower of cost or market value. We
evaluate all of our raw material inventory for slow moving product
based on recent usage, projections of future demand and market
conditions. For those units in inventory that are so identified, we
estimate their market value based on current realization trends. If
the projected net realizable value is less than cost, we provide a
provision to reflect the lower value of that inventory. This
methodology recognizes projected inventory losses at the time such
losses are evident.
o Intangible assets. When we acquire other companies or businesses we
allocate the purchase price, including expenses and assumed
liabilities, to the assets and liabilities acquired including
intangible assets and goodwill. We estimate the useful lives of the
intangible assets by factoring in the characteristics of the related
products such as:
30
existing sales contracts, patent protection, estimated future
introductions of competing products and other issues. The factors that
drive the estimate of the life of the asset are inherently uncertain.
o Long-lived assets. We review our property, intangible assets and
goodwill for possible impairment whenever events or circumstances
indicate that the carrying amount of an asset may not be recoverable.
Assumptions and estimates used in the evaluation of impairment may
affect the carrying value of long-lived assets, which could result in
impairment charges in future periods. Such assumptions include
projections of future cash flows and, in some cases, the current fair
value of the asset. In addition, our depreciation and amortization
policies reflect judgments on the estimated useful lives of assets.
o Revenue recognition. We recognize revenue when the risks and rewards
of ownership are assumed by the buyer. This generally occurs upon
delivery of product to the buyer.
o Deferred income tax assets. We have recorded deferred income tax
assets related to the temporary differences between the tax bases and
financial reporting bases of assets and liabilities. An adjustment to
income tax expense would be required in a future period if we
determine that the amount of deferred tax assets to be realized
differs from the net recorded amount.
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 or 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: (1) economic conditions in general and
in our specific market areas; (2) the significant indebtedness of our company;
(3) changes in operating strategy or development plans; (4) the competitive
environment in the sampling industry in general and in our specific market
areas; (5) changes in prevailing interest rates; (6) changes in or failure to
comply with postal regulations or other federal, state and/or local government
regulations; (7) changes in cost of goods and services; (8) changes in our
capital expenditure plans; (9) the ability to attract and retain qualified
personnel; (10) inflation; (11) liability and other claims asserted against us;
(12) labor disturbances 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,
31
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 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 2002, we generated approximately 21% of our sales from customers
outside the United States, principally in Europe. International sales are
generated primarily 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, 2002, 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.
32
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, 2002.
Name Age Position
- ---- --- --------
Thompson Dean 44 Chairman of the Board and Director
William J. Fox 46 President, Chief Executive Officer
and Director
Kenneth A. Budde 53 Senior Vice President, Chief
Financial Officer and Secretary
A. Bruce Prashker 40 Senior Vice President and Assistant
Secretary
Hugh R. Kirkpatrick 65 Director
David M. Wittels 38 Director
David A. Durkin 33 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 a
director of DeCrane Aircraft Holdings, Inc., Von Hoffmann Press, 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.
33
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 and has served in various capacities with DLJ Merchant Banking for the past
five years. Mr. Wittels also serves as a director of Mueller Holdings (N.A.),
Inc., Ziff Davis Holdings, Inc., Advanstar, Inc. and Advanstar Communications
Inc.
David A. Durkin has served as a director of Holding since May 2002. Mr.
Durkin has been a Vice President of DLJ Merchant Banking since 2000. Prior to
that, he served as a Vice President in the Leveraged Finance Group and other
roles in the Investment Banking Department of DLJ Securities Corporation since
1996. Mr. Durkin also serves as a director of Seabulk International, 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.
APPROVAL OF NON-AUDIT SERVICES
The board of directors has approved the provision of tax services by
PricewaterhouseCoopers, the Company's independent auditors, for the fiscal year
ended June 30, 2002 and the fiscal year ending June 30, 2003.
34
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 2002 $ 775,000 $ 1,190,724 -- 8,545
President, Chief Executive Officer 2001 700,000 1,125,000 -- 8,545
And Director 2000 650,000 1,214,000 888,000(2) 8,145
Kenneth A. Budde 2002 210,000 121,653 -- 6,800
Chief Financial Officer 2001 190,000 135,000 -- 6,800
2000 175,000 102,500 160,000 7,090
A. Bruce Prashker 2002 205,000 77,613 -- 6,800
Senior Vice President 2001 190,000 90,000 -- 4,787
2000 34,346 -- 50,000 --
(1) Represents amounts contributed on behalf of the named executive to
401(k) retirement savings plan and amounts paid for supplemental life
insurance premiums.
(2) Pursuant to the terms of his employment agreement, Mr. Fox received
options to acquire 5% of AHC's issued and outstanding common stock on
a pro forma 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 pro forma fully diluted basis.
OPTION GRANTS IN LAST FISCAL YEAR
There were no stock options granted during fiscal 2002 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, 2002. 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.
35
Year End Option Values
Number of securities
underlying unexercised Value of unexercised in-the-
options at June 30, 2002 money options at June 30, 2002
--------------------------------- ---------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
William J. Fox 666,000 222,000 -- --
President, Chief Executive Officer
And Director
Kenneth A. Budde 126,667 33,333 -- --
Chief Financial Officer
A. Bruce Prashker 41,667 8,333 -- --
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 is 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
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 21,000 options for shares of capital stock in fiscal 2002 and
no options for shares of capital stock of AHC were exercised in fiscal 2002.
These options vest over a three year period.
36
EMPLOYMENT AGREEMENTS
Fox Agreement
On January 27, 1999, William J. Fox entered into an employment agreement
with us 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, 2002 the agreement ends on September 1, 2004.
Mr. Fox's base salary is $788,175 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 received options
to acquire 5% of AHC's issued and outstanding common stock on a pro forma fully
diluted basis, subject to anti-dilution protection. 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, in either case 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. 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.
37
Budde Agreement
Mr. Budde is presently retained as chief financial officer pursuant to an
employment agreement that provides for an annual base salary of $220,500 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, 2003, 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.
Prashker Agreement
Mr. Prashker is presently retained as senior vice president at an annual
salary base of $215,300. Mr. Prashker has a salary continuation agreement,
whereby, if Mr. Prashker is terminated by us without cause within one year of a
change of control, Mr. Prashker is entitled to 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
2002. 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, in
consultation with certain members of our Board of Directors.
38
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 September 12, 2002 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. and affiliated entities (1) 15,921,111 98.8%
William J. Fox (2) 888,000 5.2%
Thompson Dean (3) - -
Hugh R. Kirpatrick (2) 5,000 *
David A. Durkin (3) - -
David M. Wittels (3) - -
Kenneth A. Budde (2) 160,000 *
A. Bruce Prashker (2) 41,667 *
All directors and executive officers as a group (2) 1,094,667 6.4%
- -------------
* 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");
and DLJ First ESC L.P ("First ESC"). 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 II is John B. Gorsiraweg 14,
Willemstad, Curacao, Netherlands Antilles. The address of UK Partners
is 2121 Avenue of the Stars, Fox Plaza, Suite 3000, Los Angeles,
California 90067. Does not include 18,000 shares of 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 September 12, 2002.
(3) Messrs. Dean, Durkin 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 or its affiliates, as to
which
39
such individuals disclaim beneficial ownership. The address of each of
Messrs. Dean, Durkin 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.
STOCKHOLDER NOTES
Our Company has a promissory note payable to AHC which allows us to borrow
up to $10 million at such interest rates and due as agreed upon by the Company
and AHC. Interest paid to AHC in connection with the promissory note totaled
approximately $14,000, $320,000 and $22,000 for the years ended June 30, 2002,
2001 and 2000, respectively.
40
TRANSACTIONS WITH LOEHMANN'S, INC.
In fiscal 2002 we performed marketing and design services for Loehmann's,
Inc. totaling approximately $47,000 and are in the process of performing
additional services with anticipated revenues of approximately $86,000. Mr. Fox,
our President and Chief Executive Officer, is also on the Board of Directors of
Loehmann's, Inc. We believe that our services provided to Loehmann's, Inc. are
on terms no less favorable than could have been provided to an unaffiliated
third party.
41
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. (1)
3.2 Certificate of Incorporation of AKI. (2)
3.3 Bylaws of Holding. (1)
3.4 Bylaws of AKI. (2)
4.1 Indenture dated as of June 25, 1998 between Holding and State
Street Bank and Trust Company, as Trustee. (1)
4.2 Indenture dated as of June 25, 1998 between AKI and IBJ Schroder
Trust Company, as Trustee. (2)
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. (1)
10.2 Registration Rights Agreement of AKI, dated as of June 25, 1998,
between AKI and DLJMBII. (2)
10.3 AHC Stock Option Plan. (1)
10.4 Employment Agreement dated as of February 1, 1999 between
Holding and William J. Fox. (3) +
10.5 Amendment to Employment Agreement dated as of September 17, 2001
between Holding and William J. Fox. (4) +
10.6 Salary Continuation Agreement dated as of October 1, 2001
between Arcade Marketing, Inc. and Bruce Prashker. (5) +
10.7 Employment Agreement dated as of July 1, 2000 between Holding
and Kenneth A. Budde. (6) +
42
10.8 Amended and Restated Credit Agreement dated as of December 8,
2001 between the Company and Heller Financial, Inc. (7)
10.9 Financial Advisory Agreement dated as of December 12, 1997
between AHC and DLJ. (1)
12.1 Computation of Ratio of Earnings to Fixed Charges. *
21.1 Subsidiaries of Holding. *
99.1 Certification by Chief Executive Officer.
99.2 Certification by Chief Financial Officer.
- --------------
(1) 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.
(2) 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.
(3) Incorporated by reference from Registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on February 4, 1999.
(4) Incorporated by reference from Registrant's Annual Report on Form 10-K
filed with the Securities and Exchange Commission on September 18,
2001.
(5) Incorporated by reference from Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on November 9,
2001.
(6) Incorporated by reference from Registrant's Annual Report on Form 10-K
filed with the Securities and Exchange Commission on September 28,
2000.
(7) Incorporated by reference from Registrant's Report on Form 8-K filed
with the Securities and Exchange Commission on December 26, 2001.
* Filed herewith
+ Compensatory Contract
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the three months
ended June 30, 2002.
43
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 24th day of
September, 2002.
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 A. 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 24th day of September, 2002.
SIGNATURE TITLE
--------- -----
/S/ Thompson Dean Chairman and Director
- --------------------------------
Thompson Dean
President, Chief Executive Officer
/S/ William J. Fox and Director (Principal Executive
- -------------------------------- Officer)
William J. Fox
/S/ Kenneth A. Budde Senior Vice President, Chief
- -------------------------------- Financial Officer and Secretary
Kenneth A. Budde (Principal Financial and
Accounting Officer)
/S/ David A. Durkin Director
- --------------------------------
David A. Durkin
44
/S/ Hugh R. Kirkpatrick Director
- --------------------------------
Hugh R. Kirkpatrick
/S/ David M. Wittels Director
- --------------------------------
David M. Wittels
CERTIFICATIONS
I, William J. Fox, certify that:
1. I have reviewed this annual report on Form 10-K of AKI Holding Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report.
Date: September 24, 2002
/S/ William J. Fox
- ---------------------------------
William J. Fox
Chief Executive Officer
I, Kenneth A. Budde, certify that:
1. I have reviewed this annual report on Form 10-K of AKI Holding Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report.
Date: September 24, 2002
/S/ Kenneth A. Budde
- ---------------------------------
Kenneth A. Budde
Chief Financial Officer
45
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 24th day of
September, 2002.
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 A. 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 24th day of September, 2002.
SIGNATURE TITLE
--------- -----
/S/ William J. Fox President, Chief Executive Officer,
- -------------------------------- Chairman and Director (Principal
William J. Fox Executive Officer)
/S/ Kenneth A. Budde Senior Vice President, Chief
- -------------------------------- Financial Officer and Secretary
Kenneth A. Budde (Principal Financial and
Accounting Officer)
/S/ Thompson Dean Director
- --------------------------------
Thompson Dean
/S/ David A. Durkin Director
- --------------------------------
David A. Durkin
46
/S/ Hugh R. Kirkpatrick Director
- --------------------------------
Hugh R. Kirkpatrick
/S/ David M. Wittels Director
- --------------------------------
David M. Wittels
CERTIFICATIONS:
I, William J. Fox, certify that:
1. I have reviewed this annual report on Form 10-K of AKI, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report.
Date: September 24, 2002
/S/ William J. Fox
- --------------------------------
William J. Fox
Chief Executive Officer
I, Kenneth A. Budde, certify that:
1. I have reviewed this annual report on Form 10-K of AKI, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report.
Date: September 24, 2002
/S/ Kenneth A. Budde
- --------------------------------
Kenneth A. Budde
Chief Financial Officer
47
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.
48
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS OF AKI HOLDING CORP.:
Report of Independent Accountants..................................... F-2
Consolidated Balance Sheets at June 30, 2002 and 2001................. F-3
Consolidated Statements of Operations for the years ended
June 30, 2002, 2001 and 2000 ..................................... F-4
Consolidated Statements of Stockholder's Equity
for the years ended June 30, 2002, 2001 and 2000 ................. F-5
Consolidated Statements of Cash Flows for the years ended
June 30, 2002, 2001 and 2000 ..................................... F-6
Notes to Consolidated Financial Statements............................ F-7
CONSOLIDATED FINANCIAL STATEMENTS OF AKI, INC.:
Report of Independent Accountants..................................... F-24
Consolidated Balance Sheets at June 30, 2002 and 2001 ................ F-25
Consolidated Statements of Operations for the years ended
June 30, 2002, 2001 and 2000 ..................................... F-26
Consolidated Statements of Stockholder's Equity
for the years ended June 30, 2002, 2001 and 2000 ................. F-27
Consolidated Statements of Cash Flows for the years ended
June 30, 2002, 2001 and 2000 ..................................... F-28
Notes to Consolidated Financial Statements............................ F-29
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, 2002 and 2001, and the results of
their operations and their cash flows for each of the three years in the period
ended June 30, 2002 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 2, 2002
F-2
AKI HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share information)
June 30,
----------------------------
2002 2001
---- ----
ASSETS
Current assets
Cash and cash equivalents.............................................. $ 1,875 $ 4,654
Accounts receivable, net............................................... 23,796 18,020
Inventory, net......................................................... 8,014 6,330
Prepaid expenses....................................................... 667 492
Deferred income taxes.................................................. 977 770
----------- -----------
Total current assets............................................. 35,329 30,266
Property, plant and equipment, net..................................... 19,616 15,778
Goodwill, net ......................................................... 153,277 157,334
Other intangible assets, net........................................... 13,142 6,337
Deferred charges, net.................................................. 4,059 4,381
Deferred income taxes.................................................. 692 -
Other assets........................................................... 164 88
----------- -----------
Total assets..................................................... $ 226,279 $ 214,184
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligations........................... $ - $ 503
Current portion of long-term debt...................................... 1,375 -
Accounts payable, trade................................................ 5,826 3,886
Accrued income taxes................................................... 2,007 1,642
Accrued compensation................................................... 5,338 4,715
Accrued interest....................................................... 5,570 5,443
Accrued expenses....................................................... 3,642 3,908
----------- -----------
Total current liabilities........................................ 23,758 20,097
Revolving credit line.................................................. 2,750 -
Term loan.............................................................. 8,125 -
Senior notes........................................................... 103,510 103,510
Senior discount debentures............................................. 15,901 23,926
Deferred income taxes.................................................. - 19
Other non-current liabilities.......................................... 2,338 1,863
----------- -----------
Total liabilities................................................ 156,382 149,415
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 93,656
Accumulated deficit.................................................... (7,583) (12,320)
Accumulated other comprehensive loss................................... (446) (837)
Carryover basis adjustment............................................. (15,730) (15,730)
------------ -----------
Total stockholder's equity....................................... 69,897 64,769
----------- -----------
Total liabilities and stockholder's equity....................... $ 226,279 $ 214,184
=========== ===========
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,
----------------------------------------
2002 2001 2000
---- ---- ----
Net sales..................................................... $ 120,893 $ 115,395 $ 99,811
Cost of goods sold............................................ 73,888 71,336 61,552
--------- --------- ---------
Gross profit............................................. 47,005 44,059 38,259
Selling, general and administrative expenses ................. 18,943 18,199 16,980
Amortization of goodwill and other intangible assets.......... 6,451 5,757 5,336
Gain from settlement of purchase price dispute, net........... (992) - (858)
---------- --------- ----------
Income from operations................................... 22,603 20,103 16,801
Other expenses (income):
Interest expense........................................... 15,633 16,911 17,401
Management fees to stockholders and affiliate.............. 250 250 250
--------- --------- ---------
Income (loss) before income taxes and extraordinary gain. 6,720 2,942 (850)
Income tax expense............................................ 4,658 3,449 1,596
--------- --------- ---------
Income (loss) before extraordinary gain.................. 2,062 (507) (2,446)
Extraordinary gain from early retirement of debt, net of tax.. 2,675 2,016 1,089
--------- --------- ---------
Net income (loss).......................................... $ 4,737 $ 1,509 $ (1,357)
========= ========= =========
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, 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
Net income........................ - - - 4,737 - - 4,737
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment................... - - - - 391 - 391
--------
Comprehensive income.............. 5,128
------- ----- --------- -------- --------- --------- --------
Balances, June 30, 2002........... 1,000 $ - $ 93,656 $ (7,583) $ (446) $ (15,730) $ 69,897
======= ===== ========= ======== ========= ========= ========
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,
--------------------------------------------
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Net income (loss).......................................... $ 4,737 $ 1,509 $ (1,357)
Adjustment to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization of goodwill and other
intangibles............................................ 12,096 10,119 9,738
Amortization of debt discount............................ 3,029 3,610 3,639
Amortization of loan closing costs....................... 693 808 1,050
Deferred income taxes.................................... (918) (712) 1,359
Gain from early retirement of debt....................... (3,941) (3,446) (2,087)
Other.................................................... 472 (84) (1)
Changes in operating assets and liabilities:
Accounts receivable.................................... (2,541) 3,502 (2,576)
Inventory.............................................. 690 1,427 (2,496)
Prepaid expenses, deferred charges and other assets.... (131) (400) 450
Accounts payable and accrued expenses.................. (754) 1,939 (2,637)
Income taxes........................................... 365 1,332 (155)
--------- --------- ---------
Net cash provided by operating activities.............. 13,797 19,604 4,927
--------- --------- ---------
Cash flows from investing activities:
Purchases of equipment..................................... (1,338) (3,015) (2,782)
Payments for acquisitions, net of cash acquired............ (19,422) - (16,164)
Patents.................................................... (79) (137) (150)
--------- --------- ----------
Net cash used in investing activities.................. (20,839) (3,152) (19,096)
--------- --------- ----------
Cash flows from financing activities:
Payments under capital leases for equipment................ (503) (846) (688)
Repayments of long-term debt............................... (6,805) (3,110) -
Net proceeds (repayments) on revolving loan................ 2,750 (9,000) 9,000
Proceeds from term loan, net of repayment of $500 in 2002.. 9,500 - -
Payments of loan closing costs............................. (679) - -
--------- --------- ---------
Net cash provided by (used in) financing activities.... 4,263 (12,956) 8,312
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents.......... (2,779) 3,496 (5,857)
Cash and cash equivalents, beginning of period................ 4,654 1,158 7,015
--------- --------- ---------
Cash and cash equivalents, end of period...................... $ 1,875 $ 4,654 $ 1,158
========= ========= =========
Supplemental information:
Cash paid (received) during the period for:
Interest to stockholder(s) and affiliate............... $ 14 $ 320 $ 22
Interest, other........................................ 11,600 12,233 13,188
Income taxes........................................... 6,857 4,115 1,264
Significant non-cash activities:
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 of cash 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 and Baltimore, Maryland 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.
Two customers accounted for 31.3% of net sales during the year ended
June 30, 2002. One customer accounted for 14.9% and 15.3% of net sales
during the years ended June 30, 2001 and June 30, 2000, respectively.
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)
Concentration of Purchasing
Products accounting for a significant portion 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 risk of 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 and risk of ownership 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.
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 for acquisitions prior to July 1, 2001 is amortized over a
period of up to forty years using the straight-line method. Accumulated
amortization was $20,159 and $15,353 at June 30, 2002 and June 30, 2001,
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
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)
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
intangibles assets was $4,530 and $2,442 at June 30, 2002 and June 30,
2001, 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 $98,459 and $7,067 at June 30,
2002 compared to a carrying value of $103,510 and $15,901 respectively. The
carrying value of all other financial instruments approximated fair value
at June 30, 2002.
Foreign Currency Transactions
Gains and (losses) on foreign currency transactions have been included
in the determination of net income in accordance with SFAS No. 52, "Foreign
Currency Translation." Foreign currency gains and (losses) amounted to
$301, ($403) and ($51) for the years ended June 30, 2002, 2001 and 2000,
respectively.
Research and Development Expenses
Research and development expenditures are charged to selling, general
and administrative expenses in the period incurred. Research and
development expenses totaled $1,766, $1,591 and $1,309 for the years ended
June 30, 2002, 2001 and 2000, 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.
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)
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. Management makes significant estimates in the
areas of accounts receivable, inventory, intangible assets, long-lived
assets and deferred income tax. Actual results could differ from those
estimates.
Recently Issued Accounting Standards
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, and
accordingly, the CP acquisition has been accounted for and reported in
accordance with SFAS 141.
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 adoption of SFAS 142 in future financial statements will
eliminate the amortization of goodwill, approximately $4,800 in fiscal
2002, while requiring annual tests for impairment of goodwill.
FASB Statement of Financial Accounting Standards No. 144 "Accounting
for the Impairment of Disposal of Long-Lived Assets" ("SFAS 144") was
issued in August 2001. SFAS 144 requires that long-lived assets that are to
be disposed of by sale be measured at the lower of book value or fair value
less cost to sell. SFAS 144 is effective for financial statements issued
for fiscal years beginning after December 15, 2001. The Company does not
expect a material impact in implementing SFAS 144 on its future financial
statements.
FASB Statement of Financial Accounting Standards No. 145 "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13,
and Technical Corrections" ("SFAS 145") was issued in April 2002. The most
significant aspects of this pronouncement, with respect to the Company, is
the elimination of SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt". As a result of the elimination of SFAS No. 4,
gains and losses from extinguishment of debt should be classified as
extraordinary items only if they meet the criteria in APB No. 30,
"Reporting the Results of Operations - Discontinued Events and
Extraordinary Items". The implementation of SFAS No. 145 will require
future early retirements of debt to be included in income from operations
which could materially affect income from operations. In fiscal 2002 the
Company reported an approximate $2,700 extraordinary gain from early
retirement of debt, net of tax.
FASB Statement of Financial Accounting Standards No. 146 "Accounting
for Costs Associated with Exit or Disposal Activities" ("SFAS 146") was
issued in June 2002. SFAS 146 addresses financial accounting and reporting
for costs associated with exit or disposal activities. SFAS 146 is
effective for exit or disposal activities that are initiated after December
31, 2002. The Company adopted SFAS 146 in fiscal 2002 and did not consider
the impact to be material.
F-10
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
3. SIGNIFICANT ACQUISITIONS
On December 18, 2001, the Company acquired the business including
certain assets and assumed certain liabilities of Color Prelude, Inc.
("CP") for $19,423 including direct acquisition costs of $540. The
acquisition was accounted for using the purchase method of accounting in
accordance with Statement of Financial Accounting Standards (SFAS) No. 141,
"Business Combinations". 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 $407 which
will not be amortized in accordance with Statement of Financial Accounting
Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets". The
following shows the allocation of the purchase price:
Cash............................................ $ 1
Other current assets............................ 5,680
Property, plant and equipment................... 7,695
Patents......................................... 7,750
Other intangible assets......................... 1,069
Goodwill........................................ 407
-----------
Total allocation to assets...................... $ 22,602
===========
Current liabilities............................. $ 3,179
===========
Patents are being amortized over a ten year period and other
intangible assets are being amortized over periods ranging from one to four
years.
The results of the acquired operations are included in the financial
statements since the date of acquisition. The following pro forma results
include cost savings and other effects of the planned integration and are
not necessarily indicative of the results which would have occurred if the
business combination had been in effect on the dates indicated. Pro forma
results had CP been acquired at the beginning of fiscal 2001 are as
follows:
2002 2001
---- ----
(unaudited) (unaudited)
Revenue.................................... $ 127,226 $ 129,122
Income (loss) before extraordinary items... 4,110 291
Net income (loss).......................... 4,110 2,307
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 results of the acquired operations are
included in the financial statements since the date of acquisition.
F-11
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
3. SIGNIFICANT ACQUISITIONS (Continued)
In April 2002 the Company settled a dispute with the former owners of
RetCom. In connection with the settlement the Company received
approximately $1,000 and has included this settlement amount net of related
expenses in income from operations.
In December 1999 the Company settled a dispute with the former owners
of the Predecessor. In connection with the settlement the Company received
approximately $1,200 and has included this settlement amount net of related
expenses in income from operations.
4. ACCOUNTS RECEIVABLE
The following table details the components of accounts receivable:
June 30,
----------------------------
2002 2001
---- ----
Trade accounts receivable............... $ 24,083 $ 18,487
Allowance for doubtful accounts......... (608) (836)
----------- ----------
23,475 17,651
Other accounts receivable............... 321 369
---------- ----------
$ 23,796 $ 18,020
========== ==========
5. INVENTORY
The following table details the components of inventory:
June 30,
----------------------------
2002 2001
---- ----
Raw materials
Paper................................. $ 2,180 $ 1,796
Other raw materials................... 4,216 2,697
---------- ----------
Total raw materials................ 6,396 4,493
Work in process......................... 2,468 2,587
Reserve for obsolescence................ (850) (750)
---------- ----------
Total inventory......................... $ 8,014 $ 6,330
========== ==========
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,
2002 or June 30, 2001. During the year ended June 30, 2001, certain
inventory quantity reductions caused a liquidation of LIFO inventory values
which were immaterial.
F-12
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 2002 2001
------------ ---- ----
Land...................................... $ 258 $ 258
Building.................................. 7 - 15 years 2,690 1,851
Leasehold improvements.................... 1 - 3 years 353 651
Machinery and equipment................... 5 - 7 years 32,000 23,622
Furniture and fixtures.................... 3 - 5 years 3,609 3,370
Construction in progress.................. 255 405
--------- ---------
39,165 30,157
Accumulated depreciation.................. (19,549) (14,379)
--------- ---------
$ 19,616 $ 15,778
========= =========
Depreciation expense amounted to $5,197, $4,341 and $4,381 for the
years ended June 30, 2002, 2001 and 2000, respectively.
Property held under capital lease is included in the respective
property, plant and equipment category as follows:
June 30,
2001
----
Building............................................... $ 600
---------
600
Less accumulated depreciation.......................... (500)
---------
$ 100
=========
Depreciation of assets under capital lease totaled $100, $200 and $600
for the years ended June 30, 2002, 2001 and 2000, respectively.
7. CREDIT AGREEMENT
On December 18, 2001, the Company amended and restated its Credit
Agreement. The Credit Agreement provides for a $10,000 term loan which
matures on December 31, 2006 with varying quarterly principal payments and,
under certain circumstances, payments of "excess cash flow" as defined in
the Credit Agreement. Interest on amounts borrowed accrue at a floating
rate based upon either prime or LIBOR (the weighted average interest rate
on the outstanding balance under the term loan was 6.15% at June 30, 2002).
The weighted average interest rate on the outstanding balance under the
term loan was 5.96% for the year ending June 30, 2002. Future minimum
principal payments under the term loan are as follows:
F-13
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
7. CREDIT AGREEMENT (Continued)
Principal
Payment
-------
2003................ $ 1,375
2004................ 1,875
2005................ 2,125
2006................ 2,625
2007................ 1,500
-----------
$ 9,500
===========
The Credit Agreement also provides for a revolving loan commitment up
to a maximum of $20,000 and expires on December 31, 2006. 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, 2002, the Company's borrowing base was
approximately $27,289. Interest on amounts borrowed accrue at a floating
rate based upon either prime or LIBOR (the weighted average interest rate
on the outstanding balance under the revolving loan was 6.49% and 7.75% at
June 30, 2002 and 2001, respectively). The weighted average interest rate
on the outstanding balance under the revolving loan was 6.45%, 9.58% and
9.12% for the years ended June 30, 2002, 2001 and 2000, 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 had $291
of lender guarantees outstanding at June 30, 2002. These fees totaled $65,
$59 and $69 for the years ended June 30, 2002, 2001 and 2000, 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, 2002, 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 $10,000 at such interest rates and due
as agreed upon by the Company and AHC. At June 30, 2002 no amount was
outstanding under the promissory note. Interest paid to AHC in connection
with the promissory note totaled $14, $320 and $22 for the years ended June
30, 2002, 2001 and 2000, respectively.
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
F-14
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
9. SENIOR NOTES (Continued)
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. The purchased notes were subsequently retired. 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 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 $2,219 and $7,124
at June 30, 2002 and 2001, respectively. After July 1, 2003, the Debentures
will accrue interest at a rate of 13.5% per annum, payable semi-annually,
commencing January 1, 2004. The Debentures are 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 2002, Holding purchased,
with proceeds from a distribution from AKI, Senior Discount Debentures with
a carrying value of $11,054 for $6,804 and recognized a gain, net of income
taxes, of approximately $2,676. The purchased Debentures were subsequently
retired. 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, purchased by AHC, 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
F-15
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
11. INITIAL CAPITALIZATION (Continued)
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.
12. COMMITMENTS AND CONTINGENCIES
Operating Leases
Equipment and office, warehouse and production space under operating
leases expire at various dates. Rent expense was $559, $538 and $589 for
the years ended June 30, 2002, 2001 and 2000, respectively. Future minimum
lease payments under the leases are as follows:
2003.......... $ 1,212
2004.......... 1,281
2005.......... 1,001
2006.......... 728
2007.......... 557
Thereafter.... 2,100
---------
$ 6,879
=========
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 the earlier of (1) when a total of $11,800 in
cumulative royalty payments has been paid or (2) December 31, 2003 unless
renewed by the Company for successive one-year periods. The Company
expensed $500 under this agreement for each of the three years ended June
30, 2002. The Company has paid $6,076 in cumulative royalty payments under
this agreement through June 30, 2002.
F-16
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
12. COMMITMENTS AND CONTINGENCIES (Continued)
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 of $625 per year through
the expiration of the agreement in 2012. The Company expensed $625 under
this agreement for each of the three years ended June 30, 2002.
Employment Agreements
The Company has employment and salary continuation agreements with
certain executive officers with terms through June 30, 2003 and 2004. Such
agreements provide for base salaries totaling $1,250 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 and one officer's agreement provides,
in the event of termination resulting from a change of control, a severance
benefit of two times his highest aggregate amount of base salary and bonus
in any of the three calendar years prior to the effective date of
termination.
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 Printing
Services Agreement, which expires December 31, 2004, with a former
shareholder of RetCom. The Printing Services Agreement requires annual
purchases of printing services totaling $5,000 with 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. The liability
balance at June 30, 2002 was approximately $2,600.
13. RETIREMENT PLANS
A 401(k) defined contribution plan (the "Plan") is maintained for
substantially all full-time salaried employees and certain non-union hourly
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 $323, $294 and $251 for the years ended
June 30, 2002, 2001 and 2000, respectively.
F-17
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
13. RETIREMENT PLANS (Continued)
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 $221,
$233 and $215 for the years ended June 30, 2002, 2001 and 2000,
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,
---------------------------------------------
2002 2001 2000
---- ---- ----
Income (loss) before income taxes and
extraordinary gain:
United States.................................. $ 4,578 $ 1,481 $ (1,305)
Foreign........................................ 2,142 1,461 455
--------- --------- ---------
$ 6,720 $ 2,942 $ (850)
========= ========= =========
Significant components of the provision (benefit) for income taxes are
as follows:
Year Ended June 30,
--------------------------------------------
2002 2001 2000
---- ---- ----
Current expense:
Federal........................................ $ 5,003 $ 4,288 $ 480
Foreign........................................ 1,042 526 171
State.......................................... 962 232 -
--------- --------- ---------
7,007 5,046 651
--------- --------- ---------
Deferred expense (benefit):
Federal........................................ (2,263) (1,931) 519
Foreign........................................ - - -
State.......................................... (86) 334 426
--------- --------- ---------
(2,349) (1,597) 945
--------- --------- ---------
$ 4,658 $ 3,449 $ 1,596
========= ========= =========
F-18
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
14. INCOME TAXES (Continued)
The significant components of deferred tax assets (liabilities) at
June 30, 2002 and 2001, were as follows:
June 30,
-----------------------------------------------------
2002 2001
---- ----
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------
Deferred income tax assets:
Accrued expenses........................ $ 483 $ 1,923 $ 474 $ 2,338
Allowance for doubtful accounts......... 216 - 296 -
Reserve for inventory obsolescence...... 278 - - -
Amortization of intangibles............. - 773 - 421
--------- --------- --------- ---------
977 2,696 770 2,759
Deferred income tax liability:
Property, plant and equipment........... - (2,004) - (2,778)
--------- --------- --------- ---------
Deferred tax assets (liabilities).... $ 977 $ 692 $ 770 $ (19)
========= ======== ========= =========
The income tax provision recognized by the Company for the years ended
June 30, 2002, 2001 and 2000 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,
-------------------------------------------
2002 2001 2000
---- ---- ----
Computed tax provision (benefit) at the
statutory rate................................. $ 2,285 $ 1,030 $ (289)
State income tax provision, net of
federal effect................................. 570 368 281
Nondeductible expenses........................... 1,511 2,036 1,588
Other, net....................................... 292 15 16
--------- --------- ---------
$ 4,658 $ 3,449 $ 1,596
========= ========= =========
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.
F-19
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
15. STOCK OPTIONS (Continued)
A summary of AHC stock option activity and related information for the
years ended June 30, 2002, 2001 and 2000 follows:
2002 2001 2000
------------------------ ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- ----- ------- ----- ------- -----
Outstanding, beginning of year..... 1,464,850 $ 1.00 1,509,450 $ 1.00 - $ 1.00
Granted....................... 21,000 1.00 35,500 1.00 1,519,917 1.00
Exercised..................... - - - - - -
Forfeited..................... (16,800) 1.00 (80,100) 1.00 (10,467) 1.00
--------- ------- --------- ------- --------- -------
Outstanding, end of year........... 1,469,050 $ 1.00 1,464,850 $ 1.00 1,509,450 $ 1.00
--------- ======= --------- ======= --------- =======
Exercisable, end of year........... 1,106,343 $ 1.00 640,793 $ 1.00 273,668 $ 1.00
========= ======= ========= ======= ========= =======
Weighted average remaining
contractual life................... 7.5 years 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, 2002, 2001 and 2000 would have
been $4,632, $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 2002, 2001
and 2000 was approximately $0.21, $0.23 and $0.27, respectively, 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, 2002.
F-20
AKI HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share information)
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
States France Total
------ ------ -----
Net sales:
Year ended June 30, 2000............... $ 85,418 $ 14,393 $ 99,811
Year ended June 30, 2001............... 96,845 18,550 115,395
Year ended June 30, 2002............... 103,138 17,755 120,893
Long-lived assets:
Year ended June 30, 2000............... 192,262 87 192,349
Year ended June 30, 2001............... 183,848 70 183,918
Year ended June 30, 2002............... 190,868 82 190,950
18. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following condensed balance sheets at June 30, 2002 and June 30,
2001 and condensed statements of operations, stockholder's equity and cash
flows for the years ended June 30, 2002, 2001 and 2000 for Holding should
be read in conjunction with the consolidated financial statements and notes
thereto.
BALANCE SHEETS
June 30,
---------------------------
2002 2001
---- ----
Assets
Investment in subsidiaries........................................ $ 99,583 $ 102,237
Income tax receivable............................................. 46 -
Deferred charges.................................................. 422 806
Deferred income taxes............................................. 1,923 2,338
---------- ----------
Total assets.................................................... $ 101,974 $ 105,381
========== ==========
Liabilities
Accrued income taxes.............................................. $ - $ 119
Senior discount debentures........................................ 15,901 23,926
---------- ----------
Total liabilities............................................... 15,901 24,045
---------- ----------
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 93,656
Accumulated deficit............................................... (7,583) (12,320)
----------- ----------
Total stockholder's equity...................................... 86,073 81,336
---------- ----------
Total liabilities and stockholder's equity...................... $ 101,974 $ 105,381
========== ==========
F-21
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 OPERATIONS
Year Ended June 30,
----------------------------------------
2002 2001 2000
---- ---- ----
Equity in net income of subsidiaries......................... $ 4,151 $ 2,439 $ 495
Interest expense, net........................................ (3,105) (3,699) (3,733)
---------- ---------- ----------
Income (loss) before income taxes and extraordinary gain... 1,046 (1,260) (3,238)
Income tax benefit........................................... (1,016) (1,210) (1,221)
----------- ---------- ----------
Income (loss) before extraordinary gain.................... 2,062 (50) (2,017)
Extraordinary gain from early retirement of debt, net of tax. 2,675 1,559 660
---------- ---------- ----------
Net income (loss).......................................... $ 4,737 $ 1,509 $ (1,357)
========== ========== ==========
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
Net income....................... - - - 4,737 4,737
------- ------- ----------- ---------- -----------
Balances, June 30, 2002.......... 1,000 $ - $ 93,656 $ (7,583) $ 86,073
======= ======= =========== ========== ===========
F-22
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 CASH FLOWS
Year Ended June 30,
-----------------------------------
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Net income (loss)................................................. $ 4,737 $ 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...................... (4,151) (2,439) (495)
Amortization of original issuance discount.................... 3,029 3,610 3,639
Amortization of loan closing costs............................ 76 89 94
Deferred income taxes......................................... 415 (325) (807)
Gain from early retirement of debt............................ (3,941) (2,554) (1,083)
Changes in operating assets and liabilities:
Income taxes................................................ (165) 110 9
--------- --------- --------
Net cash provided by (used in) operating activities........ - - -
--------- --------- --------
Cash flows from financing activities:
Repayments of long-term debt...................................... (6,805) - -
Distribution from subsidiary...................................... 6,805 - -
--------- --------- --------
Net cash provided by (used in) financing activities............. - - -
--------- --------- --------
Net increase (decrease) in cash and cash equivalents................ - - -
Cash and cash equivalents, beginning of period...................... - - -
--------- --------- --------
Cash and cash equivalents, end of period............................ $ - $ - $ -
========= ========= ========
19. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following is a summary of the unaudited quarterly results of
operations for Fiscal 2002 and Fiscal 2001.
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2002 2001 2001 2002 2002 Total
---- ---- ---- ---- ------
Net sales............... $ 27,381 $ 22,329 $ 35,472 $ 35,711 $ 120,893
Gross profit............ 10,667 6,400 15,115 14,823 47,005
Income from operations.. 5,026 361 8,418 8,798 22,603
Interest expense, net... 3,871 3,865 4,182 3,715 15,633
Net income (loss)....... 146 (2,697) 2,029 5,259 4,737
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
F-23
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, 2002 and 2001 and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 2002 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 2, 2002
F-24
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,
----------------------------
2002 2001
---- ----
ASSETS
Current assets
Cash and cash equivalents.............................................. $ 1,875 $ 4,654
Accounts receivable, net............................................... 23,796 18,020
Inventory, net......................................................... 8,014 6,330
Prepaid expenses....................................................... 667 492
Deferred income taxes.................................................. 977 770
---------- ----------
Total current assets............................................. 35,329 30,266
Property, plant and equipment, net..................................... 19,616 15,778
Goodwill, net ......................................................... 153,277 157,334
Other intangible assets, net........................................... 13,142 6,337
Deferred charges, net.................................................. 3,637 3,575
Other assets........................................................... 164 88
---------- ----------
Total assets..................................................... $ 225,165 $ 213,378
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligation............................ $ - $ 503
Current portion of long-term debt...................................... 1,375 -
Accounts payable, trade................................................ 5,826 3,886
Accrued income taxes................................................... 2,053 1,523
Accrued compensation................................................... 5,338 4,715
Accrued interest....................................................... 5,570 5,443
Accrued expenses....................................................... 3,642 3,908
---------- ----------
Total current liabilities........................................ 23,804 19,978
Revolving credit line.................................................. 2,750 -
Term loan.............................................................. 8,125 -
Senior notes........................................................... 103,510 103,510
Deferred income taxes.................................................. 1,231 2,357
Other non-current liabilities.......................................... 2,338 1,863
---------- ----------
Total liabilities................................................ 141,758 127,708
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............................................ 100,543 107,348
Accumulated deficit.................................................... (960) (5,111)
Accumulated other comprehensive loss................................... (446) (837)
Carryover basis adjustment............................................. (15,730) (15,730)
----------- ----------
Total stockholder's equity....................................... 83,407 85,670
---------- ----------
Total liabilities and stockholder's equity....................... $ 225,165 $ 213,378
========== ==========
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 OPERATIONS
(in thousands)
Year Ended June 30,
----------------------------------------
2002 2001 2000
---- ---- ----
Net sales..................................................... $ 120,893 $ 115,395 $ 99,811
Cost of goods sold............................................ 73,888 71,336 61,552
--------- --------- ---------
Gross profit............................................... 47,005 44,059 38,259
Selling, general and administrative expenses.................. 18,943 18,199 16,980
Amortization of goodwill and other intangible assets.......... 6,451 5,757 5,336
Gain from settlement of purchase price dispute, net........... (992) - (858)
--------- --------- ---------
Income from operations..................................... 22,603 20,103 16,801
Other expenses (income):
Interest expense........................................... 12,528 13,212 13,668
Management fees to stockholders and affiliate.............. 250 250 250
--------- --------- ---------
Income before income taxes and extraordinary gain........ 9,825 6,641 2,883
Income tax expense............................................ 5,674 4,659 2,817
--------- --------- ---------
Income before extraordinary gain......................... 4,151 1,982 66
Extraordinary gain from early retirement of debt, net
of tax...................................................... - 457 429
--------- --------- ---------
Net income................................................. $ 4,151 $ 2,439 $ 495
========= ========= =========
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 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, 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
Distribution to AKI Holding Corp.. - - (6,805) - - - (6,805)
Net income........................ - - - 4,151 - - 4,151
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment................... - - - - 391 - 391
--------
Comprehensive income.............. 4,542
------ ----- --------- -------- --------- --------- --------
Balances, June 30, 2002........... 1,000 $ - $ 100,543 $ (960) $ (446) $ (15,730) $ 83,407
====== ===== ========= ======== ========= ========= ========
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.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended June 30,
--------------------------------------------
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Net income................................................. $ 4,151 $ 2,439 $ 495
Adjustment to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization of goodwill and other
intangibles............................................ 12,096 10,119 9,738
Amortization of loan closing costs....................... 617 719 956
Deferred income taxes.................................... (1,333) (387) 2,166
Gain from early retirement of debt....................... - (892) (1,004)
Other.................................................... 472 (84) (1)
Changes in operating assets and liabilities:
Accounts receivable.................................... (2,541) 3,502 (2,576)
Inventory.............................................. 690 1,427 (2,496)
Prepaid expenses, deferred charges and other assets.... (131) (400) 450
Accounts payable and accrued expenses.................. (754) 1,939 (2,637)
Income taxes........................................... 530 1,222 (164)
--------- --------- ---------
Net cash provided by operating activities.............. 13,797 19,604 4,927
--------- --------- ---------
Cash flows from investing activities:
Purchases of equipment..................................... (1,338) (3,015) (2,782)
Payments for acquisitions, net of cash acquired............ (19,422) - (16,164)
Patents.................................................... (79) (137) (150)
--------- --------- ---------
Net cash used in investing activities.................. (20,839) (3,152) (19,096)
--------- --------- ---------
Cash flows from financing activities:
Payments under capital leases for equipment................ (503) (846) (688)
Repayments of long-term debt............................... - (3,110) -
Net proceeds (repayments) on revolving loan................ 2,750 (9,000) 9,000
Proceeds from term loan, net of repayment of $500 in 2002.. 9,500 - -
Payments of loan closing costs............................. (679) - -
Distribution to parent..................................... (6,805) - -
--------- --------- ---------
Net cash provided by (used in) financing activities.... 4,263 (12,956) 8,312
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents.......... (2,779) 3,496 (5,857)
Cash and cash equivalents, beginning of period................ 4,654 1,158 7,015
--------- --------- ---------
Cash and cash equivalents, end of period...................... $ 1,875 $ 4,654 $ 1,158
========= ========= =========
Supplemental information:
Cash paid (received) during the period for:
Interest to stockholder(s)............................. $ 14 $ 320 $ 22
Interest, other........................................ 11,600 12,233 13,188
Income taxes........................................... 6,857 4,115 1,264
Significant non-cash activities:
Contribution of equity and retirement of senior notes...... $ - $ - $ 6,486
The accompanying notes are an integral part of these consolidated
financial statements.
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)
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 and Baltimore, Maryland 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.
Two customers accounted for 31.3% of net sales during the year ended
June 30, 2002. One customer accounted for 14.9% and 15.3% of net sales
during the years ended June 30, 2001 and June 30, 2000, respectively.
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)
Concentration of Purchasing
Products accounting for a significant portion 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 risk of 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 and risk of ownership 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.
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 for acquisitions prior to July 1, 2001 is amortized over a
period of up to forty years using the straight-line method. Accumulated
amortization was $20,159 and $15,353 at June 30, 2002 and June 30, 2001,
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)
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 $4,530 and $2,442 at June 30, 2002 and June 30, 2001,
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 $98,459 at June 30, 2002, compared to a carrying value of
$103,510. The carrying value of all other financial instruments
approximated fair value at June 30, 2002.
Foreign Currency Transactions
Gains and (losses) on foreign currency transactions have been included
in the determination of net income in accordance with SFAS No. 52, "Foreign
Currency Translation." Foreign currency gains and (losses) amounted to
$301, ($403) and ($51) for the years ended June 30, 2002, 2001 and 2000,
respectively.
Research and Development Expenses
Research and development expenditures are charged to selling, general
and administrative expenses in the period incurred. Research and
development expenses totaled $1,766, $1,591 and $1,309 for the years ended
June 30, 2002, 2001 and 2000, 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
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)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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. Management makes significant estimates in the
areas of accounts receivable, inventory, intangible assets, long-lived
assets and deferred income tax. Actual results could differ from those
estimates.
Recently Issued Accounting Standards
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, and
accordingly, the CP acquisition has been accounted for and reported in
accordance with SFAS 141.
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 adoption of SFAS 142 in future financial statements will
eliminate the amortization of goodwill, approximately $4,800 in fiscal
2002, while requiring annual tests for impairment of goodwill.
FASB Statement of Financial Accounting Standards No. 144 "Accounting
for the Impairment of Disposal of Long-Lived Assets" ("SFAS 144") was
issued in August 2001. SFAS 144 requires that long-lived assets that are to
be disposed of by sale be measured at the lower of book value or fair value
less cost to sell. SFAS 144 is effective for financial statements issued
for fiscal years beginning after December 15, 2001. The Company does not
expect a material impact in implementing SFAS 144 on its future financial
statements.
FASB Statement of Financial Accounting Standards No. 145 "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13,
and Technical Corrections" ("SFAS 145") was issued in April 2002. The most
significant aspects of this pronouncement, with respect to the Company, is
the elimination of SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt". As a result of the elimination of SFAS No. 4,
gains and losses from extinguishment of debt should be classified as
extraordinary items only if they meet the criteria in APB No. 30,
"Reporting the Results of Operations - Discontinued Events and
Extraordinary Items". The implementation of SFAS No. 145 will require
future early retirements of debt to be included in income from operations
which could materially affect income from operations.
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)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
FASB Statement of Financial Accounting Standards No. 146 "Accounting
for Costs Associated with Exit or Disposal Activities" ("SFAS 146") was
issued in June 2002. SFAS 146 addresses financial accounting and reporting
for costs associated with exit or disposal activities. SFAS 146 is
effective for exit or disposal activities that are initiated after December
31, 2002. The Company adopted SFAS 146 in fiscal 2002 and did not consider
the impact to be material.
3. SIGNIFICANT ACQUISITIONS
On December 18, 2001, the Company acquired the business including
certain assets and assumed certain liabilities of Color Prelude, Inc.
("CP") for $19,423 including direct acquisition costs of $540. The
acquisition was accounted for using the purchase method of accounting in
accordance with Statement of Financial Accounting Standards (SFAS) No. 141,
"Business Combinations". 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 $407 which
will not be amortized in accordance with Statement of Financial Accounting
Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets". The
following shows the allocation of the purchase price:
Cash............................................ $ 1
Other current assets............................ 5,680
Property, plant and equipment................... 7,695
Patents......................................... 7,750
Other intangible assets......................... 1,069
Goodwill........................................ 407
-----------
Total allocation to assets...................... $ 22,602
===========
Current liabilities............................. $ 3,179
===========
Patents are being amortized over a ten year period and other
intangible assets are being amortized over periods ranging from one to four
years.
The results of the acquired operations are included in the financial
statements since the date of acquisition. The following pro forma results
include cost savings and other effects of the planned integration and are
not necessarily indicative of the results which would have occurred if the
business combination had been in effect on the dates indicated. Pro forma
results had CP been acquired at the beginning of fiscal 2001 are as
follows:
2002 2001
---- ----
(unaudited) (unaudited)
Revenue.................................... $ 127,226 $ 129,122
Income (loss) before extraordinary items... 4,110 2,780
Net income (loss).......................... 4,110 3,237
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)
3. SIGNIFICANT ACQUISITIONS (Continued)
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 results of the acquired operations are
included in the financial statements since the date of acquisition.
In April 2002 the Company settled a dispute with the former owners of
RetCom. In connection with the settlement the Company received
approximately $1,000 and has included this settlement amount net of related
expenses in income from operations.
In December 1999 the Company settled a dispute with the former owners
of the Predecessor. In connection with the settlement the Company received
approximately $1,200 and has included this settlement amount net of related
expenses in income from operations.
4. ACCOUNTS RECEIVABLE
The following table details the components of accounts receivable:
June 30,
----------------------------
2002 2001
---- ----
Trade accounts receivable............... $ 24,083 $ 18,487
Allowance for doubtful accounts......... (608) (836)
---------- ----------
23,475 17,651
Other accounts receivable............... 321 369
---------- ---------
$ 23,796 $ 18,020
========== =========
5. INVENTORY
The following table details the components of inventory:
June 30,
----------------------------
2002 2001
---- ----
Raw materials
Paper................................. $ 2,180 $ 1,796
Other raw materials................... 4,216 2,697
---------- ----------
Total raw materials................ 6,396 4,493
Work in process......................... 2,468 2,587
Reserve for obsolescence................ (850) (750)
---------- ----------
Total inventory........................ $ 8,014 $ 6,330
========== ==========
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)
5. INVENTORY (Continued)
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,
2002 or June 30, 2001. During the year ended June 30, 2001, certain
inventory quantity reductions caused a liquidation of LIFO inventory
values, which were immaterial.
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 2002 2001
------------ ---- ----
Land...................................... $ 258 $ 258
Buildings................................. 7 - 15 years 2,690 1,851
Leasehold improvements.................... 1 - 3 years 353 651
Machinery and equipment................... 5 - 7 years 32,000 23,622
Furniture and fixtures.................... 3 - 5 years 3,609 3,370
Construction in progress.................. 255 405
--------- ---------
39,165 30,157
Accumulated depreciation.................. (19,549) (14,379)
--------- ---------
$ 19,616 $ 15,778
========= =========
Depreciation expense amounted to $5,197, $4,341 and $4,381 for the
years ended June 30, 2002, 2001 and 2000, respectively.
Property held under capital lease is included in the respective
property, plant and equipment category as follows:
June 30,
2001
----
Building............................................... $ 600
---------
600
Less accumulated depreciation.......................... (500)
---------
$ 100
=========
Depreciation of assets under capital lease totaled $100, $200 and $600
for the years ended June 30, 2002, 2001 and 2000, respectively.
7. CREDIT AGREEMENT
On December 18, 2001, the Company amended and restated its Credit
Agreement. The Credit Agreement provides for a $10,000 term loan which
matures on December 31, 2006 with varying quarterly principal payments and,
under certain circumstances, payments of "excess cash flow" as defined in
the Credit Agreement. Interest on amounts borrowed accrue at a floating
rate based upon either prime or LIBOR (the weighted average
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)
7. CREDIT AGREEMENT (Continued)
interest rate on the outstanding balance under the term loan was 6.15% at
June 30, 2002). The weighted average interest rate on the outstanding
balance under the term loan was 5.96% for the year ending June 30, 2002.
Future minimum principal payments under the term loan are as follows:
Principal
Payment
-------
2003................ $ 1,375
2004................ 1,875
2005................ 2,125
2006................ 2,625
2007................ 1,500
-----------
$ 9,500
===========
The Credit Agreement also provides for a revolving loan commitment up
to a maximum of $20,000 and expires on December 31, 2006. 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, 2002, the Company's borrowing base was
approximately $27,289. Interest on amounts borrowed accrue at a floating
rate based upon either prime or LIBOR (the weighted average interest rate
on the outstanding balance under the revolving loan was 6.49% and 7.75% at
June 30, 2002 and 2001, respectively). The weighted average interest rate
on the outstanding balance under the revolving loan was 6.45%, 9.58% and
9.12% for the years ended June 30, 2002, 2001 and 2000, 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 had $291
of lender guarantees outstanding at June 30, 2002. These fees totaled $65,
$59 and $69 for the years ended June 30, 2002, 2001 and 2000, 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, 2002, 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 $10,000 at such interest rates and due
as agreed upon by the Company and AHC. At June 30, 2002, no amount was
outstanding under the promissory note. Interest paid to AHC in connection
with the promissory note totaled $14, $320 and $22 for the years ended June
30, 2002, 2001 and 2000, respectively.
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
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)
9. SENIOR NOTES (Continued)
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
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 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. The purchased notes were
subsequently retired. 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 notes were subsequently retired.
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 of cash 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.
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)
11. COMMITMENTS AND CONTINGENCIES
Operating Leases
Equipment and office, warehouse and production space under operating
leases expire at various dates. Rent expense was $559, $538 and $589 for
the years ended June 30, 2002, 2001 and 2000, respectively. Future minimum
lease payments under the leases are as follows:
2003.......... $ 1,212
2004.......... 1,281
2005.......... 1,001
2006.......... 728
2007.......... 557
Thereafter.... 2,100
---------
$ 6,879
=========
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 the earlier of (1) when a total of $11,800 in
cumulative royalty payments has been paid or (2) December 31, 2003 unless
renewed by the Company for successive one-year periods. The Company
expensed $500 under this agreement for each of the three years ended June
30, 2002. The Company has paid $6,076 in cumulative royalty payments under
this agreement through June 30, 2002.
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 of $625 per year through
the expiration of the agreement in 2012. The Company expensed $625 under
this agreement for each of the three years ended June 30, 2002.
Employee Agreements
The Company has employment and salary continuation agreements with
certain executive officers with terms through June 30, 2003 and 2004. Such
agreements provide for base salaries totaling $1,250 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 and one officer's agreement provides,
in the event of termination resulting from a change of control, a severance
benefit of two times his highest aggregate amount of base salary and bonus
in any of the three calendar years prior to the effective date of
termination.
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-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)
11. COMMITMENTS AND CONTINGENCIES (Contined)
Printing Services Agreement
In connection with the RetCom acquisition, AKI entered into a Printing
Services Agreement, which expires December 31, 2004, with a former
shareholder of RetCom. The Printing Services Agreement requires annual
purchases of printing services totaling $5,000 with 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. The liability
balance at June 30, 2002 was approximately $2,600.
12. RETIREMENT PLANS
A 401(k) defined contribution plan (the "Plan") is maintained for
substantially all full-time salaried employees and certain non-union hourly
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 $323, $294 and $251 for the years ended
June 30, 2002, 2001 and 2000, 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 $221,
$233 and $215 for the years ended June 30, 2002, 2001 and 2000,
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 before income taxes and
extraordinary gain includes the following components:
Year Ended June 30,
---------------------------------------------
2002 2001 2000
---- ---- ----
Income before income taxes and extraordinary
gain:
United States.................................. $ 7,683 $ 5,180 $ 2,428
Foreign........................................ 2,142 1,461 455
--------- --------- ---------
$ 9,825 $ 6,641 $ 2,883
========= ========= =========
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)
13. INCOME TAXES (Continued)
Significant components of the provision (benefit) for income taxes are
as follows:
Year Ended June 30,
--------------------------------------------
2002 2001 2000
---- ---- ----
Current expense:
Federal........................................ $ 5,003 $ 4,288 $ 480
Foreign........................................ 1,042 526 171
State.......................................... 962 232 -
--------- --------- ---------
7,007 5,046 651
--------- --------- ---------
Deferred expense (benefit):
Federal........................................ (1,247) (721) 1,740
Foreign........................................ - - -
State.......................................... (86) 334 426
--------- --------- ---------
(1,333) (387) 2,166
--------- --------- ---------
$ 5,674 $ 4,659 $ 2,817
========= ========= =========
The significant components of deferred tax assets and (liabilities) at
June 30, 2002 and 2001, were as follows:
June 30,
-----------------------------------------------------
2002 2001
---- ----
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------
Deferred income tax assets:
Accrued expenses........................ $ 483 $ - $ 400 $ -
Allowance for doubtful accounts......... 216 - 296 -
Reserve for inventory obsolescence...... 278 - 74 -
Amortization of intangibles............. - 773 - 421
--------- -------- --------- ---------
977 773 770 421
Deferred income tax liability:
Property, plant and equipment........... - (2,004) - (2,778)
--------- -------- --------- ---------
Deferred tax assets (liabilities).... $ 977 $ (1,231) $ 770 $ (2,357)
========= ========= ========= =========
The income tax provision recognized by the Company for the years ended
June 30, 2002, 2001 and 2000 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,
-------------------------------------------
2002 2001 2000
---- ---- ----
Computed tax provision at the
statutory rate................................. $ 3,439 $ 2,324 $ 980
State income tax provision, net of
federal effect................................. 570 368 281
Net nondeductible expenses....................... 1,373 1,952 1,540
Other, net....................................... 292 15 16
--------- --------- ---------
$ 5,674 $ 4,659 $ 2,817
========= ========= =========
F-40
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, 2002, 2001 and 2000 follows:
2002 2001 2000
------------------------ ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- ----- ------- ----- ------- -----
Outstanding, beginning of year..... 1,464,850 $ 1.00 1,509,450 $ 1.00 - $ 1.00
Granted....................... 21,000 1.00 35,500 1.00 1,519,917 1.00
Exercised..................... - - - - - -
Forfeited..................... (16,800) 1.00 (80,100) 1.00 (10,467) 1.00
--------- ------- --------- ------- --------- -------
Outstanding, end of year........... 1,469,050 $ 1.00 1,464,850 $ 1.00 1,509,450 $ 1.00
--------- ======= --------- ======= --------- =======
Exercisable, end of year........... 1,106,343 $ 1.00 640,793 $ 1.00 273,668 $ 1.00
========= ======= ========= ======= ========= =======
Weighted average remaining
contractual life................... 7.5 years 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 for the years ended June 30, 2002, 2001 and 2000 would have been
$4,046, $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 2002, 2001 and 2000 was approximately
$0.21, $0.23 and $0.27, respectively, 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, 2002.
F-41
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
States France Total
------ ------ -----
Net sales:
Year ended June 30, 2000............... $ 85,418 $ 14,393 $ 99,811
Year ended June 30, 2001............... 96,845 18,550 115,395
Year ended June 30, 2002............... 103,138 17,755 120,893
Long-lived assets:
Year ended June 30, 2000............... $ 191,038 $ 87 $ 191,125
Year ended June 30, 2001............... 183,042 70 183,112
Year ended June 30, 2002............... 189,754 82 189,836
17. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following is a summary of the unaudited quarterly results of
operations for Fiscal 2002 and Fiscal 2001.
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2002 2001 2001 2002 2002 Total
---- ---- ---- ---- -----
Net sales............... $ 27,381 $ 22,329 $ 35,472 $ 35,711 $ 120,893
Gross profit............ 10,667 6,400 15,115 14,823 47,005
Income from operations.. 5,026 361 8,418 8,798 22,603
Interest expense, net... 3,044 3,038 3,306 3,140 12,528
Net income (loss)....... 702 (2,140) 2,616 2,973 4,151
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
F-42