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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, 1999
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(b) 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 27, 1999, 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"), and the term "Holding" refers solely to AKI
Holding Corp.
PART I
ITEM 1. BUSINESS
Part I is presented with respect to both registrants submitting this
filing, Holding and AKI.
General
Our company is a leading global marketer and manufacturer of
multi-sensory, interactive sampling systems that engage the senses of touch,
sight, sound and olfactory. Our sampling systems are widely recognized in the
fragrance, cosmetics and personal care industries, as well as the household
products and food and beverage industries. We offer an extensive portfolio of
proprietary, patented and patent-pending sampling systems that can be
incorporated into various media which is designed to reach the consumer at home,
such as magazine inserts, catalog inserts, remittance envelopes, statement
enclosures and blow-ins.
Our company is a fully integrated sampling company and is positioned to
provide complete, interactive advertising programs to our customers, including
creative content and sample product and distribution.
Product sampling is one of the most effective, widely used and fastest
growing forms of promotional activity. Product sampling is particularly crucial
to the fragrance and cosmetics industries where consumers traditionally "try
before they buy" due to the highly personal nature of the products. Our
company's introduction in 1979 of the ScentStrip(R) Sampler, the first
pull-apart, microencapsulated scent sampling system, transformed the fragrance
sampling industry. By combining advertising with a sampling system, marketers
were afforded the first cost-effective means to reach consumers in their homes
on a mass scale. Though the microencapsulated fragrance sampling system remains
the most widely used product throughout the fragrance industry, our company has
developed and/or acquired a portfolio of alternative scent sampling systems, all
designed for cost-effective mass distribution, and continues to be the leading
innovator in the sampling industry.
In recent years, our company has expanded our sampling business by
developing new technologies specifically for the skincare, makeup and consumer
products markets. Although product sampling is critical to the success of these
markets, sampling programs for these products historically have been too costly
for mass production and incapable of efficiently being incorporated into
magazines, catalogs, direct mail and other printed vehicles. Our innovative
sampling systems are designed to fill the needs of these marketers by providing
a cost-effective means of reaching consumers in their homes on a mass scale with
quality renditions of skincare products, foundation, lipstick and cosmetic
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powders. Management believes that our new 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 certain
related investors (collectively, "DLJMBII") and certain members of our company's
prior management organized AHC I Acquisition Corp., a Delaware corporation
("Acquisition Corp."), 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 September 27, 1999, DLJMBII owned approximately 98.8% of the
outstanding common stock of Acquisition Corp. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--The Acquisition."
On September 15, 1999, we acquired all of the issued and outstanding
shares of capital stock of RetCom Holdings Ltd. and refinanced working capital
indebtedness of RetCom and its subsidiaries. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--RetCom Acquisition."
The acquired businesses of RetCom and its subsidiaries include a portfolio of
sampling systems catering to the fragrance, cosmetics and personal care
industries, as well as microencapsulation products and processes. The acquired
businesses also include a creative service division that engages in marketing
communications and catalogs, and a multi-media division for merchandising at
point-of-sale. The acquired businesses offer proprietary, patented and
patent-pending sampling systems that include MicroSilk(TM), MicroDot(TM), Snap
and Powder(TM), ColorDot(TM) and Ascent(TM).
Products
Our company offers a broad and diversified portfolio of innovative,
interactive sampling systems for the fragrance, cosmetics and consumer products
markets. Our major technologies are described below, including a description of
the patent protection of each such product technology. Each of our products is a
cosmetic, fragrance or consumer product sample delivery system, generally
designed to perform the same basic function, and generally sold to the same
category of customers.
- ----------------------- ------------------- ---------------------- --------------------- --------------------
Year of Patent Protection
Product Introduction Origin Target Market
- ----------------------- ------------------- ---------------------- --------------------- --------------------
- ----------------------- ------------------- ---------------------- --------------------- --------------------
ScentStrip 1979 Internally developed None Fragrance,
consumer products
ScentStrip Plus mid 1980's Internally developed None Fragrance
DiscCover 1994 Licensed Patented Fragrance,
consumer markets
Scent Seal 1995 Acquired Patented Fragrance
LiquaTouch 1997 Internally developed Patent Pending Fragrance, skin
care
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Fragrance Burst and 1989 Acquired Patented Fragrance
Pearls
Fragrance Burst 1989 Acquired Patented Fragrance
Microfragrance Acquired Trade secret Fragrance,
Scratch `n Sniff consumer markets
BeautiSeal 1997 Internally developed Patented Cosmetics
PowdaTouch 1997 Internally developed Patent Pending Cosmetics
LipSeal 1998 Internally developed Patented Cosmetics
TouchDown Nail Color 1999 Internally developed Patent Application Cosmetics
Sampler Pending
BeautiTouch 1999 Internally developed Patent Pending Cosmetics
Multi-well Sampler
- ----------------------- ------------------- ---------------------- --------------------- --------------------
Fragrance Sampling Systems
Our company's portfolio of seven traditional fragrance sampling systems
has historically accounted for substantially all of our company's sales. While
the ScentStrip technology continues to be the most widely used technology
throughout the fragrance industry, management believes that our company's new
and recently acquired sampling systems have maintained our company's competitive
position as an innovator in the industry. These sampling systems have enabled
our company to participate in almost every major new fragrance launch in recent
years.
* ScentStrip: Our company's original pull-apart, microencapsulated
fragrance sampling system continues to deliver the most cost-effective,
quality fragrance rendition.
* ScentStrip Plus: The classic, pull-apart, microencapsulated fragrance
format with the added feature of silky-to-the-touch, powdery texture.
* DiscCover: A peel-and-reveal, non-encapsulated 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.
* Scent Seal: A heat-sealed, pouch-like, pressure-sensitive format that
peels open to reveal a moist, wearable gel rendition that offers both
an olfactory and on-skin experience.
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* Fragrance Burst Perfume Pearls: A multi-sensory sampling system that
features silky-to-the-touch, pearlized perfume pearls - formulated of
85% liquid perfume oil - that release a wearable fragrance rendition
when "pearls" are touched.
* Fragrance Burst and Pearls: Combines the wearable, visible and tangible
properties of Perfume Pearls with the classic, pull-apart fragrance
burst format, delivering an olfactory and on-skin experience.
* Microfragrance Scratch `n Sniff: Microfragrance capsules are applied to
paper or stickers which affix to nearly any surface, delivering an
accurate aroma rendition when the sampling system is scratched, then
sniffed.
New Products
Our company has recently introduced six innovative new products which
management believes can account for a significant portion of our company's
future sales. All of these sampling systems have been designed for U.S. Postal
Service approval for subscription magazine periodical rates.
* BeautiSeal: A heat-sealed, pouch-like, pressure-sensitive format peels
open to deliver quality renditions of cream and lotion treatments and
liquid foundations. BeautiSeal is hygienic and spillproof and less
expensive and more versatile than existing skincare/foundation sampling
alternatives. For example, a two-sided, printed insert incorporating a
BeautiSeal sampling system generally costs less than half that of the
manufacture and magazine distribution of an equivalent sample packet.
* PowdaTouch: Applies up to four different powders on a single carrier
and is ideal for trial of a single item shade range or a complete color
story. Delivers a superior rendition of the shade, texture, finish and
application of eye shadow, powder blush, face powder, bronzer or body
powder. Management estimates that PowdaTouch sampling systems can be
produced approximately ten times faster than currently competing
products and at a reduced production rate.
* LiquaTouch: 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. Available in a
pressure sensitive format designed for U.S. Postal Service approval for
subscription magazine periodical rates, LiquaTouch is also available in
a stand-alone version, which is a cost-effective alternative to
fragrance vials. In an independent study recently conducted among male
consumers of fragrance products, LiquaTouch was shown to be preferred
among sampling systems and was also a finalist for the Fragrance
Foundation's 1997 "Innovation of The Year" award.
* LipSeal: A pressure-sensitive sampling system peels open to deliver a
superior rendition of lipstick shade, finish and texture in any formula
including volatile silicones.
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* TouchDown Nail Color Sampler: A pressure-sensitive, die-cut sticker
that temporarily "touches down" on the nail, demonstrating superior
rendition of nail enamel shades without marring a manicure.
* BeautiTouch Multi-Well Sampler: A pressure-sensitive technology
featuring multiple, individually-sealed wells on a common backing,
which peel open to deliver renditions of liquid foundations, cream and
lotion treatment and personal care items, lipstick and fragrance
ancillaries.
Formats
Our company produces a wide and versatile range of formats designed for
U.S. Postal Service approval for subscription magazine periodical rates and
which can be incorporated into almost any print media. The most common formats
for the our company's products are described below.
Magazine Inserts: Magazine inserts are available in half-, full-, two-
and four-page formats, can be die-cut, can contain any of our company's sampling
systems and are the most commonly produced among our company's formats,
accounting for approximately 44% of fiscal 1999 sales.
Catalog Inserts: Full color formats can be produced in a variety of
sizes and inserted into retail or mail order catalogs. Catalog inserts can be
produced with or without an attached envelope, which may be provided to
facilitate the return of merchandise order forms to the store. Our company has
the ability to create and produce special formats, to custom imprint with store
information and to incorporate most of our company's sampling systems.
Remittance Envelopes: Remittance envelopes, which are inserted into
store statement mailings, can be customized with a store logo and can
accommodate may of our company's sampling systems. Our company is the only
company in the sampling industry that can produce remittance envelopes in-house.
Remittance envelopes can be produced with or without our company's sampling
systems. Remittance envelope production, which is a highly customized service
business, reinforces our company's 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 company's design and has become the
industry standard.
Blow-ins: Blow-ins, which are available in all formats and sizes, can
accommodate nearly all of our company's sampling systems and are loosely
inserted (blown in) rather than bound into store catalogues, newspapers and
magazines.
In-Store Handouts: Our company has made significant advances in
replacing and expanding current methods of in-store cosmetic and fragrance
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sampling. Due to the lower cost and design flexibility of our company's
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 company's sampling systems and
items such as postcards, stickers, wrist bands, bookmarks and CD inserts. Our
company is also experiencing significant in-store business with the LiquaTouch
sampling system, as an alternative to vials, and expects increases for the
BeautiSeal and PowdaTouch sampling systems for trial of shade ranges and
formulae.
Patents and Proprietary Technology
Our company currently holds patents covering the proprietary processes
used to produce six of its products and has submitted applications for three
additional manufacturing processes. Our company has six trademarks registered in
the United States and eight trademarks filed and awaiting registration. Our
company has also filed and registered trademarks in over 15 countries around the
world, including Europe, Australia, Japan and Brazil. See "--Products."
Our company has ongoing research efforts and expects to seek additional
patents in the future covering patentable results of such research. There can be
no assurance that any pending patent applications filed by our company:
* 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,
* will not be infringed upon or designed around by others or
* will not be challenged by others and held to be invalid or
unenforceable.
In addition, many of our company's manufacturing processes are not covered by
any patent or patent application. As a result, the business of our company may
be adversely affected by competitors who independently develop technologies
substantially equivalent to those employed by our company.
Customers
Our company sells its products to prestige and mass cosmetic,
fragrance, consumer products companies, department stores and specialty
retailers including Avon Products, Inc., Calvin Klein Cosmetics (Unilever Plc),
Chanel, Inc., Coty, Inc., Cosmair/L'Oreal S.A., Elizabeth Arden (Unilever Plc),
Estee Lauder, Inc., Giorgio Beverly Hills and The Procter & Gamble Company. Our
company's top ten customers accounted for approximately 57% of sales in fiscal
1999. None of our company's customers, other than Estee Lauder, accounted for
10% or more of net sales in fiscal 1999. Our company believes that its technical
expertise, manufacturing reliability and customer support capabilities have
enabled it to develop strong relationships with its customers. Our company
employs sales and marketing personnel who possess the requisite technical
backgrounds to communicate effectively with both prospective customers and our
company's manufacturing personnel. Historically, our company has had long-term
relationships with its major customers.
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Sales and Marketing
Our company's sales and marketing efforts are organized geographically.
Our company currently has a total of ten sales executives. The U.S. sales group
consists of seven sales executives who are supervised by the Senior Vice
President of Sales & Marketing. The European sales executives are based in
Paris, France and London, England and are managed by the Senior Vice President,
International, who is based in Paris, France. Each sales executive is dedicated
to a certain number of identified customers. In addition, these sales efforts
are supported by 15 production managers/customer service representatives which
are based in Chattanooga, Tennessee and Paris, France. A portion of the
compensation for sales executives is commission-based.
Our company's marketing activities include direct contact with senior
executives in the cosmetic and fragrance industry, major support of industry
events, extensive joint marketing programs with magazines, retailers and oil
houses, press coverage in industry trade publications, trade shows and seminars,
advertising in trade publications and promotional pieces. In addition, our
company focuses its sales efforts toward three principal groups within its
customers' organizations that management believes influence the customers'
purchasing decisions:
* marketing, which selects the sampling system technology and controls
the promotional budget;
* product development, which approves our company's sampling system
rendition and approves stability testing; and
* purchasing, which buys the sampling system pieces and controls quality.
Management believes that as the pressure for creativity increases with each new
product introduction, fragrance marketers are increasingly looking for their
vendors to contribute to the overall strategy-building effort for a new
fragrance. Our company's executives routinely introduce new sampling system
formats and ideas based on our company's technologies to the marketing
departments of its customers. Our company's in-house creative and marketing
expertise and complete product line provides customers with maximum flexibility
in designing promotional programs.
Manufacturing
Our company's manufacturing processes are highly technical and largely
proprietary. Our company's 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. The manufacturing processes can be broken into three phases:
* formulation of cosmetic and fragrance product renditions in our
company's slurry laboratories for use in sampling systems;
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* manufacturing the sampler, which consists of either printing an
encapsulated slurry onto paper or producing sampling labels that
contain fragrance or other cosmetic product renditions; and
* labeling technologies (DiscCover, Scent Seal, BeautiSeal, LiquaTouch),
affixing the labels onto a piece preprinted by our company or a third
party contract supplier.
Management believes that our company's formulation capabilities are the
best in the cosmetics sampling industry. The formulation process is highly
complex because our company is trying to replicate the fragrance of a product in
a bottle containing an alcohol solution using primarily essential oils and
paper. Formulation approval is an interactive process between our company and
its customers. Our company has more than 125 different, proprietary formulations
that it utilizes in replicating different characteristics of over 500 fragrances
to obtain a customer-approved rendition. Certain of these formulations are
patented and the majority of the formulation process is based on unique and
proprietary methods. 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 preapproved. Formulation is conducted in our
company's specially designed formulation laboratories by trained specialists.
The artwork for all printed pieces has typically been furnished by the
customer or its advertising agency. Our company's prepress department is
currently being converted to state-of -the-art technology by utilizing the
receipt of customer-supplied computer disks and producing this material directly
on to plates. Our company has the capability to produce high quality printed
materials, including the covers of major fashion magazines, in connection with
fragrance sampling systems.
Our company has two different sampling component manufacturing
processes: (1) for its formulated offset paper samplers (ScentStrip, ScentStrip
Plus, PowdaTouch) and (2) for its formulated letterpress or flexo label samplers
(DiscCover, Scent Seal, BeautiSeal, LiquaTouch). Formulated paper samplers are
produced in our company's primary facility where our company carefully applies
microencapsulated slurry onto the paper during the printing process and, in a
continuous in-line operation, folds, cuts and trims the samplers for packing. A
24-hour quality control function and hourly accountability provide significant
value to the product development personnel at our company's customers, who are
responsible for sample quality.
All sampling in a label form is produced on specially modified label
and finishing equipment in our company's second facility. In addition to the
patents pending on certain of its manufacturing processes, our company uses a
number of proprietary techniques in producing label samplers. Similar to the
formulated paper operation, sampling quality control personnel evaluate all
samples by roll and provide full accountability for our company's production.
Our company also has agreements with certain European and Australian
printers and labelers which produce some quantities for global customers that
require foreign distribution. Each of these arrangements are protected by
non-competition agreements.
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Our company was recently awarded The Proctor & Gamble Pinnacle Award
which is presented to companies as recognition for having met certain quality
requirements and having demonstrated outstanding quality assurance. Our company
is currently pursuing U.S. Food and Drug Administration approval required by
other potential new customers.
Sources and Availability of Raw Materials
Generally, the raw materials used by our company in the manufacturing
of its products have been readily available from numerous suppliers and have
been purchased by our company at prices that our company believes are
competitive. Our company's encapsulated paper products utilize specific grades
of paper that are subject to comprehensive evaluation and certification by our
company for quality, consistency and fit. Our company has not experienced any
material supply shortages in the past, nor are any anticipated.
Competition
Our company's competitors, some of whom have substantially greater
capital resources than our company, are actively engaged in manufacturing
certain products similar to, or in competition with, those of our company.
Competition in our company's markets is based upon product quality, product
technologies, customer relationships, price and customer service. Our company's
principal competitors in the printed fragrance sampler market are Webcraft, a
subsidiary of Big Flower Holdings, Inc., Orlandi Inc., Nord'est, Marietta Corp.,
Klocke, Color Prelude, Rotocon, Ascent and Appliquesence. Our company also
competes with numerous manufacturers of miniatures, vials, packets, sachets,
blisterpacks and scratch and sniff products. In addition, certain cosmetics
companies produce sampling products for their own cosmetic products.
Environmental and Safety Regulation
Our company's operations are subject to extensive laws and regulations
relating to the storagage, handling, emission, transportation and discharge of
materials into the environment and the maintenance of safe conditions in the
workplace. Our company's policy is to comply with all legal requirements of
applicable environmental, health and safety laws and regulations. Our company
believes that it is in general compliance with such requirements and has
adequate professional staff and systems in place to remain in compliance,
although there can be no assurances that this is the case. Our company considers
costs for environmental compliance to be a normal cost of doing business and
includes such costs in pricing decisions.
Employees
As of August 31, 1999, our company employed 377 persons, which included
240 hourly and 137 salaried and management personnel. Substantially all of our
company's hourly employees are represented by the Graphics Communications
International Union (GCIU) local 197-M. Management considers its 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.
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RISK FACTORS
Substantial Leverage; Restrictive Covenants - Our substantial indebtedness and
restrictive covenants imposed by the terms of our indebtedness could adversely
affect the financial health of our company and prevent us from fulfilling our
obligations under our notes and debentures.
Our company has substantial indebtedness and debt service obligations.
As of June 30, 1999, Holding and AKI had total consolidated indebtedness of
approximately $146.7 million and $117.0 million, respectively. In addition,
Holding's and AKI's deficiency of earnings available to cover fixed charges for
fiscal 1999, was $5.5 million and $1.7 million, respectively. As of September
20, 1999, AKI had letters of credit outstanding in the amount of $0.6 million
and outstanding borrowings of $16.3 million under its revolving credit agreement
with Heller Financial, Inc. In addition, as of such date, borrowings of up to
approximately $3.1 million were available under the credit agreement, subject to
specified conditions. The indenture governing Holding's 13 1/2% Senior Discount
Debentures due 2009 and the indenture governing AKI's 10 1/2% Senior Notes due
2008 and the credit agreement permit our company and its Restricted Subsidiaries
(as defined in the indentures), in each case, to incur additional indebtedness
if we meet specified requirements.
The level of our company's indebtedness could have important
consequences to holders of the notes and the debentures, including, but not
limited to, the following:
* a substantial portion of cash flow from operations must be dedicated to
debt service and will not be available for other purposes;
* additional debt financing in the future for working capital, capital
expenditures or acquisitions may be limited;
* the level of indebtedness could limit flexibility in reacting to
changes in the operating environment and economic conditions generally;
* the level of indebtedness could restrict our company's ability to
increase manufacturing capacity;
* our company may face difficulties in satisfying its obligations with
respect to its indebtedness; and
* a portion of our company's borrowings bear interest at variable rates
of interest, which could result in higher interest expense in the event
of an increase in market interest rates.
The indentures and the credit agreement contain covenants that, among
other things, limit the ability of our company and its Restricted Subsidiaries
to:
* pay dividends or make certain restricted payments;
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* incur additional indebtedness and issue preferred stock;
* create liens;
* incur dividend and other payment restrictions affecting subsidiaries;
* enter into mergers, consolidations or sales of all or substantially all
of the assets of our company;
* enter into certain transactions with affiliates; and
* sell certain assets.
In addition, the credit agreement requires our company to maintain specified
financial ratios and satisfy specified financial condition tests. Our company's
ability to meet those financial ratios and tests can be affected by events
beyond its control, and there can be no assurance that our company will meet
those tests.
Ability to Service Debt - To service our company's 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 its 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 company's control,
as well as the availability of revolving credit borrowings under the credit
agreement. Our company anticipates that its operating cash flow, together with
borrowings under the credit agreement, will be sufficient to meet its operating
expenses and to service its debt requirements as they become due. However, if
our company is unable to service its indebtedness, our company may be required
to take action such as reducing or delaying capital expenditures, selling
assets, restructuring or refinancing its indebtedness or seeking additional
equity capital. There can be no assurance that any of these remedies can be
effected on satisfactory terms, if at all.
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 will be 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, 1999, Holding's subsidiaries had
$117.0 million of indebtedness and $17.1 million of other outstanding
liabilities (including trade payables, accrued liabilities and deferred taxes).
As of September 20, 1999, AKI also had letters of credit outstanding in the
amount of $0.6 million and outstanding borrowings of $16.3 million under the
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credit agreement. In addition, as of such date, borrowings of up to
approximately $3.1 million were available under the credit agreement, subject to
specified conditions. All such indebtedness effectively ranks senior to the
debentures. At June 30, 1999, Holding had no outstanding indebtedness other than
the debentures. Holding and its subsidiaries may incur additional indebtedness
in the future, subject to the limitations contained in the instruments governing
their indebtedness.
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.
Limitation on the Payment of Funds to Holding by its Subsidiaries - Holding's
ability to repay its debentures may depend on its ability to raise cash other
than through its subsidiaries.
Holding's cash flow, and consequently its ability to service debt,
including its obligations under its debentures, is dependent upon the cash flows
of its subsidiaries and the payment of funds by such subsidiaries to Holding in
the form of loans, dividends or otherwise. Holding's subsidiaries have no
obligations, contingent or otherwise, to pay any amounts due pursuant to the
debentures or to make any funds available for payment of the debentures. In
addition, AKI's credit agreement and its note indenture impose, and agreements
entered into in the future may impose, significant restrictions on the payment
of dividends and the making of loans by AKI and its subsidiaries to Holding.
Accordingly, repayment of the debentures may depend upon the ability of Holding
to effect an equity offering or to refinance the debentures.
Effective Subordination; Assets Subject to Security Interest - Your right to
receive payments on the notes and debentures is junior to our existing and
future secured indebtedness.
Under the terms of the 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 a default under the
credit agreement, whether as a result of the failure to comply with a payment or
other covenant, a cross-default or otherwise, such lender will have a prior
secured claim on the capital stock of AKI and the encumbered assets of our
company. As a result, the encumbered assets of our company would be available to
pay obligations on the notes and the debentures only after borrowings under the
credit agreement and any other secured indebtedness have been paid in full. If
the lender should attempt to foreclose on its collateral, our company's
financial condition and the value of the debentures and the notes will be
materially adversely affected and could be eliminated. As of September 20, 1999,
AKI had letters of credit outstanding in the amount of $0.6 million and
outstanding borrowings of $16.3 million under the credit agreement. In addition,
as of such date, borrowings of up to approximately $3.1 million were available
under the credit agreement, subject to specified conditions.
12
Postal Regulation - Our results of operations could be adversely affected by a
change in the U.S. Postal Service classification of our sampling systems or the
sampling products of our competitors.
Our company's sampling systems are approved by the U.S. Postal Service
for inclusion in subscription magazines mailed at periodical postage rates. Our
company's sampling systems have a significant cost advantage over certain
competing sampling products, such as miniatures, vials, packettes, sachets and
blisterpacks, because such competing products cause an increase from periodical
postage rates to the higher third-class rates for the magazine's entire
circulation. Subscription magazine sampling inserts delivered to consumers
through the U.S. Postal Service accounted for approximately 36% of our company's
net sales in fiscal 1999. There can be no assurance that the U.S. Postal Service
will not approve other competing types of sampling systems for use in
subscription magazines without requiring a postal surcharge, or that the U.S.
Postal Service will not reclassify our company's sampling systems such that they
would incur a postal surcharge. Any such action by the U.S. Postal Service could
have a material adverse effect on our company's results of operations and
financial condition.
Reliance Upon Significant Customers - Our company relies on a small number of
customers for a large portion of its revenues.
Our company's top ten customers by sales revenue accounted for
approximately 57% of our company's net sales in fiscal 1999. None of our
company's customers other than Estee Lauder accounted for 10% or more of net
sales in fiscal 1999. Although our company has long-established relationships
with most of its major customers, our company does not have long-term contracts
with any of its customers. Our company may be required by some customers to
qualify its manufacturing operations under certain supplier standards. There can
be no assurance that our company will be able to qualify under such supplier
standards or that such customers will continue to purchase sampling systems from
our company if our company's manufacturing operations are not so qualified. An
adverse change in its relationships with significant customers, including Estee
Lauder, could have a material adverse effect on our company's results of
operations and financial condition.
Competition - Our ability to compete with other companies depends, in part, on
our ability to meet customer needs on a cost-effective and timely basis and to
protect our proprietary technology.
Our company's competitors, some of whom have substantially greater
capital resources than our company, are actively engaged in manufacturing
certain products similar to those of our company. Our company's principal
competitors in the cosmetic sampling market are Webcraft, a subsidiary of Big
Flower Holdings, Inc., Orlandi Inc., Nord'est, Marietta Corp., Klocke, Color
Prelude, Rotocon, Ascent and Appliquessence. Our company also competes with
numerous manufacturers of miniatures, vials, packettes, sachets, blisterpacks,
and scratch and sniff products. In addition, certain cosmetic companies produce
sampling products for their own cosmetic products. Competition in our company's
market is based upon product quality, product technologies, customer
relationships, price and customer service. The future success of our company's
business will depend in large part upon its ability to market and manufacture
products and services that meet customer needs on a cost-effective and timely
13
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 our company will be successful in generating sales on
commercially favorable terms, if at all.
In addition, our company's success, competitive position and revenues
will depend, in part, upon its ability to protect its proprietary technologies
and to operate without infringing on the proprietary rights of others. Although
our company has certain patents and has filed, and expects to continue to file,
other patent applications, there can be no assurance that our company's issued
patents are enforceable or that its patent applications will mature into issued
patents. The expense involved in litigation regarding patent protection or a
challenge thereto has been and could be significant and any future expense, if
any, cannot be estimated by our company. A portion of our company's
manufacturing processes are not covered by any patent or patent application. As
a result, the business of our company may be adversely affected by competitors
who independently develop technologies substantially equivalent to those
employed by our company.
Dependence on Fragrance Industry; Seasonality - Our business is affected by the
advertising budgets of our customers and is seasonal in nature.
The advertising budgets of our company's customers, and therefore the
revenues of our company, are susceptible to prevailing economic and market
conditions that affect advertising expenditures, the performance of the products
of our company's customers in the marketplace and certain other factors. There
can be no assurance that reductions in advertising spending will not occur,
which could have a material adverse effect on our company's results of
operations and financial condition.
In addition, our company's sales and operating results have
historically reflected seasonal variations. Such seasonal variations are based
on the timing of our company's customers' advertising campaigns, which have
traditionally been concentrated prior to the Christmas and spring holiday
seasons. As a result, a higher level of sales are reflected in our company's
first two fiscal quarters ended December 31 when sales from such advertising
campaigns are principally recognized while our company's fourth fiscal quarter
ended June 30 typically reflects the lowest sales level of the fiscal year.
These seasonal fluctuations require our company to accurately allocate its
resources to manage our company's manufacturing capacity, which often operates
at full capacity during peak seasonal demand periods.
Availability of Raw Materials - Our results of operations and financial
condition may be adversely affected by an increase in paper prices or a decrease
in paper supply.
Paper is the primary raw material utilized by our company in producing
its sampling systems. Paper costs represented approximately 30% of our company's
cost of goods sold in each of fiscal 1997, 1998 and 1999. Significant increases
in paper costs could have a material adverse effect on our company's results of
operations and financial condition to the extent that our company is unable to
14
price its products to reflect such increases. There can be no assurance that our
company's customers would accept such price increases or the extent to which
such price increases would impact their decision to utilize our company's
sampling systems.
All of our company's encapsulated sampling systems, which accounted for
approximately 62% of our company's net sales in fiscal 1999, utilize specific
grades of paper that are subject to comprehensive evaluation and certification
by our company for quality, consistency and fit. Our company continues to
research methods of replicating the advantages of these specific grades of paper
with other available grades of paper. Until such methods are developed, a loss
of such supply of paper could have a material adverse effect on our company's
results of operations and financial condition to the extent that our company is
unable to obtain such paper elsewhere.
Risks of International Operations; Currency Fluctuations - Our company receives
a portion of its revenue from foreign countries which is subject to foreign laws
and regulations and political and economic events.
Approximately 20% of our company's net sales in fiscal 1999 were
generated outside the United States. Foreign operations are subject to certain
risks inherent in conducting business abroad, including, among others, exposure
to foreign currency fluctuations and devaluations or restrictions on money
supplies, foreign and domestic export law and regulations, price controls,
taxation, tariffs, import restrictions, and other political and economic events
beyond our company's control. Our company has not experienced any material
effects of these risks as of yet, but there can be no assurance that they will
not have such an effect in the future.
Control by DLJMBII; Conflicts of Interest - Our company is 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
Acquisition Corp. and generally exercises control over the business, policies
and affairs of Acquisition Corp., Holding, AKI and its subsidiaries through its
ownership of Acquisition Corp. DLJMBII may have interests that could be in
conflict with those of the holders of notes or the debentures and may take
actions that adversely affect the interests of the holders of the notes and
debentures.
Labor Relations; Expiration of Collective Bargaining Agreement - Our company's
business may be adversely affected by a labor dispute.
As of August 31, 1999, approximately 64% of our company's employees
worked under a collective bargaining agreement that expires on March 31, 2003.
While our company believes that its relations with its employees are good, there
can be no assurance that our company's collective bargaining agreement will be
renewed in the future. A prolonged labor dispute (which could include a work
stoppage) could have a material adverse effect on our company's business,
financial condition and results of operations.
15
Year 2000 Issues - Year 2000 problems could affect our day-to-day operations and
cause significant economic liabilities.
Our company evaluated its information technology systems and its
non-information technology systems in order to assess its exposure to Year 2000
issues. Our company expects to make the necessary modifications or changes to
its information systems to enable proper processing of transactions relating to
the Year 2000 and beyond before January 1, 2000. While our company is not
substantially dependent upon the proper function of its computer systems, a
failure of its systems could cause, among other things, inaccurate or incomplete
accounting, the inability to bill customers and the inability to process
incoming orders which may cause business interruption or financial loss. If
third parties with whom our company interacts have Year 2000 problems which are
not resolved, our company could experience, among other things, the disruption
of services including telecommunications and electrical power or financial or
accounting difficulties. Our company currently estimates that the total cost of
Year 2000 compliance will be less than $100,000. There can be no assurance that
our company's Year 2000 program will be effective or that our company will not
experience disruption or difficulties resulting from Year 2000 problems of third
parties. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000 Issues."
ITEM 2. PROPERTIES
Our company owns land and buildings in Chattanooga, Tennessee that are
used for production, administration and warehousing. Our company's executive
offices and primary facility at 1815 East Main Street are located on 2.55 acres
and encloses approximately 67,900 square feet. A second facility housing product
development and additional manufacturing areas at 1600 East Main Street is
located three blocks away on 2.49 acres and encloses approximately 36,700 square
feet. Our company also leases 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.
Our company currently has a number of web printing presses with
multi-color capability as well as envelope-converting machines and other
ancillary equipment. Our company operates a fully equipped production lab for
the manufacture of microcapsules and slurry and separate laboratories for our
company's Encapsulated Products Division and our company's research and
development facility. Our company also has a fully staffed and equipped label
manufacturing facility, which includes state-of-the-art label manufacturing
machines that have been specially modified to produce our company's products and
a complete label attaching operation. Our company also leases sales offices in
New York, New York, Paris, France and London, England.
ITEM 3. LEGAL PROCEEDINGS
Our company does not believe that there are any pending legal
proceedings that, if adversely determined, would have a material adverse effect
on the financial condition or results of operations of our company, taken as a
whole.
16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders of Holding during
the fourth quarter of fiscal 1999.
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 September 27, 1999, Acquisition Corp. 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. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
ITEM 6. SELECTED FINANCIAL DATA
The selected historical consolidated financial data presented below as
of June 30, 1995, 1996 and 1997, December 15, 1997, and for the fiscal years
ended June 30, 1995, 1996 and 1997 and the periods from July 1, 1997 to December
15, 1997 have been derived from the historical consolidated financial statements
of Arcade Holding Corporation, the predecessor to our company. The selected
historical consolidated financial data presented below as of June 30, 1998 and
1999 and for the period from December 16, 1997 to June 30, 1998 and the year
ended June 30, 1999 have been derived from the historical consolidated financial
statements of our company. The information contained in this table should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and our company's Consolidated Financial
Statements and the notes thereto included elsewhere in this report.
17
Predecessor Holding
----------- -------
July 1, 1997 December
Fiscal year ended June 30, to 16, 1997 to
December 15, June 30, June 30,
1995 1996 1997 1997 1998 1999
---- ---- ---- ---- ---- ----
Statement of Operations Data:
Net sales $ 61,794 $ 73,486 $ 77,723 $ 35,186 $ 36,066 $ 85,967
Cost of goods sold 38,333 49,862 49,467 22,809 24,518 55,199
--------- ---------- ---------- ---------- ---------- --------
Gross profit 23,461 23,624 28,256 12,377 11,548 30,768
Selling, general and
administrative expenses 8,483 10,635 13,333 5,703 5,587 14,500
Amortization of goodwill 1,113 1,234 1,234 568 2,101 4,606
--------- ----------- ---------- ---------- ---------- --------
Income from operations 13,865 11,755 13,689 6,106 3,860 11,662
Interest expense, net 6,170 6,762 6,203 2,646 11,327 16,740
Fees to stockholders 470 470 470 215 125 250
Other, net (22) 244 (101) 11 (47) 128
Income tax expense (benefit) 3,114 2,101 3,135 1,441 (2,052) (340)
--------- ---------- ----------- ---------- ---------- --------
Net income (loss) $ 4,133 $ 2,178 $ 3,982 $ 1,793 $ (5,493) $ (5,116)
========= ========== ========== ========== ========== ========
Balance Sheet Data (at end
of period):
Cash and cash equivalents $ 4,196 $ 626 $ 303 $ 4,481 $ 3,842 $ 7,015
Working capital (deficit) 39 (4,685) (36,957) (4,959) 15,046 14,853
Total Assets 85,695 82,395 77,142 77,399 214,521 213,579
Total debt and redeemable
preferred stock 64,655 60,736 54,964 55,408 144,448 146,688
Total stockholder's equity 6,572 7,932 11,225 12,716 57,084 49,797
Other Data:
Capital expenditures 1,325 2,051 2,462 807 514 2,856
Ratio of earnings to fixed
charges 2.2x 1.6x 2.1x 2.2x --- ---
_____________________
(1) For purposes of calculating the ratio of earnings to fixed charges,
"earnings" represent income (loss) before income taxes plus fixed charges.
"Fixed charges" consist of interest on all indebtedness and amortization of
deferred financing costs. Earnings were not sufficient to cover fixed
charges by $7,545 and $5,456 for the periods from December 16, 1997 to June
30, 1998 and the year ended June 30, 1999, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
The sales of our company are derived from the sale of sampling systems
to cosmetics and consumer products companies. Substantially all of our company's
sales are made directly to its customers while a small portion are made through
advertising agencies. Each customer's sampling program is unique and pricing is
negotiated based on estimated costs plus a margin. While our company and its
customers generally do not enter into long-term contracts, our company has had
long-standing relationships with the majority of its customer base. The
introduction of our company's new products, such as BeautiSeal, PowdaTouch and
LiquaTouch, has affected our company's results of operations for certain of the
periods discussed below.
18
The Acquisition
DLJMBII and certain members of our company's 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 Acquisition Corp.
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) Acquisition Corp. 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." Acquisition Corp. then contributed $1 of cash and all of its ownership
interest in AKI to Holding for 1,000 shares of Holding's common stock.
The merger corporation's senior increasing rate notes were subsequently
repaid on June 25, 1998 from the proceeds of AKI's issuance of $115.0 million of
AKI's notes and from a capital contribution from Holding. On June 25, 1998,
Holding issued and sold its debentures totaling $50.0 million in aggregate
principal amount at maturity for gross proceeds of $26.0 million, the majority
of which were used to fund Holding's equity contribution to AKI.
The Acquisition was accounted for using the purchase method of
accounting and resulted in the recognition of $153.9 million of goodwill and a
significant increase in amortization expense.
3M Acquisition
On June 22, 1998, we acquired the fragrance sampling business of the
Industrial and Consumer Products division of Minnesota Mining and Manufacturing
Company (3M) for $7.25 million in cash and the assumption of a liability of
$182,000 to one of the customers of the business. Our company financed the 3M
acquisition with borrowings under the credit agreement. Such borrowings were
subsequently repaid.
RetCom Acquisition
On September 15, 1999, we acquired all of the issued and outstanding
shares of capital stock of RetCom Holdings Ltd. at a purchase price of
19
approximately $12.2 million and refinanced working capital indebtedness of
approximately $5.1 million of RetCom Holdings Ltd. and its subsidiaries. The
purchase price and refinancing of indebtedness were initially financed by
borrowings under the credit agreement. See "--Liquidity and Capital Resources."
Results of Operations
For purposes of the following discussion, the results of operations for
the year ended June 30, 1998 reflect the combination of the results of
operations of the predecessor corporation for the period July 1, 1997 through
December 15, 1997, the date of the Acquisition, with the results of operations
of our company for the period December 16, 1997 through June 30, 1998. Due to
the effects of purchase accounting applied in the Acquisition and the additional
interest expense associated with the debt incurred to finance the Acquisition,
the results of operations of our company are not comparable in all respects to
the results of operations of the predecessor corporation.
Fiscal Year Ended June 30, 1999 Compared to Fiscal Year Ended June 30, 1998
Net Sales. Net sales for the fiscal year ended June 30, 1999 increased
$14.7 million, or 20.6%, to $86.0 million as compared to $71.3 million for the
fiscal year ended June 30, 1998. The increase was primarily attributable to a
$9.1 million increase in domestic sales of cosmetic sampling products, the $5.7
million growth of our company's European revenues and increases in sales of
consumer product samples, offset by decreases in sales to the domestic fragrance
industry.
Gross Profit. Gross profit for the fiscal year ended June 30, 1999
increased $6.9 million, or 28.9%, to $30.8 million as compared to $23.9 million
for fiscal year ended June 30, 1998. Gross profit as a percentage of net sales
increased to 35.8% in the fiscal year ended June 30, 1999, from 33.5% in the
fiscal year ended June 30, 1998. The increase in gross profit and gross profit
as a percentage of net sales is primarily attributable to the increase in net
sales discussed above and reductions in raw material costs, offset by a decrease
in certain fragrance samples pricing, changes in product sales mix, increased
costs associated with the outsourcing of European production and increased costs
associated with the initial production runs of certain customer products.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 1999 increased $3.2
million, or 28.3% to $14.5 million as compared to $11.3 million for the fiscal
year ended June 30, 1998. The increase in selling, general and administrative
expenses was primarily due to severance charges related to former executive
officers, changes in executive compensation following the Acquisition and
increased sales staffing and commissions related to the increase in net sales
and costs associated with the transition of the 3M acquisition, offset partially
by reduced advertising expenditures and staff reductions. As a result of these
factors, selling, general and administrative expenses as a percent of net sales
increased to 16.9% in the fiscal year ended June 30, 1999 from 15.8% in the
fiscal year ended June 30, 1998.
20
Income from Operations. Income from operations for the fiscal year
ended June 30, 1999 increased $1.7 million, or 17.0%, to $11.7 million as
compared to $10.0 million for the fiscal year ended June 30, 1998. Income from
operations as a percentage of net sales decreased to 13.6% in the fiscal year
ended June 30, 1999 from 14.0% in the fiscal year ended June 30, 1998,
principally as a result of the increase in amortization of goodwill and other
intangibles resulting from the Acquisition and the 3M acquisition and the
factors described above.
Interest Expense. Interest expense for the fiscal year ended June 30,
1999 increased $2.7 million, or 19.3% to $16.7 million, as compared to $14.0
million for the fiscal year ended June 30, 1998. Interest expense as a
percentage of net sales decreased to 19.4% in the fiscal year ended June 30,
1999 from 19.6% in the fiscal year ended June 30, 1998. The increase in interest
expense is due to the increased indebtedness as a result of the recapitalization
of our company in connection with the Acquisition, partially offset by the
refinancing of the merger corporation's senior increasing rate notes with the
notes and debentures.
Interest expense for AKI for the fiscal year ended June 30, 1999
decreased $0.9 million, or 6.5%, to $13.0 million, as compared to $13.9 million
for the fiscal year ended June 30, 1998. Interest expense as a percentage of net
sales decreased to 15.1% in the fiscal year ended June 30, 1999 from 19.5% in
the fiscal year ended June 30, 1998. The decrease in interest expense is due to
the decreased indebtedness as a result of the refinancing of the merger
corporation's senior increasing rate notes with the notes and Holding's equity
contribution to AKI partially offset by the recapitalization of AKI.
Management Fees and Other, Net. Management fees and other, net for the
fiscal year ended June 30, 1999 were $0.4 million as compared to $0.3 million
for the fiscal year ended June 30, 1998. Management fees and other, net as a
percentage of net sales were relatively constant for the fiscal years ended June
30, 1999 and 1998.
Income Tax Expense. The income tax benefit for the fiscal year ended
June 30, 1999 decreased $0.3 million to ($0.3) million as compared to ($0.6)
million for the fiscal year ended June 30, 1998. The decrease is due to the
increase in non-deductible goodwill amortization and non-deductible portion of
the interest expense on the debentures, offset partially by the increased net
loss before income taxes as a result of the factors described above.
Income tax expense for AKI for the fiscal year ended June 30, 1999
increased $1.4 million to $0.8 million as compared to ($0.6) million for the
fiscal year ended June 30, 1998. The increase is due to the decrease in loss
before income taxes as a result of the factors described above and increase in
non-deductible goodwill amortization.
EBITDA. EBITDA for the fiscal year ended June 30, 1999, increased $3.7
million, or 22.6%, to $20.1 million as compared to $16.4 million for the fiscal
year ended June 30, 1998, principally as a result of the factors described
above. EBITDA is income from operations plus depreciation and amortization of
goodwill and other intangibles.
21
Fiscal Year Ended June 30, 1998 Compared to Fiscal Year Ended June 30, 1997
Net Sales. Net Sales for fiscal year ended June 30, 1998 decreased $6.4
million, or 8.2%, to $71.3 million as compared to $77.7 million for fiscal year
ended June 30, 1997. The majority of this decrease was attributable to three
core customers' advertising decreases on new product launches and existing
products as a result of a management restructuring at two of these customers and
the sale of one of them. In addition there was a decrease in domestic sales of
products for fragrance sampling. These decreases were partially offset by
increased domestic and European sales of sampling products to other categories
of the cosmetics industry as well as increased sales to the consumer products
market.
Gross Profit. Gross profit for fiscal year ended June 30, 1998
decreased $4.4 million, or 15.5%, to $23.9 million as compared to $28.3 million
for fiscal year ended June 30, 1997. Gross profit as a percentage of nets sales
decreased to 33.5% in fiscal year ended June 30, 1998 from 36.4% in fiscal year
ended June 30, 1997. The gross profit decline was primarily attributable to the
absorption of fixed overhead, depreciation costs and equipment reconfiguration
costs created by shorter production runs due to lower volume and the increase in
cost of goods sold in the period subsequent to the Acquisition from the write-up
of inventory in purchase accounting.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for fiscal year ended June 30, 1998 decreased $2.1
million or 15.7%, to $11.3 million as compared to $13.4 million for fiscal year
ended June 30, 1997. The decrease in selling, general and administrative
expenses was primarily attributable to a decrease in sales commissions resulting
from the decreased level of sales and a decrease in legal costs related to our
company's pursuit of a patent infringement claim in fiscal year ended June 30,
1997. In addition, our company also had decreased expenses in fiscal year ended
June 30, 1998 versus fiscal year ended June 30, 1997 related to the
consolidation of certain acquired technologies and certain expenses relating to
reorganizing the management structure at our company's European subsidiary. As a
result of these factors, selling, general and administrative expenses as a
percentage of net sales decreased to 15.8% in fiscal year ended June 30, 1998
from 17.2% in fiscal year ended June 30, 1997.
Income from Operations. Income from operations for fiscal year ended
June 30, 1998 decreased $3.7 million, or 27.0%, to $10.0 million as compared to
$13.7 million for fiscal year ended June 30, 1997. Income from operations as a
percentage of net sales decreased to 14.0% in fiscal year ended June 30, 1998
from 17.6% in fiscal year ended June 30, 1997 principally as a result of the
factors described above and the increase in amortization of goodwill resulting
from the Acquisition.
Interest Expense. Interest expense for fiscal year ended June 30, 1998
increased $7.8 million, or 125.8% to $14.0 million as compared to $6.2 million
for fiscal year ended June 30, 1997. Interest expense as a percentage of net
sales increased to 19.6% in fiscal year ended June 30, 1998 from 8.0% in fiscal
year ended June 30, 1997. The increase in interest expense is a result of the
refinancing of our company in connection with the Acquisition.
22
Interest expense for AKI for fiscal year ended June 30, 1998 increased
$7.7 million, or 124.2% to $13.9 million as compared to $6.2 million for fiscal
year ended June 30, 1997. Interest expense as a percentage of net sales
increased to 19.5% in fiscal year ended June 30, 1998 from 8.0% in fiscal year
ended June 30, 1997. The increase in interest expense is a result of the
refinancing of our company in connection with the Acquisition.
Other Income/Expense and Management Fees. Other income/expense and
management fees for fiscal year ended June 30, 1998 decreased $0.1 million, or
25.0% to $0.3 million as compared to $0.4 million for fiscal year ended June 30,
1997. Other income/expense and management fees as a percentage of net sales
decreased to 0.4% in fiscal year ended June 30, 1998 from 0.5% in fiscal year
ended June 30, 1997. The decrease in other income/expense and management fees is
related to the decrease in management/advisory fees subsequent to the sale of
our company.
Income Tax Expenses. Income tax expense for fiscal year ended June 30,
1998 decreased $3.7 million or 119.4% to $(0.6) million as compared to $3.1
million for fiscal year ended June 30, 1997. The Company's effective tax rate
was 36.8% in 1998 and 37.6% in 1997.
EBITDA. EBITDA for fiscal year ended June 30, 1998 decreased $2.4
million, or 12.8% to $16.4 million as compared to $18.8 million for fiscal year
ended June 30, 1997, principally as a result of the factors described above.
Liquidity and Capital Resources
Our company has substantial indebtedness and significant debt service
obligations. As of June 30, 1999, our company had consolidated indebtedness in
an aggregate amount of $146.7 million (excluding trade payables, accrued
liabilities and deferred taxes), of which (1) approximately $29.7 million was a
direct obligation of Holding relating to its debentures and (2) approximately
$117.0 million was a direct obligation of AKI relating to its notes and capital
leases. At June 30, 1999, AKI also had $17.1 million in additional outstanding
liabilities (including trade payables, accrued liabilities and deferred taxes)
and letters of credit outstanding under the credit agreement in the amount of
$0.6 million. As of September 20, 1999, AKI had letters of credit outstanding in
the amount of $0.6 million and outstanding borrowings of $16.3 million under the
credit agreement.
Borrowings under the credit agreement are limited to a maximum amount
equal to $20.0 million. At June 30, 1999 and September 27, 1999, AKI had
borrowings of approximately $19.4 million and $3.1 million, respectively,
available, 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 company's choice of formulas, plus a margin. The credit
agreement will mature on December 31, 2002.
The indentures and the credit agreement permit Holding and its
Restricted Subsidiaries to incur additional indebtedness, subject to specified
23
limitations. In addition, the indentures contains restrictive covenants that,
among other things, limit the ability of Holding and its Restricted Subsidiaries
to:
* pay dividends or make certain restricted payments;
* incur additional indebtedness and issue preferred stock;
* create liens;
* incur dividend and other payment restrictions affecting subsidiaries;
* enter into mergers, consolidations or sales of all or substantially all
of the assets of our company;
* enter into certain transactions with affiliates; and
* 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. See "Risk Factors--Holding
Company Structure."
Holding's principal liquidity requirements are for debt service
requirements under the debentures. AKI's principal liquidity requirements are
for debt service requirements and fees under the notes and the credit agreement.
Historically, our company has funded its capital, debt service and operating
requirements with a combination of net cash provided by operating activities,
which was $9.8 million for fiscal 1999, together with borrowings under revolving
credit facilities. In fiscal 1998, cash totaling $3.9 million was used by
operating activities primarily due to the assumption, and subsequent settlement,
of a $5.8 million current liability arising from, and directly attributable to
the Acquisition. Net cash provided by operating activities during fiscal 1999
resulted from net income before depreciation and amortization, the collection of
an income tax refund receivable and increases in accounts payable and accrued
expenses. These factors were partially offset by increased accounts receivable
and inventory levels.
In fiscal 1998 and fiscal 1999, our company had capital expenditures of
approximately $1.3 million and $2.9 million, respectively. These capital
expenditures consisted primarily of the purchase and maintenance of
manufacturing equipment and furniture and fixtures and maintaining and upgrading
its computer systems.
On September 15, 1999, we acquired all of the issued and outstanding
shares of capital stock of RetCom Holdings Ltd. at a purchase price of
approximately $12.2 million and refinanced working capital indebtedness of
approximately $5.1 million of RetCom Holdings Ltd. and its subsidiaries. The
24
purchase price and refinancing of indebtedness were initially financed by
borrowings under the credit agreement. Our company is exploring options for the
longer-term financing of a portion of the borrowings incurred in connection with
the acquisition.
Our company may from time to time evaluate additional potential
acquisitions. There can be no assurance that additional capital sources will be
available to our company to fund additional acquisitions on terms that our
company finds acceptable, or at all.
In August 1998, Acquisition Corp. repurchased from Roger Barnett 80,000
shares of preferred stock of Acquisition Corp. for approximately $2.0 million in
cash pursuant to the exercise by Mr. Barnett of a put option on July 30, 1998
with the proceeds of a dividend from Holding.
At June 30, 1999, Acquisition Corp. had outstanding (1) $30 million of
Floating Rate Notes which bear interest at approximately 15% per annum and
mature on December 15, 2009, and (2) approximately $50.8 million of Senior
Preferred Stock which accrue dividends at 15% per annum and must be redeemed by
December 15, 2012. Interest on the floating rate 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
Acquisition Corp. and are not obligations of, or guaranteed by Holding, AKI or
any of its subsidiaries. Acquisition Corp. is a holding company and is dependant
upon the cash flows of its subsidiaries and the payment to it of funds by its
subsidiaries. The indenture relating to the debentures restricts the payment of
dividends or the making of other restricted payments by Holding to Acquisition
Corp.
In September 1999, Acquisition Corp. consummated a private placement to
DLJMBII of 15,000,000 shares of its common stock at a purchase price of $1.00
per share. A portion of the proceeds may become available to the Company 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
Acquisition Corp. to make any of these funds available.
Capital expenditures for the fiscal year ending June 30, 2000 are
budgeted to be approximately $4.0 million. Based on borrowings outstanding
(other than pursuant to the credit agreement) as of June 30, 1999 and borrowings
outstanding under the credit agreement as of September 20, 1999, our company
expects total cash payments for debt service in fiscal 2000 to be approximately
$14.0 million, consisting of $12.1 million in interest payments on the notes,
$0.9 million in capital lease obligations and $1.0 million in interest and fees
under the credit agreement. Our company also expects to make royalty payments of
approximately $1.1 million during fiscal 2000. *
Our company believes 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 its indebtedness, including the debentures and the
notes for fiscal 2000. In the event our company consummates any additional
acquisitions it may seek additional debt or equity financings subject to
compliance with the terms of the indentures.
25
At June 30, 1999, our company's cash and cash equivalents and net
working capital were $7.0 million and $14.9 million, respectively, representing
an increase in cash and cash equivalents of $3.2 million and a decrease in net
working capital of $0.2 million from June 30, 1998. Account receivables, net, at
June 30, 1999 increased 20.2% or $2.7 million over the June 30, 1998 amount,
primarily due to increased sales and an increase in days sales outstanding.
Seasonality
Our company's sales and operating results have historically reflected
seasonal variations. Such seasonal variations are based on the timing of our
company's customers' advertising campaigns, which have traditionally been
concentrated prior to the Christmas and spring holiday seasons. As a result, a
higher level of sales are reflected in our company's first two fiscal quarters
ended December 31 when sales from such advertising campaigns are principally
recognized while our company's fourth fiscal quarter ended June 30 typically
reflects the lowest sales level of the fiscal year. These seasonal fluctuations
require our company to accurately allocate its resources to manage our company's
manufacturing capacity, which often operates at full capacity during peak
seasonal demand periods.
Recently Issued Accounting Standards
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" which is effective for fiscal years beginning after June 15, 1999.
SFAS No. 133 established accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. In June 1999, the FASB issued Statement of
Financial Accounting Standards No. 137, "Accounting for Derivative Instruments
and Hedging Activities Deferral of Effective Date" which is effective for fiscal
years beginning after June 15, 2000. Our company has only utilized derivative
financial instruments to hedge our company's exposure to certain foreign
currencies. Such hedging activity has historically been minor and, as a result,
adoption of this Statement is not expected to have a material impact on our
company's financial condition or results of operations. Our company will adopt
the provisions of this Statement on July 1, 2000.
Year 2000 Issues
Our company is currently working to resolve the potential impact of the
Year 2000 on its information technology systems and its non-information
technology systems so they will properly recognize and utilize dates beyond
December 31, 1999.
Our company has in place a Year 2000 program which is being executed by
an internal project team. The objective of the Year 2000 program is to determine
and assess the risks of the Year 2000 issue and to plan and institute mitigating
actions to minimize those risks to acceptable levels. To date, all of our
company's systems have been assessed for Year 2000 compliance. Our company
relies on five computerized systems all of which required remediation, two of
which are maintained internally and the others are maintained by third party
26
vendors. Our company believes that all of these systems are currently Year 2000
compliant. Upon review of our company's non-information technology systems our
company believes that none of its manufacturing equipment is date sensitive. Of
the remaining non-information technology systems, our company believes all such
systems are Year 2000 compliant. If, however, all necessary actions are not
taken on a timely basis to ensure Year 2000 compliance, the Year 2000 issue
could have a material adverse effect on our company. See "Risk Factors--Year
2000 Issues."
To date, our company has spent approximately $80,000 on Year 2000
compliance. Although our company expects the above referenced expenditures will
be sufficient to ensure our company is Year 2000 compliant, our company has
budgeted an additional $20,000 for any unforeseen problems which may arise with
respect to Year 2000 compliance between July 1, 1999 and the Year 2000. All
expenditures with respect to Year 2000 compliance will be funded from working
capital.
Our company is communicating with its significant customers and vendors
to understand their Year 2000 issues and how they might prepare themselves to
manage those issues as they relate to our company. To date, no significant
customers or vendors have informed our company that a material Year 2000 issue
exists which will have a material effect on our company.
Our company has not formulated a contingency plan in the event it or
its significant customers or vendors are not Year 2000 compliant.
Forward-Looking Statements
The information provided in this document contains forward-looking
statements that involve a number of risks and uncertainties. A number of factors
could cause actual results, performance, achievements of our company or industry
results to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. These
factors include, but are not limited to: o the competitive environment in the
sampling industry in general and in our company's specific market areas;
* changes in prevailing interest rates;
* inflation;
* changes in cost of goods and services;
* economic conditions in general and in our company's specific market
areas;
* changes in or failure to comply with postal regulations or other
federal, state and/or local government regulations;
* liability and other claims asserted against our company;
* changes in operating strategy or development plans;
27
* the ability to attract and retain qualified personnel;
* the significant indebtedness of our company;
* labor disturbances;
* changes in our company's capital expenditure plans;
* and other factors.
In addition, such forward-looking statements are necessarily dependent upon
assumptions, estimates and dates that may be incorrect or imprecise and involve
known and unknown risk, uncertainties and other factors. Accordingly, any
forward-looking statements included herein do not purport to be predictions of
future events or circumstances and may not be realized. Forward-looking
statements can be identified by, among other things, the use of forward-looking
terminology such as "believes," "expects," "may," "should," "seeks," "pro
forma," "anticipates," "intends" or the negative of any such word, or other
variations or comparable terminology, or by discussions of strategy or
intentions. Given these uncertainties, readers are cautioned not place undue
reliance on such forward-looking statements. Our company disclaims any
obligations to update any such factors or to publicly announce the results of
any revisions to any of the forward-looking statements contained in this
document to reflect future events or developments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our company generates approximately 20% of its sales from customers
outside the United States, principally in Europe. International sales are made
mostly from our company's foreign subsidiary located in France and are primarily
denominated in the local currency. Our company's foreign subsidiary also incurs
the majority of its expenses in the local currency and uses the local currency
as its functional currency.
Our company's 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.
Our company periodically enters 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, 1999, our company's forward
exchange contracts consisted of forward contracts to sell Euros at an exchange
rate of 1.0461 per U.S. dollar and to buy British pound sterling at an exchange
rate of 1.6123 per U.S. dollar. The notational principal amounts under these
foreign exchange contracts were $1.1 million and $0.7 million, respectively.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Consolidated Financial Statements of each of
Holding and AKI, the related notes and the Report of Independent Accountants for
each of Holding and AKI commencing at page F-1 of this report, which financial
statements, notes and reports are incorporated by reference into this report.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
29
PART III
ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS OF REGISTRANT
The following table sets forth certain information with respect to the
directors and executive officers of Holding.
Name Age Position
- ---- --- --------
Thompson Dean 40 Chairman of the Board and Director
William J. Fox 43 President, Chief Executive Officer and Director
Kenneth A. Budde 50 Chief Financial Officer
Hugh R. Kirkpatrick 62 Director
Mark P. Michaels 39 Director
David M. Wittels 35 Director
Roger L. Barnett 35 Director
Thompson Dean has served as Chairman of the Board and a Director of
Holding since December 1997. Mr. Dean is the Managing Partner of DLJ Merchant
Banking II, Inc. ("DLJ Merchant Banking") and the general partner of DLJ
Merchant Banking Partners II, L.P. Mr. Dean serves as a director of Commvault
Inc., Von Hoffman Press, Inc., Manufacturers' Services Limited and Phase
Metrics, 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") (and
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 is a
Director and Vice Chairman of the Board of The Hain Food Group, Inc.
(NASDAQ: HAIN).
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.
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.
30
Mark P. Michaels has served as a director of Holding since June 1998.
Mr. Michaels has been a Principal of DLJ Merchant Banking since 1997. Prior
thereto, Mr. Michaels was a consultant with McKinsey & Company, Inc. from 1987
to 1996.
David M. Wittels has served as a director of Holding since December
1997. Mr. Wittels is a Principal of DLJ Merchant Banking and has served in
various capacities with DLJ Merchant Banking since 1986. Mr. Wittels serves as a
director of Wilson Greatbatch Limited.
Roger L. Barnett has served as director of our company (or its
predecessor) since November 1993. Mr. Barnett is the chief executive officer of
Beauty.Com. From 1995 to February 1999, Mr. Barnett served as President and
Chief Executive Officer of our company and from 1994 to 1995, he served as
Senior Vice President and Vice President of our company.
Compensation of Directors
Except for Messrs. Kirkpatrick and Barnett, directors of Holding will
not receive compensation for services rendered in that capacity, but will be
reimbursed for out-of-pocket expenses incurred by them in connection with their
travel to and attendance at board meetings and committees of the board. Messrs.
Kirkpatrick and Barnett will receive an annual fee of $20,000 per year plus
reasonable out-of-pocket expenses in connection with travel to and attendance at
meetings of the board of directors and committees of the board.
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 (1) each
person who served as our company's chief executive officer in fiscal 1999, (2)
our other most highly compensated executive officer whose total annual
compensation exceeded $100,000 and (3) our other most highly compensated
executive officer whose total annual compensation exceed $100,000 but was not an
employee of our company at June 30, 1999 (collectively, the "named executive
officers").
31
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(2) 1999 $242,308 $250,000 ------(3) ------
President, Chief Executive Officer 1998 ------ ------ ------ ------
And Director 1997 ------ ------ ------ ------
Roger L. Barnett(2) 1999 309,711 ------(4) ------ $3,577
President, Chief Executive Officer 1998 367,083 ------ 32,500(5) 3,670
And Director 1997 210,000 275,000 ------ 5,700
Kenneth A. Budde 1999 154,327 80,625 ------ 9,077
Chief Financial Officer 1998 120,000 75,000 ------ ------
1997 100,000 50,000 ------ ------
Barry Miller(6) 1999 219,153 ------ ------ 120
Chief Operating Officer 1998 23,692 ------ ------ ------
1997 ------ ------ ------ ------
(1) Represents amounts contributed on behalf of the named executive to our
company's 401(k) retirement savings plan.
(2) On February 1, 1999, Mr. Barnett resigned as president and chief executive
officer of our company and Mr. Fox was engaged as president and chief
executive officer.
(3) Pursuant to the terms of his employment agreement, Mr. Fox is entitled to
receive options to acquire 5% of Acquisition Corp.'s issued and outstanding
common stock on a fully diluted basis, which options have not yet been
granted. See "--Equity Based Compensation" and "--Fox Employment
Agreement."
(4) Does not include $353,275 to which Mr. Barnett is entitled in connection
with his resignation from our company. See "Certain Relationships and
Related Transactions--Employment Arrangements."
(5) These options were forfeited upon Mr. Barnett's resignation from our
company.
(6) Mr. Miller's employment with our company commenced in May 1998 and was
terminated in May 1999.
Equity-Based Compensation
No options were granted by Acquisition Corp., Holding or AKI in fiscal
1999. Pursuant to the terms of his employment agreement, Mr. Fox is entitled to
receive options to acquire 5% of Acquisition Corp.'s issued and outstanding
common stock on a fully diluted basis, which options have not yet been granted.
See "--Fox Employment Agreement." In addition, no options for shares of capital
stock of Acquisition Corp., Holding or AKI were exercised in fiscal 1999.
Acquisition Corp. adopted the 1998 Stock Option Plan for certain key
employees and directors of Acquisition Corp. and any parent or subsidiary
32
corporation of Acquisition Corp. 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 Acquisition Corp. 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
100,000 shares of common stock of Acquisition Corp. The option plan will be
administered by the board of directors or a compensation committee to be
designated by the board of directors. Pursuant to the option plan, Acquisition
Corp. may grant options, including options that become exercisable as
performance standards determined by the committee are met, to key employees and
directors of Acquisition Corp. and any parent or subsidiary corporation. The
terms of any such grant will be determined by the committee and set forth in a
separate grant agreement. The exercise price will be at least equal to the fair
market value per share of Acquisition Corp. common stock on the date of grant,
provided that the exercise price shall not be less than $1.00 per share. Options
may be exercisable for up to ten years. The committee has the right to
accelerate the right to exercise any option granted under the option plan
without effecting the expiration date thereof. Upon the occurrence of a change
in control (as defined in the option plan) of Acquisition Corp., 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 Acquisition Corp.
common stock for which such option is then exercisable, an amount equal to the
excess of the then fair market value of such share of Acquisition Corp.
common stock over the per share exercise price.
Fox Employment Agreement
On January 27, 1999, William J. Fox entered into an employment
agreement with our company effective February 1, 1999. The term of the agreement
began on the effective date and will end on the third anniversary of the
effective date, provided, that beginning on the first anniversary of the
effective date, the term shall automatically be extended for one additional day
each day, unless either party provides notice not to extend.
Pursuant to his employment agreement, Mr. Fox's base salary is $600,000
and he will be eligible to receive a performance-based bonus of 25%, 100% or
200% of his base salary upon achievement of targeted goals, and other incentive
payments.
Pursuant to the terms of his employment agreement, Mr. Fox is entitled
to receive options to acquire 5% of Acquisition Corp.'s issued and outstanding
common stock on a fully diluted basis, subject to anti-dilution protection,
which options have not yet been granted. Once granted, these options will vest
at specified dates and upon the occurrence of specified conditions. In addition,
upon a change in control (as defined in the employment agreement), all time
vested options vest and all performance vested options vest if the DLJ Entities
(as defined in the employment agreement) achieve certain levels of return on
their equity investments.
If Mr. Fox's employment is terminated by our company without cause or
by Mr. Fox for good reason, our company 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 twelve month period following the date of
33
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 our company without cause or by our company for good reason,
and one year if Mr. Fox's employment is terminated for any other reason.
Compensation Committee Interlocks and Insider Participation
None of Acquisition Corp., Holding or AKI had a compensation committee
during fiscal 1999. No executive officer participated in deliberations regarding
executive compensation. Each of William J. Fox and Roger L. Barnett were
executive officers during fiscal 1999 and served on the board of directors.
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 Acquisition
Corp. The following table sets forth certain information as of September 27,
1999 with respect to the beneficial ownership of Acquisition Corp. common stock
by (1) owners of more than five percent of such Acquisition Corp. common stock,
(2) each director and named executive officer of Holding and (3) all directors
and executive officers of Holding, as a group.
Percentage of
Shares Outstanding
Beneficially Acquisition Corp.
Owned Common Stock
Beneficial Owner
DLJ Merchant Banking Partners, II, L.P. and related investors (1) (2) 15,921,111 98.8%
William J. Fox --- ---
Thompson Dean (3) --- ---
Roger L. Barnett (2) 134,325 *
Hugh R. Kirpatrick --- ---
Mark Michaels (3) --- ---
David M. Wittels (3) --- ---
Kenneth A. Budde --- ---
All directors and executive officers as a group (2) (3) 134,325 *
34
- -------------
* 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"). See "Certain Relationships and Related Transactions-Transactions
with DLJMBII, and their Affiliates." The address of each of DLJMBII,
DLJMBII-A, Diversified Partners, Diversified Partners-A, DLJ Funding
II, Millennium Partners, Millennium Partners-A, EAB Partners and First
ESC is 277 Park Avenue, New York, New York 10172. The address of
Offshore Partners 11 is John B. Gorsiraweg 14, Willemstad, Curacao,
Netherlands Antilles. The address of UK Partners is 2121 Avenue of the
Stars, Fox Plaza, Suite 3000, Los Angeles, California 90067. Does not
include 18,000 shares of Acquisition Corp. Common Stock held directly
by the Scratch & Sniff Funding, Inc., an affiliate of DLJMBII.
(2) See "Certain Relationships and Related Transactions."
(3) Messrs. Dean, Michaels and Wittels are officers of DLJ Merchant
Banking, an affiliate of DLJMBII. Share data shown for such individuals
excludes shares shown as held by DLJMBII, as to which such individuals
disclaim beneficial ownership. The address of each of Messrs. Dean,
Michaels and Wittels is 277 Park Avenue, New York, New York 10172.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Transactions with DLJMBII and their Affiliates
Messrs. Dean, Michaels and Wittels, who are directors of AKI and
officers and directors of Holding and Acquisition Corp., are officers of DLJ
Merchant Banking. DLJ Merchant Banking, together with DLJMBII, beneficially own,
in the aggregate, approximately 98.8% of the outstanding common stock of
Acquisition Corp.
Pursuant to an agreement between Donaldson, Lufkin & Jenrette
Securities Corporation ("DLJ") and Acquisition Corp., DLJ will receive an annual
fee of $250,000 for acting as the exclusive financial and investment banking
advisor to our company ending December 31, 2002. Our company has agreed to
indemnify DLJ in connection with its acting as financial advisor.
Stockholders Agreement
In connection with the Acquisition, Acquisition Corp., DLJMBII, certain
investors in our company prior to the Acquisition, including Roger L. Barnett
and certain other signatories thereto, 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 Acquisition Corp. (including
securities exercisable for or convertible or exchangeable into capital stock of
Acquisition Corp.) and agreements among the parties thereto as to the governance
of Acquisition Corp. and, indirectly, Holding and AKI.
Pursuant to the stockholders agreement, the board of directors of
Acquisition Corp. consists of six members. DLJMBII has the right to nominate
35
four of the directors of Acquisition Corp. and the prior investors have the
right to nominate one director of Acquisition Corp., provided that DLJMBII and
the prior investors maintain a specified minimum level of equity investment in
Acquisition Corp. In addition, the stockholders agreement provides that the
Chief Executive Officer of Acquisition Corp. be nominated as a director of
Acquisition Corp.
The stockholders agreement contains restrictions on the ability of each
holder of capital stock of Acquisition Corp. to transfer any capital stock of
Acquisition Corp. to any person designated by the board of directors of
Acquisition Corp. to be an "Adverse Person." In addition, the prior investors
are restricted in their ability to transfer capital stock of Acquisition Corp.
prior to the date that is the earlier of (1) the consummation of a qualifying
initial public offering or (2) December 15, 2002, except to DLJMBII or a party
who is a prior investor, or pursuant to an offering of equity securities
registered under the Securities Act.
The other material provisions of the stockholders agreement provide,
subject to specified exceptions, (1) certain preemptive rights to the holders of
capital stock of Acquisition Corp., (2) "drag along" rights to DLJMBII to
require the remaining holders of capital stock of Acquisition Corp. to sell a
percentage of their ownership and (3) "tag along" rights to the holders of
capital stock of Acquisition Corp., other than DLJMBII, with respect to sales of
capital stock of Acquisition Corp. by DLJMBII.
Pursuant to the stockholders agreement, DLJMBII was granted the right
to demand up to three registrations on Form S-1 or the equivalent to sell
Acquisition Corp. common stock (or if Acquisition Corp. is eligible to use Form
S-3, the number of demand rights is unlimited) and all holders of capital stock
of Acquisition Corp. were granted certain customary "piggyback" registration
rights to register their common stock in any registration statement filed by
Acquisition Corp.
Employment Arrangements
On June 17, 1998, Roger Barnett was retained as president and chief
executive officer of our company pursuant to the terms of his employment
agreement. On February 1, 1999, Mr. Barnett resigned as president and chief
executive officer and our company engaged William J. Fox as president and chief
executive officer. Under the terms of his employment agreement, Mr. Barnett was
entitled to receive payments aggregating $500,000, of which $353,275 was
required to be paid in fiscal 1999 and the remainder of which will be paid in
fiscal 2000.
Put Option
In August 1998, Acquisition Corp. repurchased from Roger Barnett 80,000
shares of preferred stock of Acquisition Corp. for approximately $2.0 million in
cash pursuant to the exercise by Mr. Barnett of a put option on July 30, 1998
with the proceeds of a dividend from Holding.
36
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The financial statements listed on the accompanying
index to such financial statements are filed as part
of this report.
2. Financial Statement Schedule
None.
3. Exhibits and Exhibit Index.
3.1 Certificate of Incorporation of Holding.*
3.2 Certificate of Incorporation of AKI.**
3.3 Bylaws of Holding.*
3.4 Bylaws of AKI.**
4.1 Indenture dated as of June 25, 1998 between Holding and State
Street Bank and Trust Company, as Trustee.*
4.2 Indenture dated as of June 25, 1998 between AKI and IBJ Schroder
Trust Company, as Trustee.**
4.3 Form of 13 1/2% Senior Discount Debentures due July 1, 2009
(included in Exhibit 4.1(a)).
4.4 Form of 10 1/2% Senior Discount Debentures due July 1, 2008
(included in Exhibit 4.1(b)).
4.5 Registration Rights Agreement of Holding, dated as of June 25,
1998 between Holding and Donaldson, Lufkin and Jenrette
("DLJ").*
4.6 Registration Rights Agreement of AKI, dated as of June 25, 1998,
between AKI and DLJ.**
10.1 Acquisition Corp. Stock Option Plan.*
10.2 Option Letter Agreement relating to the Time Vesting Options
dated as of June 17, 1998 between Acquisition Corp. and Roger L.
Barnett.*
10.3 Option Letter Agreement relating to the Standard Option dated as
of June 17, 1998 between Acquisition Corp. and Roger L.
Barnett.*
10.4 Employment Agreement dated as of June 17, 1998 between Holding
and Roger L. Barnett.*
38
10.5 Employment Agreement dated as of May 12, 1998 between Holding
and Barry Miller.*
10.6 Employment Agreement dated as of February 1, 1999 between
Holding and William J. Fox.***
10.7 Stockholders Agreement dated as of December 15, 1997 between
Acquisition Corp., DLJMBII and certain other investors including
Roger L. Barnett.*
10.8 Credit Agreement, dated as of April 30, 1996, as amended by
Amendment No. 1, dated December 12, 1997, and as further amended
by Amendment No. 2, dated October 30, 1998, between the Company
and Heller Financial, Inc.*
10.9 Amendment No. 3 to the Credit Agreement, dated August 30, 1999,
between the Company and Heller Financial.+
10.10 Amendment No. 4 to the Credit Agreement, dated September 21,
1999, between the Company and Heller Financial, Inc.+
10.11 Securities Purchase Agreement dated as of December 15, 1997
between Holding and Scratch & Sniff Funding, Inc.*
10.12 Asset Purchase Agreement dated as of May 28, 1998 between AKI
and Minnesota, Mining and Manufacturing Company.*
10.13 Stock Purchase Agreement dated as of November 14, 1997, as
amended on December 2, 1997 and December 12, 1997 among the
Company and DLJMBII and certain related investors.*
10.14 Financial Advisory Agreement dated as of December 12, 1997
between Acquisition Corp. and DLJ.*
10.15 Replacement Stock Option Agreement dated as of December 15, 1997
between Acquisition Corp. and Roger L. Barnett.*
10.16 Option Substitution Agreement dated as of December 15, 1997
among Holding, Acquisition Corp., and Roger L. Barnett.*
10.17 Put and Call Agreement dated as of December 15, 1997, as amended
on February 2, 1998 and April 1, 1998, among Roger L. Barnett,
Acquisition Corp., and DLJMBII.*
10.18 Termination of Put and Call Agreement dated June 17, 1997 among
DLJMBII, Barnett, and Acquisition Corp.*
10.19 Stock Purchase Agreement, by and among AKI and each of Michael
Berman, Paul Pearl, Stuart Fleischer, Jay Gartlan, Retail TCA
Corporation, a New York corporation, Retail TCB Corporation, a
New York corporation, and Sleepeck Printing Company, an Illinois
corporation, dated as of September 2, 1999.+
12.1 Computation of Ratio of Earnings to Fixed Charges.+
21.1 Subsidiaries of Holding.+
23.1 Consent of PricewaterhouseCoopers LLP.+
23.2 Consent of PricewaterhouseCoopers LLP.+
39
27.1 Financial Data Schedule.+
27.2 Financial Data Schedule.+
- --------------
* Incorporated by reference from Registrant's Registration Statement on
Form S-4, File No. 333-60991 filed with the Securities and Exchange
Commission on August 7, 1998.
** Incorporated by reference from Registrant's Registration Statement on
Form S-4, File No. 333-60989 filed with the Securities and Exchange
Commission on August 7, 1998.
*** Incorporated by reference from Registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on February 4, 1999.
+ Filed herewith.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the three months
ended June 30, 1999.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, AKI Holding Corp. has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on the 28th day of
September, 1999.
AKI HOLDING CORP.
(Registrant)
By: /S/ WILLIAM J. FOX
_________________________________
William J. Fox
President and Chief Executive Officer
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 28th day of September, 1999.
SIGNATURE TITLE
/S/ THOMPSON DEAN Chairman and Director
- ------------------------
Thompson Dean
/S/ WILLIAM J. FOX President, Chief Executive Officer and Director
- ------------------------ (Principal Executive Officer)
William J. Fox
/S/ KENNETH BUDDE Chief Financial Officer (Principal Financial and
- ------------------------ Accounting Officer)
Kenneth Budde
/S/ DAVID WITTELS Director
- ------------------------
David Wittels
/S MARK MICHAELS Director
- ------------------------
Mark Michaels
/S/ HUGH KIRKPATRICK Director
- ------------------------
Hugh Kirkpatrick
Director
- ------------------------
Roger L. Barnett
41
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 28th day of
September, 1999.
AKI, INC.
(Registrant)
By: /S/ WILLIAM J. FOX
_________________________________
William J. Fox
President, Chief Executive Officer and
Chairman
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 28th day of September, 1999.
SIGNATURE TITLE
/S/ WILLIAM J. FOX President, Chief Executive Officer, Chairman and
- ------------------------ Director (Principal Executive Officer)
William J. Fox
/S/ KENNETH BUDDE Chief Financial Officer (Principal Financial and
- ------------------------ Accounting Officer)
Kenneth Budde
/S/ DAVID WITTELS Director
- ------------------------
David Wittels
/S/ THOMPSON DEAN Director
- ------------------------
Thompson Dean
/S MARK MICHAELS Director
- ------------------------
Mark Michaels
/S/ HUGH KIRKPATRICK Director
- ------------------------
Hugh Kirkpatrick
Director
- ------------------------
Roger L. Barnett
42
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.
43
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANACIAL STATEMENTS OF AKI HOLDING CORP.:
Report of Independent Accountants........................................... F-2
Report of Independent Accountants........................................... F-3
Consolidated Balance Sheets at June 30, 1998 and 1999....................... F-4
Consolidated Statements of Operations for the year ended June 30, 1997 and
for the period from July 1, 1997 through December 15, 1997 and for the
period from December 16, 1997
through June 30, 1998 and for the year ended June 30, 1999.............. F-5
Consolidated Statements of Changes in Stockholder(s) Equity for the year
ended June 30, 1997 and for the period from July 1, 1997 through
December 15, 1997 and for the period from December 16, 1997 through
June 30, 1998 and for the year ended
June 30, 1999........................................................... F-6
Consolidated Statements of Cash Flows for the year ended June 30, 1997 and
for the period from July 1, 1997 through December 15, 1997 and for the
period from December 16, 1997
through June 30, 1998 and for the year ended June 30, 1999.............. F-7
Notes to Consolidated Financial Statements.................................. F-8
CONSOLIDATED FINANACIAL STATEMENTS OF AKI, INC.:
Report of Independent Accountants...........................................F-31
Report of Independent Accountants...........................................F-32
Consolidated Balance Sheets at June 30, 1998 and 1999.......................F-33
Consolidated Statements of Operations for the year ended June 30, 1997 and
for the period from July 1, 1997 through December 15, 1997 and for the
period from December 16, 1997
through June 30, 1998 and for the year ended June 30, 1999..............F-34
Consolidated Statements of Changes in Stockholder(s) Equity for the year
ended June 30, 1997 and for the period from July 1, 1997 through
December 15, 1997 and for the period from December 16, 1997 through
June 30, 1998 and for the year
ended June 30, 1999.....................................................F-35
Consolidated Statements of Cash Flows for the year ended June 30, 1997 and
for the period from July 1, 1997 through December 15, 1997 and for the
period from December 16, 1997
through June 30, 1998 and for the year ended June 30, 1999..............F-36
Notes to Consolidated Financial Statements..................................F-37
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, of changes in stockholder's
equity and of cash flows present fairly, in all material respects, the financial
position of AKI Holding Corp. (a wholly-owned subsidiary of AHC I Acquisition
Corp.) and Subsidiaries (the "Successor"), at June 30, 1998 and 1999, and the
results of their operations and their cash flows for the period from December
16, 1997 through June 30, 1998 and the year ended June 30, 1999 in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1999 except for Note 19
which is as of September 15, 1999
F-2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
AKI Holding Corp. and Subsidiaries
In our opinion, the accompanying consolidated statements of operations, of
changes in stockholders' equity and of cash flows of Arcade Holding Corporation
and Subsidiaries (the "Predecessor") present fairly, in all material respects,
the results of their operations and their cash flows for the year ended June 30,
1997 and the period from July 1, 1997 through December 15, 1997 in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1998
F-3
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share information)
The accompanying notes are an integral part of these consolidated
financial statements.
Successor
---------
June 30, 1998 June 30, 1999
------------- -------------
ASSETS
Current assets
Cash and cash equivalents..................................... $ 3,842 $ 7,015
Accounts receivable, net...................................... 13,550 16,287
Inventory..................................................... 2,078 5,109
Income tax refund receivable.................................. 5,155 32
Prepaid expenses.............................................. 379 452
Deferred income taxes......................................... 827 400
----------- -----------
Total current assets.................................... 25,831 29,295
Property, plant and equipment, net............................ 18,936 18,511
Goodwill, net ................................................ 151,842 147,990
Deferred charges, net......................................... 6,535 6,839
Other intangible assets, net.................................. 7,289 6,560
Deferred income taxes......................................... 3,888 4,338
Other assets.................................................. 200 46
----------- -----------
Total assets............................................ $ 214,521 $ 213,579
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligations.................. $ 609 $ 688
Current portion of other notes payable........................ 1,330 -
Accounts payable, trade....................................... 4,293 3,400
Accrued income taxes.......................................... 100 497
Accrued compensation.......................................... 2,497 2,527
Accrued interest.............................................. 167 6,047
Accrued expenses.............................................. 1,789 1,283
----------- -----------
Total current liabilities............................... 10,785 14,442
Long-term portion of capital lease obligations................ 1,489 1,349
Senior notes.................................................. 115,000 115,000
Senior discount debentures.................................... 26,020 29,651
Deferred income taxes......................................... 4,143 3,340
----------- -----------
Total liabilities....................................... 157,437 163,782
Commitments and contingencies (see Note 14)
Stockholder's equity
Common stock, $0.01 par, 1,000 shares authorized; 1,000
shares issued and outstanding at June 30, 1998 and June 30, 1999 - -
Additional paid-in capital.................................... 78,364 78,364
Accumulated deficit........................................... (5,493) (12,472)
Accumulated other comprehensive loss.......................... (57) (365)
Carryover basis adjustment.................................... (15,730) (15,730)
----------- ------------
Total stockholder's equity.............................. 57,084 49,797
----------- -----------
Total liabilities and stockholder's equity.............. $ 214,521 $ 213,579
=========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands)
Predecessor Successor
----------- ---------
July 1, December 16,
1997 1997
Year Ended through through Year Ended
June 30, December 15, June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Net sales................................. $ 77,723 $ 35,186 $ 36,066 $ 85,967
Cost of goods sold........................ 49,467 22,809 24,518 55,199
--------- --------- --------- ---------
Gross profit......................... 28,256 12,377 11,548 30,768
Selling, general and administrative expenses 13,333 5,703 5,587 14,500
Amortization of goodwill
and other intangible assets............ 1,234 568 2,101 4,606
--------- --------- --------- ---------
Income from operations............... 13,689 6,106 3,860 11,662
Other expenses (income):
Interest expense to stockholder(s) and
affiliate........................... 5,196 2,143 10,785 -
Interest expense, other................ 1,007 503 542 16,740
Management fees to stockholders........
and affiliate........................ 470 215 125 250
Other, net............................. (101) 11 (47) 128
--------- --------- --------- ---------
Income (loss) before income taxes.... 7,117 3,234 (7,545) (5,456)
Income tax expense (benefit).............. 3,135 1,441 (2,052) (340)
--------- --------- --------- ----------
Net income (loss).................... $ 3,982 $ 1,793 $ (5,493) $ (5,116)
========= ========= ========= =========
F-5
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER(S) EQUITY
(dollars in thousands, except share information)
Retained Accumulated
Additional Stock Earnings Other Carryover
Common Stock Paid-in Purchase (Accumulated Comprehensive Basis
Shares Amount Capital Warrants Deficit) Loss Adjustment Total
------ ------ ---------------- ------- ---- ---------- -----
Predecessor
-----------
Balances, June 30, 1996....... 48,000 $ 1 $4,889 $1,923 $ 1,199 $ (80) $ - $ 7,932
Net Income.................... - - - - 3,982 - - 3,982
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment.............. - - - - - (73) - (73)
----------
Comprehensive income.......... 3,909
Preferred stock dividend...... - - - - (616) - - (616)
------- ------- ------ ------ -------- -------- --------- ---------
Balances, June 30, 1997....... 48,000 1 4,889 1,923 4,565 (153) - 11,225
Net income.................... - - - - 1,793 - - 1,793
Other comprehensive income, net
of tax :
Foreign currency translation
adjustment.............. - - - - - (19) - (19)
----------
Comprehensive income.......... 1,774
Preferred stock dividend...... - - - - (283) - - (283)
------- ------- ------ ------ -------- -------- --------- ---------
Balances, December 15, 1997... 48,000 $ 1 $4,889 $1,923 $ 6,075 $ (172) $ - $ 12,716
======= ======= ====== ====== ======== ======== ========= =========
___________________________________________________________________________________________________________________
Successor
---------
Balances, December 16, 1997... - $ - $ - $ - $ - $ - $ - $ -
Initial capitalization 1,000 - 78,364 - - - - 78,364
(see Note 13)...............
Carryover basis adjustment.... - - - - - - (15,730) (15,730)
Net loss...................... - - - - (5,493) - - (5,493)
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment.............. - - - - - (57) - (57)
----------
Comprehensive loss............ (5,550)
------- ------- ------ ------ -------- -------- --------- ---------
Balances, June 30, 1998....... 1,000 - 78,364 - (5,493) (57) (15,730) 57,084
Net loss...................... - - - - (5,116) - - (5,116)
Other comprehensive loss, net of tax:
Foreign currency translation
adjustment.............. - - - - - (308) - (308)
----------
Comprehensive loss............ (5,424)
Dividend to AHC I Acquisition Corp. - - - - (1,863) - - (1,863)
--- --- ---- ------ -------- -------- --------- ----------
Balances, June 30, 1999....... 1,000 $ - $78,364 $ - $(12,472) $ (365) $ (15,730) $ 49,797
======= ======= ======= ====== ======== ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
F-6
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Predecessor Successor
----------- ---------
July 1, December 16,
Year 1997 1997 Year
ended through through ended
June 30, December 15, June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Cash flows from operating activities:
Net income (loss)..................... $ 3,982 $ 1,793 $ (5,493) $ (5,116)
Adjustment to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization of goodwill
and other intangibles............. 5,084 2,456 3,954 8,487
Amortization of debt discount....... 560 233 139 3,631
Amortization of loan closing costs.. 258 101 3,808 727
Deferred income taxes............... (297) (460) (2,035) (544)
Gain on sale of equipment...... - - - (50)
Other............................... (138) (18) (57) (308)
Changes in operating assets and liabilities:
Accounts receivable............... 2,546 1,153 (4,562) (2,737)
Inventory......................... (550) 69 543 (3,031)
Prepaid expenses, deferred charges and
other assets.................... (101) (62) (453) (975)
Income taxes...................... (1,163) 699 767 5,238
Accounts payable and accrued expenses (1,239) (1,036) (5,432) 4,511
--------- --------- ------ ------
Net cash provided by (used in) operating
activities...................... 8,942 4,928 (8,821) 9,833
--------- --------- --------- ---------
Cash flows from investing activities:
Purchases of equipment................ (2,462) (807) (514) (2,856)
Proceeds from sale of equipment....... 38 - - 50
Payments for acquisitions, net of cash acquired - - (141,403) -
------- --------- --------- ---------
Net cash used in investing activities (2,424) (807) (141,917) (2,806)
--------- --------- --------- ---------
Cash flows from financing activities:
Payments under capital leases for equipment (2,359) (249) (308) (661)
Net proceeds (repayments) on line of credit 4,338 2,362 (6,700) -
Proceeds from issuance of senior increasing rate
notes, net of offering costs....... - - 119,735 -
Payments on senior increasing rate notes - - (123,500) -
Proceeds from issuance of senior notes, net
of offering costs................... - - 110,158 -
Proceeds from issuance of senior discount
debentures, net of offering costs... - - 24,699 -
Proceeds from issuance of common stock - - 76,001 -
Redemption of preferred stock......... - - (8,678) -
Repayment of loans payable to stockholder (7,004) (1,851) (36,649) -
Repayment of other notes payable...... (1,200) (50) (50) (1,330)
Dividends paid on preferred stock..... (616) (155) (128) -
Dividend paid to AHC I Acquisition Corp. - - - (1,863)
---------- -------- --------- ---------
Net cash provided by (used in)
financing activities.............. (6,841) 57 154,580 (3,854)
--------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents (323) 4,178 3,842 3,173
Cash and cash equivalents, beginning of period 626 303 - 3,842
--------- -------- --------- ---------
Cash and cash equivalents, end of period. $ 303 $ 4,481 $ 3,842 $ 7,015
========= ========= ======== =========
Supplemental information:
Cash paid (received) during the period for:
Interest to stockholder(s)...... $ 4,559 $ 1,146 $ 11,503 $ -
Interest, other..................... 917 459 214 6,512
Income taxes........................ 4,594 1,222 (784) (5,123)
Significant non-cash activities:
Assets acquired under capital lease... $ - $ - $ - $ 600
F-7
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except 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. Arcade is engaged in
interactive advertising for consumer products companies and has a specialty
in the design, production and distribution of sampling systems from its
Chattanooga, Tennessee facilities, and distributes its products in Europe
through its French subsidiary, Arcade Europe S.A.R.L. As more fully
described in Note 3, DLJ Merchant Banking Partners II, L.P. and certain
related investors (collectively, "DLJMBII") and certain members of the
Predecessor organized AHC I Acquisition Corp. ("Acquisition Corp.") and AHC
I Merger Corp. ("Merger Corp.") for purposes of acquiring the Predecessor.
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, Acquisition Corp. contributed $1 and all of
its ownership interest in AKI to AKI Holding Corp. ("Holding," the
"Successor" or the "Company") for all of the outstanding equity of Holding.
Unless otherwise indicated, all references to years refer to the
Predecessor's, AKI's and Holding's fiscal year, June 30.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. All significant
intercompany transactions have been eliminated.
Reclassification
Certain prior year amounts have been reclassified to conform with the
current year presentation.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid investments with an original maturity of three
months or less at the time of purchase to be cash equivalents.
Concentration of Credit Risk
The Company maintains its cash in bank deposit accounts which, at
times, may exceed federally insured limits. The Company has not experienced
any losses in such accounts; in addition, the Company believes it is not
exposed to any significant credit risk on cash and cash equivalents. The
Company grants credit terms in the normal course of business to its
customers and as part of its ongoing procedures, the Company monitors the
credit worthiness of its customers. The Company does not believe that it is
subject to any unusual credit risk beyond the normal credit risk attendant
in its business.
F-8
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Two customers accounted for 23.5% and 35.3% of the Predecessor's net
sales during the year ended June 30, 1997 and the period from July 1, 1997
through December 15, 1997, respectively. One customer accounted for 13.3%
of net sales during the period from December 16, 1997 through June 30,
1998. Two customers accounted for 26.8% of net sales during the year ended
June 30, 1999.
Concentration of Purchasing
Products accounting for a majority of the Company's net sales utilize
specific grades of paper that are produced exclusively for the Company by
one domestic supplier. The Company does not have a purchase agreement with
the supplier and is not aware of any other suppliers of these specific
grades of paper. These products can be manufactured using other grades of
paper; however, the Company believes these specific grades of paper provide
the Company with an advantage over its competitors. The Company is
currently researching methods of replicating the advantages of these
specific grades of paper with other grades of paper available from multiple
suppliers. Until such methods are developed, a loss of supply of these
specific grades of paper and the resulting competitive advantage could
cause a possible loss of sales which could adversely affect operating
results.
Revenue Recognition and Accounts Receivable
Product sales are recognized upon shipment, net of estimated discounts.
Accounts receivable are accounted for net of allowances for doubtful
accounts.
Inventory
Paper inventory is stated at the lower of cost or market using the
last-in, first-out (LIFO) method; all other inventories are stated at the
lower of cost or market using the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Expenditures that
extend the economic lives or improve the efficiency of equipment are
capitalized. The costs of maintenance and repairs are expensed as incurred.
Upon retirement or disposal, the related cost and accumulated depreciation
are removed from the respective accounts and any gain or loss is recorded.
Depreciation is computed using the straight-line method based on the
estimated useful lives of the assets as indicated in Note 6 for financial
reporting purposes and accelerated methods for tax purposes. Leasehold
improvements are depreciated over the shorter of their estimated useful
lives or the lease term.
F-9
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Goodwill
The aggregate purchase price of business acquisitions was allocated to
the assets and liabilities of the acquired companies based on their
respective fair values as of the acquisition dates. Goodwill represents the
excess purchase price paid over the fair value of net identifiable assets
acquired and is amortized over forty years using the straight-line method.
Accumulated amortization was $2,087 and $5,939 at June 30, 1998 and June
30, 1999, respectively.
Management periodically reviews the value of its goodwill and other
long-lived assets to determine if an impairment has occurred. The potential
impairment of recorded goodwill and other long-lived assets is measured by
the undiscounted value of expected future operating cash flows in relation
to its net capital investment. Based on its review, management does not
believe that an impairment of its goodwill or its other long-lived assets
has occurred.
Deferred Charges
Deferred charges are primarily comprised of debt issuance costs which
are being amortized using the effective interest method over the terms of
the related debt. Such costs are included in the accompanying consolidated
balance sheets, net of accumulated amortization.
Other Intangible Assets
Other intangible assets include a covenant not to compete and other
intangible assets resulting from the acquisition of the fragrance sampling
business of Minnesota Mining and Manufacturing Company ("3M") (see Note 3)
in June 1998 and are being amortized over ten years using the straight-line
method. Accumulated amortization related to these intangibles was $729 at
June 30, 1999.
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 $112,000 and $22,508, respectively, at June 30,
1999 compared to a carrying value of $115,000 and $29,651, respectively, as
of the same date. The carrying value of the Senior Notes and Senior
Discount Debentures approximated fair value at June 30, 1998. The carrying
value of all other financial instruments approximated fair value at June
30, 1998 and June 30, 1999.
F-10
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Foreign Currency Transactions
Gains and losses on foreign currency transactions with third parties
have been included in the determination of net income in accordance with
SFAS No. 52, "Foreign Currency Translation." Foreign currency losses and
(gains) amounted to $387, $(44), $(52) and $91 for the year ended June 30,
1997, the period from July 1, 1997 through December 15, 1997, the period
from December 16, 1997 through June 30, 1998 and the year ended June 30,
1999, 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 $1,263, $664, $717 and $1,136 for the year
ended June 30, 1997, the period from July 1, 1997 through December 15,
1997, the period from December 16, 1997 through June 30, 1998 and for the
year ended June 30, 1999, respectively.
Income Taxes
Income taxes are provided in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." Accordingly,
deferred tax assets and liabilities are recognized at the applicable income
tax rates based upon future tax consequences of temporary differences
between the tax bases and financial reporting bases of assets and
liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse. Deferred tax assets are reduced, if
necessary, by the amount of any tax benefits that, based on available
evidence, are not expected to be realized.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Comprehensive Income (Loss)
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 130 ("SFAS No. 130") on July 1, 1998. This statement
establishes standards for reporting and displaying comprehensive income and
its components in the financial statements. This statement also requires
that comparative information for earlier periods be reclassified. As the
Company only has two items of comprehensive income, net income and foreign
currency translations, adoption of this statement did not have a material
effect upon the Company's financial position or results of operations.
F-11
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
3. SIGNIFICANT ACQUISITIONS
DLJMBII and certain members of the Predecessor organized Acquisition
Corp. and Merger Corp. for purposes of acquiring the Predecessor. Merger
Corp. was a wholly-owned subsidiary of Acquisition Corp. and was initially
capitalized by Acquisition Corp. with an equity contribution of $78,363,
comprised of $76,000 of cash (see Note 12) and $2,363 of non-cash
consideration in the form of an option to purchase Senior Preferred Stock
of Acquisition Corp. (see Note 17). Immediately following this equity
contribution, Merger Corp. issued $123,500 of senior increasing rate notes
(the "Bridge Loans") to an entity with an ownership interest in Acquisition
Corp. The Bridge Loans had a stated maturity of December 15, 1998 and had
an interest rate equal to the greater of (i) 10.0% per annum and (ii) a
daily floating rate of prime plus 2.25% plus an additional percentage
amount equal to (a) 1.0% from and including the interest payment date on
June 15, 1998 or (b) 1.5% from and including the interest payment date on
September 15, 1998. Merger Corp. received cash proceeds from the issuance
of the Bridge Loans of $119,735, net of $3,765 of associated debt issuance
costs.
On December 15, 1997, Merger Corp. acquired all of the equity interests
of the Predecessor (the "Acquisition") for a total cost of $197,730 which
consisted of $138,634 cash paid for equity interests and direct
acquisitions costs, $2,363 in non-cash consideration in the form of an
option to purchase Senior Preferred Stock of Acquisition Corp. (see Note
17) and the assumption of $56,733 in debt, preferred stock and related
interest and dividends, including a capital lease obligation. Included in
the amount of direct acquisition costs was approximately $2,022 paid to an
entity that has an ownership interest in Acquisition Corp. Merger Corp.
then merged with and into the Predecessor and the combined entity assumed
the name AKI. Subsequent to the Acquisition, Acquisition Corp. contributed
$1 of cash and all of its ownership interest in AKI to Holding for all of
the outstanding equity of Holding. Since all companies are under common
control and since Holding and Acquisition Corp. have no operations other
than those related to AKI, the contribution was accounted for as if it were
a pooling of interests.
The Acquisition was accounted for using the purchase method of
accounting. In accordance with the consensus reached by the Emerging Issues
Task Force of the Financial Accounting Standards Board in Issue 88-16,
"Basis in Leveraged Buyout Transactions," the purchase price allocation
required an adjustment for the continuing interest attributable to
management's ownership interest in the Predecessor carried over in
connection with the Acquisition. As a result, a reduction in stockholders'
equity of $15,730 was recorded which represents the difference between the
fair value of the Company's assets and the related book value attributable
to the interest of the continuing shareholders' investment in the
Predecessor. The remaining purchase price has been allocated to assets and
liabilities based upon estimates of their respective fair value as
determined by management and third-party appraisals with respect to
property, plant and equipment.
In connection with the Acquisition, the Company repaid the outstanding
balance and related interest of the Predecessor's loans payable to a
shareholder of $37,374, the outstanding balance and related interest of the
Predecessor's line of credit of $6,278 and the outstanding balance and
related dividends on the Predecessor's preferred stock of $8,806.
F-12
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
3. SIGNIFICANT ACQUISITIONS (Continued)
The following shows the acquisition costs and the allocation of the
purchase price:
Acquisition costs
Cash paid for stock.......................................... $ 134,403
Direct acquisition costs..................................... 4,231
-----------
138,634
Non-cash consideration for stock
in the form of an option to purchase Senior
Preferred Stock of Acquisition Corp. (see Note 17)......... 2,363
-----------
Total....................................................... 140,997
Less--Carryover basis adjustment............................ (15,730)
-----------
Purchase price to be allocated.............................. $ 125,267
===========
Summary allocation of purchase price
Cash........................................................ $ 4,481
Other current assets........................................ 17,782
Property, plant and equipment............................... 20,132
Deferred income taxes....................................... 2,953
Other assets................................................ 329
Goodwill.................................................... 153,929
-----------
Total allocation to assets.................................. $ 199,606
===========
Current liabilities......................................... $ 13,190
Long-term debt (including current portion) and related interest 47,927
Deferred income taxes.......................................... 4,416
Preferred stock and related dividends.......................... 8,806
-----------
Total liabilities assumed..................................... $ 74,339
===========
Included in cash paid for stock of $134,403 is $19,342 related to the
purchase and retirement of 11,201 options of the Predecessor. In addition,
the non-cash consideration for stock of $2,363 was incurred to acquire and
retire the remaining 1,370 options of the Predecessor (see Note 17).
On June 22, 1998, the Company acquired (the "3M Acquisition") the
fragrance sampling business of the Industrial and Consumer Products
division of 3M for approximately $7,250 in cash and the assumption of
liabilities of approximately $182. The only tangible assets acquired were
approximately $143 of equipment. The acquisition was accounted for using
the purchase method of accounting and resulted in assigning value to
certain intangible assets, including a covenant not to compete, totaling
approximately $7,289 which are being amortized on a straight line basis
over a period of 10 years.
F-13
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
3. SIGNIFICANT ACQUISITIONS (Continued)
Unaudited pro forma results for the Company assuming the Acquisition,
the 3M Acquisition and the Refinancing had occurred as of the beginning of
each applicable fiscal year are presented below:
Unaudited Pro Forma Results
for the Year Ended
------------------
June 30, June 30,
1997 1998
---- ----
Net sales....................... $ 87,771 $ 81,831
Income from operations.......... 9,565 5,838
Interest expense, net........... 16,640 16,730
Net loss........................ (6,102) (8,573)
On June 25, 1998, the Bridge Loans were repaid, without penalty, with
the proceeds from the Senior Note offering (see Note 9) and the Senior
Discount Debenture offering (see Note 10) (collectively, the
"Refinancing"). Contemporaneous with the repayment of the Bridge Loans, the
Company wrote-off the unamortized balance of debt issuance costs associated
with the Bridge Loans of $1,795 to interest expense.
4. ACCOUNTS RECEIVABLE
The following table details the components of accounts receivable:
June 30, June 30,
1998 1999
---- ----
Trade accounts receivable.............. $ 13,782 $ 16,349
Allowance for doubtful accounts........ (277) (251)
---------- ---------
13,505 16,098
Other accounts receivable.............. 45 189
--------- --------
$ 13,550 $ 16,287
========= ========
F-14
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
5. INVENTORY
The following table details the components of inventory:
June 30, June 30,
1998 1999
---- ----
Raw materials
Paper.................................... $ 556 $ 1,088
Other raw materials...................... 1,024 2,328
--------- --------
Total raw materials................... 1,580 3,416
Work in process............................ 498 1,693
--------- --------
Total inventory............................ $ 2,078 $ 5,109
========= ========
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,
1998 or June 30, 1999.
6. PROPERTY, PLANT AND EQUIPMENT
The following table details the components of property, plant and
equipment as well as their estimated useful lives:
Estimated June 30, June 30,
Useful Lives 1998 1999
------------ ---- ----
Land........................... $ 256 $ 258
Building....................... 7 - 15 years 1,048 1,648
Leasehold improvements......... 1 - 3 years 153 579
Machinery and equipment........ 5 - 7 years 17,146 19,483
Furniture and fixtures......... 3 - 5 years 1,634 2,084
Construction in progress....... 552 193
--------- --------
20,789 24,245
Accumulated depreciation....... (1,853) (5,734)
--------- ---------
$ 18,936 $ 18,511
========= =========
Depreciation expense amounted to $3,850, $1,888, $1,853 and $3,881 for
the year ended June 30, 1997, the period from July 1, 1997 through December
15, 1997, the period from December 16, 1997 through June 30, 1998 and the
year ended June 30, 1999, respectively.
F-15
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
6. PROPERTY, PLANT AND EQUIPMENT (Continued)
Property held under capital lease is included in the respective
property, plant and equipment category as follows:
June 30, June 30,
1999 1998
---- ----
Machinery and equipment.................. $ 3,000 $ 3,000
Building................................. - 600
--------- --------
3,000 3,600
Less accumulated depreciation............ (275) (790)
--------- ---------
$ 2,725 $ 2,810
========= ========
Depreciation of assets under capital lease totaled $633, $232, $275 and
$515 for the year ended June 30, 1997, the period from July 1, 1997 through
December 15, 1997, the period from December 16, 1997 through June 30, 1998
and the year ended June 30, 1999, respectively. Future minimum lease
payments under the remaining lease are as follows:
Payment Interest
2000...................... $ 884 $ 197
2001...................... 948 100
2002...................... 529 27
--------- --------
$ 2,361 $ 324
========= ========
7. LINE OF CREDIT
On April 30, 1996, the Predecessor entered into a line of credit
agreement (the "Credit Agreement"), which was amended on December 12, 1997,
in connection with the Acquisition, and amended again on September 30,
1998. The Credit Agreement provides for a revolving loan commitment up to a
maximum of $20,000 and expires on December 31, 2002. Borrowings are limited
to a borrowing base consisting of accounts receivable, inventory and
property, plant and equipment which serve as collateral for the borrowings.
As of June 30, 1999, the Company's borrowing base was approximately
$17,500. Interest on amounts borrowed accrue at a floating rate based upon
either prime or LIBOR (9.25% and 8.50% at June 30, 1998 and June 30, 1999,
respectively). The weighted average interest rate on the outstanding
balance under the Credit Agreement was 9.31%, 9.50%, 9.25% and 8.51% for
the year ended June 30, 1997, the period from July 1, 1997 through December
15, 1997, the period from December 16, 1997 through June 30, 1998 and the
year ended June 30, 1999, respectively.
F-16
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
7. LINE OF CREDIT (Continued)
The Company is required to pay commitment fees on the unused portion of
the revolving loan commitment at a rate of approximately 0.5% per annum. In
addition, the Company is required to pay fees equal to 2.5% of the average
daily outstanding amount of lender guarantees. The Company had $600 of
lender guarantees outstanding at June 30, 1998 and June 30, 1999. These
fees totaled $109, $30, $59 and $111 for the year ended June 30, 1997, the
period from July 1, 1997 through December 15, 1997, the period from
December 16, 1997 through June 30, 1998 and the year ended June 30, 1999,
respectively. The Credit Agreement contains certain financial covenants and
other restrictions including restrictions on additional indebtedness and
restrictions on the payment of dividends.
As of June 30, 1999, the Company was in compliance with all debt
covenants. However, the Company expects to be in violation of certain loan
covenants in Fiscal 2000. Management expects to obtain loan amendments
and/or waivers in Fiscal 2000 with respect to such covenants. If management
is unable to obtain loan amendments and/or waivers in Fiscal 2000, the
Company may need to seek additional sources of financing.
8. LOANS PAYABLE TO STOCKHOLDER
The Predecessor entered into a Senior Loan Agreement and two
Subordinated Loan Agreements (collectively, the "Loan Agreements") with a
party that had owned the Predecessor's preferred stock and a significant
portion of its common stock. The Loan Agreements were collateralized by
substantially all the assets of the Predecessor. The Loan Agreements
limited the Predecessor's ability to incur additional indebtedness, pay
dividends and purchase fixed assets. Additionally, the Loan Agreements
required that certain financial covenants be maintained. The Predecessor
was not in compliance with all such covenants at June 30, 1997. However,
this debt was subsequently retired upon the acquisition of the Predecessor
as discussed in Note 3. All amounts borrowed under the Senior Loan
Agreement bore interest at prime plus 1.50%.
The Predecessor borrowed $30,000 under the Subordinated Loan
Agreements, of which $23,000 was designated as Loan I and $7,000 was
designated as Loan II. Loan I bore interest, payable quarterly, at 12%
until November 4, 1998, and then would have converted to prime plus 4%.
Loan II bore interest, payable quarterly, at 7%. The outstanding amount of
the subordinated loans was net of unamortized debt discounts, which were
being amortized over the term of the related loan.
In connection with Loan II, the Predecessor issued a warrant to
purchase 19,233 shares of common stock at $0.05 per share. The warrant was
exercisable until November 4, 2003. The Predecessor valued the warrants at
$100 each based on the fair market value of a share of the underlying
common stock resulting from a sale with a third party. In connection with
the warrant issued, the Predecessor recorded a debt discount of $1,923. In
connection with the sale of the Predecessor on December 15, 1997 (see Note
3), all outstanding warrants were purchased from the holder by the buyer of
the Predecessor and retired.
F-17
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
9. SENIOR NOTES
On June 25, 1998, AKI completed a private placement of $115,000 of
Senior Notes (the "Senior Notes"). 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 Senior Notes mature on July 1,
2008 and may be redeemed at the option of AKI, in whole or in part, at any
time on or after July 1, 2003 at a price equal to 105.25% of the
outstanding principal balance plus accrued and unpaid interest. The
placement of the Senior Notes yielded 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 customary covenants including restrictions on
the declaration and payment of dividends by AKI to Holding and limitations
on the incurrence of additional indebtedness. On December 22, 1998, AKI
completed the registration of its Senior Notes with the Securities and
Exchange Commission.
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 $23,980 and
$20,349 at June 30, 1998 and June 30, 1999, 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 customary
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.
F-18
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
11. OTHER NOTES PAYABLE
On June 9, 1995, the Predecessor acquired all of the issued and
outstanding stock of Scent Seal Inc. ("Scent Seal"). The acquisition of
Scent Seal did not have a material impact on the financial position or
results of operations of the Predecessor and was accounted for as a
purchase transaction whereby the purchase cost was allocated to the fair
value of the net assets acquired. In connection with the acquisition of
Scent Seal, the Predecessor issued $3,627 in noninterest bearing promissory
notes (the "Notes") to an employee of the Predecessor who was previously a
Scent Seal stockholder. The Predecessor recorded a debt discount of $649 in
connection with the issuance of the Notes to reflect an effective interest
rate of 10%. The discount was being amortized over the term of the Notes.
Under certain provisions of the Scent Seal acquisition agreement, the
Company was permitted to reduce the outstanding principal balance of the
Notes based upon the ultimate realization of assets acquired and settlement
of liabilities assumed. In June 1998, the Company reached a settlement with
the holder of the Notes under these provisions which resulted in the
reduction of the outstanding principal balance of the Notes of $120. The
remaining principal balance of the Notes of $1,330 was repaid in July 1998
in accordance with the terms of the Notes.
12. REDEEMABLE PREFERRED STOCK OF THE PREDECESSOR
In connection with the 1993 acquisition of Arcade, the Predecessor
authorized and issued 8,000 shares of 7% cumulative, $1 par value
redeemable preferred stock at $1,000 per share. The redeemable preferred
stock prohibited the Predecessor from acquiring its common stock as long as
the preferred stock was outstanding and restricted the payment of common
stock dividends. Accrued and unpaid dividends of $678 accrued through
December 31, 1994, were added to the outstanding balance. The redeemable
preferred stock would have been redeemable on December 31, 2001, at
liquidation value of $1,000 per share plus accrued and unpaid dividends. In
conjunction with the sale of the Predecessor on December 15, 1997 (see Note
3), all outstanding redeemable preferred stock was redeemed at $1,000 per
share plus accrued and unpaid dividends.
13. INITIAL CAPITALIZATION
In conjunction with the Acquisition, Acquisition Corp. issued $30,000
of Floating Rate Notes, $50,279 of Manditorily 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 and bear interest at a rate equal to the rate in effect on the
Bridge Loans (see Note 3) plus 2.50%. After the completion of the
Refinancing (see Note 3) on June 25, 1998, the Floating Rate Notes bear
interest at 15% per annum. Interest is payable quarterly and can be settled
through the issuance of additional Floating Rate Notes through maturity at
the discretion of Acquisition Corp. The original issuance discount of
$5,389 is being amortized using the effective interest method over the life
of the Floating Rate Notes. The unamortized balance of the original
issuance discount was $5,152 and $4,470 at June 30, 1998 and June 30, 1999,
respectively. The Floating Rate Notes mature on December 15, 2009 and are
held by affiliates of the primary shareholder of Acquisition Corp. The
Senior Preferred Stock accretes in value at 15% per annum and must be
redeemed by December 15, 2012. The Floating Rate Notes and Senior Preferred
Stock are general unsecured obligations of Acquisition Corp.
F-19
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
13. INITIAL CAPITALIZATION (Continued)
The cash proceeds from the issuance of the Floating Rate Notes, Senior
Preferred Stock and Common Stock of approximately $76,000 and a Manditorily
Redeemable Senior Preferred Stock Option of $2,363 (see Note 17) were
contributed by Acquisition Corp. to AKI in exchange for 1,000 shares of
AKI's Common Stock. Subsequent to the capitalization of AKI, Acquisition
Corp. contributed $1 of cash and all of its ownership interest in AKI to
Holding for all of the outstanding equity of Holding.
Acquisition Corp. has no other operations other than the Company.
Absent addition financing by Acquisition Corp., the Company's operations
represent the only current source of funds available to service the
Floating Rate Notes and Manditorily Redeemable Senior Preferred Stock;
however, the Company is not obligated to pay or otherwise guarantee the
Floating Rate Notes and Manditorily Redeemable Senior Preferred Stock.
14. COMMITMENTS AND CONTINGENCIES
Operating Leases
Equipment and office, warehouse and production space under operating
leases expire at various dates. Rent expense was $443, $192, $198 and $338
for the year ended June 30, 1997, the period from July 1, 1997 through
December 15, 1997, the period from December 16, 1997 through June 30, 1998
and the year ended June 30, 1999, respectively. Future minimum lease
payments under these leases are as follows:
2000.............. $ 162
2001.............. 138
--------
$ 300
========
Royalty Agreements
Royalty agreements are maintained for certain technologies used in
the manufacture of certain products. Under the terms of one royalty
agreement, payments are required based on a percentage of net sales of
those products manufactured with the specific technology, or a minimum of
$500 per year. This agreement expires in 2003 or when a total of $12,500 in
cumulative royalty payments has been paid. The Company expensed $761, $437,
$516 and $500 under this agreement for the year ended June 30, 1997, the
period from July 1, 1997 through December 15, 1997, the period from
December 16, 1997 through June 30, 1998 and the year ended June 30, 1999,
respectively. The Company has paid $4,576 in cumulative royalty payments
under this agreement through June 30, 1999.
Under the terms of another agreement, royalty payments are required
based on the number of products sold that were manufactured with the
specific licensed technology, or a minimum payment per year. These minimum
payments for years after fiscal 1999 are $625 through the expiration of the
agreement in 2012. The Company expensed $475, $241, $284 and $575 under
this agreement for the year ended June 30, 1997, the period from July 1,
1997 through December 15, 1997, the period from December 16, 1997 through
June 30, 1998 and the year ended June 30, 1999, respectively.
F-20
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
14. COMMITMENTS AND CONTINGENCIES (Continued)
Employment Agreements
The Company has employment agreements with certain officers with terms
through February 1, 2002. Such agreements provide for base salaries
totaling $825 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. One of the employment
agreements also provides severance benefits of up to two years of base
salary if the officer's services are terminated under certain conditions.
During fiscal 1999, two executive officers employment was terminated
with the Company. In accordance with the terms of former officers'
employment agreements, the Company was obligated for severance benefits of
approximately $610. The Company had paid approximately $457 of these
benefits by June 30, 1999. The remaining balance of $153 is included in
accrued compensation at June 30, 1999.
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.
15. RETIREMENT PLANS
A 401(k) defined contribution plan (the "Plan") is maintained for
substantially all full-time salaried employees. Applicable employees who
have six months of service and have attained age 21 are eligible to
participate in the Plan. Employees may elect to contribute a percentage of
their earnings to the Plan in accordance with limits prescribed by law.
Contributions to the Plan are determined annually by the Company and
generally are a matching percentage of employee contributions. Costs
associated with the Plan totaled $180, $95, $113 and $201 for the year
ended June 30, 1997, the period from July 1, 1997 through December 15,
1997, the period from December 16, 1997 through June 30, 1998 and the year
ended June 30, 1999, respectively.
Certain hourly employees are covered under a multiemployer defined
benefit plan administered under a collective bargaining agreement. Costs
(determined by union contract) under the defined benefit plan were $143,
$80, $81 and $204 for the year ended June 30, 1997, the period from July 1,
1997 through December 15, 1997, from December 16, 1997 through June 30,
1998 and for the year ended June 30, 1999, respectively.
F-21
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
16. INCOME TAXES
The Company is included in the consolidated federal income tax return
filed by Acquisition Corp. for periods subsequent to December 15, 1997.
Income taxes related to the Company for the period from December 16, 1997
through June 30, 1999 were determined on a separate entity basis. The
Company files separate state income tax returns and calculates its state
tax provision on a separate company basis. Any income taxes payable or
receivable by the consolidated group are settled or received by AKI. The
Predecessor was not part of a consolidated group.
For financial reporting purposes, income (loss) before income taxes
includes the following components:
July 1, December 16,
1997 1997
Year Ended through through Year Ended
June 30, December 15, June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Income (loss) before income taxes:
United States.................... $ 7,609 $ 3,298 $ (8,227) $ (5,978)
Foreign.......................... (492) (64) 682 522
---------- ---------- --------- ---------
$ 7,117 $ 3,234 $ (7,545) $ (5,456)
========== ========== ========= =========
Significant components of the provision (benefit) for income taxes are as
follows:
July 1, December 16,
1997 1997
Year Ended through through Year Ended
June 30, December 15 June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Current expense (benefit):
Federal.......................... $ 2,880 $ 1,623 $ - $ -
Foreign.......................... - - 104 204
State............................ 552 278 (121) -
--------- --------- ---------- ---------
3,432 1,901 (17) 204
--------- --------- ---------- ---------
Deferred expense (benefit):
Federal.......................... (90) (376) (1,916) (481)
Foreign.......................... (165) (25) 162 -
State............................ (42) (59) (281) (63)
---------- --------- ---------- ----------
(297) (460) (2,035) (544)
---------- --------- --------- ----------
$ 3,135 $ 1,441 $ (2,052) $ (340)
========== ========= ========= =========
F-22
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
16. INCOME TAXES (Continued)
The significant components of deferred tax assets and deferred tax
liability at June 30, 1998 and 1999, were as follows:
June 30, 1998 June 30, 1999
---------------------- ---------------------
Current Noncurrent Current Noncurrent
---------------------- ---------------------
Deferred income tax assets:
Accrued expenses........................ $ 719 $ - $ 308 $ -
Allowance for doubtful accounts......... 108 - 92 -
Net operating loss carryforwards........ - 2,966 - 4,338
Preferred stock option.................. - 922 - -
--------- --------- --------- ---------
827 3,888 400 4,338
Deferred income tax liability:
Property, plant and equipment......... - 4,143 - 3,340
--------- --------- --------- ---------
$ 827 $ (255) $ 400 $ 998
========= ========== ========= =========
The income tax provision recognized by the Predecessor for the year ended June 30, 1997 and the period
from July 1, 1997 through December 15, 1997 and by the Company for the period from December 16, 1997
through June 30, 1998 and the year ended June 30, 1999 differs from the amount determined by applying the
applicable U.S. statutory federal income tax rate to pretax income as a result of the following:
July 1, December 16,
1997 1997
Year Ended through through Year Ended
June 30, December 15, June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Computed tax provision (benefit)
at the statutory rate................... $ 2,420 $ 1,100 $ (2,565) $ (1,855)
State income tax provision (benefit),
net of federal effect................... 335 145 (265) (152)
Nondeductible expenses.................... 455 193 723 1,655
Other, net................................ (75) 3 55 12
---------- --------- ---------- ----------
$ 3,135 $ 1,441 $ (2,052) $ (340)
========= ========= ========== ==========
In conjunction with the Acquisition, the Company recognized an income tax benefit of $7,327 related to
the excess of the redemption price over the strike price of certain non-qualified options of the
Predecessor redeemed and retired by the Company. This benefit was recorded as a reduction to goodwill.
F-23
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
16. INCOME TAXES (continued)
Due to the Company's current year losses and certain transactions made
in conjunction with the Acquisition, the Company has recorded a long-term
deferred tax asset of $4,338 reflecting cumulative net operating loss
carryforwards available to offset future federal taxable income of
approximately $10,000 and future state taxable income of approximately
$17,500 at June 30, 1999. These cumulative net operating loss carryforwards
expire in varying amounts through 2019. Realization is dependent on
generating sufficient taxable income prior to expiration of the loss
carryforwards. Although realization is not assured, management believes
that it is more likely than not that all of the deferred tax asset will be
realized. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term if estimates of future taxable
income during the carryforward period are reduced.
17. STOCK OPTIONS
The Predecessor sponsored a key employee stock option plan under
which a maximum of 12,571 shares of the Predecessor's common stock could be
reserved for nonqualified options; all stock options were granted with an
exercise price equal to the fair market value of $100 per share. All
options vested ratably over five years and would have expired ten years
from the grant date.
The Predecessor accounted for its employee stock options under
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB 25"). Under APB 25, because the exercise price of the
Predecessor's employee stock options equaled the market value of the
underlying stock on the date of grant, no compensation expense was
recognized.
A summary of the Predecessor's stock option activity and related
information follows:
June 30, 1997
Weighted
Average
Exercise
Options Price
Outstanding, beginning of year...... 12,571 $ 100
Granted........................... - -
Exercised......................... - -
Forfeited......................... - -
-------- -------
Outstanding, end of year............ 12,571 $ 100
======== =======
Exercisable, end of year............ 5,866 $ 100
======== =======
Weighted average remaining
contractual life.................. 7.3 years
F-24
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
17. STOCK OPTIONS (Continued)
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("SFAS 123"), requires disclosure of pro forma
information regarding net income for option grants subsequent to December
15, 1995. Because all of the Predecessor's options were granted prior to
that date, no pro forma adjustments to net income or disclosure of
information would apply under SFAS 123.
As a result of the sale of the Predecessor on December 15, 1997 (see
Note 3), all outstanding options became immediately vested and exercisable
under the terms of the original individual stock option agreements. In
connection with the Acquisition, the Company purchased and retired 11,201
options of the Predecessor for $19,342. The remaining 1,370 options of the
Predecessor, which had a cumulative exercise price of $137, were exchanged
at fair value for an option to purchase 100,000 shares of Acquisition
Corp.'s Senior Preferred Stock with a cumulative stated valued of $2,500
("the Preferred Stock Option"). The 1,370 options were subsequently
retired. The Preferred Stock Option had an exercise price of $137. The
total consideration of $21,705 used to purchase and retire the outstanding
options of the Predecessor was included in the cost of the Acquisition (see
Note 3).
The Preferred Stock Option was issued with a Put and Call Option (the
"Put and Call Option") which granted the officer the right to compel
DLJMBII to purchase the 100,000 shares of Senior Preferred Stock obtainable
under the Preferred Stock Option, together with certain common equity
interests in Acquisition Corp. held by the officer, for $2,590. The Put and
Call Option also granted DLJMBII the right to purchase the equity
interests, both common and preferred, of the officer for the same amount.
The Put and Call Option had a stated termination of June 30, 1998. The
officer agreed to terminate the Put and Call Option and enter into a new
put option (the "Put Option") dated June 17, 1998. The Put Option granted
the officer an irrevocable option to require Acquisition Corp. to purchase
80,000 shares of the Senior Preferred Stock obtainable under the Preferred
Stock Option, for $2,000 in cash. As the terms of the Put Option were
generally more restrictive than the Put and Call Option, no compensation
expense was recognized as a result of the transaction. On July 30, 1998,
the officer exercised the Preferred Stock Option and Put Option. To provide
Acquisition Corp. the funds to redeem the 80,000 shares of Senior Preferred
Stock, Holding issued Acquisition Corp. a dividend of $1,863 in cash on
such date.
Subsequent to the Acquisition, Acquisition Corp. adopted the 1998 Stock
Option Plan ("Option Plan") for certain key employees and directors of
Acquisition Corp. and any parent or subsidiary of Acquisition Corp. The
Option Plan authorizes the issuance of options to acquire up to 100,000
shares of Acquisition Corp. Common Stock. The terms of each individual
options grant are determined by the Board of Directors. The exercise price
for each grant is required to be set at least equal to the fair market
value per share of Acquisition Corp. provided that the exercise price shall
not be less than $1.00 per share. Options may be exercisable for up to ten
years.
F-25
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
17. STOCK OPTIONS (Continued)
On June 17, 1998, Acquisition Corp. granted an officer of the Company
options to purchase 32,500 shares of Acquisition Corp. Common Stock. All
options have an exercise price of $1.00 per share and a term of 10 years.
These options were forfeited during 1999 upon the resignation of the
officer.
The Company has elected to account for its stock based compensation
with employees under the intrinsic value method as permitted under FAS 123.
Under the intrinsic value method, because the stock price of the Company's
employee stock options equaled the fair value of the underlying stock on
the date of grant, no compensation expense was recognized. If the Company
had elected to recognize compensation expense based on the fair value of
the options at grant date as prescribed by FAS 123, the net loss for the
period from December 16, 1997 through June 30, 1998 and the year ended June
30, 1999 would have been $(5,494) and $(5,119), 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 of 5.4%. The weighted
average fair value at date of grant of options granted during 1998 was
approximately $0.41 per option.
18. RELATED PARTY TRANSACTIONS
The Predecessor made payments to a company controlled by a stockholder
of the Predecessor of $612 for the year ended June 30, 1997 and $160 for
the period from July 1, 1997 through December 15, 1997, for management
fees, bonuses and expense reimbursements.
The Predecessor made payments to another stockholder of $120 for the
year ended June 30, 1997 and $55 for the period from July 1, 1997 through
December 15, 1997, for management fees.
The Successor made payments to an affiliate of DLJMBII of $125 and
$250 for the period from December 16, 1997 through June 30, 1998 and the
year ended June 30, 1999, respectively, for financial advisory fees. In
addition, the Company had approximately $2,401 of cash on deposit with a
financial institution affiliated with DLJMBII as of June 30, 1998.
19. SUBSEQUENT EVENT
On September 15, 1999, AKI acquired all of the equity interests in
RetCom Holdings Ltd. and its subsidiaries for a total cost of approximately
$12,000 and refinanced working capital indebtedness of approximately $4,500
of RetCom Holdings Ltd. and its subsidiaries. The purchase price and
refinancing of indebtedness were initially financed by borrowings under the
credit agreement.
F-26
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
20. 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
Predecessor
-----------
Net sales:
Year ended June 30, 1997............. $ 70,660 $ 7,063 $ 77,723
Period from July 1, 1997
through December 15, 1997.......... 32,600 2,586 35,186
Successor
---------
Net sales:
Period from December 16, 1997
through June 30, 1998.............. $ 29,162 $ 6,904 $ 36,066
Year ended June 30, 1999............. 71,056 14,911 85,967
Long-lived assets:
June 30, 1998........................ 188,532 158 188,690
June 30, 1999........................ 184,177 107 184,284
F-27
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
21. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following condensed balance sheet at June 30, 1998 and June 30,
1999 and condensed statement of operations, changes in stockholder's equity
and cash flows for the period from December 16, 1997 through June 30, 1998
and the year ended June 30, 1999 for Holding should be read in conjunction
with the consolidated financial statements and notes thereto.
BALANCE SHEETS
June 30, June 30,
1998 1999
---- ----
Assets
Cash.............................................................. $ 2,201 $ -
Investment in subsidiaries........................................ 95,408 92,817
Deferred charges.................................................. 1,263 1,520
Deferred income taxes............................................. 19 1,206
---------- -----------
Total assets.................................................... $ 98,891 $ 95,543
========== ===========
Liabilities
Senior Discount Debentures........................................ $ 26,020 $ 29,651
Stockholder's equity
Common Stock, $0.01 par value, 1,000 shares authorized;
1,000 shares issued and outstanding............................. - -
Additional paid-in capital........................................ 78,364 78,364
Accumulated deficit............................................... (5,493) (12,472)
---------- -----------
Total stockholder's equity...................................... 72,871 65,892
---------- -----------
Total liabilities and stockholder's equity...................... $ 98,891 $ 95,543
========== ===========
STATEMENT OF OPERATIONS
December 16,
1997
through Year ended
June 30, June 30
1998 1999
---- ----
Equity in losses of subsidiaries.................................. $ (5,454) $ (2,591)
Interest expense, net............................................. (58) (3,712)
---------- ------------
Loss before income taxes........................................ (5,512) (6,303)
Income tax benefit................................................ (19) (1,187)
---------- -----------
Net loss........................................................ $ (5,493) $ (5,116)
========== ============
F-28
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
21. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)
STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY
Additional
Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----
Balances, December 16, 1997...... - $ - $ - $ - $ -
Initial capitalization........... 1,000 - 78,364 - 78,364
Net loss......................... - - - (5,493) (5,493)
------- ------- ----------- ----------- ------------
Balances, June 30, 1998.......... 1,000 - 78,364 (5,493) 72,871
Net loss......................... - - - (5,116) (5,116)
Dividend to AHC I
Acquisition Corp............... - - - (1,863) (1,863)
------- ------- ----------- ---------- -----------
Balances, June 30, 1999.......... 1,000 $ - $ 78,364 $ (12,472) $ 65,892
======= ======= =========== ========== ===========
STATEMENT OF CASH FLOWS
December 16,
1997
through Year ended
June 30, June 30,
1998 1999
---- ----
Cash flows from operating activities:
Net loss............................................................ $ (5,493) $ (5,116)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Net change in investment in subsidiaries.......................... 5,454 2,591
Amortization of original issuance discount and loan closing costs. 58 3,722
Deferred income taxes............................................. (19) (1,187)
Increase in deferred charges...................................... - (348)
---------- -----------
Net cash provided by (used in) operating activities............. - (338)
---------- ------------
Cash flows from investing activities:
Capital contributed to subsidiary................................... (22,499) -
---------- -----------
Cash flows from financing activities:
Proceeds from issuance of stock..................................... 1 -
Proceeds from issuance of Senior Discount Debentures................ 24,699 -
Dividend paid to AHC I Acquisition Corp............................. - (1,863)
---------- -----------
Net cash provided by (used in) financing activities............. 24,700 (1,863)
---------- ------------
Net increase (decrease) in cash and cash equivalents.............. 2,201 (2,201)
Cash and cash equivalents, beginning of period.................... - 2,201
---------- -----------
Cash and cash equivalents, end of period.......................... $ 2,201 $ -
========== ===========
F-29
AKI HOLDING CORP. AND SUBSIDIARIES
(a wholly-owned subsidiary of AHC I Acquisition Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
22. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following is a summary of the unaudited quarterly results of operations
for Fiscal 1998 and Fiscal 1999.
Predecessor Successor
October 1, December 16,
1997 1997
Quarter Ended through through Quarter Ended Quarter Ended
September 30, December 15, December 31, March 31, June 30, Full
Fiscal 1998 1997 1997 1997 1998 1998 Year
---- ---- ---- ---- ---- ----
Net sales............. $ 21,928 $ 13,258 $ 2,791 $ 19,191 $ 14,084 $ 71,252
Gross profit.......... 8,306 4,071 813 7,256 3,479 23,925
Income from operations 4,680 1,426 153 3,603 104 9,966
Interest expense, net. 1,451 1,195 759 4,404 6,164 13,973
Net income (loss)..... 1,796 (3) (443) (887) (4,163) (3,700)
Successor
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30, Full
Fiscal 1999 1998 1998 1999 1999 Year
---- ---- ---- ---- ----
Net sales............. $ 24,024 $ 20,437 $ 24,518 $ 16,988 $ 85,967
Gross profit.......... 8,603 6,777 9,691 5,697 30,768
Income from operations 4,337 2,331 4,616 378 11,662
Interest expense, net. 4,096 4,149 4,258 4,237 16,740
Net loss.............. (324) (1,579) (364) (2,849) (5,116)
F-30
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, of changes in stockholder's
equity and of cash flows present fairly, in all material respects, the financial
position of AKI, Inc. (a wholly-owned subsidiary of AKI Holding Corp.) and
Subsidiaries (the "Successor"), formerly known as Arcade Holding Corporation
(the "Predecessor"), at June 30, 1998 and 1999 and the results of their
operations and their cash flows for the period from December 16, 1997 through
June 30, 1998 and the year ended June 30, 1999 in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1999 except for Note 18
which is as of September 15, 1999
F-31
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
AKI, Inc. and Subsidiaries
In our opinion, the accompanying consolidated statements of operations, of
changes in stockholders' equity and of cash flows of Arcade Holding Corporation
and Subsidiaries present fairly, in all material respects, the results of their
operations and their cash flows for the year ended June 30, 1997 and the period
from July 1, 1997 through December 15, 1997 in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1998
F-32
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share
information)
Successor
---------
June 30, 1998 June 30, 1999
------------- -------------
ASSETS
Current assets
Cash and cash equivalents..................................... $ 1,641 $ 7,015
Accounts receivable, net...................................... 13,550 16,287
Inventory..................................................... 2,078 5,109
Income tax refund receivable.................................. 5,155 32
Prepaid expenses.............................................. 379 452
Deferred income taxes......................................... 827 400
--------- ---------
Total current assets.................................... 23,630 29,295
Property, plant and equipment, net............................ 18,936 18,511
Goodwill, net ................................................ 151,842 147,990
Deferred charges, net......................................... 5,272 5,319
Other intangible assets, net.................................. 7,289 6,560
Deferred income taxes......................................... 3,869 3,132
Other assets.................................................. 200 46
--------- ---------
Total assets............................................ $ 211,038 $ 210,853
========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligation................... $ 609 $ 688
Current portion of other notes payable........................ 1,330 -
Accounts payable, trade....................................... 4,293 3,400
Accrued income taxes.......................................... 100 497
Accrued compensation.......................................... 2,497 2,527
Accrued interest.............................................. 167 6,047
Accrued expenses.............................................. 1,789 1,283
--------- ---------
Total current liabilities............................... 10,785 14,442
Long-term portion of capital lease obligation................. 1,489 1,349
Senior notes.................................................. 115,000 115,000
Deferred income taxes......................................... 4,143 3,340
--------- ---------
Total liabilities....................................... 131,417 134,131
Commitments and contingencies (see Note 13)
Stockholder's equity
Preferred stock, $0.01 par, 8,700 shares authorized; no shares
issued or outstanding at June 30, 1998 and June 30, 1999.. - -
Common stock, $0.01 par, 100,000 shares authorized; 1,000
shares issued and outstanding at June 30, 1998 and June 30, 1999 - -
Additional paid-in capital.................................... 100,862 100,862
Accumulated deficit........................................... (5,454) (8,045)
Accumulated other comprehensive loss.......................... (57) (365)
Carryover basis adjustment.................................... (15,730) (15,730)
--------- ---------
Total stockholder's equity.............................. 79,621 76,722
--------- ---------
Total liabilities and stockholder's equity.............. $ 211,038 $ 210,853
========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-33
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands)
Predecessor Successor
July 1, December 16,
1997 1997
Year Ended through through Year Ended
June 30, December 15, June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Net sales.......................................... $ 77,723 $ 35,186 $ 36,066 $ 85,967
Cost of goods sold................................. 49,467 22,809 24,518 55,199
----------- ------------ ---------- ---------
Gross profit.................................. 28,256 12,377 11,548 30,768
Selling, general and administrative expenses....... 13,333 5,703 5,587 14,500
Amortization of goodwill and
other intangibles............................... 1,234 568 2,101 4,606
----------- ------------ ---------- ---------
Income from operations........................ 13,689 6,106 3,860 11,662
Other expenses (income):
Interest expense to stockholder(s) and
affiliate.................................... 5,196 2,143 10,785 -
Interest expense, other......................... 1,007 503 484 13,028
Management fees to stockholders
and affiliate................................. 470 215 125 250
Other, net...................................... (101) 11 (47) 128
----------- ------------ ---------- ---------
Income (loss) before income taxes............. 7,117 3,234 (7,487) (1,744)
Income tax expense (benefit)....................... 3,135 1,441 (2,033) 847
----------- ------------ ---------- ---------
Net income (loss)............................. $ 3,982 $ 1,793 $ (5,454) $ (2,591)
=========== ============ ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-34
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER(S) EQUITY
(dollars in thousands, except share information)
Retained Accumulated
Addititonal Stock Earnings Other Carryover
Common Stock Paid-in Purchase (Accumulated Comprehensive Basis
Shares Amount Capital Warrants Deficit) Loss Adjustment Total
------ ------ ------ -------- ------- ---- ---------- -----
Predecessor
-----------
Balances, June 30, 1996...... 48,000 $ 1 $ 4,889 $1,923 $ 1,199 $ (80) $ - $ 7,932
Net income................... - - - - 3,982 - - 3,982
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment.............. - - - - - (73) - (73)
--------
Comprehensive income......... 3,909
Preferred stock dividend..... - - - - (616) - - (616)
------- ------- --------- ------ ---------- --------- -------- ---------
Balances, June 30, 1997...... 48,000 1 4,889 1,923 4,565 (153) - 11,225
Net income................... - - - - 1,793 - - 1,793
Other comprehensive income, net
of tax:
Foreign currency translation
adjustment.............. - - - - - (19) - (19)
--------
Comprehensive income......... 1,774
Preferred stock dividend..... - - - - (283) - - (283)
------- ------- --------- ------ ---------- --------- -------- ---------
Balances, December 15, 1997.. 48,000 $ 1 $ 4,889 $1,923 $ 6,075 $ (172) $ - $ 12,716
======= ======= ========= ====== ========= ========= ======== ========
- -------------------------------------------------------------------------------------------------------------------
Successor
---------
Balances, December 16, 1997.. - $ - $ - $ - $ - $ - $ - $ -
Initial capitalization 1,000 - 78,363 - - - - 78,363
(see Note 12)
Carryover basis adjustment... - - - - - - (15,730) (15,730)
Equity contribution by Holding - - 22,499 - - - - 22,499
Net loss..................... - - - - (5,454) - - (5,454)
Other comprehensive loss, net of tax:
Foreign currency translation
adjustment.............. - - - - - (57) - (57)
--------
Comprehensive loss........... (5,511)
------- ------- --------- ------ --------- --------- -------- --------
Balances, June 30, 1998...... 1,000 - 100,862 - (5,454) (57) (15,730) 79,621
Net loss..................... - - - - (2,591) - - (2,591)
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment.............. - - - - - (308) - (308)
--------
Comprehensive loss........... (2,899)
------- ------- --------- ------ --------- --------- -------- --------
Balances, June 30, 1999...... 1,000 $ - $ 100,862 $ - $ (8,045) $ (365) $(15,730) $ 76,722
======= ======= ========= ====== ========= ========= ======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
F-35
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Predecessor Successor
July 1, December 16,
1997 1997
Year Ended through through Year Ended
June 30, December 15, June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Cash flows from operating activities:
Net income (loss)........................... $ 3,982 $ 1,793 $ (5,454) $ (2,591)
Adjustment to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization of goodwill
and other intangibles................... 5,084 2,456 3,954 8,487
Amortization of debt discount............. 560 233 81 -
Amortization of loan closing costs........ 258 101 3,808 636
Deferred income taxes..................... (297) (460) (2,016) 643
Gain on sale of equipment................. - - - (50)
Other..................................... (138) (18) (57) (308)
Changes in operating assets and liabilities:
Accounts receivable..................... 2,546 1,153 (4,562) (2,737)
Inventory............................... (550) 69 543 (3,031)
Prepaid expenses, deferred charges and
other assets.......................... (101) (62) (453) (627)
Income taxes............................ (1,163) 699 767 5,238
Accounts payable and accrued expenses... (1,239) (1,036) (5,432) 4,511
--------- --------- --------- ---------
Net cash provided by (used in) operating
activities............................ 8,942 4,928 (8,821) 10,171
--------- --------- --------- ---------
Cash flows from investing activities:
Purchases of equipment...................... (2,462) (807) (514) (2,856)
Proceeds from sale of equipment............. 38 - - 50
Payments for acquisitions, net of cash acquired - - (141,403) -
--------- --------- ---------- ----------
Net cash used in investing activities... (2,424) (807) (141,917) (2,806)
--------- --------- --------- ---------
Cash flows from financing activities:
Payments under capital leases for equipment. (2,359) (249) (308) (661)
Net proceeds (repayments) on line of credit. 4,338 2,362 (6,700) -
Proceeds from issuance of senior increasing rate
notes, net of offering costs............. - - 119,735 -
Payments on senior increasing rate notes.... - - (123,500) -
Proceeds from issuance of senior notes, net
of offering costs......................... - - 110,158 -
Proceeds from issuance of common stock...... - - 98,499 -
Redemption of preferred stock............... - - (8,678) -
Repayment of loans payable to stockholder... (7,004) (1,851) (36,649) -
Repayment of other notes payable............ (1,200) (50) (50) (1,330)
Dividends paid on preferred stock........... (616) (155) (128) -
--------- --------- ---------- ---------
Net cash provided by (used in)
financing activities.................... (6,841) 57 152,379 (1,991)
--------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents (323) 4,178 1,641 5,374
Cash and cash equivalents, beginning of period 626 303 - 1,641
--------- --------- --------- ---------
Cash and cash equivalents, end of period...... $ 303 $ 4,481 $ 1,641 $ 7,015
========= ========= ========= =========
Supplemental information: Cash paid (received) during the period for:
Interest to stockholder(s)................ $ 4,559 $ 1,146 $ 11,503 $ -
Interest, other........................... 917 459 214 6,512
Income taxes.............................. 4,594 1,222 (784) (5,123)
Significant non-cash activities:
Assets acquired under capital lease......... $ - $ - $ - $ 600
The accompanying notes are an integral part of these consolidated
financial statements.
F-36
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
1. ORGANIZATION 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. Arcade is engaged in
interactive advertising for consumer products companies and has a specialty
in the design, production and distribution of sampling systems from its
Chattanooga, Tennessee facilities, and distributes its products in Europe
through its French subsidiary, Arcade Europe S.A.R.L. As more fully
described in Note 3, DLJ Merchant Banking Partners II, L.P. and certain
related investors (collectively, "DLJMBII") and certain members of the
Predecessor organized AHC I Acquisition Corp. ("Acquisition Corp.") and AHC
I Merger Corp. ("Merger Corp.") for purposes of acquiring the Predecessor.
On December 15, 1997, Merger Corp. acquired all of the equity interests of
the Predecessor 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, Acquisition Corp.
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.
Unless otherwise indicated, all references to years refer to the
Predecessor's and AKI's fiscal year, June 30.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. All significant
intercompany transactions have been eliminated.
Reclassification
Certain prior year amounts have been reclassified to conform with the
current year presentation.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid investments with an original maturity of three
months or less at the time of purchase to be cash equivalents.
Concentration of Credit Risk
The Company maintains its cash in bank deposit accounts which, at
times, may exceed federally insured limits. The Company has not experienced
any losses in such accounts; in addition, the Company believes it is not
exposed to any significant credit risk on cash and cash equivalents. The
Company grants credit terms in the normal course of business to its
customers and as part of its ongoing procedures, the Company monitors the
credit worthiness of its customers. The Company does not believe that it is
subject to any unusual credit risk beyond the normal credit risk attendant
in its business.
F-37
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Two customers accounted for 23.5% and 35.3% of the Predecessor's net
sales during the year ended June 30, 1997 and the period from July 1, 1997
through December 15, 1997, respectively. One customer accounted for 13.3%
of net sales during the period from December 16, 1997 through June 30,
1998. Two customers accounted for 26.8% of net sales during the year ended
June 30, 1999.
Concentration of Purchasing
Products accounting for a majority of the Company's net sales utilize
specific grades of paper that are produced exclusively for the Company by
one domestic supplier. The Company does not have a purchase agreement with
the supplier and is not aware of any other suppliers of these specific
grades of paper. These products can be manufactured using other grades of
paper; however, the Company believes these specific grades of paper provide
the Company with an advantage over its competitors. The Company is
currently researching methods of replicating the advantages of these
specific grades of paper with other grades of paper available from multiple
suppliers. Until such methods are developed, a loss of supply of these
specific grades of paper and the resulting competitive advantage could
cause a possible loss of sales which could adversely affect operating
results.
Revenue Recognition and Accounts Receivable
Product sales are recognized upon shipment, net of estimated discounts.
Accounts receivable are accounted for net of allowances for doubtful
accounts.
Inventory
Paper inventory is stated at the lower of cost or market using the
last-in, first-out (LIFO) method; all other inventories are stated at the
lower of cost or market using the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Expenditures that
extend the economic lives or improve the efficiency of equipment are
capitalized. The costs of maintenance and repairs are expensed as incurred.
Upon retirement or disposal, the related cost and accumulated depreciation
are removed from the respective accounts and any gain or loss is recorded.
Depreciation is computed using the straight-line method based on the
estimated useful lives of the assets as indicated in Note 6 for financial
reporting purposes and accelerated methods for tax purposes. Leasehold
improvements are depreciated over the shorter of their estimated useful
lives or the lease term.
F-38
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Goodwill
The aggregate purchase price of business acquisitions was allocated to
the assets and liabilities of the acquired companies based on their
respective fair values as of the acquisition dates. Goodwill represents the
excess purchase price paid over the fair value of net identifiable assets
acquired and is amortized over forty years using the straight-line method.
Accumulated amortization was $2,087 and $5,939 at June 30, 1998 and June
30, 1999, respectively.
Management periodically reviews the value of its goodwill and other
long-lived assets to determine if an impairment has occurred. The potential
impairment of recorded goodwill and other long-lived assets is measured by
the undiscounted value of expected future operating cash flows in relation
to its net capital investment. Based on its review, management does not
believe that an impairment of its goodwill or other long-lived assets has
occurred.
Deferred Charges
Deferred charges are primarily comprised of debt issuance costs which
are being amortized using the effective interest method over the terms of
the related debt. Such costs are included in the accompanying consolidated
balance sheets, net of accumulated amortization.
Other Intangible Assets
Other intangible assets include a covenant not to compete and other
intangible assets resulting from the acquisition of the fragrance sampling
business of Minnesota Mining and Manufacturing Company ("3M") (see Note 3)
in June 1998 and are being amortized over ten years using the straight-line
method. Accumulated amortization related to these intangible assets was
$729 at June 30, 1999.
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
$112,000 at June 30, 1999 compared to a carrying value of $115,000 as of
the same date. The carrying value of the Senior Notes approximated fair
value at June 30, 1998. The carrying value of all other financial
instruments approximates fair value at June 30, 1998 and June 30, 1999.
F-39
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Foreign Currency Transactions
Gains and losses on foreign currency transactions with third parties
have been included in the determination of net income in accordance with
SFAS No. 52, "Foreign Currency Translation." Foreign currency losses and
(gains) amounted to $387, ($44), ($52) and $91 for the year ended June 30,
1997, the period from July 1, 1997 through December 15, 1997, the period
from December 16, 1997 through June 30, 1998 and the year ended June 30,
1999, 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 $1,263, $664, $717 and $1,136 for the year
ended June 30, 1997, the period from July 1, 1997 through December 15,
1997, the period from December 16, 1997 through June 30, 1998 and the year
ended June 30, 1999, respectively.
Income Taxes
Income taxes are provided in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." Accordingly,
deferred tax assets and liabilities are recognized at the applicable income
tax rates based upon future tax consequences of temporary differences
between the tax bases and financial reporting bases of assets and
liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse. Deferred tax assets are reduced, if
necessary, by the amount of any tax benefits that, based on available
evidence, are not expected to be realized.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Comprehensive Income (Loss)
The Company adopted the provision of Statement of Financial Accounting
Standards No. 130 ("SFAS No. 130") on July 1, 1998. This Statement
establishes standards for reporting and displaying comprehensive income and
its components in the financial statements. This Statement also requires
that comparative information for earlier periods be reclassified. As the
Company only has two items of comprehensive income, net income and foreign
currency translations, adoption of this statement did not have a material
effect upon the Company's financial position or results of operations.
F-40
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
3. SIGNIFICANT ACQUISITIONS
DLJMBII and certain members of the Predecessor organized Acquisition
Corp. and Merger Corp. for purposes of acquiring the Predecessor. Merger
Corp. was a wholly-owned subsidiary of Acquisition Corp. and was initially
capitalized by Acquisition Corp. with an equity contribution of $78,363,
comprised of $76,000 of cash (see Note 12) and $2,363 of non-cash
consideration in the form of an option to purchase Senior Preferred Stock
of Acquisition Corp. (see Note 16). Immediately following this equity
contribution, Merger Corp. issued $123,500 of senior increasing rate notes
(the "Bridge Loans") to an entity with an ownership interest in Acquisition
Corp. The Bridge Loans had a stated maturity of December 15, 1998 and had
an interest rate equal to the greater of (i) 10.0% per annum and (ii) a
daily floating rate of prime plus 2.25% plus an additional percentage
amount equal to (a) 1.0% from and including the interest payment date on
June 15, 1998 or (b) 1.5% from and including the interest payment date on
September 15, 1998. Merger Corp. received cash proceeds from the issuance
of the Bridge Loans of $119,735, net of $3,765 of associated debt issuance
costs.
On December 15, 1997, Merger Corp. acquired all of the equity interests
of the Predecessor (the "Acquisition") for a total cost of $197,730 which
consisted of $138,634 cash paid for equity interests and direct acquisition
costs, $2,363 in non-cash consideration in the form of an option to
purchase Senior Preferred Stock of Acquisition Corp. (see Note 16) and the
assumption of $56,733 in debt, preferred stock and related interest and
dividends, including a capital lease obligation. Included in the amount of
direct acquisition costs was approximately $2,022 paid to an entity that
has an ownership interest in Acquisition Corp. Merger Corp. then merged
with and into the Predecessor and the combined entity assumed the name AKI.
Subsequent to the Acquisition, Acquisition Corp. contributed $1 of cash and
all of its ownership interest in AKI to Holding for all of the outstanding
equity of Holding. Since all companies are under common control and since
Holding and Acquisition Corp. have no operations other than those related
to the Company, the contribution was accounted for as if it were a pooling
of interests.
The Acquisition was accounted for using the purchase method of
accounting. In accordance with the consensus reached by the Emerging Issues
Task Force of the Financial Accounting Standards Board in Issue 88-16,
"Basis in Leveraged Buyout Transactions," the purchase price allocation
required an adjustment for the continuing interest attributable to
management's ownership interest in the Predecessor carried over in
connection with the Acquisition. As a result, a reduction in stockholders'
equity of $15,730 was recorded which represents the difference between the
fair value of the Company's assets and the related book value attributable
to the interest of the continuing shareholders' investment in the
Predecessor. The remaining purchase price has been allocated to assets and
liabilities based upon estimates of their respective fair value as
determined by management and third-party appraisals with respect to
property, plant and equipment.
In connection with the Acquisition, the Company repaid the outstanding
balance and related interest of the Predecessor's loans payable to a
shareholder of $37,374, the outstanding balance and related interest of the
Predecessor's line of credit of $6,278 and the outstanding balance and
related dividends on the Predecessor's preferred stock of $8,806.
F-41
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
3. SIGNIFICANT ACQUISITIONS (Continued)
The following shows the acquisition costs and the allocation of the
purchase price:
Acquisition costs
Cash paid for stock....................................................... $ 134,403
Direct acquisition costs.................................................. 4,231
-----------
138,634
Non-cash consideration for stock in the form of an
option to purchase Senior Preferred Stock of
Acquisition Corp. (see Note 16)......................................... 2,363
-----------
Total..................................................................... 140,997
Less--Carryover basis adjustment........................................... (15,730)
-----------
Purchase price to be allocated............................................ $ 125,267
===========
Summary allocation of purchase price
Cash...................................................................... $ 4,481
Other current assets...................................................... 17,782
Property, plant and equipment............................................. 20,132
Deferred income taxes..................................................... 2,953
Other assets.............................................................. 329
Goodwill.................................................................. 153,929
-----------
Total allocation to assets................................................ $ 199,606
===========
Current liabilities....................................................... $ 13,190
Long-term debt (including current portion) and related interest........... 47,927
Deferred income taxes..................................................... 4,416
Preferred stock and related dividends..................................... 8,806
-----------
Total liabilities assumed................................................. $ 74,339
===========
Included in cash paid for stock of $134,403 is $19,342 related to the
purchase and retirement of 11,201 options of the Predecessor. In addition,
the non-cash consideration for stock of $2,363 was incurred to acquire and
retire the remaining 1,370 options of the Predecessor (see Note 16).
On June 22, 1998, the Company acquired (the "3M Acquisition") the
fragrance sampling business of the Industrial and Consumer Products
division of 3M for approximately $7,250 in cash and the assumption of
liabilities of approximately $182. The only tangible assets acquired were
approximately $143 of equipment. The acquisition was accounted for using
the purchase method of accounting and resulted in assigning value to
certain intangible assets, including a covenant not to compete, totaling
approximately $7,289 which are being amortized on a straight line basis
over a period of 10 years.
F-42
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
3. SIGNIFICANT ACQUISITIONS (Continued)
Unaudited pro forma results for the Company assuming the Acquisition,
the 3M Acquisition and the Refinancing had occurred as of the beginning of
each applicable fiscal year are presented below:
Unaudited Pro Forma Results
for the Year Ended
June 30, June 30,
1997 1998
---- ----
Net sales..................... $ 87,771 $ 81,831
Income from operations........ 9,565 5,838
Interest expense, net......... 12,961 13,049
Net loss...................... (3,665) (6,091)
On June 25, 1998, the Bridge Loans were repaid, without penalty, with
the proceeds from the Senior Note offering (see Note 9) and the equity
contribution from Holding (see Note 12) (collectively, the "Refinancing").
Contemporaneous with the repayment of the Bridge Loans, the Company
wrote-off the unamortized balance of debt issuance costs associated with
the Bridge Loans of $1,795 to interest expense.
4. ACCOUNTS RECEIVABLE
The following table details the components of accounts receivable:
June 30, June 30,
1998 1999
---- ----
Trade accounts receivable........... $ 13,782 $ 16,349
Allowance for doubtful accounts..... (277) (251)
--------- --------
13,505 16,098
Other accounts receivable........... 45 189
--------- --------
$ 13,550 $ 16,287
========= ========
F-43
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
5. INVENTORY
The following table details the components of inventory:
June 30, June 30,
1998 1999
---- ----
Raw materials
Paper................................. $ 556 $ 1,088
Other raw materials................... 1,024 2,328
--------- --------
Total raw materials................ 1,580 3,416
Work in process......................... 498 1,693
--------- --------
Total inventory......................... $ 2,078 $ 5,109
========= ========
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,
1998 or June 30, 1999.
6. PROPERTY, PLANT AND EQUIPMENT
The following table details the components of property, plant and
equipment as well as their estimated useful lives:
Estimated June 30, June 30,
Useful Lives 1998 1999
------------ ---- ----
Land............................ $ 256 $ 258
Buildings....................... 7 - 15 years 1,048 1,648
Leasehold improvements.......... 1 - 3 years 153 579
Machinery and equipment......... 5 - 7 years 17,146 19,483
Furniture and fixtures.......... 3 - 5 years 1,634 2,084
Construction in progress........ 552 193
--------- --------
20,789 24,245
Accumulated depreciation........ (1,853) (5,734)
--------- --------
$ 18,936 $ 18,511
========= ==========
Depreciation expense amounted to $3,850, $1,888, $1,853 and $3,881 for
the year ended June 30, 1997, the period from July 1, 1997 through December
15, 1997, the period from December 16, 1997 through June 30, 1998 and the
year ended June 30, 1999, respectively.
F-44
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
6. PROPERTY, PLANT AND EQUIPMENT (Continued)
Property held under capital lease is included in the respective
property, plant and equipment category as follows:
June 30, June 30,
1998 1999
---- ----
Machinery and equipment.................. $ 3,000 $ 3,000
Building................................. - 600
--------- --------
3,000 3,600
Less accumulated depreciation............ (275) (790)
--------- --------
$ 2,725 $ 2,810
========= ========
Depreciation of the assets under capital lease totaled $633, $232, $275
and $515 for the year ended June 30, 1997, the period from July 1, 1997
through December 15, 1997, the period from December 16, 1997 through June
30, 1998 and the year ended June 30, 1999, respectively. Future minimum
lease payments under the remaining leases are as follows:
Payment Interest
2000............................ $ 884 $ 197
2001............................ 948 100
2002............................ 529 27
--------- --------
$ 2,361 $ 324
========= ========
7. LINE OF CREDIT
On April 30, 1996, the Predecessor entered into a line of credit
agreement (the "Credit Agreement"), which was amended on December 12, 1997,
in connection with the Acquisition, and amended again on September 30,
1998. The Credit Agreement provides for a revolving loan commitment up to a
maximum of $20,000 and expires on December 31, 2002. Borrowings are limited
to a borrowing base consisting of accounts receivable, inventory and
property, plant and equipment which serve as collateral for the borrowings.
As of June 30, 1999, the Company's borrowing base was approximately
$17,500. Interest on amounts borrowed accrue at a floating rate based upon
either prime or LIBOR (9.25% and 8.50% at June 30, 1998 and June 30, 1999,
respectively). The weighted average interest rate on the outstanding
balance under the Credit Agreement was 9.31%, 9.50%, 9.25% and 8.51% for
the year ended June 30, 1997, the period from July 1, 1997 through December
15, 1997, the period from December 16, 1997 through June 30, 1998 and the
year ended June 30, 1999, respectively.
F-45
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
7. LINE OF CREDIT (Continued)
The Company is required to pay commitment fees on the unused portion of
the revolving loan commitment at a rate of approximately 0.5% per annum. In
addition, the Company is required to pay fees equal to 2.5% of the average
daily outstanding amount of lender guarantees. The Company had $600 of
lender guarantees outstanding at June 30, 1998 and June 30, 1999. These
fees totaled $109, $30, $59 and $111 for the year ended June 30, 1997, the
period from July 1, 1997 through December 15, 1997, the period from
December 16, 1997 through June 30, 1998 and the year ended June 30, 1999,
respectively. The Credit Agreement contains certain financial covenants and
other restrictions including restrictions on additional indebtedness and
restrictions on the payment of dividends.
As of June 30, 1999, the Company was in compliance with all debt
covenants. However, the Company expects to be in violation of certain loan
covenants in Fiscal 2000. Management expects to obtain loan amendments
and/or waivers in Fiscal 2000 with respect to such covenants. If management
is unable to obtain loan amendments and/or waivers in Fiscal 2000, the
Company may need to seek additional sources of financing.
8. LOANS PAYABLE TO STOCKHOLDER
The Predecessor entered into a Senior Loan Agreement and two
Subordinated Loan Agreements (collectively, the "Loan Agreements") with a
party that had owned the Predecessor's preferred stock and a significant
portion of its common stock. The Loan Agreements were collateralized by
substantially all the assets of the Predecessor. The Loan Agreements
limited the Predecessor's ability to incur additional indebtedness, pay
dividends and purchase fixed assets. Additionally, the Loan Agreements
required that certain financial covenants be maintained. The Predecessor
was not in compliance with all such covenants at June 30, 1997. However,
this debt was subsequently retired upon the acquisition of the Predecessor
as discussed in Note 3. All amounts borrowed under the Senior Loan
Agreement bore interest at prime plus 1.50%.
The Predecessor borrowed $30,000 under the Subordinated Loan
Agreements, of which $23,000 was designated as Loan I and $7,000 was
designated as Loan II. Loan I bore interest, payable quarterly, at 12%
until November 4, 1998, and then would have converted to prime plus 4%.
Loan II bore interest, payable quarterly, at 7%. The outstanding amount of
the subordinated loans was net of unamortized debt discounts, which were
being amortized over the term of the related loan.
In connection with Loan II, the Predecessor issued a warrant to
purchase 19,233 shares of common stock at $0.05 per share. The warrant was
exercisable until November 4, 2003. The Predecessor valued the warrants at
$100 each based on the fair market value of a share of the underlying
common stock resulting from a sale with a third party. In connection with
the warrant issued, the Predecessor recorded a debt discount of $1,923. In
connection with the sale of the Predecessor on December 15, 1997 (see Note
3), all outstanding warrants were purchased from the holder by the buyer of
the Predecessor and retired.
F-46
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
9. SENIOR NOTES
On June 25, 1998, the Company completed a private placement of $115,000
of Senior Notes (the "Senior Notes"). The Senior Notes are general
unsecured obligations of the Company and bear interest at 10.5% per annum,
payable semi-annually on January 1 and July 1. The Senior Notes mature on
July 1, 2008 and may be redeemed at the option of the Company, in whole or
in part, at any time on or after July 1, 2003 at a price equal to 105.25%
of the outstanding principal balance plus accrued and unpaid interest. The
placement of the Senior Notes yielded the Company net proceeds of $110,158
after deducting offering expenses of $4,842, including $3,450 of
underwriting fees paid to an affiliate of the stockholder. The Senior Notes
are redeemable at the option of the Company, in whole or part, at any time
after July 1, 2003 at a price of up to 105.25% of the outstanding principal
balance plus accrued and unpaid interest. Prior to July 1, 2003, the
Company is permitted to repurchase up to 35% of the Senior Notes at a
redemption price of up to 110.5% of the aggregate principal amount plus
accrued and unpaid interest with the net proceeds of one or more public
equity offerings. The Senior Notes contain certain customary 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.
10. OTHER NOTES PAYABLE
On June 9, 1995, the Predecessor acquired all of the issued and
outstanding stock of Scent Seal Inc. ("Scent Seal"). The acquisition of
Scent Seal did not have a material impact on the financial position or
results of operations of the Predecessor and was accounted for as a
purchase transaction whereby the purchase cost was allocated to the fair
value of the net assets acquired. In connection with the acquisition of
Scent Seal, the Predecessor issued $3,627 in noninterest bearing promissory
notes (the "Notes") to an employee of the Predecessor who was previously a
Scent Seal stockholder. The Predecessor recorded a debt discount of $649 in
connection with the issuance of the Notes to reflect an effective interest
rate of 10%. The discount was being amortized over the term of the Notes.
Under certain provisions of the Scent Seal acquisition agreement, the
Company was permitted to reduce the outstanding principal balance of the
Notes based upon the ultimate realization of assets acquired and settlement
of liabilities assumed. In June 1998, the Company reached a settlement with
the holder of the Notes under these provisions which resulted in the
reduction of the outstanding principal balance of the Notes of $120. The
remaining principal balance of the Notes of $1,330 was repaid in July 1998
in accordance with the terms of the Notes.
F-47
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
11. REDEEMABLE PREFERRED STOCK OF PREDECESSOR
In connection with the 1993 acquisition of Arcade, the Predecessor
authorized and issued 8,000 shares of 7% cumulative, $1 par value
redeemable preferred stock at $1,000 per share. The redeemable preferred
stock prohibited the Predecessor from acquiring its common stock as long as
the preferred stock was outstanding and restricted the payment of common
stock dividends. Accrued and unpaid dividends of $678 accrued through
December 31, 1994, were added to the outstanding balance. The redeemable
preferred stock would have been redeemable on December 31, 2001, at
liquidation value of $1,000 per share plus accrued and unpaid dividends. In
conjunction with the sale of Predecessor on December 15, 1997 (see Note 3),
all outstanding redeemable preferred stock was redeemed at $1,000 per share
plus accrued and unpaid dividends.
12. INITIAL CAPITALIZATION
In conjunction with the Acquisition, Acquisition Corp. issued $30,000
of Floating Rate Notes, $50,279 of Manditorily 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 and bear interest at a rate equal to the rate in effect on the
Bridge Loans (see Note 3) plus 2.50%. After the completion of the
Refinancing (see Note 3) on June 25, 1998, the Floating Rate Notes bear
interest at 15% per annum. Interest is payable quarterly and can be settled
through the issuance of additional Floating Rate Notes through maturity at
the discretion of Acquisition Corp. The original issuance discount of
$5,389 is being amortized using the effective interest method over the life
of the Floating Rate Notes. The unamortized balance of the original issue
discount was $5,152 and $4,740 at June 30, 1998 and June 30, 1999,
respectively. The Floating Rate Notes mature on December 15, 2009 and are
held by affiliates of the primary shareholder of Acquisition Corp. The
Senior Preferred Stock accretes in value at 15% per annum and must be
redeemed by December 15, 2012. The Floating Rate Notes and Senior Preferred
Stock are general unsecured obligations of Acquisition Corp.
The cash proceeds from the issuance of the Floating Rate Notes, Senior
Preferred Stock and Common Stock of approximately $76,000 and a Senior
Preferred Stock option of $2,363 (see Note 16) were contributed by
Acquisition Corp. to the Company in exchange for 1,000 shares of the
Company's Common Stock. Subsequent to the initial capitalization of the
Company, Acquisition Corp. contributed $1 and all of its ownership interest
in the Company to Holding for all of the outstanding equity of Holding.
F-48
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
12. INITIAL CAPITALIZATION (Continued)
On June 25, 1998, Holding completed a private offering of $50,000
Senior Discount Debentures (the "Debentures"). The Debentures do not accrue
or pay interest until July 1, 2003 and were issued with an original
issuance discount of $24,038. The original issuance discount 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
$23,980 and $20,349 at June 30, 1998 and June 30, 1999, 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 of 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 are general
unsecured obligations of Holding. With the proceeds of the Debenture
offering, Holding contributed $22,499 of cash to the Company. No additional
shares were issued to Holding as a result of this contribution. On December
22, 1998, Holding completed the registration of its Senior Discount
Debentures with the Securities and Exchange Commission.
Acquisition Corp. and Holding have no other operations other than the
Company. Absent additional financing by Acquisition Corp. or Holding, the
Company's operations represent the only current source of funds available
to service the Floating Rate Notes, Senior Preferred Stock and Debentures;
however, the Company is not obligated to pay or otherwise guarantee the
Floating Rate Notes, Senior Preferred Stock and Debentures.
13. COMMITMENTS AND CONTINGENCIES
Operating Leases
Equipment and office, warehouse and production space under operating
leases expire at various dates. Rent expense was $443, $192, $198 and $338
for the year ended June 30, 1997, the period from July 1, 1997 through
December 15, 1997, the period from December 16, 1997 through June 30, 1998
and the year ended June 30, 1999, respectively. Future minimum lease
payments under these leases are as follows:
2000.............. $ 162
2001.............. 138
--------
$ 300
========
F-49
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
13. COMMITMENTS AND CONTINGENCIES (Continued)
Royalty Agreements
Royalty agreements are maintained for certain technologies used in the
manufacture of certain products. Under the terms of one royalty agreement,
payments are required based on a percentage of net sales of those products
manufactured with the specific technology, or a minimum of $500 per year.
This agreement expires in 2003 or when a total of $12,500 in cumulative
royalty payments has been paid. The Company expensed $761, $437, $516 and
$500 under this agreement for the year ended June 30, 1997, the period from
July 1, 1997 through December 15, 1997, the period from December 16, 1997
through June 30, 1998 and the year ended June 30, 1999, respectively. The
Company has paid $4,576 in cumulative royalty payments under this agreement
through June 30, 1999.
Under the terms of another agreement, royalty payments are required
based on the number of products sold that were manufactured with the
specific licensed technology, or a minimum payment per year. These minimum
payments for years after fiscal 1999 are $625 per year through the
expiration of the agreement in 2012. The Company expensed $475, $241, $284
and $575 under this agreement for the year ended June 30, 1997, the period
from July 1, 1997 through December 15, 1997, the period from December 16,
1997 through June 30, 1998 and the year ended June 30, 1999, respectively.
Employment Agreements
The Company has employment agreements with certain officers with terms
through February 1, 2002. Such agreements provide for base salaries
totaling $825 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. One of the employment
agreements also provides severance benefits of up to two years of base
salary if the officer's services are terminated under certain conditions.
During fiscal 1999, two executive officers employment was terminated
with the Company. In accordance with the terms of former officers'
employment agreements, the Company was obligated for severance benefits of
approximately $610. The Company had paid approximately $457 of these
benefits by June 30, 1999. The remaining balance of $153 is included in
accrued compensation at June 30, 1999.
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-50
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
14. RETIREMENT PLANS
A 401(k) defined contribution plan (the "Plan") is maintained for
substantially all full-time salaried employees. Applicable employees who
have six months of service and have attained age 21 are eligible to
participate in the Plan. Employees may elect to contribute a percentage of
their earnings to the Plan in accordance with limits prescribed by law.
Contributions to the Plan are determined annually by the Company and
generally are a matching percentage of employee contributions. Costs
associated with the Plan totaled $180, $95, $113 and $201 for the year
ended June 30, 1997, the period from July 1, 1997 through December 15,
1997, the period from December 16, 1997 through June 30, 1998 and the year
ended June 30, 1999, respectively.
Certain hourly employees are covered under a multiemployer defined
benefit plan administered under a collective bargaining agreement. Costs
(determined by union contract) under the defined benefit plan were $143,
$80, $81 and $204 for the year ended June 30, 1997, the period from July 1,
1997 through December 15, 1997, from December 16, 1997 through June 30,
1998 and the year ended June 30, 1999, respectively.
15. INCOME TAXES
The Company is included in the consolidated federal income tax return
filed by Acquisition Corp. for periods subsequent to December 15, 1997.
Income taxes related to the Company for the period from December 16, 1997
through June 30, 1999 were determined on a separate entity basis. The
Company files separate state income tax returns and calculates its state
tax provision on a separate company basis. Any income taxes payable or
receivable by the consolidated group are settled or received by the
Company. The Predecessor was not part of a consolidated group.
For financial reporting purposes, income (loss) before income taxes
includes the following components:
July 1, December 16,
1997 1997
Year Ended through through Year Ended
June 30, December 15, June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Income (loss) before income taxes:
United States................. $ 7,609 $ 3,298 $ (8,169) $ (2,266)
Foreign....................... (492) (64) 682 522
--------- --------- ---------- ---------
$ 7,117 $ 3,234 $ (7,487) $ (1,744)
======== ======== ========= =========
F-51
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
15. INCOME TAXES (Continued)
Significant components of the provision (benefit) for income taxes are
as follows:
July 1, December 16,
1997 1997
Year Ended through through Year Ended
June 30, December 15, June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Current expense (benefit):
Federal....................... $ 2,880 $ 1,623 $ - $ -
Foreign....................... - - 104 204
State......................... 552 278 (121) -
-------- ---------- ---------- ---------
3,432 1,901 (17) 204
-------- ---------- ---------- ---------
Deferred expense (benefit):
Federal....................... (90) (376) (1,900) 569
Foreign....................... (165) (25) 162 -
State......................... (42) (59) (278) 74
-------- --------- ---------- ---------
(297) (460) (2,016) 643
-------- --------- ---------- ---------
$ 3,135 $ 1,441 $ (2,033) $ 847
======== ========== ========== =========
The significant components of deferred tax assets and deferred tax
liability at June 30, 1998 and 1999, were as follows:
June 30, 1998 June 30, 1999
------------------------ ------------------------
Current Noncurrent Current Noncurrent
------------------------ ------------------------
Deferred income tax assets:
Accrued expenses................... $ 719 $ - $ 308 $ -
Allowance for doubtful accounts.... 108 - 92 -
Net operating loss carryforwards... - 2,947 - 3,132
Preferred stock option............. - 922 - -
--------- --------- --------- ---------
827 3,869 400 3,132
Deferred income tax liability:
Property, plant and equipment...... - 4,143 - 3,340
--------- --------- --------- ---------
$ 827 $ (274) $ 400 $ (208)
========= ========= ========= =========
F-52
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
15. INCOME TAXES (Continued)
The income tax provision recognized by the Predecessor for the year
ended June 30, 1997, the period from July 1, 1997 through December 15, 1997
and by the Company for the period from December 16, 1997 through June 30,
1998 and the year ended June 30, 1999, differs from the amount determined
by applying the applicable U.S. statutory federal income tax rate to pretax
income as a result of the following:
July 1, December 16,
1997 1997
Year Ended through through Year Ended
June 30, December 15, June 30, June 30,
1997 1997 1998 1999
---- ---- ---- ----
Computed tax provision (benefit)
at statutory rate.................... $ 2,420 $ 1,100 $ (2,546) $ (593)
State income tax provision (benefit),..
net of federal effect................ 335 145 (263) (49)
Nondeductible expenses................. 455 193 720 1,477
Other, net............................. (75) 3 56 12
--------- --------- --------- ---------
$ 3,135 $ 1,441 $ (2,033) $ 847
========= ========= ========== =========
In conjunction with the Acquisition, the Company recognized an income
tax benefit of $7,327 related to the excess of the redemption price over
the strike price of certain non-qualified options of the Predecessor
redeemed and retired by the Company. This benefit was recorded as a
reduction to goodwill.
Due to the Company's current year losses and certain transactions made
in conjunction with the Acquisition, the Company has recorded a long-term
deferred tax asset of $3,132 reflecting cumulative net operating loss
carryforwards available to offset future federal taxable income of
approximately $6,900 and future state taxable income of approximately
$15,600 at June 30, 1999. These cumulative net operating loss carryforwards
expire in varying amounts through 2019. Realization is dependent on
generating sufficient taxable income prior to expiration of the loss
carryforwards. Although realization is not assured, management believes
that it is more likely than not that all of the deferred tax asset will be
realized. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term if estimates of future taxable
income during the carryforward period are reduced.
F-53
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
16. STOCK OPTIONS
The Predecessor sponsored a key employee stock option plan under which
a maximum of 12,571 shares of the Predecessor's common stock could be
reserved for nonqualified options; all stock options were granted with an
exercise price equal to the fair market value of $100 per share. All
options vested ratably over five years and would have expired ten years
from the grant date.
The Predecessor accounted for its employee stock options under
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB 25"). Under APB 25, because the exercise price of the
Predecessor's employee stock options equaled the market value of the
underlying stock on the date of grant, no compensation expense was
recognized.
A summary of the Predecessor's stock option activity and related
information follows:
June 30, 1997
Weighted
Average
Exercise
Options Price
Outstanding, beginning of year......... 12,571 $ 100
Granted........................... - -
Exercised......................... - -
Forfeited......................... - -
-------- -------
Outstanding, end of year............... 12,571 $ 100
======== =======
Exercisable, end of year............... 5,866 $ 100
======== =======
Weighted average remaining
contractual life.................. 7.3 years
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("SFAS 123"), requires disclosure of pro forma
information regarding net income for option grants subsequent to December
15, 1995. Because all of the Predecessor's options were granted prior to
that date, no pro forma adjustments to net income or disclosure of
information would apply under SFAS 123.
As a result of the sale of the Predecessor on December 15, 1997 (see
Note 3), all outstanding options became immediately vested and exercisable
under the terms of the original individual stock option agreements. In
connection with the Acquisition, the Company purchased and retired 11,201
options of the Predecessor for $19,342. The remaining 1,370 options of the
Predecessor held by an officer, which had a cumulative exercise price of
$137, were exchanged at fair value for an option to purchase 100,000 shares
of Acquisition Corp.'s Senior Preferred Stock with a cumulative stated
value of $2,500 (the "Preferred Stock Option"). The 1,370 options were
subsequently retired. The Preferred Stock Option had an exercise price of
$137. The total consideration of $21,705 used to purchase and retire the
outstanding options of the Predecessor was included in the cost of the
Acquisition (see Note 3).
F-54
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
16. STOCK OPTIONS (Continued)
The Preferred Stock Option was issued with a Put and Call Option (the
"Put and Call Option") which granted the officer the right to compel
DLJMBII to purchase the 100,000 shares of Senior Preferred Stock obtainable
under the Preferred Stock Option, together with certain common equity
interests in Acquisition Corp. held by the officer, for $2,590. The Put and
Call Option also granted DLJMBII the right to purchase the equity
interests, both common and preferred, of the officer for the same amount.
The Put and Call Option had a stated termination on June 30, 1998. The
officer agreed to terminate the Put and Call Option and enter into a new
put option (the "Put Option") dated June 17, 1998. The Put Option granted
the officer an irrevocable option to require Acquisition Corp. to purchase
80,000 shares of the Senior Preferred Stock obtainable under the Preferred
Stock Option for $2,000 in cash. As the terms of the Put Option were
generally more restrictive than the Put and Call Option, no compensation
expense was recognized as a result of the transaction. On July 30, 1998,
the officer exercised the Preferred Stock Option and Put Option. To provide
Acquisition Corp. the funds to redeem the 80,000 shares of Senior Preferred
Stock, Holding issued Acquisition Corp. a dividend of $1,863 in cash on
such date.
Subsequent to the Acquisition, Acquisition Corp. adopted the 1998 Stock
Option Plan ("Option Plan") for certain key employees and directors of
Acquisition Corp. and any parent or subsidiary of Acquisition Corp. The
Option Plan authorizes the issuance of options to acquire up to 100,000
shares of Acquisition Corp. Common Stock. The terms of each individual
options grant are determined by the Board of Directors. The exercise price
for each grant is required to be set at least equal to the fair market
value per share of Acquisition Corp. provided that the exercise price shall
not be less than $1.00 per share. Options may be exercisable for up to ten
years.
On June 17, 1998, Acquisition Corp. granted an officer of the Company
options to purchase 32,500 shares of Acquisition Corp. Common Stock. All
options had an exercise price of $1.00 per share and a term of 10 years.
These options were forfeited during 1999 upon the resignation of the
officer.
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 loss
for the period from December 16, 1997 through June 30, 1998 and the year
ended June 30, 1999 would have been $(5,455) and $(2,593), 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 of 5.4%. The
weighted average fair value at date of grant of options granted during 1998
was approximately $0.41 per option.
F-55
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
17. RELATED PARTY TRANSACTIONS
The Predecessor made payments to a company controlled by a stockholder
of the Predecessor of $612 for the year ended June 30, 1997 and $160 for
the period from July 1, 1997 through December 15, 1997, for management
fees, bonuses and expense reimbursements.
The Predecessor made payments to another stockholder of $120 for the
year ended June 30, 1997 and $55 for the period from July 1, 1997 through
December 15, 1997, for management fees.
The Successor made payments to an affiliate of DLJMBII of $125 and $250
for the period from December 16, 1997 through June 30, 1998 and the year
ended June 30, 1999, respectively, for financial advisory fees. In
addition, the Successor had approximately $200 of cash on deposit with a
financial institution affiliated with DLJMBII as of June 30, 1998.
18. SUBSEQUENT EVENT
On September 15, 1999, AKI acquired all of the equity interests in
RetCom Holdings Ltd. and its subsidiaries for a total cost of approximately
$12,000 and refinanced working capital indebtedness of approximately $4,500
of RetCom Holdings Ltd. and its subsidiaries. The purchase price and
refinancing of indebtedness were initially financed by borrowings under the
credit agreement.
19. 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
Predecessor
-----------
Net sales:
Year ended June 30, 1997...... $ 70,660 $ 7,063 $ 77,723
Period from July 1, 1997
through December 15, 1997... 32,600 2,586 35,186
________________________________________________________________________
Successor
---------
Net sales:
Period from December 16, 1997
through June 30, 1998....... $ 29,162 $ 6,904 $ 36,066
Year ended June 30, 1999...... 71,056 14,911 85,967
Long-lived assets:
June 30, 1998................. 187,250 158 187,408
June 30, 1999................. 181,451 107 181,558
F-56
AKI, INC. AND SUBSIDIARIES
(a wholly-owned subsidiary of AKI Holding Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share information)
20. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following is a summary of the unaudited quarterly results of operations
for Fiscal 1998 and Fiscal 1999.
Predecessor Successor
October 1, December 16,
1997 1997
Quarter Ended through through Quarter Ended Quarter Ended
September 30, December 15, December 31, March 31, June 30, Full
Fiscal 1998 1997 1997 1997 1998 1998 Year
---- ---- ---- ---- ---- ----
Net sales............. $ 21,928 $ 13,258 $ 2,791 $ 19,191 $ 14,084 $ 71,252
Gross profit.......... 8,306 4,071 813 7,256 3,479 23,925
Income from operations 4,680 1,426 153 3,603 104 9,966
Interest expense, net. 1,451 1,195 759 4,404 6,106 13,915
Net income (loss)..... 1,796 (3) (443) (887) (4,124) (3,661)
Successor
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30, Full
Fiscal 1999 1998 1998 1999 1999 Year
---- ---- ---- ---- ----
Net sales............. $ 24,024 $ 20,437 $ 24,518 $ 16,988 $ 85,967
Gross profit.......... 8,603 6,777 9,691 5,697 30,768
Income from operations 4,337 2,331 4,616 378 11,662
Interest expense, net. 3,210 3,244 3,298 3,276 13,028
Net income (loss)..... 273 (970) 281 (2,175) (2,591)