APPLIED GRAPHICS TECHNOLOGIES INC - 10-Q Quarterly Report

Back to GetFilings.com

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 1-16431

APPLIED GRAPHICS TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)

DELAWARE 13-3864004
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

450 WEST 33RD STREET
NEW YORK, NY
(Address of principal executive offices)

10001
(Zip Code)

212-716-6600
(Registrant's telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last
report)
N/A

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

The number of shares of the registrant's common stock outstanding as of
July 31, 2002, was 9,147,565.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

PART I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

APPLIED GRAPHICS TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

See Notes to Interim Consolidated Financial Statements
1

APPLIED GRAPHICS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

See Notes to Interim Consolidated Financial Statements
2

APPLIED GRAPHICS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

See Notes to Interim Consolidated Financial Statements
3

APPLIED GRAPHICS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)

See Notes to Interim Consolidated Financial Statements
4

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS OF DOLLARS)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of
Applied Graphics Technologies, Inc., and its subsidiaries (the "Company"), which
have been prepared in accordance with the instructions to Form 10-Q and,
therefore, do not include all information and footnotes necessary for a fair
presentation of financial position, results of operations, and cash flows in
conformity with generally accepted accounting principles, should be read in
conjunction with the notes to consolidated financial statements contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001. In
the opinion of the management of the Company, all adjustments (consisting
primarily of normal recurring accruals) necessary for a fair presentation have
been included in the financial statements. The operating results of any quarter
are not necessarily indicative of results for any future period.

Certain prior-period amounts in the accompanying financial statements have
been reclassified to conform with the 2002 presentation.

2. SALE OF PUBLISHING BUSINESS

On April 10, 2002, the Company sold its publishing business. Net proceeds
from the sale were approximately $33,500, of which $31,500 were used to repay
term loans outstanding under the Company's credit facility and $2,000 are being
held in escrow under the terms of the sale. The escrow will be available to
satisfy any claims related to the working capital transferred at closing and
contractual warranties. Any remaining escrow balance as of March 31, 2003, will
be used to further repay the outstanding term loans.

The Company recognized a loss on disposal of the publishing business of
$6,943 that was based on the terms of the sale and is subject to change based on
potential working capital adjustments resulting from the finalization of the
closing date balance sheet. The loss on disposal is included as a component of
the loss from discontinued operations in the Consolidated Statement of
Operations for the six months ended June 30, 2002.

The accompanying financial statements have been presented to reflect the
operation of the publishing business as a discontinued operation. The results of
operations of the publishing business for the six and three months ended June
30, 2002 and 2001, are presented as Discontinued Operations in the accompanying
Consolidated Statements of Operations as follows:

The results of operations of the publishing business include an allocation
of interest expense of $580 and $646 for the six months ended June 30, 2002 and
2001, respectively, and $325 for the three months ended June 30, 2001. The
allocated interest expense consisted solely of the interest expense on the
Company's borrowings under its credit facility, which represents the interest
expense not directly attributable to the Company's other operations. Interest
expense was allocated based on the ratio of the net assets of the discontinued
operation to the sum of the consolidated net assets of the Company and the
outstanding borrowings under the Company's credit facility.

5

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF DOLLARS)

3. GOODWILL AND OTHER INTANGIBLE ASSETS

On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." Under SFAS No.
142, acquired goodwill and other intangible assets with indefinite useful lives
are no longer amortized over an estimated useful life, but instead are subject
to an impairment test. Intangible assets with finite useful lives continue to be
amortized over their useful lives.

Upon the initial application of SFAS No. 142, the Company incurred an
impairment charge of $328,529 relating to its goodwill, of which $321,952
related to the Company's content management services business and $6,577 related
to the Company's broadcast media distribution services business. The fair value
of each reporting unit was determined based on applying a multiple to each
reporting unit's earnings before interest, taxes, depreciation, and
amortization. The Company reported the impairment charge, net of a tax benefit
of $654, as a cumulative effect of a change in accounting principle.

In the second quarter of 2002, the Company made a contingent payment in the
form of cash and shares of common stock in the aggregate amount of $1,440 as
additional consideration for the acquisition of one of its digital services
businesses. In June 2002, the Company recognized a charge for the impairment of
goodwill for this $1,440 of additional consideration based on the estimated fair
value of this business. The impairment charge was determined using the same
methodology that the Company used upon the adoption of SFAS No. 142. The Company
reviewed the value of the goodwill associated with this business due to having
incurred a similar impairment charge in the prior year.

The Company's intangible assets not subject to amortization under SFAS No.
142 consist entirely of goodwill. The changes in the carrying amount of goodwill
during the six months ended June 30, 2002, and the full year ended December 31,
2001, were as follows:

The Company's intangible assets subject to amortization under SFAS No. 142
consist entirely of contract acquisition costs, which represent consideration
paid by the Company to enter into certain long-term contracts. Contract
acquisition costs are amortized on a straight-line basis over the life of the
underlying contract. The gross carrying amount and accumulated amortization of
contract acquisition costs were as follows:

6

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF DOLLARS)

Amortization expense associated with contract acquisition costs was $174
and $399 for the six months ended June 30, 2002 and 2001, respectively, and $93
and $199 for the three months ended June 30, 2002 and 2001, respectively. The
estimated amortization expense for each of the next five full fiscal years is as
follows:

2002.................................................. $357
2003.................................................. $405
2004.................................................. $307
2005.................................................. $305
2006.................................................. $288

The adjusted net loss and loss per share for the six months and three
months ended June 30, 2001, reflecting the add back of the amortization of
goodwill, were as follows:

4. RESTRUCTURING

The Company initiated various restructuring plans in prior periods (the
"2001 Fourth Quarter Plan," the "2001 Second Quarter Plan," the "2000 Second
Quarter Plan," the "1999 Fourth Quarter Plan," and the "1998 Fourth Quarter
Plan," respectively) under which it continues to make certain payments. The
amounts included in "Other current liabilities" in the accompanying Consolidated
Balance Sheet as of June 30, 2002, for the future costs of the various
restructuring plans, and the amounts charged against the respective
restructuring liabilities during the six months ended June 30, 2002, were as
follows:

In July 2002, the Company initiated a plan (the "2002 Third Quarter Plan")
to consolidate its Grand Rapids, MI, and Battle Creek, MI, operations into a new
facility in Battle Creek. The Company anticipates completing the 2002 Third
Quarter Plan in September 2002, and estimates the restructuring charge related
to the 2002 Third Quarter Plan to be approximately $1,500.

7

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF DOLLARS)

5. INVENTORY

The components of inventory were as follows:

6. LONG TERM DEBT AND SUBORDINATED NOTES

Under the terms of its credit facility, the Company was obligated to
satisfy certain milestones in connection with raising amounts to repay
borrowings. The consummation of the sale of the publishing business satisfied
one such milestone and resulted in the elimination of a previous increase in
interest rates of 100 basis points that had been in effect since January 1,
2002. The Company failed, however, to satisfy two other milestones with
deadlines of February 28, 2002, and April 30, 2002. Failure to satisfy the first
milestone resulted in a fee of $500 being paid to the Company's lenders. Failure
to satisfy the second milestone resulted in, effective May 1, 2002, an increase
in interest rates of 100 basis points and the issuance of warrants with an
exercise price of $0.01 to the Company's lenders to purchase 453,377 shares of
the Company's common stock. Such warrants, which become exercisable upon the
earlier of January 15, 2003, or an event of default under the credit facility,
had a fair value of $404 on the date of issuance. The warrants were recorded as
deferred financing costs, which are being amortized over the remaining term of
the Company's credit facility and, since the warrants are to be settled in
shares of the Company's common stock, as an increase in additional paid-in
capital.

As part of its overall effort to restructure its debt, the Company
initiated a tender offer in July 2002 to acquire all of its outstanding
subordinated notes for an aggregate purchase price of $3,000. The tender offer
was originally scheduled to expire on July 30, 2002, but the Company has
extended the tender offer until August 27, 2002, as the minimum tender condition
was not satisfied. As a result of the tender offer being extended, the Company
did not pay the semi-annual interest payment on the subordinated notes that was
due July 31, 2002. Such failure to pay interest on the subordinated notes does
not constitute an event of default unless payment is not made by August 30,
2002, the expiration of a 30-day grace period. The Company has obtained from its
senior lenders a waiver of any default under the Company's credit facility
resulting from any failure to pay the interest on the subordinated notes, either
before or after the expiration of the grace period. There can be no assurances
that the tender offer to acquire the subordinated notes will be successful.

At June 30, 2002, all amounts outstanding under the Company's credit
facility, which matures in April 2003, are classified as a current liability in
the accompanying Consolidated Balance Sheet. The Company continues to be engaged
in discussions with its lenders to renegotiate the terms of its credit facility.
These discussions are currently focused on the deferral of cash interest
payments on a portion of the debt, an extension of the maturity of the credit
facility by several years, and several other significant modifications. Any
renegotiation of terms will be subject to various contingencies, including
retiring at least 90% of the subordinated notes on terms satisfactory to the
lenders. In connection with any such agreement, the lenders would likely receive
warrants for an additional portion of the Company's outstanding common stock in
addition to fees. There can be no assurances as to the terms or the success of
any renegotiation of the Company's credit facility.

8

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF DOLLARS)

7. DERIVATIVES

The fair value of the Company's interest rate swaps was a net loss of
$1,954 and $1,311 at June 30, 2002 and 2001, respectively. The Company
recognized a non-cash benefit of $63 and $13 for the six months ended June 30,
2002 and 2001, respectively, and a non-cash charge of $289 and a non-cash
benefit of $251 for the three months ended June 30, 2002 and 2001, respectively,
which consisted of the following:

The company expects $149 of the loss in "Accumulated other comprehensive
income (loss)" to be reclassified into earnings in the next twelve months.

8. INCOME TAXES

In connection with the impairment of goodwill incurred upon the initial
adoption of SFAS No. 142 (see Note 3 to the Interim Consolidated Financial
Statements), the Company recognized a deferred tax asset of $16,806. At June 30,
2002, the Company had a consolidated deferred tax asset balance before valuation
allowance of $35,788. Based on its most recent projections, the Company does not
believe that it is more likely than not that the benefit associated with the
deferred tax assets will be entirely realized in the future. During the six
months ended June 30, 2002, the Company established a valuation allowance in the
amount of $16,152, all of which was included as part of the cumulative effect of
a change in accounting principle.

9. RELATED PARTY TRANSACTIONS

Sales to, purchases from, and administrative charges incurred with related
parties during the six and three months ended June 30, 2002 and 2001, were as
follows:

Administrative charges include charges for rent incurred for leases with
affiliates and for certain legal, administrative, and computer services provided
by affiliates.

9

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF DOLLARS)

10. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Payments of interest and income taxes for the six months ended June 30,
2002 and 2001, were as follows:

Noncash investing and financing activities for the six months ended June
30, 2002 and 2001, were as follows:

11. SEGMENT INFORMATION

Segment information relating to results of operations for the six and three
months ended June 30, 2002 and 2001, was as follows:

10

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF DOLLARS)

Segment information relating to the Company's assets as of June 30, 2002,
and December 31, 2001, was as follows:

The total assets of the content management services segment decreased by
$329,260 due primarily to the impairment of goodwill recorded upon the initial
adoption of SFAS No. 142 (see Note 3 to the Interim Consolidated Financial
Statements).

12. RECENTLY ISSUED ACCOUNTING STANDARDS

Statement of Financial Accounting Standards (SFAS) No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities," was issued in June 2002, and
is effective for exit or disposal activities initiated after December 31, 2002.
SFAS No. 146 addresses financial accounting and reporting for costs incurred in
connection with exit or disposal activities, including restructurings, and
supercedes Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." Under SFAS No.
146, a liability related to an exit or disposal activity is not recognized until
such liability has actually been incurred, as opposed to a liability being
recognized at the time of a commitment to an exit plan, which was the standard
for liability recognition under EITF Issue No. 94-3. The Company does not expect
the adoption of SFAS No. 146 to have a material effect on its financial
condition or results of operations.

11

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

Certain statements made in this Quarterly Report on Form 10-Q are
"forward-looking" statements (within the meaning of the Private Securities
Litigation Reform Act of 1995, as amended). Such statements involve known and
unknown risks, uncertainties, and other factors that may cause actual results,
performance, or achievements of the Company to be materially different from any
future results, performance, or achievements expressed or implied by such
forward-looking statements. Although the Company believes that the expectations
reflected in such forward-looking statements are based upon reasonable
assumptions, the Company's actual results could differ materially from those set
forth in the forward-looking statements. Certain factors that might cause such a
difference include the following: the ability of the Company to successfully
renegotiate the terms of its credit facility; the ability of the Company to
successfully complete its tender offer for its subordinated notes; the ability
of the Company to maintain compliance with the financial covenant requirements
under its credit facility; the ability of Kmart Corporation ("Kmart") to
successfully emerge from bankruptcy; the impact of technological advancements on
the ability of customers and competitors to provide services comparable to those
provided by the Company; the continued softness in the advertising market; the
timing of completion and the success of the Company's restructuring plans and
integration efforts; the rate and level of capital expenditures; and the
adequacy of the Company's credit facility and cash flows to fund cash needs.

The results of operations of the Company's publishing business are reported
as a discontinued operation for all periods presented. The following discussion
and analysis (in thousands of dollars) should be read in conjunction with the
Company's Interim Consolidated Financial Statements and notes thereto.

Management must make certain estimates and assumptions in preparing the
financial statements of the Company. Certain of these estimates and assumptions
relate to matters that are inherently uncertain as they pertain to future
events. These estimates and assumptions include the fair value of goodwill,
future estimated taxable income, the collectibility of accounts receivable, and
the timing and amount of the settlement on certain lease obligations relating to
vacant properties. While management believes that the estimates and assumptions
used were appropriate, actual results could differ significantly from those
estimates under different conditions.

RESULTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 2002, COMPARED WITH 2001

Revenues in the first six months of 2002 were $32,137 lower than in the
comparable period in 2001. Revenues in the 2002 period decreased by $31,440 from
content management services and $1,254 from digital services, and were partially
offset by increased revenues of $557 from broadcast media distribution services.
Decreased revenues from content management services primarily resulted from a
weaker advertising market in the first six months of 2002 as compared to the
2001 period, which adversely impacted the Company's operations servicing
advertising agencies and magazine publishers.

Gross profit decreased by $5,417 in the first six months of 2002. The gross
profit percentage in the first six months of 2002 was 32.0% as compared to 30.0%
in the 2001 period. The increase in the gross profit percentage primarily
resulted from improved operating efficiencies and cost cutting related to the
Company's operational restructuring and integration efforts.

Selling, general, and administrative expenses in the first six months of
2002 were $9,357 lower than in the 2001 period primarily as a result of the
Company's cost cutting initiatives in response to the decrease in revenue.
Selling, general, and administrative expenses as a percent of revenue were 29.7%
in the 2002 period and 29.6% in the 2001 period. Selling, general, and
administrative expenses in the 2002 period include charges of $1,234 for
nonrestructuring-related employee termination costs and $793 for consultants
retained to assist the Company with its restructuring and integration efforts.
Selling, general, and administrative expenses in 2001 include a charge of $767
for nonrestructuring-related employee termination costs and $1,174 for
consultants retained to assist the Company with its restructuring and
integration efforts. Adjusting for these

12

other charges, selling, general, and administrative expenses as a percent of
revenue were 28.7% and 28.8% in 2002 and 2001, respectively.

Interest expense in the first six months of 2002 was $2,511 lower than in
the 2001 period due primarily to reduced borrowings outstanding under the
Company's credit facility. In April 2002, the Company used the net proceeds from
the sale of its publishing business to repay borrowings under its credit
facility.

The Company recorded an income tax benefit of $486 in the first six months
of 2002. The benefit recognized was at a lower rate than the statutory rate due
primarily to the projected annual permanent items related to the nondeductible
portion of the goodwill impairment charge and meals and entertainment expenses.

The Company incurred a loss on disposal of $6,943 in the first six months
of 2002 in connection with the sale of its publishing business in April 2002.
Such loss is included as a component of the loss from discontinued operations in
the Consolidated Statement of Operations for the six months ended June 30, 2002.

On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." Under SFAS No.
142, acquired goodwill and other intangible assets with indefinite useful lives
are no longer amortized over an estimated useful life, but instead are subject
to an impairment test. Intangible assets with finite useful lives continue to be
amortized over their useful lives. Upon the initial application of SFAS No. 142,
the Company incurred an impairment charge of $328,529 relating to its goodwill.
The Company reported the impairment charge, net of a tax benefit of $654, as a
cumulative effect of a change in accounting principle. During the six months
ended June 30, 2002, the Company incurred an additional impairment charge of
$1,440 relating to goodwill associated with a contingent payment made during the
period.

Revenues from business transacted with affiliates for the six months ended
June 30, 2002 and 2001, totaled $2,763 and $5,084, respectively, representing
1.4% and 2.2%, respectively, of the Company's revenues.

THREE MONTHS ENDED JUNE 30, 2002, COMPARED WITH 2001

Revenues in the second quarter of 2002 were $12,931 lower than in the
comparable period in 2001. Revenues in the 2002 period decreased by $12,750 from
content management services and $735 from digital services, and were partially
offset by increased revenues of $554 from broadcast media distribution services.
Decreased revenues from content management services primarily resulted from a
weaker advertising market in the second quarter of 2002 as compared to the 2001
period, which adversely impacted the Company's operations servicing advertising
agencies and magazine publishers.

Gross profit decreased by $1,340 in the second quarter of 2002. The gross
profit percentage in the second quarter of 2002 was 32.7% as compared to 30.2%
in the 2001 period. The increase in the gross profit percentage primarily
resulted from improved operating efficiencies and cost cutting related to the
Company's operational restructuring and integration efforts.

Selling, general, and administrative expenses in the second quarter of 2002
were $4,383 lower than in the 2001 period primarily as a result of the Company's
cost cutting initiatives in response to the decrease in revenue. Selling,
general, and administrative expenses as a percent of revenue decreased to 28.4%
in the 2002 period from 29.0% in the 2001 period. Selling, general, and
administrative expenses in the 2002 period include charges of $735 for
nonrestructuring-related employee termination costs and $166 for consultants
retained to assist the Company with its restructuring and integration efforts.
Selling, general, and administrative expenses in 2001 include a charge of $348
for nonrestructuring-related employee termination costs and $1,174 for
consultants retained to assist the Company with its restructuring and
integration efforts. Adjusting for these other charges, selling, general, and
administrative expenses as a percent of revenue were 27.5% and 27.7% in 2002 and
2001, respectively.

During the second quarter of 2002, the Company incurred an impairment
charge of $1,440 relating to goodwill associated with a contingent payment made
during the period.

13

Interest expense in the second quarter of 2002 was $611 lower than in the
2001 period. Reduced borrowings resulted in a reduction in interest expense of
$1,151, which was partially offset by an increase of $540 related to additional
non-cash charges associated with the Company's interest rate swap agreements.

The Company recorded an income tax provision of $29 in the second quarter
of 2002. The provision recognized was at a lower rate than the statutory rate
due primarily to the projected annual permanent items related to the
nondeductible portion of the goodwill impairment charge and meals and
entertainment expenses.

Revenues from business transacted with affiliates for the three months
ended June 30, 2002 and 2001, totaled $1,448 and $2,376, respectively,
representing 1.4% and 2.0%, respectively, of the Company's revenues.

FINANCIAL CONDITION

As part of its overall effort to restructure its debt, the Company
initiated a tender offer in July 2002 to acquire all of its outstanding
subordinated notes for an aggregate purchase price of $3,000. The tender offer
was originally scheduled to expire on July 30, 2002, but the Company has
extended the tender offer until August 27, 2002, as the minimum tender condition
was not satisfied. As a result of the tender offer being extended, the Company
did not pay the semi-annual interest payment on the subordinated notes that was
due July 31, 2002. Such failure to pay interest on the subordinated notes does
not constitute an event of default unless payment is not made by August 30,
2002, the expiration of a 30-day grace period. The Company has obtained from its
senior lenders a waiver of any default under the Company's credit facility
resulting from any failure to pay the interest on the subordinated notes, either
before or after the expiration of the grace period. There can be no assurances
that the tender offer to acquire the subordinated notes will be successful.

In March 2002, the Company entered into an amendment to its credit facility
(the "Sixth Amendment") that extended the maturity through April 2003. In
connection with the Sixth Amendment, the Company incurred fees of $250 and
agreed to issue warrants with a nominal exercise price to its lenders to
purchase 5% of the Company's outstanding common stock. The warrants become
immediately issuable and exercisable if a definitive agreement for an overall
restructuring of the Company's credit facility is not entered into by September
30, 2002. In addition, as part of the Sixth Amendment, available borrowings
under the Company's revolving credit line were reduced to $66,000 from $81,000.
The Company does not believe that the reduced borrowing capacity will have a
material adverse effect on its financial condition or liquidity. The Company had
available borrowing capacity under its revolving credit line of $34,721 as of
June 30, 2002.

The Company continues to be engaged in discussions with its lenders to
renegotiate the terms of its credit facility. These discussions are currently
focused on the deferral of cash interest payments on a portion of the debt, an
extension of the maturity of the credit facility by several years, and several
other significant modifications. Any renegotiation of terms will be subject to
various contingencies, including retiring at least 90% of the subordinated notes
on terms satisfactory to the lenders. In connection with any such agreement, the
lenders would likely receive warrants for an additional portion of the Company's
outstanding common stock in addition to fees. In the event the Company is unable
to successfully restructure its credit facility or obtain other sources of
financing, the Company would be unable to repay the borrowings under the credit
facility upon maturity in April 2003. There can be no assurances as to the terms
or the success of any renegotiation of the Company's credit facility.

Under the terms of its credit facility, the Company was obligated to
satisfy certain milestones in connection with raising amounts to repay
borrowings. The consummation of the sale of the publishing business satisfied
one such milestone and resulted in the elimination of a previous increase in
interest rates of 100 basis points that had been in effect since January 1,
2002. The Company failed, however, to satisfy two other milestones with
deadlines of February 28, 2002, and April 30, 2002. Failure to satisfy the first
milestone resulted in a fee of $500 being paid to the Company's lenders. Failure
to satisfy the second milestone resulted in, effective May 1, 2002, an increase
in interest rates of 100 basis points and the issuance of warrants with an
exercise price of $0.01 to the Company's lenders to purchase 453,377 shares of
the Company's common stock. Such warrants become exercisable upon the earlier of
January 15, 2003, or an event of default under the credit facility.
14

Under the terms of its credit facility, the Company must comply with
certain quarterly covenants related to leverage ratios, interest coverage
ratios, fixed charge coverage ratios, and capital spending. In addition, the
Company must satisfy a minimum cumulative EBITDA (as defined in the credit
facility) covenant. If the Company does not satisfy such minimum cumulative
EBITDA covenant for any non-quarter month end, the Company's short-term
borrowing availability would be limited until such time as the Company is in
compliance with the covenant, but such failure would not constitute an event of
default. The Company was in compliance with all covenants at June 30, 2002.
Based on current projections, the Company believes that it will be able to
remain in compliance with the covenant requirements throughout 2002, although
there can be no assurance that such compliance will be maintained.

On January 22, 2002, Kmart, one of the Company's two largest customers,
filed for protection under Chapter 11 of the United States Bankruptcy Code. A
particular class of vendors was afforded critical vendor status by the
bankruptcy court. The Company has been treated as a critical vendor, and has
been paid substantially all of its accounts receivable for services rendered to
Kmart prior to its bankruptcy filing. The Company continues to be paid under its
normal trade terms for services rendered to Kmart subsequent to January 22,
2002.

During the first six months of 2002, goodwill decreased by $328,681 due
primarily to the impairment charge recognized upon the initial adoption of SFAS
No. 142 (see Note 3 to the Interim Consolidated Financial Statements).

During the first six months of 2002, the Company repaid $31,500 of term
loans and deposited $2,000 into an escrow account with proceeds from the sale of
its publishing business. In addition, the Company invested $6,681 in facility
construction and new equipment and repaid $581 of notes and capital lease
obligations. Such amounts were primarily funded by borrowings under its
revolving credit facility and cash from operating activities.

Cash flows from operating activities of continuing operations during the
first six months of 2002 increased by $4,328 as compared to the comparable
period in 2001 due primarily to the timing of vendor payments and an increase in
cash from operating income, partially offset by payments made during the period
related to the Company's restructuring plans, growth in inventory due to the
timing of work performed for retailers, and the timing of customer collections.

The Company expects to spend approximately $14,000 over the course of the
next twelve months for capital improvements, essentially all of which is for
modernization. The Company intends to finance these expenditures under leasing
arrangements, with working capital, or with borrowings under its credit
facility.

In July 2002, the Company initiated a plan (the "2002 Third Quarter Plan")
to consolidate its Grand Rapids, MI, and Battle Creek, MI, operations into a new
facility in Battle Creek. The Company anticipates completing the 2002 Third
Quarter Plan in September 2002, and estimates the restructuring charge related
to the 2002 Third Quarter Plan to be approximately $1,500.

Statement of Financial Accounting Standards (SFAS) No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities," was issued in June 2002, and
is effective for exit or disposal activities initiated after December 31, 2002.
SFAS No. 146 addresses financial accounting and reporting for costs incurred in
connection with exit or disposal activities, including restructurings, and
supercedes Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." Under SFAS No.
146, a liability related to an exit or disposal activity is not recognized until
such liability has actually been incurred, as opposed to a liability being
recognized at the time of a commitment to an exit plan, which was the standard
for liability recognition under EITF Issue No. 94-3. The Company does not expect
the adoption of SFAS No. 146 to have a material effect on its financial
condition or results of operations.

The Company believes that the cash flow from operations, including
potential improvements in operations as a result of its integration and
restructuring efforts, and available borrowing capacity, subject to the
Company's ability to remain in compliance with the financial covenants under its
credit facility, will provide sufficient cash flows to fund its cash needs
throughout 2002.
15

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Company's primary exposure to market risk is interest rate risk. The
Company had $179,311 outstanding under its credit facility at June 30, 2002.
Interest rates on funds borrowed under the Company's credit facility vary based
on changes to the prime rate or LIBOR. The Company partially manages its
interest rate risk through two interest rate swap agreements under which the
Company pays a fixed rate and is paid a floating rate based on the three month
LIBOR rate. The notional amounts of the two interest rate swaps totaled $50,000
at June 30, 2002. A change in interest rates of 1.0% would result in a change in
income before taxes of $1,293 based on the outstanding balance under the
Company's credit facility and the notional amounts of the interest rate swap
agreements at June 30, 2002.

16

PART II -- OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

In May 2002, pursuant to the terms of its credit facility, the Company
issued warrants with an exercise price of $0.01 to its lenders to purchase
453,377 shares of the Company's common stock. Such warrants become exercisable
upon the earlier of January 15, 2003, or an event of default under the Company's
credit facility. The issuance of such securities by the Company were effected
without registration based on reliance upon the exemption from registration
provided by Section 4(2) of the Securities Act of 1933 for private placements.

In June 2002, the Company issued 80,000 shares of its common stock as
additional consideration to the former shareholders of Agile Enterprise, Inc.,
which the Company acquired in September 1998. The issuance of such securities by
the Company were effected without registration based on reliance upon the
exemption from registration provided by Section 4(2) of the Securities Act of
1933 for private placements.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

As previously disclosed in its Annual Report on Forms 10-K for the years
ended December 31, 2001 and 2000, a subsidiary of the Company, Wace Group
Limited ("Wace"), is in arrears on the dividend payments related to its 8%
Cumulative Convertible Redeemable Preference Shares. Wace has been prohibited
from making dividend payments due to its lack of distributable reserves, and has
not made a dividend payment since July 1999. The arrearage, which is included as
part of "Minority interest" in the Consolidated Balance Sheets, totals
$7,571,000 at August 8, 2002.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

The annual meeting of the stockholders of Applied Graphics Technologies,
Inc., was held on June 13, 2002. The stockholders voted on the following matter:

1. The election of the following eleven directors of the Company for
terms expiring at the 2003 annual meeting of stockholders:

17

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits:

2.1 Agreement and Plan of Merger, dated as of February 13, 1998,
by and among Devon Group, Inc., Applied Graphics
Technologies, Inc., and AGT Acquisition Corp. (Incorporated
by reference to Exhibit No. 2.2 forming part of the
Registrant's Report on Form 10-K (File No. 0-28208) filed
with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended, for the fiscal
year ended December 31, 1997).
2.2 Stock Purchase Agreement dated as of April 11, 2002, by and
among DPG Holdings, Inc., Devon Group, Inc., and Applied
Graphics Technologies, Inc. (Incorporated by reference to
Exhibit No. 2.2 forming part of the Registrant's Report on
Form 10-Q (File No. 1-16431) filed with the Securities and
Exchange Commission under the Securities Exchange Act of
1934, as amended, for the quarterly period ended March 31,
2002).
3.1(a) First Restated Certificate of Incorporation (Incorporated by
reference to Exhibit No. 3.1 forming part of the
Registrant's Registration Statement on Form S-1 (File No.
333-00478) filed with the Securities and Exchange Commission
under the Securities Act of 1933, as amended).
3.1(b) Certificate of Amendment of First Restated Certificate of
Incorporation (Incorporated by reference to Exhibit No.
3.1(b) forming part of the Registrant's Report on Form 10-Q
(File No. 0-28208) filed with the Securities and Exchange
Commission under the Securities Exchange Act of 1934, as
amended, for the quarterly period ended June 30, 1998).
3.1(c) Second Certificate of Amendment of First Restated
Certificate of Incorporation (Incorporated by reference to
Exhibit No. 3.1(c) forming part of the Registrant's Report
on Form 10-K (File No. 0-28208) filed with the Securities
and Exchange Commission under the Securities Exchange Act of
1934, as amended, for the fiscal year ended December 31,
2000).
3.2(a) Amended and Restated By-Laws of Applied Graphics
Technologies, Inc. (Incorporated by reference to Exhibit No.
3.2 forming part of Amendment No. 3 to the Registrant's
Registration Statement on Form S-1 (File No. 333-00478)
filed with the Securities and Exchange Commission under the
Securities Act of 1933, as amended).
3.2(b) Amendment to Amended and Restated By-Laws of Applied
Graphics Technologies, Inc. (Incorporated by reference to
Exhibit No. 3.3 forming part of the Registrant's
Registration Statement on Form S-4 (File No. 333-51135)
filed with the Securities and Exchange Commission under the
Securities Act of 1933, as amended).
3.2(c) Amendment to Amended and Restated By-Laws of Applied
Graphics Technologies, Inc. (Incorporated by reference to
Exhibit No. 3.2(c) forming part of Registrant's Report on
Form 10-Q (File No. 0-28208) filed with the Securities and
Exchange Commission under the Securities Exchange Act of
1934, as amended, for the quarterly period ended September
30, 2000).
4 Specimen Stock Certificate (Incorporated by reference to
Exhibit 7 forming part of Registrant's Registration
Statement on Form 8-A (File No. 1-16431) filed with the
Securities and Exchange Commission under the Securities
Exchange Act of 1934, as amended, on April 5, 2001).
10.2 Applied Graphics Technologies, Inc. 1996 Stock Option Plan
(Incorporated by reference to Exhibit No. 10.2 forming part
of Amendment No. 3 to the Registrant's Registration
Statement on Form S-1 (File No. 333-00478) filed with the
Securities and Exchange Commission under the Securities Act
of 1933, as amended).
10.3 Applied Graphics Technologies, Inc. Non-Employee Directors
Nonqualified Stock Option Plan (Incorporated by reference to
Exhibit No. 10.3 forming part of Amendment No. 3 to the
Registrant's Registration Statement on Form S-1 (File No.
333-00478) filed with the Securities and Exchange Commission
under the Securities Act of 1933, as amended).

18

10.6(a)(i) Employment Agreement, effective as of November 30, 2000,
between the Company and Joseph D. Vecchiolla (Incorporated
by reference to Exhibit No. 10.6(a) forming part of the
Registrant's Report on Form 10-K (File No. 0-28208) filed
with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended, for the fiscal
year ended December 31, 2000).
10.6(a)(ii) Amendment No. 1 to Employment Agreement, dated as of March
1, 2002, by and between the Company and Joseph D.
Vecchiolla. (Incorporated by reference to Exhibit No.
10.6(a)(ii) forming part of the Registrant's Report on Form
10-K (File No. 1-16431) filed with the Securities and
Exchange Commission under the Securities Exchange Act of
1934, as amended, for the fiscal year ended December 31,
2001).
10.6(b) Agreement and General Release, effective June 4, 2000,
between the Company and Louis Salamone, Jr. (Incorporated by
reference to Exhibit No. 10.6 (b) forming part of the
Registrant's Report on Form 10-Q (File No. 0-28208) filed
with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended, for the
quarterly period ended June 30, 2000).
10.6(c) Agreement and General Release, dated December 15, 2000,
between the Company and Derek Ashley (Incorporated by
reference to Exhibit No. 10.6(c)(ii) forming part of the
Registrant's Report on Form 10-K (File No. 0-28208) filed
with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended, for the fiscal
year ended December 31, 2000).
10.6(d) Separation Agreement, effective December 18, 2000, between
the Company and Scott Brownstein (Incorporated by reference
to Exhibit No. 10.6(d)(iii) forming part of the Registrant's
Report on Form 10-K (File No. 0-28208) filed with the
Securities and Exchange Commission under the Securities
Exchange Act of 1934, as amended, for the fiscal year ended
December 31, 2000).
10.7 Form of Registration Rights Agreement (Incorporated by
reference to Exhibit No. 10.7 forming part of Amendment No.
3 to the Registrant's Registration Statement on Form S-1
(File No. 333-00478) filed with the Securities and Exchange
Commission under the Securities Act of 1933, as amended).
10.8 Applied Graphics Technologies, Inc., 1998 Incentive
Compensation Plan, as Amended and Restated (Incorporated by
reference to Exhibit No. 10.8 forming part of Registrant's
Report on Form 10-Q (File No. 0-28208) filed with the
Securities and Exchange Commission under the Securities
Exchange Act of 1934, as amended, for the quarterly period
ended June 30, 1999).
10.8(a) Amendment No. 1, dated as of May 8, 2000, to the Applied
Graphics Technologies, Inc., Amended and Restated 1998
Incentive Compensation Plan (Incorporated by reference to
Exhibit No. 10.8(a) forming part of the Registrant's Report
on Form 10-Q (File No. 0-28208) filed with the Securities
and Exchange Commission under the Securities Exchange Act of
1934, as amended, for the quarterly period ended June 30,
2000).
10.9(a) Amended and Restated Credit Agreement, dated as of March 10,
1999, among Applied Graphics Technologies, Inc., Other
Institutional Lenders as Initial Lenders, and Fleet Bank,
N.A. (Incorporated by reference to Exhibit No. 99.2 of the
Registrant's Report on Form 8-K (File No. 0-28208) filed
with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended, on March 22,
1999).
10.9(b) Amendment No. 1, dated as of June 2, 1999, to the Amended
and Restated Credit Agreement among Applied Graphics
Technologies, Inc., Other Institutional Lenders as Initial
Lenders, and Fleet Bank, N.A. (Incorporated by reference to
Exhibit No. 10.9(b) forming part of Registrant's Report on
Form 10-Q (File No. 0-28208) filed with the Securities and
Exchange Commission under the Securities Exchange Act of
1934, as amended, for the quarterly period ended June 30,
1999).

19

10.9(c) Amendment No. 2, dated July 28, 1999, to the Amended and
Restated Credit Agreement among Applied Graphics
Technologies, Inc., Other Institutional Lenders as Initial
Lenders, and Fleet Bank, N.A. (Incorporated by reference to
Exhibit No. 10.9(c) forming part of Registrant's Report on
Form 10-Q (File No. 0-28208) filed with the Securities and
Exchange Commission under the Securities Exchange Act of
1934, as amended, for the quarterly period ended September
30, 1999).
10.9(d) Amendment No. 3, dated as of July 21, 2000, to the Amended
and Restated Credit Agreement among Applied Graphics
Technologies, Inc., Other Institutional Lenders as Initial
Lenders, and Fleet Bank, N.A. (Incorporated by reference to
Exhibit No. 10.9(d) forming part of the Registrant's Report
on Form 10-Q (File No. 0-28208) filed with the Securities
and Exchange Commission under the Securities Exchange Act of
1934, as amended, for the quarterly period ended June 30,
2000).
10.9(e) Amendment No. 4, dated as of August 11, 2000, to the Amended
and Restated Credit Agreement among Applied Graphics
Technologies, Inc., Other Institutional Lenders as Initial
Lenders, and Fleet Bank, N.A. (Incorporated by reference to
Exhibit No. 10.9(e) forming part of the Registrant's Report
on Form 10-Q (File No. 0-28208) filed with the Securities
and Exchange Commission under the Securities Exchange Act of
1934, as amended, for the quarterly period ended June 30,
2000).
10.9(f) Fifth Amendment, dated as of July 27, 2001, to the Amended
and Restated Credit Agreement by and among Applied Graphics
Technologies, Inc., the lenders party thereto, and Fleet
National Bank, as agent. (Incorporated by reference to
Exhibit No. 10.9(f) forming part of the Registrant's Report
on Form 10-Q (File No. 1-16431) filed with the Securities
and Exchange Commission under the Securities Exchange Act of
1934, as amended, for the quarterly period ended June 30,
2001).
10.9(g) Sixth Amendment, dated March 21, 2002, to the Amended and
Restated Credit Agreement by and among Applied Graphics
Technologies, Inc., the lenders party thereto, and Fleet
National Bank, as agent. (Incorporated by reference to
Exhibit No. 10.9(g) forming part of the Registrant's Report
on Form 10-K (File No. 1-16431) filed with the Securities
and Exchange Commission under the Securities Exchange Act of
1934, as amended, for the fiscal year ended December 31,
2001).
10.10 Consulting Agreement, dated as of March 1, 2001, by and
between the Company and Knollwood Associates, LLC.
(Incorporated by reference to Exhibit No. 10.10 forming part
of the Registrant's Report on Form 10-Q (File No. 1-16431)
filed with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended, for the
quarterly period ended March 31, 2001).
99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

- ---------------

(b) The Registrant did not file any reports on Form 8-K during the quarter ended
June 30, 2002.

20

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

APPLIED GRAPHICS TECHNOLOGIES, INC.
(Registrant)

By: /s/ FRED DRASNER
------------------------------------
Fred Drasner
Chairman of the Board and
Chief Executive Officer

Date: August 14, 2002

/s/ KENNETH G. TOROSIAN
--------------------------------------
Kenneth G. Torosian
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)

Date: August 14, 2002

21