FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to _____________
Commission File Number: 333-60989
AKI, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3785856
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1815 East Main Street
Chattanooga, TN 37404
(Address of principal executive offices) (Zip Code)
(423) 624-3301
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has 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) has been subject to such filing
requirements for the past 90 days (X) Yes ( ) No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) ( ) Yes (X) No
As of January 31, 2004, 1,000 shares of common stock of AKI, Inc., $.01 par
value, were outstanding.
AKI, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
AKI, Inc. and Subsidiaries
Consolidated Condensed Balance Sheets
- December 31, 2003
- June 30, 2003
Consolidated Condensed Statements of Operations
- Three months ended December 31, 2003
- Three months ended December 31, 2002
- Six months ended December 31, 2003
- Six months ended December 31, 2002
Consolidated Condensed Statements of Changes in
Stockholder's Equity
- Six months ended December 31, 2003
Consolidated Condensed Statements of Cash Flows
- Six months ended December 31, 2003
- Six months ended December 31, 2002
Notes to Consolidated Condensed Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 3. Quantitative and Qualitative Discussions About Market Risk
Item 4. Controls and Procedures
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
AKI, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(dollars in thousands, except share and per share information)
December 31, June 30,
2003 2003
------------- -------------
(unaudited) (unaudited)
ASSETS
Current assets
Cash and cash equivalents.................................................. $ 2,352 $ 1,470
Accounts receivable, net................................................... 20,588 20,267
Inventory.................................................................. 8,931 7,265
Income tax receivable...................................................... 95 1,011
Prepaid expenses........................................................... 1,568 671
Deferred income taxes...................................................... 808 808
------------- -------------
Total current assets.................................................... 34,342 31,492
Property, plant and equipment, net......................................... 14,489 16,584
Goodwill .................................................................. 152,994 152,994
Other intangible assets, net............................................... 10,406 11,307
Deferred charges, net...................................................... 2,704 3,032
Other assets............................................................... 140 138
------------- -------------
Total assets............................................................ $ 215,075 $ 215,547
============= =============
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of long-term debt.......................................... $ 2,000 $ 1,875
Accounts payable, trade.................................................... 5,679 5,444
Accrued compensation....................................................... 3,985 4,333
Accrued interest........................................................... 5,551 5,502
Accrued expenses........................................................... 3,480 3,661
------------- -------------
Total current liabilities............................................... 20,695 20,815
Revolving credit line...................................................... 3,437 10,000
Term loan.................................................................. 5,250 6,250
Senior notes............................................................... 103,510 103,510
Promissory note to affiliate............................................... 375 -
Deferred income taxes...................................................... 793 1,142
Other non-current liabilities.............................................. 1,150 1,740
------------- -------------
Total liabilities....................................................... 135,210 143,457
Stockholder's equity
Common stock, $0.01 par 100,000 shares authorized;
1,000 shares issued and outstanding..................................... - -
Additional paid-in capital................................................. 85,667 82,512
Retained earnings.......................................................... 9,031 4,873
Accumulated other comprehensive income .................................... 897 435
Carryover basis adjustment................................................. (15,730) (15,730)
------------- -------------
Total stockholder's equity.............................................. 79,865 72,090
------------- -------------
Total liabilities and stockholder's equity.............................. $ 215,075 $ 215,547
============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
AKI, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(dollars in thousands)
Three months ended Six months ended
------------------------------------- -------------------------------------
December 31, 2003 December 31, 2002 December 31, 2003 December 31, 2002
----------------- ----------------- ----------------- -----------------
(unaudited) (unaudited) (unaudited) (unaudited)
Net sales...................................... $ 32,616 $ 31,644 $ 69,874 $ 62,044
Cost of goods sold............................. 22,283 20,704 45,818 39,219
--------- --------- --------- ---------
Gross profit................................ 10,333 10,940 24,056 22,825
Selling, general and administrative expenses... 5,379 4,740 10,064 9,404
Amortization of other intangibles.............. 286 286 572 572
--------- --------- --------- ---------
Income from operations...................... 4,668 5,914 13,420 12,849
Other expenses:
Interest expense............................ 3,238 3,220 6,452 6,408
Management fees and other, net.............. 100 62 200 125
--------- --------- --------- ---------
Income before income taxes.................. 1,330 2,632 6,768 6,316
Income tax expense............................. 503 999 2,610 2,426
--------- --------- --------- ---------
Net income.................................. $ 827 $ 1,633 $ 4,158 $ 3,890
========= ========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
AKI, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(dollars in thousands, except share information)
Accumulated
Retained Other
Additional Earnings Comprehensive Carryover
Common Stock Paid-in (Accumulated Income Basis
Shares Dollars Capital Deficit) (Loss) Adjustment Total
------ ------- ------- -------- ------ ---------- -----
Balances, June 30, 2003 (unaudited)....... 1,000 $ - $ 82,512 $ 4,873 $ 435 $ (15,730) $ 72,090
Capital contribution from AKI Holding
Corp.................................. 3,155 3,155
Net income (unaudited).................... 4,158 4,158
Other comprehensive loss, net of tax:
Foreign currency translation
adjustment (unaudited)............... 462 462
----------
Comprehensive income (unaudited).......... 4,620
-------- -------- ---------- ---------- -------- ---------- ----------
Balances, December 31, 2003 (unaudited)... 1,000 $ - $ 85,667 $ 9,031 $ 897 $ (15,730) $ 79,865
======== ======== ========== ========== ======== ========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
AKI, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Six months ended
-----------------------------------------
December 31, 2003 December 31, 2002
----------------- -----------------
(unaudited) (unaudited)
Cash flows from operating activities
Net income................................................................ $ 4,158 $ 3,890
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of other intangibles...................... 3,692 3,724
Amortization of debt issuance cost...................................... 328 282
Deferred income taxes................................................... (349) (321)
Other................................................................... (130) (326)
Changes in operating assets and liabilities:
Accounts receivable................................................... (321) 4,460
Inventory............................................................. (1,666) 535
Prepaid expenses, deferred charges and other assets................... (897) (537)
Accounts payable and accrued expenses................................. (245) (3,609)
Income taxes.......................................................... 916 (3,247)
----------- -----------
Net cash provided by operating activities.......................... 5,486 4,851
----------- -----------
Cash flows from investing activities
Purchases of equipment.................................................... (621) (1,297)
Patents................................................................... (75) (71)
----------- -----------
Net cash used in investing activities............................... (696) (1,368)
----------- -----------
Cash flows from financing activities
Net repayments on revolving loan.......................................... (6,563) (250)
Net repayments on term loan............................................... (875) (500)
Net proceeds from promissory note to affiliate............................ 375 355
Capital contribution from parent.......................................... 3,155 -
Distribution to parent.................................................... - (3,192)
----------- -----------
Net cash used in financing activities............................... (3,908) (3,587)
----------- -----------
Net increase (decrease) in cash and cash equivalents......................... 882 (104)
Cash and cash equivalents, beginning of period............................... 1,470 1,875
----------- -----------
Cash and cash equivalents, end of period..................................... $ 2,352 $ 1,771
=========== ===========
Supplemental information
Net cash paid (received) during the period for:
Interest................................................................ $ 5,986 $ 5,980
Income taxes............................................................ (893) 6,092
The accompanying notes are an integral part of
these consolidated financial statements.
AKI, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(dollars in thousands, except share and per share information)
1. BASIS OF PRESENTATION
AKI, Inc. ("AKI") is the successor to Arcade Holding Corporation (the
"Predecessor"), which was acquired by AHC I Acquisition, Corp. ("AHC") in
December 1997. AHC was organized for the purpose of acquiring all of the
equity interests of the Predecessor and subsequent to such acquisition, AHC
contributed $1 and all of its ownership interest to AKI Holding Corp.
("Holding") for all of the outstanding equity of Holding. Accordingly, AKI
is a wholly owned subsidiary of Holding, which is a wholly owned subsidiary
of AHC.
AKI is engaged in multi-sensory, interactive marketing activities
primarily from the sale of printed advertising materials with sampling
systems and other sampling products to fragrance, cosmetics and consumer
products companies, and creative services. Products are produced and
distributed from Chattanooga, Tennessee and Baltimore, Maryland facilities
and distributed in Europe through its French subsidiary, Arcade Europe
S.A.R.L.
Recently Issued Accounting Standards
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"), an
amendment of FASB Statement No. 123. SFAS 148 amends SFAS 123, "Accounting
for Stock-Based Compensation", to provide alternative methods of transition
for a voluntary change to the fair value method of accounting for
stock-based employee compensation. In addition, SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosures in
both annual and interim financial statements. Certain of the disclosure
modifications are required for fiscal years and interim periods ending
after December 15, 2002 and are included in the notes to these consolidated
condensed financial statements.
FASB Interpretation No. 46 "Consolidation of Variable Interest
Entities" ("FIN 46") was issued in January 2003. FIN 46 requires an
investor with a majority of the variable interests in a variable interest
entity ("VIE") to consolidate the entity and also requires majority and
significant variable interest investors to provide certain disclosures. A
VIE is an entity in which the equity investors do not have a controlling
interest, or the equity investment at risk is insufficient to finance the
entity's activities without receiving additional subordinated financial
support from the other parties. In December 2003, FIN 46(R) was issued,
which delays until the period ending March 31, 2004, the application of the
provisions of FIN 46 for VIEs created prior to January 31, 2003. The
Company is currently reviewing its investments and other arrangements to
determine whether any of its investee companies are VIEs. The Company does
not expect to identify any significant VIEs that would be consolidated, but
may be required to make additional disclosures. The Company's maximum
exposure related to any investment that may be determined to be in a VIE is
limited to the amount invested. The provisions of FIN 46 are effective
immediately for all arrangements entered into with new VIEs created after
January 31, 2003. The Company has not invested in any new VIEs created
after January 31, 2003.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS
149 amended and clarified accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities under SFAS 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133"). SFAS 149 amended SFAS 133 regarding
implementation issues raised in relation to the application of the
definition of a derivative, particularly regarding the meaning of an
"underlying" and the characteristics of a derivative that contains
financing components. The amendments set forth in SFAS 149 improve
financial reporting by requiring that contracts with comparable
characteristics be accounted for similarly. In particular, SFAS 149
clarifies under what circumstances a contract with an initial net
investment meets the characteristic of a derivative as discussed in SFAS
133. In addition, it clarifies when a derivative contains a financing
component that warrants special reporting in the statement of cash flows.
SFAS 149 was effective for contracts entered into or modified after June
30, 2003. The Company's adoption of this statement will not have any
significant impact on the Company's financial condition or results of
operations.
AKI, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(dollars in thousands, except share and per share information)
1. BASIS OF PRESENTATION (continued)
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 establishes standards for how an issuer classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as
equity. SFAS 150 was developed in response to concerns expressed about
issuers' classification in the statement of financial position of certain
financial instruments that have characteristics of both liabilities and
equity, but that have been presented either entirely as equity or between
the liabilities section and the equity section of the balance sheet. SFAS
150 was effective for financial instruments entered into or modified after
May 31, 2003, and otherwise was effective at the beginning of the first
interim period beginning after June 15, 2003. SFAS 150 did not affect the
Company's balance sheet presentation of its debt and equity financial
instruments.
Interim financial statements
The interim consolidated condensed balance sheet at December 31, 2003
and the interim consolidated condensed statements of operations for the
three and six months ended December 31, 2003 and 2002, the interim
consolidated condensed statements of cash flows for the six months ended
December 31, 2003 and 2002 and the interim consolidated condensed statement
of changes in stockholder's equity for the six months ended December 31,
2003 are unaudited, and certain information and footnote disclosure related
thereto, normally included in financial statements prepared in accordance
with generally accepted accounting principles, have been omitted. The June
30, 2003 consolidated condensed balance sheet was derived from the audited
balance sheet for the year then ended. In management's opinion, the
unaudited interim consolidated condensed financial statements were prepared
following the same policies and procedures used in the preparation of the
audited financial statements and all adjustments, consisting only of normal
recurring adjustments to fairly present the financial position, results of
operations and cash flows with respect to the interim consolidated
condensed financial statements, have been included. The results of
operations for the interim periods are not necessarily indicative of the
results for the entire year. The interim consolidated condensed financial
statements should be read in conjunction with the financial statements and
notes thereto for the year ended June 30, 2003 as filed on Form 10-K.
Stock Based Compensation
The Company has elected to account for its stock based compensation
with employees under the intrinsic value method of Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees", as
permitted under SFAS No. 123, "Accounting for Stock-Based Compensation".
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. The Company
adopted the disclosure provision of SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", an amendment of SFAS
No. 123, effective for interim periods beginning after December 15, 2002.
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 would have been as follows:
AKI, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(dollars in thousands, except share and per share information)
1. BASIS OF PRESENTATION (continued)
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ ------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported.................. $ 827 $ 1,633 $ 4,158 $ 3,890
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects....... 8 9 16 18
--------- --------- --------- ---------
Pro forma net income..................... $ 819 $ 1,624 $ 4,142 $ 3,872
========= ========= ========= =========
2. INVENTORY
The following table details the components of inventory:
December 31, 2003 June 30, 2003
----------------- -------------
(unaudited) (unaudited)
Raw materials
Paper.......................... $ 1,676 $ 1,740
Other raw materials............ 4,418 2,353
----------- -----------
Total raw materials........ 6,094 4,093
Work in process.................... 3,653 3,857
Reserve for obsolescence........... (816) (685)
------------ -----------
Total inventory.................... $ 8,931 $ 7,265
=========== ===========
3. COMPREHENSIVE INCOME
Comprehensive income consists of net income, plus certain changes in
assets and liabilities that are not included in net income but are instead
reported within a separate component of shareholders' equity under
generally accepted accounting principles. The Company's comprehensive
income was as follows:
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ ------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income................................. $ 827 $ 1,633 $ 4,158 $ 3,890
Other comprehensive income (loss),
net of tax:
Foreign currency translation
adjustments............................ 659 (7) 462 366
--------- --------- --------- ---------
Comprehensive income....................... $ 1,486 $ 1,626 $ 4,620 $ 4,256
========= ========= ========= =========
AKI, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(dollars in thousands, except share and per share information)
4. CONTINGENCIES
The Beautiful Bouquet Company, Ltd. (the "Licensor") filed suit
against the Company alleging breaches of a Patent and Know-How License
agreement, as amended (the "License Agreement"). The Licensor alleges the
Company committed a number of breaches, including a breach of fiduciary
duty owed to the Licensor, and is seeking to recover unspecified amounts.
The Company believes that it did not breach any provision of the License
Agreement, and intends to vigorously defend against such claims.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Our sales are derived primarily through our multi-sensory, interactive
marketing activities primarily from the sale of printed advertising
materials with sampling systems and other sampling products to fragrance,
cosmetics and consumer products companies, and also from creative services.
Substantially all of our sales are made directly to our customers while a
small portion are made through advertising and promotional agencies. Each
of our customer's marketing programs is unique and pricing is negotiated
based on estimated costs plus a margin. While our company and its customers
generally do not enter into long-term contracts, we have long-standing
relationships with the majority of our customer base.
Results of Operations
Three Months Ended December 31, 2003 Compared to Three Months
Ended December 31, 2002
Net Sales. Net sales for the three months ended December 31, 2003 increased
$1.0 million, or 3.2%, to $32.6 million, as compared to $31.6 million for the
three months ended December 31, 2002. The increase in net sales was primarily
attributable to increased sales of sampling technologies for advertising and
marketing of domestic fragrance products and international cosmetic products and
impact of foreign exchange rates. The increased sales were partially offset by
decreased sales of sampling technologies for advertising and marketing of
domestic cosmetic products and international fragrance products.
Gross Profit. Gross profit for the three months ended December 31, 2003
decreased $0.6 million, or 5.5%, to $10.3 million, as compared to $10.9 million
for three months ended December 31, 2002. Gross profit as a percentage of net
sales decreased to 31.6% in the three months ended December 31, 2003, from 34.5%
in the three months ended December 31, 2002. The decrease in gross profit and
the decrease in gross profit as a percentage of net sales is due to changes in
product and format mix and reduction in prices of certain fragrance sampling
products in response to competitive pressures.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended December 31, 2003 increased
$0.7, or 14.9%, to $5.4 million, as compared to $4.7 million for the three
months ended December 31, 2002. Selling, general and administrative expenses as
a percent of net sales increased to 16.6% in the three months ended December 31,
2003, from 14.9% in the three months ended December 31, 2002. The increase in
selling, general and administrative expenses and the increase in selling,
general and administrative expenses as a percent of net sales is primarily due
to foreign exchange rates, foreign exchange losses, increased consulting fees
and loss on sublease of former office space.
Income from Operations. Income from operations for the three months ended
December 31, 2003 decreased $1.2 million, or 20.3%, to $4.7 million, as compared
to $5.9 million for the three months ended December 31, 2002. Income from
operations as a percentage of net sales decreased to 14.4% in the three months
ended December 31, 2003, from 18.7% in the three months ended December 31, 2002.
The decrease in income from operations and income from operations as a
percentage of net sales is principally the result of the factors described
above.
Interest Expense. Interest expense (which includes the amortization of
deferred financing costs) for the three months ended December 31, 2003 was $3.2
million consistent with the $3.2 million for the three months ended December 31,
2002. Outstanding borrowings and related interest rates during the three months
ended December 31, 2003 and 2002 were relatively consistent.
Income Tax Expense. Income tax expense for the three months ended December
31, 2003 decreased $0.5 million to $0.5 million. Our effective tax rate was 39%
in the three months ended December 31, 2003 and 2002.
Six Months Ended December 31, 2003 Compared to Six Months
Ended December 31, 2002
Net Sales. Net sales for the six months ended December 31, 2003 increased
$7.9 million, or 12.7%, to $69.9 million, as compared to $62.0 million for the
six months ended December 31, 2002. The increase in net sales was primarily
attributable to increased sales of sampling technologies for advertising and
marketing of domestic fragrance and consumer products, international cosmetic
products and impact of foreign exchange rates. The increases were partially
offset by decreased sales of sampling technologies for advertising and marketing
of domestic cosmetic products and international fragrance products.
Gross Profit. Gross profit for the six months ended December 31, 2003
increased $1.3 million, or 5.7%, to $24.1 million, as compared to $22.8 million
for six months ended December 31, 2002. Gross profit as a percentage of net
sales decreased to 34.5% in the six months ended December 31, 2003, from 36.8%
in the six months ended December 31, 2002.. The increase in gross profit is
primarily due to the increase in sales volume. The decrease in gross profit as a
percentage of net sales is due to increased premium labor costs, changes in
product and format mix and reduction in prices of certain fragrance sampling
products in response to competitive pressures.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the six months ended December 31, 2003 increased
$0.7, or 7.5%, to $10.1 million, as compared to $9.4 million for the six months
ended December 31, 2002. The increase in selling, general and administrative
expenses is primarily due to foreign exchange rates, increased consulting fees,
increased office rent and loss on sublease of former office space. Selling,
general and administrative expenses as a percent of net sales decreased to 14.5%
in the six months ended December 31, 2003, from 15.2% in the six months ended
December 31, 2002 primarily because these costs are largely fixed.
Income from Operations. Income from operations for the six months ended
December 31, 2003 increased $0.6 million, or 4.7%, to $13.4 million, as compared
to $12.8 million for the six months ended December 31, 2002. Income from
operations as a percentage of net sales decreased to 19.2% in the six months
ended December 31, 2003, from 20.7% in the six months ended December 31, 2002.
The increase in income from operations and decrease in income from operations as
a percentage of net sales is principally the result of the factors described
above.
Interest Expense. Interest expense (which includes the amortization of
deferred financing costs) for the six months ended December 31, 2003 increased
$0.1 million, or 1.6%, to $6.5 million, as compared to $6.4 million for the six
months ended December 31, 2002. Outstanding borrowings and related interest
rates during the six months ended December 31, 2003 and 2002 were relatively
consistent.
Income Tax Expense. Income tax expense for the six months ended December
31, 2003 increased $0.2 million to $2.6 million. Our effective tax rate was 39%
in the six months ended December 31, 2003 and 2002.
Liquidity and Capital Resources
We have substantial indebtedness and significant debt service obligations.
As of December 31, 2003, we had consolidated indebtedness in an aggregate amount
of $114.6 million (excluding trade payables, accrued liabilities, deferred taxes
and other non-current liabilities) relating to our notes, term loan, revolving
loan and promissory note to affiliate. Borrowings at December 31, 2003 included
$3.4 million under the revolving loan and $7.3 million under the term loan and
$0.4 million on the promissory note to affiliate. At December 31, 2003 we had
$16.3 million available under the revolving loan. At December 31, 2003, we also
had $20.6 million in additional outstanding liabilities (including trade
payables, accrued liabilities, deferred taxes and other non-current
liabilities).
Our principal liquidity requirements are for debt service requirements and
fees under the notes, term loan and revolving loan. Historically, we have funded
our capital, debt service and operating requirements with a combination of net
cash provided by operating activities, together with borrowings under the
revolving loan and promissory note to affiliate. During the six months ended
December 31, 2003, cash totaling $5.5 million was provided by operating
activities resulting from net income before depreciation and amortization and a
decrease in income tax receivable, partially offset by an increase in inventory,
prepaid insurance and foreign value added tax
receivable. During the six months ended December 31, 2002, cash totaling $4.9
million was provided by operating activities resulting from net income before
depreciation and amortization and a decrease in accounts receivable, partially
offset by decreases in accounts payable, accrued compensation and accrued income
taxes.
We define Adjusted EBITDA (also referred to as EBITDA in our credit
agreement) as net income or loss plus income taxes, interest expense, loss from
early retirement of debt, depreciation, amortization and impairment loss of
goodwill and amortization of other intangibles less gain from early retirement
of debt. Adjusted EBITDA is not a measure of financial or operating performance,
cash flow or liquidity under generally accepted accounting principles, and
should not be used by itself or in the place of net income, cash flows from
operating activities or other income or cash flow statement data prepared in
accordance with generally accepted accounting principles as a financial or
liquidity measure.
We use Adjusted EBITDA to manage and evaluate our business operations. Our
management evaluates Adjusted EBITDA because it excludes certain cash and
non-cash items that are either beyond our immediate control or that we believe
are not characteristic of our underlying business operation for the period in
which they are recorded, or both. We believe the presentation of Adjusted EBITDA
is relevant because Adjusted EBITDA is a measurement that we and our lenders use
to comply with our debt covenants and establish our interest rate on a portion
of our debt. Investors should be aware that the way by which we calculate
Adjusted EBITDA may not be comparable with similarly titled measures presented
by other companies and comparisons of such amounts could be misleading unless
all companies and analysts calculate such measures in the same manner.
The calculation of Adjusted EBITDA for AKI is as follows (dollars in
millions):
Three Months Ended Six Months Ended
December 31, December 31,
----------------------------- -----------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income........................ $ 0.8 $ 1.6 $ 4.2 $ 3.9
Income tax expense................ 0.5 1.0 2.6 2.4
Interest expense.................. 3.2 3.2 6.4 6.4
Depreciation and amortization
of other intangibles........... 1.9 1.9 3.7 3.7
----------- ----------- ----------- -----------
Adjusted EBITDA................... $ 6.4 $ 7.7 $ 16.9 $ 16.4
=========== =========== =========== ===========
In the six months ended December 31, 2003 and 2002, we had capital
expenditures of approximately $0.6 million and $1.3 million, respectively. These
capital expenditures consisted primarily of the purchase of manufacturing
equipment and upgrading our computer systems.
We may from time to time evaluate 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. Additional
capital resources, if available, may be on terms generally less favorable and/or
more restricted than the terms of our current credit facilities.
Capital expenditures for the twelve months ending June 30, 2004 are
currently estimated to be between $5.0 million and $5.5 million. Based on
borrowings outstanding as of December 31, 2003, we expect total cash payments
for debt service for the twelve months ending June 30, 2004 to be approximately
$14.2 million, consisting of $1.9 million in principal payments under the term
loan, $10.9 million in interest payments on the Notes and $1.4 million in
interest and fees under the credit agreement. We also expect to make royalty
payments of approximately $1.2 million during the twelve months ending June 30,
2004.
At December 31, 2003, AKI's cash and cash equivalents and net working
capital were $2.4 million and $13.6 million, respectively, representing an
increase in cash and cash equivalents of $0.9 million and an increase in net
working capital of $2.9 million from June 30, 2003. The increase in working
capital is primarily due to the increase in cash and cash equivalents, inventory
and prepaid expenses.
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.
Contingencies
The Beautiful Bouquet Company, Ltd. (the "Licensor") filed suit against the
Company alleging breaches of a Patent and Know-How License agreement, as amended
(the "License Agreement"). The Licensor alleges the Company committed a number
of breaches, including a breach of fiduciary duty owed to the Licensor, and is
seeking to recover unspecified amounts.
The Company believes that it did not breach any provision of the License
Agreement, and intends to vigorously defend against its claims. However, if
Licensor were to prevail in this lawsuit, the Company's financial condition,
results of operations and cash flows could be materially adversely affected.
Recently Issued Accounting Standards
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS 148"), an amendment of FASB
Statement No. 123. SFAS 148 amends SFAS 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS
123 to require prominent disclosures in both annual and interim financial
statements. Certain of the disclosure modifications are required for fiscal
years and interim periods ending after December 15, 2002 and are included in the
notes to these consolidated condensed financial statements.
FASB Interpretation No. 46 "Consolidation of Variable Interest Entities"
("FIN 46") was issued in January 2003. FIN 46 requires an investor with a
majority of the variable interests in a variable interest entity ("VIE") to
consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A VIE is an entity in which
the equity investors do not have a controlling interest, or the equity
investment at risk is insufficient to finance the entity's activities without
receiving additional subordinated financial support from the other parties. In
December 2003, FIN 46(R) was issued, which delays until the period ending March
31, 2004, the application of the provisions of FIN 46 for VIEs created prior to
January 31, 2003. The Company is currently reviewing its investments and other
arrangements to determine whether any of its investee companies are VIEs. The
Company does not expect to identify any significant VIEs that would be
consolidated, but may be required to make additional disclosures. The Company's
maximum exposure related to any investment that may be determined to be in a VIE
is limited to the amount invested. The provisions of FIN 46 are effective
immediately for all arrangements entered into with new VIEs created after
January 31, 2003. The Company has not invested in any new VIEs created after
January 31, 2003.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amended
and clarified accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"). SFAS 149 amended SFAS 133 regarding implementation issues raised
in relation to the application of the definition of a derivative, particularly
regarding the meaning of an "underlying" and the characteristics of a derivative
that contains financing components. The amendments set forth in SFAS 149 improve
financial reporting by requiring that contracts with comparable characteristics
be accounted for similarly. In particular, SFAS 149 clarifies under what
circumstances a contract with an initial net investment meets the characteristic
of a derivative as discussed in SFAS 133. In addition, it clarifies when a
derivative contains a financing component that warrants special reporting in the
statement of cash flows. SFAS 149 was effective for contracts entered into or
modified after June 30, 2003. The Company's adoption of this statement will not
have any significant impact on the Company's financial condition or results of
operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. SFAS 150 was developed
in response to concerns expressed about issuers' classification in the statement
of financial position of certain financial instruments that have characteristics
of both liabilities and equity, but that have been presented either entirely as
equity or between the liabilities section and the equity section of the balance
sheet. SFAS 150 was effective for financial instruments entered into or modified
after May 31, 2003, and otherwise was effective at the beginning of the first
interim period beginning after June 15, 2003. SFAS 150 did not affect the
Company's balance sheet presentation of its debt and equity financial
instruments.
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. We also advise you to read the
section entitled "Risk Factors" in the Company's annual report on Form 10K filed
with the SEC on September 26, 2003.
In addition, such forward-looking statements are necessarily dependent upon
assumptions, estimates and dates that may be incorrect or imprecise and involve
known and unknown risk, uncertainties and other factors. Accordingly, any
forward-looking statements included herein do not purport to be predictions of
future events or circumstances and may not be realized. Forward-looking
statements can be identified by, among other things, the use of forward-looking
terminology such as "believes," "expects," "may," "should," "seeks," "pro
forma," "anticipates," "intends" or the negative of any such word, or other
variations or comparable terminology, or by discussions of strategy or
intentions. Given these uncertainties, readers are cautioned not to place undue
reliance on such forward-looking statements. We disclaim any obligations to
update any such 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We generate approximately 24% of our sales from customers outside the
United States, principally in Europe. International sales are made mostly from
our foreign subsidiary located in France and are primarily denominated in the
local currency. Our foreign subsidiary also incurs the majority of its expenses
in the local currency and uses the local currency as its functional currency.
Our major principal cash balances are held in U.S. dollars. Cash balances
in foreign currencies are held to minimum balances for working capital purposes
and therefore have a minimum risk to currency fluctuations.
We periodically enter into forward foreign currency exchange contracts to
hedge certain exposures related to selected transactions that are relatively
certain as to both timing and amount and to hedge a portion of the production
costs expected to be denominated in foreign currencies. The purpose of entering
into these hedge transactions is to minimize the impact of foreign currency
fluctuations on the results of operations and cash flows. Gains and losses on
the hedging activities are recognized concurrently with the gains and losses
from the underlying transactions. At December 31, 2003, there were no forward
exchange contracts outstanding.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. The Company's chief
executive officer and chief financial officer have evaluated the effectiveness
of the design and operation of the Company's disclosure controls and procedures
(as defined in Exchange Act Rule 13a-14(c)) as of the end of the period covered
by this quarterly report. Based on that evaluation, the chief executive officer
and chief financial officer have concluded as of the end of the period covered
by this report that the Company's disclosure controls and procedures are
effective.
(b) Changes in Internal Controls. There have not been any significant
changes in the Company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Item 1 of Part II of our previous quarterly report on Form 10-Q for
discussion of litigation that has been commenced against us regarding allegation
of breaches of an agreement.
We are not currently a party to any other legal proceedings the adverse
outcome of which, individually or in the aggregate, we believe could have a
material adverse effect on our business, financial condition, results of
operations or cash flows.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.*
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.*
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to section 906 of the Sarbanes-Oxley Act of 2002.*
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AKI, INC.
Date: February 6, 2004 By: /s/ Kenneth A. Budde
-----------------------------------
Kenneth A. Budde
Senior Vice President &
Chief Financial Officer
(Principal Financial and Accounting
Officer)