APPLIED GRAPHICS TECHNOLOGIES INC - 10-K Annual Report

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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 DECEMBER 31, 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
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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 IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
450 WEST 33RD STREET, NEW YORK, NY 10001
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 212-716-6600

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT: NONE

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 [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's 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]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]

The aggregate market value of Registrant's voting and non-voting common
equity held by non-affiliates based on the closing price on The American Stock
Exchange on June 28, 2002, was $4,005,996.

The number of shares of the Registrant's Common Stock outstanding as of
February 28, 2003, was 9,147,565 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's 2003 Definitive Proxy Statement to be filed
with the Securities and Exchange Commission are incorporated by reference into
Part III hereof.

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TABLE OF CONTENTS

PART I

Certain statements made in this Annual Report on Form 10-K 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 restructure its
credit facility or achieve a recapitalization by July 15, 2003; the ability of
the Company to retain customers; the ability of the Company to maintain
compliance with the covenant requirements under its existing or any future
credit arrangements; the ability of Kmart Corporation to successfully emerge
from bankruptcy; the ability to attract and retain management; 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 impact of geopolitical events on the
economy; the success of the Company's restructuring plans and integration
efforts; and the adequacy of the Company's existing or future credit
arrangements and cash flows to fund cash needs.

ITEM 1. BUSINESS.

GENERAL

Applied Graphics Technologies, Inc. and its subsidiaries (the "Company")
primarily provide digital media asset management services. Through its various
divisions and significant operations, including the Black Dot Group and Seven
Worldwide, the Company offers content management services, broadcast media
distribution services, and an array of digital services to retailers, magazine
and book publishers, advertising agencies, consumer goods companies,
entertainment companies, and automobile manufacturers.

Through Portal Publications, Ltd. and its subsidiaries ("Portal"), the
Company published greeting cards, calendars, art prints, and other wall decor
items, and sold these products primarily to mass-market merchants, card shops,
bookstores, art galleries, designers, and framers. The Company sold Portal in
April 2002.

The Company was incorporated in Delaware on December 12, 1995. On April 16,
1996, simultaneous with the consummation of the initial public offering of its
common stock, the Company acquired substantially all of the assets and certain
related liabilities relating to the prepress, digital imaging services, and
related businesses of Applied Printing Technologies, L.P. ("Applied Printing").

SEGMENT INFORMATION

See Note 24 to the Company's Consolidated Financial Statements for
financial information about industry segments.

SERVICES

The Company's digital media asset management business consists of content
management services, digital services, and broadcast media distribution
services.

Content Management Services. The Company's content management services
include advertising creation services, prepress services, electronic
transmission services, and limited print services. The scope of the Company's
content management services and the range of customers that can make use of
these services continue to evolve with the expansion of electronic distribution
channels and the ability to create digital archives.

The Company provides a full range of advertising creation services for
certain of its customers, primarily retailers. Such services include strategic
marketing, creative design, photography, and page development. The Company's
strategic marketing services assist customers in reaching a broader audience
with targeted

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messages through the use of research, surveys, and media planning. The creative
design services offered by the Company provide customers with a creative concept
along with the requisite art direction, copywriting, and design for their
advertising and marketing materials. The Company's photographic services provide
a wide range of digital and traditional photographic services that include model
booking, prop acquisition, location procurement, set design, and studio
photography.

The Company offers a full range of prepress services to its customers
regardless of whether the advertising creation services are performed by the
Company, an advertising agency, or the customer. Prepress services combine text
with black and white and full-color picture and graphic content into page format
for publication in print and distribution on the World Wide Web, or via e-mail,
proprietary on-line services, and CD-ROM. The Company also provides prepress
services for packaging of consumer products.

The Company also provides electronic design, digital advertising
composition, and transmission of display advertising to newspapers. In addition,
the Company provides printing services primarily as an ancillary service to
certain customers, primarily those in the entertainment industry. For these
customers, the Company prints movie posters, CD covers, video covers, and
promotional materials. The Company also offers specialty printing for large
format requirements such as movie posters, billboards, and other outdoor
signage.

Digital Services. The Company offers a broad range of digital services and
products, including archiving systems, interactive services, brand management
solutions, and publishing systems. The technologies used to offer these services
have either been developed, in whole or in part, by the Company or are licensed
from third parties at market or below market rates.

Broadcast Media Distribution Services. In its broadcast media distribution
business, the Company receives a master copy of a commercial on video or
audiotape, duplicates the tape, and ships the copies electronically or via air
freight to radio and television stations for rebroadcast. In December 1996, the
Company entered into a ten-year contract with Initiative Media Corp.
("Initiative"), a subsidiary of The Interpublic Group of Companies, Inc., under
which Initiative is obligated to direct all of its broadcast media distribution
business to the Company.

CUSTOMERS

The Company's digital media asset management customer base encompasses a
wide variety of enterprises and organizations, including retailers, publishers,
advertising agencies, consumer goods companies, entertainment companies, and
automobile manufacturers. The Company's two largest customers are Sears Roebuck
& Co. ("Sears") and Kmart Corporation ("Kmart"). For the years ended December
31, 2002, 2001, and 2000, revenues from Sears represented approximately 11.5%,
11.3%, and 9.1%, respectively, and revenues from Kmart represented approximately
11.8%, 11.1%, and 8.3%, respectively, of the Company's consolidated revenues.
The Company's five largest nonaffiliated customers accounted for approximately
36% of total revenues in 2002. A significant reduction in business from any of
these five top customers could have a material adverse effect on the Company.
The Company's fifty largest nonaffiliated customers accounted for approximately
69% of the Company's revenues in 2002. Revenues from many of the Company's large
customers are an aggregation of revenues for services provided by the Company to
different groups within a customer, which the Company believes may limit its
exposure to losing all of the business of a larger customer. For both Sears and
Kmart, however, there is no such aggregation, and all revenues are derived from
providing services to a single customer entity. The Company provides services to
Sears under a long-term agreement that expires on May 31, 2007, although the
contract is subject to certain early termination provisions. In most other cases
there is no contractual arrangement that would prevent customers from selecting
other means to perform some or all of their work.

On January 22, 2002, Kmart 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.

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In 2002, approximately 1.2% of the Company's total revenues came from
business with affiliates. Such affiliates include U.S. News & World Report,
L.P., Daily News, L.P., and Applied Printing, companies beneficially owned by
Mortimer B. Zuckerman, the former Chairman of the Board of Directors and a
director of the Company, and Fred Drasner, Chief Executive Officer and Chairman
of the Board of Directors of the Company.

SALES AND MARKETING

The Company relies primarily on its general managers and regional sales
organizations to market its content management services. Because they have
conducted business together over several years, personnel at each facility have
established strong working relationships with particular customer industries
that are prevalent around its location. These relationships also extend to
advertising agencies that perform work for these customers.

The Company maintains a separate sales force to market digital services to
both its content management customers and to new customers. The Company also has
a separate sales force to market its broadcast media distribution services.

COMPETITION

Content Management Services: Content management services, especially
prepress services, are performed primarily by three types of businesses: (i)
independent providers, such as Schawk, Inc., and Southern Graphics Systems,
Inc., that typically do not also offer commercial printing services as a
principal part of their overall business, (ii) commercial printers, such as R.
R. Donnelley & Sons, Co., Quebecor World, Inc., and Quad/Graphics, Inc., that
provide prepress and other image management services as an adjunct to their
printing businesses, and (iii) customers that perform certain services
themselves using available desktop publishing technologies. The industry is
fragmented and serviced by a large number of regional and local businesses and
few national enterprises. Commercial printers providing prepress services
generally compete on the basis of the convenience of "one-stop shopping" for
prepress and printing services, and on the basis of price by bundling the cost
of prepress and other content management services with the printing cost or by
substantially discounting the separate prepress services. A customer might
prefer services by a printer where price is the primary consideration, and
quality of and control over the artistic process are not key concerns.
Independent providers, such as the Company, generally are able to offer a higher
level of specialization, customization, and individualized service and also
provide customers with the flexibility to select the printer of their choice,
thus giving the customer greater leverage in negotiating for printing services.
A customer would look to perform its own prepress services internally if the
customer believed that control over the process was advantageous and quality of
the product was not paramount. Customers typically provide for themselves only a
portion of the prepress services they need, augmenting their own capabilities,
as needed, with third-party services usually from independent providers.

The Company competes for prepress work on the basis of quality of service,
price of service, and the ability to satisfy demanding customers. The Company
believes that not every prepress provider can meet the demands of the types of
customers served by the Company. Among this smaller group, the Company competes
primarily based on historical reliability of service and on price. The Company
believes it maintains competitive prices by efficiently implementing new
technologies into its prepress businesses. Additionally, the Company believes
that it is able to maintain competitive prices by coordinating its customers'
in-house capabilities with its own equipment, thereby minimizing redundant
processes and lowering customer costs. In addition, the Company competes for
prepress work based on its ability to provide other digital imaging services.
For example, the Company provides digital archiving services for prepress
customers at a lower cost than if purchased on a stand-alone basis because of
the Company's ability to efficiently integrate the prepress and archiving
processes.

Independent prepress providers typically provide services based upon a
customer's request for which the provider is paid on a per-job basis. In most
cases, there is no contractual arrangement that would prevent a

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customer from changing prepress providers. The Company does, however, seek
multi-year contracts with customers for whom it provides services at the
customer's location.

The Company competes for advertising creation services primarily with major
advertising agencies and professional photography studios primarily on the basis
of quality of service.

Digital Services: In the area of digital imaging and archiving, the
Company competes with a small number of software-development companies marketing
products to manage image databases.

Broadcast Media Distribution Services: In the broadcast media distribution
business, the Company competes with many local and/or regional suppliers as well
as national suppliers, such as Vyvx, Inc., a subsidiary of The Williams
Companies, Inc., Digital Generation Systems, Inc., and VDI Media. These services
are typically provided on a per-job basis. The Company generally has no
contractual arrangements that would prevent a customer from changing providers,
other than the aforementioned agreement with Initiative Media. The Company
believes competition is based on quality of duplication, speed, and reliability
of distribution as well as price.

EMPLOYEES

As of December 31, 2002, the Company had approximately 3,200 total
employees, approximately 3,065 of whom were full-time employees. Of the total
employees, approximately 1,750 were salaried employees and approximately 1,450
were hourly employees. Approximately 240 of the Company's employees were covered
by collective bargaining agreements. The Company has never experienced a work
stoppage and believes that its relationships with its employees, both unionized
and nonunionized, are satisfactory.

GEOGRAPHIC INFORMATION

See Note 24 to the Company's Consolidated Financial Statements for
financial information about geographic regions. Operating income from foreign
operations was approximately $5,243,000, $21,000, and $1,801,000 for the years
ended December 31, 2002, 2001, and 2000, respectively.

DISCONTINUED OPERATIONS

Publishing. The Company sold Portal in April 2002 and reports it as a
discontinued operation. Net proceeds from the sale were approximately
$33,500,000, of which $31,500,000 were used to repay term loans outstanding
under the Company's credit facility and $2,000,000 were originally held in
escrow under the terms of the sale.

Through Portal, the Company published greeting cards, posters, art prints,
calendars, original artwork, and other wall decor items. The product lines
ranged from moderately priced items intended for a broad customer base to higher
quality items consisting of fine art reproductions, limited edition prints, and
upscale posters intended for a narrower and more selective customer base. The
Company obtained the images for its publishing products by purchasing the rights
to publish photographs and artwork that were either in an artist's stock or were
commissioned specifically for the Company's use. Images were also obtained from
the public domain primarily through photo libraries. The Company's publishing
products were printed by outside vendors that were selected based upon quality,
ability to deliver, and price. The products were delivered directly to the
Company's warehouses, from where shipments were made directly to customers. The
Company's publishing customers were primarily mass-market merchants, card shops,
bookstores, art galleries, institutional customers, and framers. The Company
relied on an internal sales force, independent representatives, and its senior
executives to sell its publishing products. Sales of mass-market publishing
products were managed through in-store service programs that enhanced the
ability of a product to be carried by customers for many years. In the
publishing business, the Company primarily competed with local, regional, and
national producers of posters and art prints. Approximately 15% of the
publishing business' revenue was generated from the sale of greeting cards,
where the Company competed with major greeting card companies such as Hallmark
Cards, Inc., and American Greetings Corporation. The Company believed
competition was based on reliability of service, timeliness of delivery, and the
ability to select images with mass-market appeal.

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ITEM 2. PROPERTIES.

The Company rents its corporate headquarters in New York City under a lease
that expires in 2011 and operates its principal facilities at the locations
indicated below.

New York City
(3 content management facilities; 1 broadcast facility)

Atlanta, Georgia
(1 content management facility)

Chicago, Illinois
metropolitan area
(5 content management facilities)

Detroit, Michigan
metropolitan area
(3 content management facilities; 1 broadcast facility)

Los Angeles, California
metropolitan area
(1 content management facility;
1 broadcast facility)

Carlstadt, New Jersey
(1 content management facility)

Wilmington, Ohio
(1 broadcast facility)

Pontiac, Illinois
(1 content management facility)

Rochester, New York
(1 digital facility)

Seattle, Washington
(1 content management facility)

San Diego, California
(1 content management facility)

San Francisco, California
metropolitan area
(2 content management facilities)

Dallas, Texas
(1 content management facility)

Omaha, Nebraska
(1 content management facility)

Battle Creek, Michigan
(1 content management facility)

Orlando, Florida
(1 content management facility)

Nashua, New Hampshire
(1 digital facility)

International Locations:

United Kingdom
(4 content management facilities)

Australia
(1 content management facility)

The Company owns eight of the content management facilities. The remaining
facilities are operated under leases that expire in 2003 through 2015. The
Company also provides on-site services at certain customer locations where
services are performed only for that specific customer. The Company believes
that its facilities are adequate to meet its needs.

ITEM 3. LEGAL PROCEEDINGS.

The Company is contingently liable as a result of transactions arising in
the ordinary course of business and is involved in certain legal proceedings in
which damages and other remedies are sought. In the opinion of Company
management, after review with counsel, the ultimate resolution of these matters
will not have a material effect on the Company's financial condition or results
of operations.

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

There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 2002.

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EXECUTIVE OFFICERS OF THE COMPANY

The following table lists the executive officers of the Company. Officers
are appointed by the Board of Directors and serve at the discretion of the
Board.

Fred Drasner has served as Chief Executive Officer since May 2002, as
Chairman of the Board of Directors since June 2001, and as Chairman of the
Company since April 1996. He also served as Chief Executive Officer of the
Company from 1996 until April 2000. Mr. Drasner has been co-owner of Pro
Football, Inc., d/b/a The Washington Redskins, since July 1999. He has been the
Chief Executive Officer of Daily News, L.P. ("Daily News"), and Co-Publisher of
the New York Daily News since 1993, Co-Chairman of U.S. News & World Report,
L.P. ("U.S. News"), since 1998, and Chief Executive Officer of U.S. News from
1985 to 1998, and Chairman and Chief Executive Officer of Applied Printing
Technologies, L.P. ("Applied Printing"), since 1988. Mr. Drasner served as
Co-Chairman from 1998 to 1999 and Vice-Chairman and Chief Executive Officer from
1986 to 1998 of The Atlantic Monthly Company and as Co-Chairman of Fast Company
Media Group, L.L.C. ("Fast Company"), from January 1999 until October 2000.

Joseph D. Vecchiolla joined the Company in May 2000 as its Senior Vice
President and Chief Financial Officer, and has served as Chief Operating Officer
since December 2000 and President since August 2001. From February 1999 through
April 2000 he served as Vice President of Marketing and Vice President of
Finance at Favorite Brands International, which was acquired by Nabisco in
November 1999. Favorite Brands International filed for protection under Chapter
11 of the U.S. Bankruptcy Code in March 1999. From May 1997 until February 1999
he served as President of Old Greenwich Capital Corporation.

Marne Obernauer, Jr., served as Vice Chairman from May 1998 until February
2003. Mr. Obernauer joined the Company in May 1998 in connection with the merger
with Devon Group, Inc. ("Devon"). Prior to joining the Company, and up until its
merger with the Company, he served as Chief Executive Officer of Devon from 1980
and as Chairman of the Board of Directors of Devon from 1986.

Martin D. Krall has been Executive Vice President, Chief Legal Officer, and
Secretary of the Company, Daily News, Applied Printing, and U.S. News since
January 1995. Mr. Krall served as Executive Vice President, Chief Legal Officer,
and Secretary of The Atlantic Monthly Company from 1995 to 1999 and as Executive
Vice President, Chief Legal Officer, and Secretary of Fast Company.

Kenneth G. Torosian has served as Senior Vice President and Chief Financial
Officer since September 2001 and as Treasurer since November 2002. Prior to
that, Mr. Torosian served as Vice President of Finance from August 2000 until
September 2001, and Corporate Controller from January 1997 until August 2000.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

The Company's common stock commenced trading on The American Stock Exchange
(AMEX symbol: AGD) in April 2001. Prior to that, the Company's common stock
traded on the Nasdaq National Market (NASDAQ symbol: AGTX). The following table
sets forth the high and low closing sales price for each period indicated.

As of February 28, 2003, there were approximately 86 holders of record of
the Company's common stock. No dividends have been paid since April 17, 1996,
the date the Company's common stock commenced trading. The Company is prohibited
from paying dividends under its existing credit facility.

In February 2003, the Company received notification from The American Stock
Exchange (the "Exchange") that the Company is currently not in compliance with
certain listing standards of the Exchange. The Company has submitted a plan to
the Exchange setting forth the steps the Company intends to take in order to
regain compliance with the listing standards. There can be no assurances that
the plan will be accepted by the Exchange. In the event that the plan is not
accepted by the Exchange or the Company fails to satisfy the terms of the plan,
the Company's common stock may be delisted from the Exchange.

The following table sets forth certain information as of December 31, 2002,
with respect to the Company's equity compensation plans under which equity
securities of the Company are authorized for issuance.

EQUITY COMPENSATION PLAN INFORMATION

The Company does not have any equity compensation plans that have not been
authorized by its stockholders.

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ITEM 6. SELECTED FINANCIAL DATA.

No dividends have been paid on the Company's common stock.

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(a) Amounts in 2002 include charges of $3,359, $73,899, and $2,203 for
restructurings, impairments of long-lived assets, and
nonrestructuring-related employee termination costs, respectively. (See Note
4, Note 5, and Note 6 to the Consolidated Financial Statements).

(b) Amounts in 2001 include charges of $16,167, $8,952, $2,769, and $2,046 for
restructurings, impairments of long-lived assets, losses on disposals of
property and equipment, and nonrestructuring-related employee termination
costs, respectively. (See Note 4, Note 5, and Note 6 to the Consolidated
Financial Statements).

(c) Amounts in 2000 include gains on disposal of property and equipment of
$2,327 and gains on sales of businesses of $16,590, as well as charges of
$1,241 and $2,056 for impairment of long-lived assets and
nonrestructuring-related employee termination costs, respectively. (See Note
4 and Note 6 to the Consolidated Financial Statements).

(d) Amounts in 1999 include charges of $3,572, $6,302, and $2,402 for
restructurings, impairment of long-lived assets, and a loss on disposal and
abandonment of fixed assets, respectively.

(e) Amounts in 1998 include charges of $8,550, $3,150, and $2,509 for
restructurings, abandonment of a business, and impairment of intangible
assets, respectively.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

The following discussion and analysis (in thousands of dollars) should be
read in conjunction with the Company's Consolidated Financial Statements and
notes thereto.

CRITICAL ACCOUNTING POLICIES

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. Management believes that the estimates and assumptions used in preparing
the financial statements of the Company were the most appropriate at that time,
although actual results could differ significantly from those estimates under
different conditions. Management has discussed these estimates and assumptions,
including the related disclosure included in this annual report on Form 10-K,
with the audit committee of the Company's board of directors.

The accompanying financial statements have been prepared on a going concern
basis, which contemplates continuity of operations, realization of assets, and
liquidation of liabilities in the ordinary course of business (see Note 1 to the
Consolidated Financial Statements).

In assessing the carrying value of goodwill in accordance with Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets," the Company compared such carrying value of each of its reporting units
to their fair values. The Company estimated the fair value of its reporting
units by applying a multiple to each reporting unit's earnings before interest,
taxes, depreciation, and amortization ("EBITDA"). In estimating the fair value
of its reporting units, the Company had to make various assumptions, including,
but not limited to, projections of each reporting unit's future EBITDA, the fair
value of each reporting unit's net assets, and the EBITDA multiple a willing
buyer would apply to each reporting unit's EBITDA to determine its fair value.
Based on the use of these assumptions in estimating the fair value of each
reporting unit, the Company incurred impairment charges relating to its goodwill
as no value was ascribed to the goodwill at December 31, 2002, as compared to a
carrying value of $405,839 at December 31, 2001. A change in the Company's
assumptions, including, but not limited to, higher EBITDA for any reporting
unit, lower fair market values of net assets, or a buyer willing to pay more
than the assumed EBITDA multiple could result in the goodwill of certain
reporting units to have a fair value greater than zero. Such an outcome would
not have an impact on the Company's results of operations or financial position
because under SFAS No. 142 the carrying value of goodwill cannot be increased
once it has been impaired.

In assessing the recoverability of its deferred tax assets, the Company
compared the carrying value of its deferred tax assets to the tax-effected
projections of its taxable income over future periods in which such assets could
be realized. In estimating its future taxable income, the Company had to make
various assumptions about its future operating performance, the stability of the
markets and customers the Company serves, and the future financial position of
the Company. Based on the Company's estimates, a valuation allowance of $17,539
was established against the carrying value of the Company's deferred tax assets
at December 31, 2002, resulting in net deferred tax assets of $15,857, as
compared to net deferred tax assets of $20,050 at December 31, 2001, against
which no valuation allowance had been established. A change in the Company's
assumptions, including better or worse operating performance than projected, the
loss of a significant customer, or a deterioration in the markets served by the
Company would result in a change in the amount of deferred tax assets that will
be recovered by the Company, and therefore will result in an adjustment to the
valuation allowance established at December 31, 2002. Such adjustment, either
positive or negative, would be reflected as a component of the Company's
provision for income taxes.

In assessing the carrying value of its accounts receivable, the Company
estimated the recoverability by making assumptions regarding the financial
stability of its customers and the validity of any potential claims raised by
its customers. Based on the Company's estimates, an allowance for doubtful
accounts of $7,832 was established at December 31, 2002, compared to an
allowance of $8,269 at December 31, 2001. A change in the Company's assumptions,
including the financial stability of the Company's customers, would result in
the Company recovering an amount of its accounts receivable that differs from
its current carrying value. Such

9

difference, either positive or negative, would be reflected as a component of
the Company's selling, general, and administrative expense.

In assessing the carrying value of the liabilities associated with its
various restructuring efforts, the Company had to estimate the timing and amount
of future payments to be made under certain contractual obligations, primarily
those relating to building leases. In making such estimates, the Company has to
make various assumptions, including but not limited to, the real estate rental
market in future periods, the financial stability of the Company's existing
subtenants, the willingness of existing subtenants to renew their subleases, and
the timing and pricing of any future subleases. Based on the Company's
estimates, the carrying value of the Company's restructuring liabilities was
$10,585 at December 31, 2002, as compared to $13,730 at December 31, 2001. A
change in the Company's assumptions, including, but not limited to, the timing
and pricing of any future sublease arrangements, the willingness of existing
subtenants to renew their subleases, and the ability of existing subtenants to
continue to meet their current obligations would result in the Company paying
amounts that differ from the current carrying value of its restructuring
liabilities. Such difference, either positive or negative, would be reflected as
a restructuring charge or restructuring income.

RESULTS OF OPERATIONS

The results of operations of the Company's publishing business are reported
as a discontinued operation for all periods presented.

Year ended December 31, 2002, compared with 2001

Revenues in 2002 were $44,432, or 9.5%, lower than in the comparable period
in 2001. Revenues in the 2002 period decreased by $46,822 from content
management services and $955 from digital services, and were partially offset by
increased revenues of $3,345 from broadcast media distribution services.
Decreased revenues from content management services primarily resulted from a
weaker advertising market in 2002 as compared to the 2001 period, which
adversely impacted the Company's operations servicing advertising agencies and
magazine publishers, the loss of business from an advertising agency that
brought its work in house, and a decrease in revenues from retailers due to
certain customer initiatives in 2001 not repeated in 2002. Increased revenues
from broadcast media distribution services resulted from additional volume of
premium services provided for which the Company receives higher rates.

Gross profit decreased by $722 in 2002 as compared to the 2001 period. The
gross profit percentage was 34.2% in 2002 as compared to 31.1% 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, as well as from the
higher-margin premium services revenue in the broadcast media distribution
services business.

Selling, general, and administrative expenses in 2002 were $18,386 lower
than in 2001 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 28.9% in 2002 and 30.1% in 2001.

The results of operations in 2002 include restructuring charges of $3,359,
of which $2,059 related to a plan initiated by the Company during the third
quarter of 2002 (the "2002 Third Quarter Plan") and $1,300 related to
adjustments to various restructuring plans initiated in prior years (see Note 5
to the Consolidated Financial Statements). Under the 2002 Third Quarter Plan,
the Company consolidated its Grand Rapids, MI, and Battle Creek, MI, operations
into a new facility in Battle Creek, and consolidated its Dallas, TX, operation
into less space at its existing location. The Company terminated nine employees
as part of the 2002 Third Quarter Plan. The charge of $2,059 consisted of $1,828
for facility closure costs, $155 for future rental obligations on abandoned
equipment, and $76 for employee termination costs.

The $1,300 restructuring charge incurred in 2002 relating to restructuring
plans initiated in prior years primarily resulted from an adjustment to the
liability associated with a plan initiated in the fourth quarter of 2001 under
which the Company closed and consolidated fifteen content management facilities
and administrative offices (the "2001 Fourth Quarter Plan"). The liability
associated with the 2001 Fourth Quarter Plan was

10

adjusted in 2002 to reflect current market conditions and revised estimates
relating to the Company's various building lease obligations.

The Company does not anticipate any material adverse effect on future
results of operations from the facility closings since the majority of the work
performed at such locations has been transferred to its other facilities. The
employees terminated under the restructuring plans were principally production
workers, sales people, and administrative support staff. The Company completed
all of its restructuring plans by December 31, 2001, except for the 2001 Fourth
Quarter Plan, which was completed during 2002, and the 2002 Third Quarter Plan,
which the Company anticipates completing by September 30, 2003.

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 annual impairment test. Intangible assets with finite useful lives
continue to be amortized over their useful lives. The results of operations in
2002 includes a goodwill impairment charge of $73,216 primarily related to the
annual impairment test under SFAS No. 142 that was performed on December 31,
2002.

The results of operations also include other impairment charges of $683, of
which $211 related to equipment abandoned in connection with the 2002 Third
Quarter Plan, $322 related to the write off of certain software development
projects, and $150 related to the write off of contract acquisition costs
resulting from the termination of a customer contract with an affiliate.

Interest expense in 2002 was $5,005 lower than in the 2001 period due
primarily to reduced borrowings outstanding under the Company's credit facility,
lower interest rates during 2002, and a non-cash benefit of $2,159 as compared
to the 2001 period associated with the Company's interest rate swap
arrangements. These decreases were partially offset by a decrease in interest
allocated to discontinued operations from $1,295 in 2001 to $580 in 2002.

Other expense of $1,159 in 2002 includes $548 for a litigation settlement,
including legal fees, $434 of professional fees incurred in connection with
negotiations related to the Company's credit facility, and $297 of expenses
related to a tender offer to acquire the Company's outstanding subordinated
notes that did not succeed and lapsed in August 2002.

The Company recorded an income tax benefit of $643 in 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.

In connection with the sale of its publishing business in April 2002, the
Company incurred a loss from discontinued operations in 2002 of $6,010, which
consisted of a loss on disposal of $6,943 and income from operations of $933.

Upon the initial application of SFAS No. 142, the Company incurred a pretax
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.

The Company conducted business with Applied Printing Technologies, L.P.
("Applied Printing"), an entity beneficially owned by Fred Drasner, the Chief
Executive Officer and the Chairman of the Board of Directors of the Company, and
Mortimer B. Zuckerman, a director and the former Chairman of the Board, which
owned approximately 22.0% of the Company's outstanding common stock at December
31, 2002. The Company also conducted business with other affiliates, including
the Daily News, L.P., and U.S. News & World Report, L.P., both of which are
beneficially owned by Mr. Drasner and Mr. Zuckerman. Sales to related parties
for the years ended December 31, 2002, 2001, and 2000, totaled $4,974, $9,307,
and $11,401, respectively, representing 1.2%, 2.0%, and 2.0%, respectively, of
the Company's revenues.

11

Year ended December 31, 2001, compared with 2000

Revenues in 2001 were $98,252 lower than in 2000. Revenues in the 2001
period decreased by $74,449 from content management services, $18,937 from
digital services, and $4,866 from broadcast media distribution services.
Decreased revenues from content management services primarily resulted from the
softening advertising market, which adversely impacted the Company's East Coast
prepress operations and its Midwest prepress and creative services operations,
as well as from the loss of a low-margin customer at the Company's West Coast
operations and reduced volumes at the Company's operations in the United
Kingdom. The Company also experienced anticipated reductions in revenues
associated with both the sale of its photographic laboratory business in April
2000 and the closing of one of its Atlanta content management facilities in June
2000. Decreased revenues from digital services primarily resulted from the sale
of the Company's digital portrait systems business in December 2000 and a
decrease in revenues resulting from the contraction of Internet-related
business. Decreased revenues from broadcast media distribution services
primarily resulted from the softening advertising market and from price
reductions made under a long-term contract with a significant customer.

Gross profit decreased $45,395 in 2001 as a result of the decrease in
revenues for the year as discussed above. The gross profit percentage in 2001
was 31.1% as compared to 33.7% in the 2000 period. This decrease in the gross
profit percentage primarily resulted from the decrease in revenues from content
management services and digital services discussed above, which resulted in
lower absorption of fixed manufacturing costs, as well as from reduced margins
from broadcast media distribution services as a result of the price reductions
given to a significant customer. Additionally, the gross profit percentage was
adversely impacted by the sale of the digital portrait systems business in
December 2000, which had higher margins than the Company's other operations.
Such decreases were partially offset by an increase in margins resulting from
the sale of the photographic laboratory business in April 2000, which had lower
margins than the Company's other content management operations, and from cost
cutting related to the Company's restructuring and integration efforts.

Selling, general, and administrative expenses in 2001 were $14,361 lower
than in 2000, but as a percent of revenue increased to 30.1% in 2001 from 27.4%
in 2000 due to the Company's cost cutting initiatives not keeping pace with the
significant decline in revenue during the year.

The loss on disposal of property and equipment was $2,769 in 2001,
primarily resulting from equipment disposed of in connection with the Company's
restructuring and integration efforts.

The results of operations in 2001 include a restructuring charge of $16,167
related to various restructuring efforts initiated by the Company (see Note 5 to
the Consolidated Financial Statements). The restructuring charge in 2001
includes a charge of $13,918 related to the 2001 Fourth Quarter Plan and a
charge of $1,703 related to a plan initiated in the second quarter of 2001 (the
"2001 Second Quarter Plan"). In addition, the Company incurred a net charge in
2001 of $546 related to various restructuring plans initiated in prior years.

The charge of $13,918 for the 2001 Fourth Quarter Plan consisted of $10,384
for facility closure costs, $3,374 for employee termination costs for 235
employees, and $160 for costs for rental obligations on abandoned equipment. The
charge of $1,703 for the 2001 Second Quarter Plan, under which the Company
consolidated certain content management facilities in Chicago, IL, and relocated
one such facility in New York City, consisted of $884 for facility closure costs
and $819 for employee termination costs for 66 employees.

The $546 restructuring charge incurred in 2001 relating to restructuring
plans initiated in prior years primarily resulted from an adjustment to the
liability associated with a plan initiated in the second quarter of 2000 under
which the Company closed one of its content management facilities in Atlanta, GA
(the "2000 Second Quarter Plan"). The liability associated with the 2000 Second
Quarter Plan was adjusted in 2001 due to the Company not being able to resolve
its building lease obligation within the timeframe initially anticipated.

In December 2001, the Company incurred an impairment charge of $7,176
primarily related to one of its digital services businesses that experienced a
downturn in its operations that was not anticipated to abate in

12

the foreseeable future. Also in December 2001, the Company incurred a charge of
$1,776 related to the impairment of property and equipment in connection with
its restructuring and integration efforts.

Interest expense in 2001 was $4,396 lower than in 2000 due primarily to the
reduced borrowings outstanding under the Company's credit facility as well as an
overall reduction in interest rates throughout 2001. This decrease was partially
offset by a non-cash charge of $1,763 related to four interest rate swap
agreements entered into by the Company that are accounted for in accordance with
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivatives and Hedging Activities," which was adopted by the Company on January
1, 2001. In addition, $3,847 of interest expense was allocated to discontinued
operations in 2000 as compared to $1,295 in 2001.

The Company recorded an income tax benefit of $10,056 in 2001. The benefit
recognized was at a lower rate than the statutory rate due primarily to
additional Federal taxes on foreign earnings and the projected annual permanent
items related to nondeductible goodwill and the nondeductible portion of meals
and entertainment expenses.

As a result of the substantial modifications to the principal payment
schedule resulting from an amendment to the Company's credit facility entered
into in 2001, the Company's financial statements reflect an extinguishment of
old debt and the incurrence of new debt. Accordingly, the Company recognized a
loss on extinguishment in 2001 of approximately $3,410, net of taxes of
approximately of $2,451, as an extraordinary item. The Company also incurred
additional fees of $906 in 2001 in connection with the amendment to the
Company's credit facility.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2002, the total amount outstanding under the Company's
credit facility was $162,214, of which $24,391 was outstanding under a revolving
credit line and $137,823 was outstanding under three term loans. The Company had
additional available borrowing capacity under the revolving credit line of
approximately $40,000 at December 31, 2002. The available borrowing capacity
under the revolving credit line is net of the aggregate letters of credit
outstanding, which totaled $1,556 at December 31, 2002. Interest rates on funds
borrowed under the Company's credit facility varied from either LIBOR or the
prime rate in effect at the time of the borrowing, plus a factor. Borrowings
under the Company's credit facility are secured by all of the inventory,
receivables, and real and personal property of the Company and certain of its
subsidiaries.

The terms of the Company's credit facility contain certain milestones in
connection with raising amounts to repay borrowings. The consummation of the
sale of the publishing business in April 2002 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 did not
satisfy two other milestones with deadlines of February 28, 2002, and April 30,
2002. Not satisfying the first milestone resulted in a fee of $500 being paid to
the Company's lenders. Not satisfying 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 became
exercisable on January 15, 2003.

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
became obligated to issue warrants with an exercise price of $0.01 to its
lenders to purchase 453,377 shares of the Company's common stock if a definitive
agreement for an overall restructuring of the credit facility was not reached by
September 30, 2002. Such warrants were issued in October 2002 and were
immediately exercisable. Also as part of the Sixth Amendment, available
borrowings under the Company's revolving credit line were reduced to $66,000
from $81,000.

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
did not succeed and lapsed on August 27, 2002, with none of the tendered
subordinated notes being accepted by the Company for payment. Consequently, the
semi-annual interest payment on the subordinated notes, which

13

was due on July 31, 2002, but was not paid by the Company while the tender offer
remained open, was paid on August 30, 2002. Such failure to pay the interest on
its initial due date did not constitute an event of default since payment was
made by the expiration of a 30-day grace period. In connection with the lapsed
tender offer, the Company incurred expenses of $297 that are included as a
component of "Other income (expense)" in the Consolidated Statement of
Operations for the year ended December 31, 2002.

In April 2003, the Company entered into an amended and restated credit
agreement (the "Amended Credit Agreement") that extended the maturity of the
credit facility through April 2004. In connection with the Amended Credit
Agreement, the Company incurred fees totaling $2,000 to be paid quarterly and
issued immediately exercisable warrants with an exercise price of $0.01 per
share to its lenders to purchase 453,378 shares of the Company's common stock.
As part of the Amended Credit Agreement, the Company agreed that the failure of
the Company and its senior lenders to consummate a restructuring or
recapitalization on or before July 15, 2003, will constitute an event of
default. Such an event of default will result in the automatic acceleration of
amounts outstanding under the Amended Credit Agreement. Also as part of the
Amended Credit Agreement, the Company agreed that in addition to scheduled
principal payments, it would permanently repay $20,000 of borrowings by December
31, 2003. Failure to repay such borrowings would not constitute an event of
default, but would result in the Company paying additional fees of $2,000 to its
lenders upon maturity of the credit facility. Additionally, under the Amended
Credit Agreement, maximum availability under the Company's revolving credit line
was reduced from $66,000 to $63,500, and will be further reduced to $62,500 on
July 1, 2003, $60,500 on October 1, 2003, and $60,000 on January 1, 2004. Also,
the ability to borrow funds at interest rates based on LIBOR was restricted to
only those periods in which the Company's trailing twelve-month EBITDA (as
defined in the Amended Credit Agreement) exceeds $50,000. The Company does not
anticipate exceeding this EBITDA threshold, and therefore the Amended Credit
Agreement effectively requires the Company to borrow funds at interest rates
based on the prime rate for the foreseeable future. The Company does not believe
that the reduced borrowing capacity will have a material adverse effect on its
financial condition or liquidity. Had the Company been required to borrow funds
at interest rates based on the prime rate throughout 2002, the Company would
have incurred additional interest expense of approximately $3,800.

Upon issuance of the warrants in April 2003 in connection with the Amended
Credit Agreement, the Company's lenders held warrants issued directly by the
Company that are convertible into approximately 12.9% of the Company's
outstanding common stock. In addition, in July 2001, Applied Printing granted a
call option to the Company's lenders to purchase 680,067 shares of the Company's
common stock held by Applied Printing at a purchase price of $0.01 per share.
This call option became exercisable on January 15, 2003. The combination of the
call option granted by Applied Printing and the warrants issued directly by the
Company provide the Company's lenders with instruments that are convertible into
approximately 19.4% of the Company's common stock.

In order to avoid an event of default under the Amended Credit Agreement,
the Company continues to negotiate with its senior lenders to consummate a
restructuring or recapitalization by July 2003. Any such restructuring or
recapitalization would most likely require an amendment or a repurchase at a
significant discount of the Company's subordinated notes. There can be no
assurances that the Company will reach an agreement with its senior lenders
before July 2003. The Company is also seeking other sources of financing,
including an overall recapitalization that would include an infusion of outside
equity and the settlement, at a significant discount, of amounts due to the
lenders for amounts borrowed under the credit facility, amounts due to holders
of the Company's subordinated notes, and amounts due to holders of preference
shares of a subsidiary of the Company. One such set of discussions with a third
party resulted in an offer being made that was accepted by most of the Company's
senior lenders, in both number of lenders and dollar amount of commitment, but
was rejected by a few of the senior lenders for not containing sufficient
consideration. The Company, however, continues to seek an overall
recapitalization, and another third party is currently in discussions with the
Company's senior lenders regarding an infusion of equity and the settlement of
their debt obligations at a significant discount. There can be no assurances as
to the terms or the success of any recapitalization, including the amount of new
equity and the amount of capital stock to be issued in connection

14

therewith. The potential impact of any such recapitalization on the holders of
the Company's presently outstanding common stock is similarly unknown at this
time.

In the event that the Company is unable to restructure its credit facility
or obtain other sources of financing by July 2003, including an overall
recapitalization, the Company will seek to obtain a waiver from its senior
lenders for the event of default under the Amended Credit Agreement. There can
be no assurances that the Company will be able to obtain such waiver, which
would require unanimous approval from the Company's senior lenders.

In connection with the Company's discussions with third parties regarding
an infusion of outside equity, the Company did not pay the semi-annual interest
payment on the subordinated notes due on January 31, 2003, until February 28,
2003. Such failure to pay the interest on its initial due date did not
constitute an event of default since payment was made by the expiration of a
30-day grace period.

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 monthly 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 December 31, 2002. Based on current projections, the Company believes that it
will be able to remain in compliance with the covenant requirements throughout
2003, although there can be no assurance that such compliance will be
maintained.

In accordance with the requirements of its credit facility, the Company has
outstanding two interest rate swap agreements with an aggregate notional amount
of $50,000 that expire in August 2003. Under the swap agreements, the Company
paid a fixed rate of 5.798% per annum on a quarterly basis and was paid a
floating rate based on the three-month LIBOR rate in effect at the beginning of
each quarterly payment period.

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 2002, the Company wrote off all of its goodwill due to the
impairment charges recognized in accordance with SFAS No. 142.

During 2002 the Company made a $32,002 mandatory non-scheduled repayment of
term loans and retained $1,500 in an escrow account with proceeds from the sale
of its publishing business. In addition, the Company made $12,185 of scheduled
repayments of term loans, repaid $1,087 of notes and capital lease obligations,
paid $1,671 in debt financing fees, and made contingent payments related to
acquisitions of $720. The Company also invested $11,923 in facility
construction, new equipment, and software-related projects. Such amounts were
primarily generated from cash from operating activities.

Cash flows from operating activities of continuing operations during 2002
increased by $10,773 as compared to 2001 due primarily to cash generated from
operations and the timing of vendor payments, partially offset by payments made
during the year related to the Company's restructuring plans and growth in
inventory due to the timing of work performed.

The Company expects to spend approximately $12,000 over the course of the
next twelve months for capital improvements and management information systems,
essentially all of which is for modernization. The Company intends to finance a
substantial portion of these expenditures with working capital or borrowings
under its credit facility.

At December 31, 2002, the Company had a liability of approximately $10,585
for the future costs related to its restructuring charges and a liability of
$9,064 for dividends in arrears on preference shares of a
15

subsidiary. The Company also has minimum debt payments in 2003, inclusive of
capital lease obligations, of approximately $14,050.

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 and to restructure its credit facility or achieve a
recapitalization by July 2003, will provide sufficient cash flows to fund its
cash needs through 2003.

The Company does not believe that inflation has had a material impact on
its business.

RECENT ACCOUNTING PRONOUNCEMENTS

Statement of Financial Accounting Standards (SFAS) No. 145, "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections," was issued in April 2002. Among other changes, SFAS No.
145 rescinded Statement of Financial Accounting Standards (SFAS) No. 4,
"Reporting Gains and Losses from Extinguishment of Debt," which required all
gains and losses from the extinguishment of debt to be aggregated and, if
material, to be classified as an extraordinary item, net of related income tax
effects. The rescission of SFAS No. 4 is effective for fiscal years beginning
after May 15, 2002. The primary impact of SFAS No. 145 on the Company is that
future gains and losses from the extinguishment of debt will be subject to the
criteria of Accounting Principles Board (APB) Opinion No. 30, "Reporting the
Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary Unusual and Infrequently Occurring Events and
Transactions." Therefore, debt extinguishments in future periods may not be
classified as extraordinary items, net of related income tax effects, but
instead as a component of income from continuing operations, and previously
reported debt extinguishments may be subject to reclassification.

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 impact of the adoption
of SFAS No. 146 on the Company's financial condition or results of operations is
not determinable since SFAS No. 146 only affects restructuring efforts initiated
in future periods.

Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure," was issued in December
2002, and is effective for fiscal years ending after December 15, 2002. SFAS No.
148 provides alternative methods of transition for any entity that voluntarily
changes to the fair value based method of accounting for stock-based employee
compensation. The Company does not expect the adoption of SFAS No. 148 to have a
material effect on its financial condition or results of operations.

Financial Accounting Standards Board Interpretation No. (FIN) 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others," was issued in November 2002. FIN
45 elaborates on certain disclosure requirements and clarifies certain
recognition criteria related to guarantees. The disclosure requirements of FIN
45 are effective for periods ending after December 15, 2002, and the recognition
criteria of FIN 45 are effective on a prospective basis for guarantees issued or
modified after December 31, 2002. The impact of FIN 45 on the Company's
financial condition or results of operations is not determinable since FIN 45
primarily impacts guarantees issued or modified in future periods.

16

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Company's primary exposure to market risk is interest rate risk. The
Company had $162,214 outstanding under its credit facility at December 31, 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 December 31, 2002. A change in interest rates of 1.0% would result in an
annual change in income before taxes of $1,122 based on the outstanding balance
under the Company's credit facility and the notional amounts of the interest
rate swap agreements at December 31, 2002.

17

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

18

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders
of Applied Graphics Technologies, Inc.

We have audited the accompanying consolidated balance sheets of Applied
Graphics Technologies, Inc. and subsidiaries ("the Company") as of December 31,
2002 and 2001, and the related consolidated statements of operations,
stockholders' equity (deficit), and cash flows for each of the three years in
the period ended December 31, 2002. Our audits also included the financial
statement schedule listed in the Index at Item 15. These consolidated financial
statements and the financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and the financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company as of December 31,
2002 and 2001 and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2002, in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.

As discussed in Note 4 to the consolidated financial statements, on January
1, 2002, the Company adopted the non-amortization and impairment provisions for
goodwill. Also, as discussed in Note 11 to the consolidated financial
statements, on January 1, 2001, the Company modified the accounting for
derivative instruments and hedging activities.

The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company's existing credit
facility matures on April 30, 2004. The Company's ability to comply with the
terms of its existing credit facility during 2003, as discussed in Note 1 to the
consolidated financial statements, raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1 to the consolidated financial statements. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

/s/ DELOITTE & TOUCHE LLP

New York, New York
April 15, 2003

19

APPLIED GRAPHICS TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)

See Notes to Consolidated Financial Statements
20

APPLIED GRAPHICS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)

See Notes to Consolidated Financial Statements
21

APPLIED GRAPHICS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)

See Notes to Consolidated Financial Statements
22

APPLIED GRAPHICS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)

See Notes to Consolidated Financial Statements

23

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER-SHARE AMOUNTS)

1. ORGANIZATION AND BASIS OF PRESENTATION

Applied Graphics Technologies, Inc., and its subsidiaries (the "Company")
primarily provide digital media asset management services. Through its various
divisions and significant operations, including Black Dot Group and Seven
Worldwide, the Company offers content management services, broadcast media
distribution services, and an array of digital services to retailers, magazine
and book publishers, advertising agencies, consumer goods companies,
entertainment companies, and automobile manufacturers.

The accompanying financial statements have been prepared on a going concern
basis, which contemplates continuity of operations, realization of assets, and
liquidation of liabilities in the ordinary course of business, and do not
reflect adjustments that might result if the Company were unable to continue as
a going concern. The Company's existing credit facility matures on April 30,
2004, although if the Company and its senior lenders do not consummate a
restructuring or recapitalization on or before July 15, 2003, the Company will
be in default under its credit facility. Such an event of default will result in
the automatic acceleration of amounts outstanding under the Company's credit
facility. The Company's ability to continue reporting on a going concern basis
is dependent on the ability of the Company to restructure its credit facility or
obtain other sources of financing, including a recapitalization, by July 2003,
or to obtain a waiver from its senior lenders for the event of default under the
credit facility.

The Company has been pursuing an overall recapitalization that would
include an infusion of outside equity and the settlement, at a significant
discount, of the Company's long-term obligations. One set of discussions with a
third party resulted in an offer being made that was accepted by most of the
Company's senior lenders, in both number of lenders and dollar amount of
commitment, but was rejected by a few of the senior lenders for not containing
sufficient consideration. Another third party is currently in discussions with
the Company's senior lenders regarding an alternative offer. There can be no
assurance that the Company will reach an agreement with its senior lenders to
restructure its credit facility or that an overall recapitalization will be
achieved before July 2003. In the event that the Company is unable to
restructure its credit facility or obtain other sources of financing by July
2003, including an overall recapitalization, the Company will seek to obtain a
waiver from its senior lenders for the event of default under the Company's
credit facility. There can be no assurance that the Company will be able to
obtain such waiver, which would require unanimous approval from the Company's
senior lenders.

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION: The Consolidated Financial Statements include
the accounts of the Company and all of its subsidiaries. All intercompany
accounts and transactions have been eliminated in the Consolidated Financial
Statements.

CASH AND CASH EQUIVALENTS: Cash and cash equivalents include all cash
balances and highly liquid investments having original maturities of three
months or less.

MARKETABLE SECURITIES: Realized gains and losses on marketable securities
sold were determined on a specific identification basis and are included in
"Other income (expense) -- net" in the Consolidated Statements of Operations.
Unrealized gains and losses on investments are included as a component of "Other
comprehensive loss," net of any related tax effect. Proceeds from the sale of
marketable securities were $1,675 during 2001, which resulted in a realized gain
of $665.

24

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

INVENTORY: Raw materials are valued at the lower of cost (cost being
determined on a weighted average basis) or market. Work-in-process, consisting
of labor, materials, and overhead on partially completed projects, is recorded
at the lower of cost or net realizable value.

PROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment is stated
at cost. Depreciation is computed principally on the straight-line method over
the estimated useful lives of the assets, which generally range from 30 years
for buildings to three years for certain machinery and equipment. Leasehold
improvements and amounts recorded under capital leases are amortized on the
straight-line method over the shorter of the terms of the leases or their
estimated useful lives.

LONG-LIVED ASSETS: The Company evaluates the recoverability of its
long-lived assets by comparing their carrying value to the expected future
undiscounted cash flows to be generated from such assets when events or
circumstances indicate that an impairment may have occurred.

GOODWILL AND OTHER INTANGIBLES: 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 annual impairment test. Intangible
assets with finite useful lives continue to be amortized over their useful
lives. The impairment of goodwill upon the adoption of SFAS No. 142 was reported
as a cumulative effect of a change in accounting principle.

REVENUE RECOGNITION: Revenues from content management services and
broadcast media distribution services are recognized at the time projects are
shipped or transmitted to the customer. Revenues for digital archiving services
are recognized on a per-image basis as items are prepared and scanned. Revenue
from the licensing of software and the sale of digital equipment is recognized
upon the later of delivery or satisfaction of significant obligations.

INCOME TAXES: The Company accounts for income taxes under the provisions
of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for
Income Taxes." Foreign subsidiaries are taxed according to regulations existing
in the countries in which they do business. Provision has not been made for
United States income taxes on distributions that may be received from foreign
subsidiaries, which are considered to be permanently invested overseas.

FOREIGN CURRENCY TRANSLATION: Assets and liabilities of foreign operations
are translated from the functional currency into United States dollars using the
exchange rate at the balance sheet date. Revenues and expenses of foreign
operations are translated from the functional currency into United States
dollars using the average exchange rate for the period. Adjustments resulting
from the translation into United States dollars are included as a component of
"Other comprehensive loss."

DERIVATIVE FINANCIAL INSTRUMENTS: Effective January 1, 2001, the Company
accounts for its interest rate swap agreements in accordance with the provisions
of Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended and interpreted.
Accordingly, the fair value of the interest rate swaps are recorded as an asset
or liability in the statement of financial position, with the change in fair
value reflected as a component of interest expense or other comprehensive income
depending on the intended use of the swaps. Prior to January 1, 2001, the
effective date of SFAS No. 133, the interest rate swaps were treated as hedges,
and amounts receivable or payable under the swaps were recorded as current
assets or liabilities, respectively, with gains or losses recognized as an
adjustment to interest expense.

EMPLOYEE STOCK OPTIONS: The Company accounts for stock-based employee
compensation based on the intrinsic value of stock options granted in accordance
with the provisions of Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees." Information relating to stock-based
employee compensation, including the pro forma effects had the Company accounted
for stock-based

25

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

employee compensation based on the fair value of stock options granted in
accordance with Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation," is as follows:

ESTIMATES: The preparation of these financials 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 disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

RECENTLY ISSUED ACCOUNTING STANDARDS: Statement of Financial Accounting
Standards (SFAS) No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," was issued in
April 2002. Among other changes, SFAS No. 145 rescinded Statement of Financial
Accounting Standards (SFAS) No. 4, "Reporting Gains and Losses from
Extinguishment of Debt," which required all gains and losses from the
extinguishment of debt to be aggregated and, if material, to be classified as an
extraordinary item, net of related income tax effects. The rescission of SFAS
No. 4 is effective for fiscal years beginning after May 15, 2002. The primary
impact of SFAS No. 145 on the Company is that future gains and losses from the
extinguishment of debt will be subject to the criteria of Accounting Principles
Board (APB) Opinion No. 30, "Reporting the Results of Operations -- Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary Unusual
and Infrequently Occurring Events and Transactions." Therefore, debt
extinguishments in future periods may not be classified as extraordinary items,
net of related income tax effects, but instead as a component of income from
continuing operations, and previously reported debt extinguishments may be
subject to reclassification.

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 impact of the adoption
of SFAS No. 146 on the Company's financial condition or results of operations is
not determinable since SFAS No. 146 only affects restructuring efforts initiated
in future periods.

Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure," was issued in December
2002, and is effective for fiscal years ending after December 15, 2002. SFAS No.
148 provides alternative methods of transition for any entity that voluntarily

26

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

changes to the fair value based method of accounting for stock-based employee
compensation. The Company does not expect the adoption of SFAS No. 148 to have a
material effect on its financial condition or results of operations.

Financial Accounting Standards Board Interpretation No. (FIN) 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others," was issued in November 2002. FIN
45 elaborates on certain disclosure requirements and clarifies certain
recognition criteria related to guarantees. The disclosure requirements of FIN
45 are effective for periods ending after December 15, 2002, and the recognition
criteria of FIN 45 are effective on a prospective basis for guarantees issued or
modified after December 31, 2002. The impact of FIN 45 on the Company's
financial condition or results of operations is not determinable since FIN 45
primarily impacts guarantees issued or modified in future periods.

3. DISCONTINUED OPERATIONS AND SALE OF BUSINESSES

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 were
originally held in escrow under the terms of the sale. The Company received $500
from the escrow in November 2002, with the remaining $1,500 of escrow available
to satisfy any claims related to contractual warranties. Any remaining escrow
balance will be used to further repay the outstanding borrowings under the
Company's credit facility.

In connection with the Company's adoption of a plan approved by its Board
of Directors in June 2000 to sell the publishing business, the results of
operations of this business were reported as a discontinued operation in the
Company's financial statements in 2000, and included an estimated loss on
disposal of $98,280. In April 2002, the Company recognized an additional loss on
disposal of the publishing business of $6,943, subject to the settlement of
outstanding contingencies. The losses on disposal are included as a component of
"Income (loss) from discontinued operations" in the Consolidated Statements of
Operations.

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 years ended December 31, 2002,
2001, and 2000, 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, $1,295, and $3,847 for the years ended December 31,
2002, 2001 and 2000, respectively. The allocated interest expense consisted
solely of the interest expense on the Company's borrowings under its credit
facility, which represented 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.

27

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In December 2000, the Company sold certain assets that were primarily
dedicated to its digital portrait system business for approximately $22,500, and
realized a gain of $16,649. In August 2000, the Company sold its events-based
digital photography business for $220, and realized a loss of $59 subsequent to
incurring an impairment charge of $658 during the year (see Note 6 to the
Consolidated Financial Statements). In April 2000, the Company sold its
photographic laboratory business for approximately $11,800, and did not realize
a gain or loss on the sale of this business. The revenues, gross profit, and
operating income from these operations included in the Company's results of
operations in 2000 were $23,251, $8,638, and $4,919, respectively.

4. GOODWILL AND OTHER INTANGIBLE ASSETS

The Company's intangible assets not subject to amortization under SFAS No.
142 consist entirely of goodwill. Upon the initial application of SFAS No. 142
on January 1, 2002, 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.

At December 31, 2002, the Company incurred an additional impairment charge
of $71,776 relating to its goodwill, of which $70,135 related to the Company's
content management business and $1,641 related to the Company's broadcast media
distribution business. The methodology used for this impairment charge was the
same as that used upon the initial adoption of SFAS No. 142. The multiples used
to determine the fair value of each reporting unit at December 31, 2002, were
lower than those used upon the initial adoption of SFAS No. 142 due to a decline
in market conditions of the Company's industry and the overall economy.

In the second quarter of 2002, the Company made a contingent payment
totaling $1,440 consisting of $720 in cash and 80,000 shares of common stock 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 an impairment charge in 2001 related to this business (see Note 6 to
the Consolidated Financial Statements).

The changes in the carrying amount of goodwill during the years ended
December 31, 2002 and 2001, were as follows:

During 2002, goodwill related to the Company's content management business
was reduced by $5,000 from the reversal of a tax contingency related to a prior
period acquisition.

28

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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, which generally does not exceed five years. The gross
carrying amount and accumulated amortization of contract acquisition costs were
as follows:

The Company incurred an impairment charge of $150 during the third quarter
of 2002 for the write off of the unamortized balance of contract acquisition
costs related to a customer contract with an affiliate that was terminated prior
to its expiration. Such charge is included as a component of "Other impairment
charges" in the Consolidated Statement of Operations.

Amortization expense associated with contract acquisition costs was $342,
$798, and $745 for the years ended December 31, 2002, 2001, and 2000,
respectively. The estimated amortization expense for each of the next four years
is as follows:

2003........................................................ $364
2004........................................................ $364
2005........................................................ $335
2006........................................................ $301

The adjusted net loss and loss per share for the years ended December 31,
2001 and 2000, reflecting the add back of the amortization of goodwill, were as
follows:

5. RESTRUCTURING

The Company initiated a plan during the third quarter of 2002 (the "2002
Third Quarter Plan") to consolidate its Grand Rapids, MI, and Battle Creek, MI,
operations into a new facility in Battle Creek, and to consolidate its Dallas,
TX, operation into less space at its existing location.

In 2001, the Company initiated two separate plans to restructure certain of
its operations (the "2001 Second Quarter Plan" and the "2001 Fourth Quarter
Plan", respectively). As part of the 2001 Second Quarter Plan, the Company
consolidated certain of its content management operations in Chicago into a
single facility and relocated one of its content management facilities in New
York City. As part of the 2001 Fourth Quarter Plan, the Company consolidated
three of its content management operations in Chicago, IL,

29

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

into a single facility, closed three of its New York metropolitan area content
management facilities, with the work being transferred into existing facilities
in New Jersey and New York City, and closed five regional content management
photo studios, with the work being transferred into existing studios in Chicago
and Atlanta, GA. In addition, the Company closed its content management facility
in Washington, DC, closed two administrative offices, one in the New York
metropolitan area and one in Chicago, and consolidated its content management
operations in London into three floors of its existing space.

In June 2000, the Company closed one of its content management facilities
in Atlanta (the "2000 Second Quarter Plan"). In 1999, the Company initiated two
separate plans to restructure certain of its operations (the "1999 Third Quarter
Plan" and the "1999 Fourth Quarter Plan," respectively). As part of the 1999
Third Quarter Plan, the Company closed a content management facility in Los
Angeles, CA, transferring the work to its other Los Angeles facility, and
consolidated two of its San Francisco, CA, content management facilities into a
single new location. As part of the 1999 Fourth Quarter Plan, the Company closed
a content management facility in each of New York City and Chicago, transferring
the work to other facilities operated by the Company in those cities,
redistributed work among its various New York metropolitan area facilities, and
streamlined certain operations in the United Kingdom. In 1998, the Company
initiated two separate plans to restructure certain of its operations (the "1998
Second Quarter Plan" and the "1998 Fourth Quarter Plan," respectively). As part
of the 1998 Second Quarter Plan, the Company closed a content management
facility in each of New Jersey and San Francisco, and vacated a portion of a
content management facility in Chicago, transferring the work to other
facilities operated by the Company in those areas. As part of the 1998 Fourth
Quarter Plan, the Company closed several content management facilities in
Chicago, transferring the work to other facilities operated by the Company in
that city.

The results of operations for the years ended December 31, 2002, 2001, and
2000, include restructuring charges (income) as follows:

The components of the restructuring charges (income) incurred in 2002 were
as follows:

The charge for employee termination costs related to approximately nine
employees for the 2002 Third Quarter Plan. The Company also incurred an
impairment charge of $211 related to equipment abandoned in

30

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

connection with the 2002 Third Quarter Plan. Such charge is included as a
component of "Other impairment charges" in the Consolidated Statement of
Operations.

The components of the restructuring charges (income) incurred in 2001 were
as follows:

The charge for employee termination costs related to approximately 235
employees for the 2001 Fourth Quarter Plan and 66 employees for the 2001 Second
Quarter Plan. In addition, the loss on disposal of property and equipment of
$2,769 in 2001 primarily resulted from the disposal of equipment in connection
with the restructuring plans and integration efforts initiated during the year.

The components of the restructuring charges (income) incurred in 2000 were
as follows:

The charge for employee termination costs related to approximately 37
employees for the 2000 Second Quarter Plan.

The remaining liability for future payments and the other amounts charged
against the respective restructuring liabilities in 2002 and 2001 were as
follows:

31

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The number of employees paid during the years ended December 31, 2002,
2001, and 2000 that resulted in a reduction of the various restructuring plans'
liabilities for employee termination costs was as follows:

The Company periodically adjusts the liabilities associated with its
various restructuring plans to reflect changes in estimates originally made when
the plans were initiated. In 2002, the Company adjusted the liability associated
with the 2001 Fourth Quarter Plan to reflect additional estimated costs of the
Company's future building lease and other rental obligations, partially offset
by less than anticipated employee termination costs due to the voluntary
resignation of certain employees. Also in 2002, the Company adjusted the
liability associated with the 1999 Fourth Quarter Plan and the 1998 Fourth
Quarter Plan to reflect favorable settlements on certain building lease
obligations.

In 2001, the Company adjusted the liability associated with the 2000 Second
Quarter Plan, the 1999 Fourth Quarter Plan, and the 1998 Fourth Quarter Plan.
The adjustments related to changes in estimates of the Company's future building
lease and other rental obligations.

The Company does not anticipate any material adverse effect on its future
results of operations from the facility closings since all work performed at
such locations has been or will be transferred to its other facilities. The
employees terminated under the restructuring plans were principally production
workers, sales people, and administrative support staff. The Company completed
the 2001 Fourth Quarter Plan during 2002. The Company completed the 2001 Second
Quarter Plan during 2001. The Company completed the 1999 Third Quarter Plan,
1999 Fourth Quarter Plan, and the 2000 Second Quarter Plan during 2000. The
Company completed both the 1998 Second Quarter Plan and the 1998 Fourth Quarter
Plan during 1999. The Company anticipates completing the 2002 Third Quarter Plan
by September 30, 2003. The remaining liabilities for these plans primarily
represent future rental obligations for abandoned property and equipment.

The Company is continuing to pursue operating efficiencies and synergies
and, as a result, may incur additional restructuring charges.

32

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. OTHER IMPAIRMENT CHARGES

Impairments and other charges for the years ended December 31, 2002, 2001,
and 2000, consisted of the following:

During 2002, the Company incurred a charge of $322 for the write off of
certain software development costs related to projects that are no longer being
pursued. In July 2002, the Company incurred a charge of $150 for the write off
of the unamortized balance of contract acquisition costs related to a customer
contract with an affiliate that was terminated prior to its expiration. The
Company also incurred a charge of $211 for the impairment of equipment abandoned
in connection with the 2002 Third Quarter Plan.

In December 2001, the Company incurred an impairment charge of $7,176
primarily related to one of its digital services businesses that experienced a
downturn in its operations that was not anticipated to abate in the foreseeable
future. Also in December 2001, the Company incurred a charge of $1,776 for the
impairment of property and equipment in connection with the 2001 Fourth Quarter
Plan.

In June 2000, the Company incurred a charge of $583 from the impairment of
equipment abandoned in connection with the 2000 Second Quarter Plan. In May
2000, the Company commenced a plan to sell its events-based digital photography
business. In connection with such action, the Company incurred a charge of $658
for the write down of long-lived assets related to this business. The Company
consummated the sale of this business in August 2000 for approximately $220, and
realized a loss of $59. The revenues, negative gross profit, and operating loss
from this business included in the Company's results of operations for the year
ended December 31, 2000, were $590, $168, and $722, respectively.

7. INVENTORY

The components of inventory at December 31 were as follows:

33

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment at December 31 consisted of the following:

9. ACCRUED EXPENSES

Accrued expenses at December 31 consisted of the following:

10. LONG-TERM DEBT

Long-term debt at December 31 consisted of the following:

The Company entered into its current credit facility, which consists of
three term loans and a revolving credit line, in 1999 to finance certain
acquisitions. Borrowings under the credit facility are secured by all of the
inventory, receivables, and real and personal property of the Company and
certain of its subsidiaries. Interest rates on funds borrowed under the credit
facility varied from either LIBOR or the prime rate in effect at the time of the
borrowing, plus a factor. The Company is also required to pay a commitment fee
of 0.5% of unused borrowings under the revolving credit line. Commitment fees
are included as a component of interest expense.

34

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The terms of the Company's credit facility contain certain milestones in
connection with raising amounts to repay borrowings. The consummation of the
sale of the publishing business in April 2002 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 did not
satisfy two other milestones with deadlines of February 28, 2002, and April 30,
2002. Not satisfying the first milestone resulted in a fee of $500 being paid to
the Company's lenders. Not satisfying 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
became exercisable on January 15, 2003, 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.

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
became obligated to issue additional warrants with an exercise price of $0.01 to
its lenders to purchase 453,377 shares of the Company's common stock if a
definitive agreement for an overall restructuring of the credit facility was not
reached by September 30, 2002. Such warrants, which were exercisable immediately
upon issuance in October 2002, had a fair value of $170. These warrants were
accounted for in the same manner as the warrants issued in May 2002.

The Company entered into an amendment to its credit facility in July 2001
(the "Fifth Amendment") that, among other changes, accelerated the maturity to
January 2003. As a result of the substantial modifications to the principal
payment schedule resulting from the Fifth Amendment, the Company's financial
statements reflect an extinguishment of old debt and the incurrence of new debt.
Accordingly, the Company recognized a loss on extinguishment of $3,410, net of
taxes of $2,451, as an extraordinary item. The Company also incurred additional
fees of $906 in 2001 in connection with the Fifth Amendment, which were deferred
and are being included as a component of interest expense over the remaining
term of the credit facility.

Under the terms of its credit facility, as amended, the Company must comply
with certain quarterly covenants related to leverage ratios, interest coverage
ratios, fixed charge ratios, and capital spending. In addition, the Company must
satisfy a minimum cumulative EBITDA 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 December 31, 2002.
Based on current projections, the Company believes it will be able to remain in
compliance with the covenant requirements through 2003, although there can be no
assurance that such compliance will be maintained.

At December 31, 2002, $162,214 was outstanding under the Company's credit
facility, of which $24,391 was outstanding under the revolving credit line and
$137,823 was outstanding under the term loans. The average variable rate on
borrowings under the Company's credit facilities for the years ended December
31, 2002, 2001, and 2000, was 7%, 8%, and 10%, respectively. The Company is
prohibited from paying dividends on its common stock under the terms of the
credit facility.

35

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The principal payments on debt are due as follows:

2003........................................................ $ 13,632
2004........................................................ 150,008
--------
Total....................................................... 163,640
Less current portion........................................ 13,632
--------
Total long-term debt........................................ $150,008
========

In April 2003, the Company entered into an amended and restated credit
agreement (the "Amended Credit Agreement") that extended the maturity of the
credit facility through April 2004. In connection with the Amended Credit
Agreement, the Company incurred fees totaling $2,000 to be paid quarterly and
issued immediately exercisable warrants with an exercise price of $0.01 per
share to its lenders to purchase 453,378 shares of the Company's common stock.
As part of the Amended Credit Agreement, the Company agreed that the failure of
the Company and its senior lenders to consummate a restructuring or
recapitalization on or before July 15, 2003, will constitute an event of
default. Such an event of default will result in the automatic acceleration of
amounts outstanding under the Amended Credit Agreement. Also as part of the
Amended Credit Agreement, the Company agreed that in addition to scheduled
principal payments, it would permanently repay $20,000 of borrowings by December
31, 2003. Failure to repay such borrowings would not constitute an event of
default, but would result in the Company paying additional fees of $2,000 to its
lenders upon maturity of the credit facility. Additionally, under the Amended
Credit Agreement, maximum availability under the Company's revolving credit line
was reduced from $66,000 to $63,500, and will be further reduced to $62,500 on
July 1, 2003, $60,500 on October 1, 2003, and $60,000 on January 1, 2004, Also,
the ability to borrow funds at interest rates based on LIBOR was restricted to
only those periods in which the Company's trailing twelve-month EBITDA (as
defined in the Amended Credit Agreement) exceeds $50,000. The Company does not
anticipate exceeding this EBITDA threshold, and therefore the Amended Credit
Agreement effectively requires the Company to borrow funds at interest rates
based on the prime rate for the foreseeable future. The Company does not believe
that the reduced borrowing capacity will have a material adverse effect on its
financial condition or liquidity.

In order to avoid an event of default under the Amended Credit Agreement,
the Company continues to negotiate with its senior lenders to consummate a
restructuring or recapitalization by July 2003. Any such restructuring or
recapitalization would most likely require an amendment or a repurchase at a
significant discount of the Company's subordinated notes. There can be no
assurances that the Company will reach an agreement with its senior lenders
before July 2003. The Company is also seeking other sources of financing,
including an overall recapitalization that would include an infusion of outside
equity and the settlement, at a significant discount, of amounts due to the
lenders for amounts borrowed under the credit facility, amounts due to holders
of the Company's subordinated notes, and amounts due to holders of preference
shares of a subsidiary of the Company. One such set of discussions with a third
party resulted in an offer being made that was accepted by most of the Company's
senior lenders, in both number of lenders and dollar amount of commitment, but
was rejected by a few of the senior lenders for not containing sufficient
consideration. The Company, however, continues to seek an overall
recapitalization, and another third party is currently in discussions with the
Company's senior lenders regarding an infusion of equity and the settlement of
their debt obligations at a significant discount. There can be no assurances as
to the terms or the success of any recapitalization, including the amount of new
equity and the amount of capital stock to be issued in connection therewith. The
potential impact of any such recapitalization on the holders of the Company's
presently outstanding common stock is similarly unknown at this time.

In the event that the Company is unable to restructure its credit facility
or obtain other sources of financing by July 2003, including an overall
recapitalization, the Company will seek to obtain a waiver from its

36

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

senior lenders for the event of default under the Amended Credit Agreement.
There can be no assurances that the Company will be able to obtain such waiver,
which would require unanimous approval from the Company's senior lenders.

11. DERIVATIVES

In accordance with the terms of its credit facility, the Company originally
entered into four interest rate swap agreements with an aggregate notional
amount of $90,000, one of which expired in August 2001 (the "August 2001 Swap"),
one of which expired in December 2001 (the "December 2001 Swap") (together, the
"2001 Swaps"), and two of which expire in August 2003 (the "2003 Swaps")
(collectively, the "Swaps"). The 2003 Swaps have an aggregate notional amount of
$50,000. Under the 2003 Swaps, the August 2001 Swap, and the December 2001 Swap,
the Company paid a fixed rate of 5.798%, 5.69%, and 6.45%, respectively, per
annum on a quarterly basis and was paid a floating rate based on the three-month
LIBOR rate in effect at the beginning of each quarterly payment period. Through
December 31, 2000, the Company accounted for the Swaps as hedges against the
variable interest rate component of the Company's credit facility.

On January 1, 2001, the Company adopted SFAS No. 133, as amended and
interpreted. In accordance with the provisions of SFAS No. 133, the Company
designated the Swaps as cash flow hedging instruments of the variable interest
rate component of the Company's credit facility. Upon the adoption of SFAS No.
133, the fair value of the Swaps, a net loss of $26, was recognized in "Other
noncurrent liabilities" and reflected, net of tax, as a cumulative effect of a
change in accounting principle in "Other comprehensive loss." As designated
hedging instruments, the change in fair value of the Swaps representing their
ineffectiveness was recognized as a component of interest expense in the
Consolidated Statement of Operations. The remaining change in fair value, which
represented the effective portion of the Swaps, was recognized as a component of
"Other comprehensive loss."

All previous hedging relationships terminated as a result of the debt
extinguishment recorded by the Company in connection with the Fifth Amendment.
Accordingly, the loss in "Accumulated other comprehensive loss" of $1,052
pertaining to the Swaps on the effective date of the Fifth Amendment is being
reclassified into earnings over the shorter of the remaining term of the
individual Swaps or the remaining term of the Company's credit facility.
Subsequent to the effective date of the Fifth Amendment, the 2003 Swaps did not
qualify for future hedge accounting, and the Company did not redesignate the
2001 Swaps as hedges. Therefore, all changes in fair value of the Swaps
subsequent to the termination of the hedging relationships have been and will be
included as a component of interest expense. The Company expects $21 of the loss
in "Accumulated other comprehensive loss" to be reclassified into earnings in
January 2003.

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APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The fair value of the Company's interest rate swaps was a net loss of
$1,403 and $2,235 at December 31, 2002 and 2001, respectively. The Company
recognized as a component of interest expense a non-cash benefit of $396 and a
non-cash charge of $1,763 for the years ended December 31, 2002 and 2001,
respectively, which consisted of the following:

12. SUBORDINATED NOTES AND MINORITY INTEREST

At the time of the acquisition by the Company of Wace Group Limited
("Wace") on May 21, 1999, Wace had L39,164, or approximately $62,733, of 8%
Cumulative Convertible Redeemable Preference Shares (the "Preference Shares")
outstanding. The Preference Shares carry the right to a fixed cumulative
preferential dividend of 8% and are redeemable on July 31, 2005, subject to the
availability of distributable reserves. On July 5, 1999, the Company offered
each holder of the Preference Shares the right to exchange such Preference
Shares, at an equivalent nominal rate, for subordinated notes issued by the
Company (the "Subordinated Notes"). As of December 31, 2002, L18,574, or
approximately $29,894, of the Preference Shares had been exchanged for
Subordinated Notes. The Subordinated Notes, which bear interest at a fixed
annual rate of 10% and mature on October 31, 2005, are subject to redemption by
the Company at any time after July 31, 2000. The initial redemption premium is
4% and decreases in 0.5% increments every six months until July 31, 2005, at
which time the Subordinated Notes are redeemable at par. The Subordinated Notes
are listed on the London Stock Exchange.

The Company recorded dividends of $2,476, $2,373, and $2,500 on the
Preference Shares for the years ended December 31, 2002, 2001, and 2000,
respectively, which are reflected as "Minority interest" in the Consolidated
Statements of Operations. Due to the lack of distributable reserves in Wace, the
Company is prohibited from making, and has not made, a dividend payment on the
Preference Shares since July 1999. Accrued dividends totaling $9,064 and $5,794
are included as part of "Minority Interest" in the Consolidated Balance Sheets
at December 31, 2002 and 2001, respectively. The Company incurred interest
expense of $2,791, $2,675, and $2,814 on the Subordinated Notes for the years
ended December 31, 2002, 2001, and 2000, respectively.

As part of its overall effort to restructure its debt, the Company
initiated a tender offer in July 2002 to acquire all of the outstanding
Subordinated Notes for an aggregate purchase price of $3,000. The tender offer
did not succeed and lapsed on August 27, 2002, with none of the tendered
Subordinated Notes being accepted by the Company for payment. Consequently, the
semi-annual interest payment on the Subordinated Notes, which was due on July
31, 2002, but was not paid by the Company while the tender offer remained open,
was paid on August 30, 2002. Such failure to pay the interest on its initial due
date did not constitute an event of default since payment was made by the
expiration of a 30-day grace period. In connection with the lapsed tender offer,
the Company incurred expenses of $297 that are included as a component of "Other
income (expense)" in the Consolidated Statement of Operations for the year ended
December 31, 2002.

In connection with the Company's discussions with third parties regarding
an infusion of outside equity, the Company did not pay the semi-annual interest
payment on the Subordinated Notes due on January 31,

38

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2003, until February 28, 2003. Such failure to pay the interest on its initial
due date did not constitute an event of default since payment was made by the
expiration of a 30-day grace period.

13. LEASES

The Company leases certain property and equipment used in its operations
under agreements that are classified as both capital and operating leases. Such
agreements generally include provisions for inflation-based rate adjustments
and, in the case of leases for buildings and office space, payments of certain
operating expenses and property taxes.

Future minimum rental payments required under capital leases and operating
leases that have initial or remaining noncancelable lease terms in excess of one
year are as follows:

Assets recorded under capital leases are included in property, plant, and
equipment as follows:

Total rental expense under operating leases amounted to $19,018, $24,587,
and $23,657, for the years ended December 31, 2002, 2001, and 2000,
respectively.

39

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. INCOME TAXES

The components of the provision (benefit) for income taxes were as follows:

The provision (benefit) for income taxes varied from the Federal statutory
income tax rate due to the following:

40

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company generated income (loss) from continuing operations before
provision for income taxes and minority interest for the years ended December
31, 2002, 2001, and 2000 as follows:

The components of the net deferred tax asset at December 31 were as
follows:

The Company has a net operating loss carryforward of $25,475 at December
31, 2002, of which $5,829 expires in 2021 and $19,646 expires in 2022. The
Company also has a capital loss carryforward of $3,470 relating to the sale of
its publishing business in April 2002 that expires in 2007. 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 future periods. Accordingly, the Company established a valuation
allowance in the amount of $17,539, of which $16,152 was included as part of the
cumulative effect of a change in accounting principle and $1,387, which related
to the capital loss carryforward, was included as part of the results of
discontinued operations.

15. STOCK OPTIONS

The Company has granted stock options under plans adopted in 1996 (the
"1996 Plans") and a plan adopted in 1998 (the "1998 Plan"). Under the 1996
Plans, options to purchase common stock of the Company were granted to key
employees of the Company and its affiliates. Options granted to employees under
the 1996 Plans have a term of ten years and initially became exercisable over a
five-year period in varying amounts, but in no event less than 5% or more than
25% in any year for any individual optionee. In May 2000, all outstanding
employee option grants under the 1996 Plans were amended to provide for ratable

41

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

vesting over the five-year period. Also under the 1996 Plans, options were
granted to members of the Board of Directors who were not employees. Under the
1996 Plans, newly appointed nonemployee directors were granted 10,000 options
that vested ratably over a two-year period, and on each anniversary of their
appointment were granted an additional 2,000 options that were fully vested on
the grant date. All options granted to nonemployee directors under the 1996
Plans had an exercise price equal to the fair market value on the grant date and
have a term of ten years. The 1996 Plans provided for a maximum of 1,680,000
shares of the Company's common stock to be available for issuance upon exercise
of options.

As of the adoption of the 1998 Plan, no further grants were made under the
1996 Plans. The 1998 Plan allows for the granting of options to purchase common
stock of the Company to employees of the Company and its affiliates, nonemployee
directors, and independent contractors. Options are granted under the 1998 Plan
to members of the Board of Directors who are not employees of the Company or any
of its affiliates in the same manner as under the provisions of the 1996 Plans.
Options granted under the 1998 Plan have a term of ten years unless a shorter
term is established at the date of grant. Initially, options granted under the
1998 Plan vested over a five-year period and, unless an alternative vesting
schedule was established in individual award agreements, vested 20% on the first
anniversary of the grant date, 5% on each of the second through fourth
anniversaries of the grant date, and 65% on the fifth anniversary of the grant
date. In May 2000, the 1998 Plan was amended to change the standard vesting
schedule on future grants to be ratable over a five-year period unless an
alternative vesting schedule is established in individual award agreements. In
addition, in May 2000, all outstanding grants under the 1998 Plan were amended
to provide for ratable vesting over a five-year period. The 1998 Plan provides
for a maximum of 2,800,000 shares of the Company's common stock to be available
for issuance upon exercise of options. At December 31, 2002, approximately
123,000 shares remained available for the issuance of stock options.

Information relating to activity in the Company's stock option plans is
summarized in the following table. All option grants included in the following
table had exercise prices equal to market price.

42

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Information relating to options outstanding at December 31, 2002, is
summarized as follows:

The Company accounts for the issuance of stock options to employees and
nonemployee directors in accordance with the provisions of APB No. 25, which
requires compensation cost to be measured at the date of grant based on the
intrinsic value of the options granted. The intrinsic value of an option is
equal to the difference between the market price of the common stock on the date
of grant and the exercise price of the option. There was no compensation cost
recognized by the Company on the options granted to employees and nonemployee
directors for the years ended December 31, 2002, 2001, and 2000.

The Company accounts for the issuance of stock options to nonemployees,
other than directors, in accordance with the provisions of SFAS No. 123, which
requires the cost of a transaction to be measured at the date of grant based on
the fair value of the options granted. SFAS No. 123 also provides for an
alternative measurement of compensation cost based on the fair value of the
options granted to employees and directors. The fair value of an option is based
on the intrinsic value as well as the time value of the option. The fair value
of stock options granted was estimated on the grant dates using the
Black-Scholes option-pricing model. During 2001, the Company granted 30,000
options with a three-year vesting period to employees of its affiliates who
provide legal support services. The fair value of these option grants of
approximately $86 is being recognized as compensation expense over the vesting
period. In addition, during 2001 the Company granted 20,833 options with a fair
value of $8 to a nonemployee director for consulting services. For the years
ended December 31, 2002, 2001, and 2000, the Company incurred $11, $41, and $21,
respectively, of compensation expense related to all nonemployee option grants.

The following weighted average assumptions were used in calculating the
fair value of options granted:

16. EARNINGS PER SHARE

Basic earnings per share of common stock are computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding. Diluted earnings per share of common stock are computed by giving
effect to all dilutive potential shares. There were no reconciling items to net
income to arrive at income available to common stockholders. The number of
common shares used in

43

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the computation of basic and diluted earnings per share for the years ended
December 31, 2002, 2001, and 2000, including pro forma computations, are
summarized as follows:

The number of shares used in the calculation of diluted earnings per share
for the year ended December 31, 2002, excludes approximately 323,000 incremental
shares related to stock options and warrants. Such incremental shares are
excluded from the calculation of diluted earnings per share due to their
antidilutive effect.

17. RELATED PARTY TRANSACTIONS

At December 31, 2002, Applied Printing Technologies, L.P. ("Applied
Printing"), an entity beneficially owned by Fred Drasner, Chief Executive
Officer and Chairman of the Board of Directors of the Company, and Mortimer B.
Zuckerman, the former Chairman of the Board of Directors and a director of the
Company, owned approximately 22.0% of the Company's outstanding common stock.
The Company conducted business with Applied Printing and other affiliates
beneficially owned by Mr. Drasner and Mr. Zuckerman, including the Daily News,
L.P. (the "Daily News") and U.S. News & World Report, L.P. ("U.S. News"). The
Company does not guarantee any arrangements on behalf of its affiliates and has
not entered into any transactions with affiliates outside of the normal course
of business other than those disclosed.

DUE TO/FROM AFFILIATES -- Affiliates owed the Company $405 and $4,028 at
December 31, 2002 and 2001, respectively, representing trade receivables. The
Company owed affiliates $442 and $1,278 at December 31, 2002 and 2001,
respectively.

AFFILIATE SALES AND PURCHASES -- The Company provided content management
and digital services to U.S. News, the Daily News, and Applied Printing
primarily pursuant to written agreements. The Company also occasionally provides
services to and purchases services from related parties in addition to those
services covered by these agreements. Sales to and purchases from related
parties for the years ended December 31, 2002, 2001, and 2000, were as follows:

Sales to affiliates represented 1.2%, 2.0%, and 2.0%, of the Company's
revenues for the years ended December 31, 2002, 2001, and 2000, respectively.

SHARED SERVICES -- The Company receives certain legal, computer, and
administrative services from the Daily News and U.S. News. For such services,
the Company incurred charges of $970, $1,454, and $1,138, for the years ended
December 31, 2002, 2001, and 2000, respectively.

LEASES -- The Company leased office space in Washington, D.C., from U.S.
News for which it incurred charges of $47, $275, and $267, for the years ended
December 31, 2002, 2001, and 2000, respectively. The lease for this space was
terminated in February 2002 in connection with the termination of the agreement
with U.S. News to provide services. The Company leased a facility in New York
City from the Daily News for the years ended December 31, 2002 and 2001, and a
portion of the year ended December 31, 2000, for which the Company incurred
charges of $104, $101, and $15, respectively. The Company also incurred charges
with
44

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

U.S. News of $390, $360, and $220 for the years ended December 31, 2002, 2001,
and 2000, respectively, for leasing additional space used by the Company at its
corporate headquarters in New York City. The Company also incurred charges with
Applied Printing of $71 in 2001 for leasing certain office space and equipment.

18. RETIREMENT PLANS

The Company has a defined contribution plan in which eligible employees who
have attained 21 years of age may contribute on both a pretax and after-tax
basis. Company contributions vest ratably over each of the first five years of
service. The Company also has other various defined contribution plans covering
employees at certain acquired operations who meet certain eligibility
requirements. Company contributions to all plans totaled $2,746, $3,736, and
$3,278 for the years ended December 31, 2002, 2001, and 2000, respectively.

The Company also contributes to various multi-employer benefit plans that
cover employees pursuant to collective bargaining agreements. The total
contributions to multi-employer plans charged to operations for the years ended
December 31, 2002, 2001, and 2000, were $553, $620, and $807, respectively.

19. COMMITMENTS AND CONTINGENT LIABILITIES

The Company is contingently liable as a result of transactions arising in
the ordinary course of business and is involved in certain legal proceedings in
which damages and other remedies are sought. In the opinion of Company
management, after review with counsel, the ultimate resolution of these matters
will not have a material effect on the Company's Consolidated Financial
Statements.

20. GUARANTEES

In connection with the acquisition of Wace in May 1999, the Company assumed
an obligation to indemnify the purchaser of a business formerly owned by Wace
for certain tax positions taken in the United Kingdom related to such business.
If the tax authorities in the United Kingdom rule against the position taken by
Wace, the Company would be required to reimburse the purchaser for the
additional tax due for the periods such business was owned by Wace. The maximum
amount for which the Company may be held liable is approximately $6,200. The
Company has recorded a liability of approximately $2,200 related to this matter,
which is included as part of "Other current liabilities" in the Consolidated
Balance Sheet at December 31, 2002. Additionally, at the time of the sale, Wace
established an escrow fund related to this matter, which had a balance of $6,400
at December 31, 2002.

In connection with the sales of certain businesses formerly owned by the
Company, the Company agreed to indemnify the respective purchasers for breaches
of certain standard representations and warranties, including tax and
environmental matters. In the event any such indemnification obligation were to
be triggered, the Company may be liable to the extent that the damages incurred
by the purchaser exceed certain thresholds contained in the sale agreements.
There is no limit on the Company's maximum exposure for these matters. The
Company has recorded a liability of $1,500 related to such potential
contingencies on the sale of its publishing business, which is included as part
of "Other current liabilities" in the Consolidated Balance Sheet at December 31,
2002. At the time of the sale of its publishing business, the Company
established an escrow fund for such contingencies, which had a balance of $1,500
at December 31, 2002.

The Company has entered into subleases with third parties relating to
properties no longer occupied and equipment no longer used by the Company. Under
certain of these subleases, the third party remits payment directly to the
landlord or lessor, although the Company remains the primary obligor for the
lease payments. If any of these third parties ceased to remit payment directly
to the landlord or lessor, the Company would be liable to make such payments.
The maximum potential amount for which the Company can be held liable is
approximately $4,900. The Company has recorded a liability of approximately
$1,000 related to these

45

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

subleases, which is included as part of "Other current liabilities" in the
Consolidated Balance Sheet at December 31, 2002.

21. CONCENTRATION OF CREDIT RISK

Other than interest rate swap agreements (see Note 11 to the Consolidated
Financial Statements), financial instruments that potentially subject the
Company to concentrations of credit risk consist principally of cash equivalents
and trade receivables. The Company maintains cash balances and cash equivalents
with high credit quality financial institutions.

The Company provides credit to customers on an uncollateralized basis after
evaluating customer creditworthiness. The Company's customers are not
concentrated in any specific geographic region, but are concentrated in the
publishing, advertising agency, entertainment, and retailing businesses. The
Company's five largest nonaffiliated customers provided 36%, 33%, and 28% of
revenues for the years ended December 31, 2002, 2001, and 2000, respectively. In
addition, amounts due from these customers represented 33% and 31% of trade
accounts receivable at December 31, 2002 and 2001, respectively. The Company's
two largest customers are Sears Roebuck & Co. ("Sears") and Kmart Corporation
("Kmart"). For the years ended December 31, 2002, 2001, and 2000, revenues from
Sears represented approximately 11.5%, 11.3%, and 9.1%, respectively, and
revenues from Kmart represented approximately 11.8%, 11.1%, and 8.3%,
respectively, of the Company's consolidated revenues.

Any termination or significant disruption of the Company's relationships
with any of its principal customers could have a material adverse effect on the
Company's business, financial condition, results of operations, and cash flows.

On January 22, 2002, Kmart 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.

22. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Payments of interest and income taxes were as follows:

46

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Noncash investing and financing activities were as follows:

23. FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of financial instruments have been determined by
the Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required in interpreting market
data to develop estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts that the Company could
realize in a current market exchange.

The carrying amount and estimated fair values of financial instruments at
December 31 are summarized as follows:

The following methods and assumptions were used to estimate the fair value
of financial instruments presented above:

CASH AND CASH EQUIVALENTS -- the carrying amount is a reasonable
approximation of fair value.

OTHER CURRENT ASSETS -- the carrying amount of non-trade accounts
receivable is a reasonable approximation of fair value.

LONG-TERM DEBT -- the fair value of notes payable, including the current
portion, is estimated by discounting the future streams of payments using the
rate at which the Company can currently obtain funds under its credit facility.
The carrying amount of the amounts outstanding under the Company's credit
facility is a reasonable approximation of fair value since it is a variable-rate
obligation.

47

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

SUBORDINATED NOTES -- the fair value of the Subordinated Notes at December
31, 2002 and 2001, is estimated based on quoted market prices.

MINORITY INTEREST -- the fair value of the Preference Shares is estimated
by discounting the future stream of payments using the rate at which the Company
can currently obtain funds under its credit facility.

OBLIGATIONS UNDER CAPITAL LEASES -- the fair value of obligations under
capital leases, including the current portion, is estimated by discounting the
future streams of payments using the rate at which the Company can currently
obtain funds under its credit facility.

INTEREST RATE SWAP AGREEMENTS -- the fair value of the interest rate swap
agreements is the estimated amount the Company would receive or have to pay to
terminate the agreements.

24. SEGMENT INFORMATION

The Company has determined that its only reportable segment is content
management services. The content management services segment provides creative
and editorial design services and prepress services, which combine text with
pictures and graphics into page layout format for reproduction. The Company
provides content management services to retailers, magazine and book publishers,
advertising agencies, consumer goods companies, entertainment companies, and
automobile manufacturers.

The Company identifies its reportable segments based on the services
provided by its various operations. The content management services segment is
an aggregation of such services the Company offers at its own facilities and the
similar services provided at customer locations under facilities management
contracts. The Company's other operating segments are broadcast media
distribution services and digital services, neither of which are reportable
segments because they do not meet the quantitative thresholds, and are reported
as "Other operating segments" in the following disclosure.

The Company previously reported its publishing business as a reportable
segment. This segment, which sells greeting cards, calendars, art prints, and
other wall decor products to mass-market merchants, card shops, bookstores, art
galleries, designers, and framers, was sold in April 2002 and is reported as a
discontinued operation (see Note 3 to the Consolidated Financial Statements).

The Company measures profit or loss of its segments based on operating
income. Operating income for segments excludes amortization of intangible
assets, gain (loss) on disposal of property and equipment, gain on sale of
businesses, restructuring income (charges), and impairment charges. The
accounting policies used to measure operating income of the segments are the
same as those outlined in Note 2 to the Consolidated Financial Statements.

Segment information relating to results of continuing operations was as
follows:

48

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Segment information related to the Company's assets was as follows:

49

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's publishing business generated revenues in foreign countries
of $3,792, $13,846, and $15,038 for the years ended December 31 2002, 2001, and
2000, respectively, and had long-lived assets in foreign countries of $733 as of
December 31, 2001. Segment information for continuing operations relating to
geographic regions for 2002, 2001, and 2000 was as follows:

25. COMPREHENSIVE INCOME

Comprehensive income includes all changes to equity that are not the result
of transactions with shareholders and is comprised of net income and other
comprehensive income. No income tax effect is reported for unrealized gains and
losses from foreign currency translation adjustments since they relate to
indefinite investments in foreign subsidiaries. The components of "Other
comprehensive loss" in the Consolidated Statements of Operations, including
related tax effects, for the years ended December 31, 2002, 2001, and 2000, were
as follows:

50

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The after-tax components of "Accumulated other comprehensive loss" in the
Consolidated Balance Sheets at December 31 were as follows:

26. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

51

APPLIED GRAPHICS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

- ---------------
(1) Includes a gain of $115 on disposal of property and equipment.

(2) Includes a charge of $1,440 related to the impairment of goodwill and a loss
of $234 on disposal of property and equipment.

(3) Includes a restructuring charge of $2,059, a charge of $361 related to the
impairment of long-lived assets, and a loss on disposal of property and
equipment of $182.

(4) Includes a charge of $71,776 related to the impairment of goodwill, a
restructuring charge of $1,300, a charge of $322 related to the impairment
of long-lived assets, and a gain on disposal of property and equipment of
$71.

(5) Includes a gain on the sale of marketable securities of $665.

(6) Includes a restructuring charge of $1,167 and a loss on disposal of property
and equipment of $1,948.

(7) Includes a loss on disposal of property and equipment of $266.

(8) Includes a restructuring charge of $15,000, a charge of $8,952 related to
the impairment of long-lived assets, and a loss on disposal of property and
equipment of $527.

52

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

53

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

(a)Directors. -- The information with respect to directors required by this
item is incorporated herein by reference to the Company's 2003
Definitive Proxy Statement to be separately filed with the Securities
and Exchange Commission by April 30, 2003.

(b)Executive Officers. -- The information with respect to officers required
by this item is included at the end of Part I of this document under the
heading Executive Officers of the Company.

ITEM 11. EXECUTIVE COMPENSATION.

The information required by this item is incorporated herein by reference
to the Company's 2003 Definitive Proxy Statement to be separately filed with the
Securities and Exchange Commission by April 30, 2003.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.

Except as set forth below, the information required by this item is
incorporated herein by reference to the Company's 2003 Definitive Proxy
Statement to be separately filed with the Securities and Exchange Commission by
April 30, 2003.

The following table sets forth certain information as of December 31, 2002,
with respect to the Company's equity compensation plans under which equity
securities of the Company are authorized for issuance.

EQUITY COMPENSATION PLAN INFORMATION

The Company does not have any equity compensation plans that have not been
authorized by its stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information required by this item is incorporated herein by reference
to the Company's 2003 Definitive Proxy Statement to be separately filed with the
Securities and Exchange Commission by April 30, 2003.

ITEM 14. CONTROLS AND PROCEDURES.

(a) The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the rules and
forms of the Securities and Exchange Commission. Such information is accumulated
and communicated to the Company's management, including its principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. The Company's management, including its
principal executive officer and principal financial officer, recognizes that any
set of controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives.

54

Within 90 days prior to the filing date of this annual report on Form 10-K,
the Company has carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's principal
executive officer and the Company's principal financial officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based on such evaluation, the Company's principal executive
officer and principal financial officer concluded that the Company's disclosure
controls and procedures are effective.

(b) There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of their evaluation in connection with the
preparation of this annual report on Form 10-K.

55

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a) Listed below are the documents filed as a part of this report:

1. Financial Statements and the Independent Auditors' Report:

Independent Auditors' Report.

Consolidated Balance Sheets as of December 31, 2002 and 2001.

Consolidated Statements of Operations for the Years Ended December 31,
2002, 2001, and 2000.

Consolidated Statements of Cash Flows for the Years Ended December 31,
2002, 2001, and 2000.

Consolidated Statements of Stockholders' Equity (Deficit) for the
Years Ended December 31, 2002, 2001, and 2000.

Notes to Consolidated Financial Statements.

2. Financial Statement Schedules:

Schedule II -- Valuation and Qualifying Accounts for the years ended
December 31, 2002, 2001, and 2000.

3. 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 Annual 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 Quarterly
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 Quarterly 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 Annual
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).

56

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 Quarterly
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).
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 Annual 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 Annual 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).
10.7 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).

57

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
Quarterly 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
Quarterly 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 Second Amended and Restated Credit Agreement, dated as of
April 15, 2003, among Applied Graphics Technologies, Inc.,
Other Institutional Lenders, and Fleet National Bank as
Administrative Agent.
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 Quarterly 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).
21 Subsidiaries of the Registrant.
23 Consent of Deloitte & Touche LLP.
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 December 31, 2002.

58

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 (Duly authorized officer)

Date: April 15, 2003

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on April 15, 2003.

59

CERTIFICATION

I, Fred Drasner, certify that:

1. I have reviewed this annual report on Form 10-K of Applied Graphics
Technologies, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):

(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

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

April 15, 2003

60

CERTIFICATION

I, Kenneth G. Torosian, certify that:

1. I have reviewed this annual report on Form 10-K of Applied Graphics
Technologies, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):

(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ KENNETH G. TOROSIAN
--------------------------------------
Kenneth G. Torosian
Senior Vice President, Chief Financial
Officer, and Treasurer

April 15, 2003

61

APPLIED GRAPHICS TECHNOLOGIES, INC.

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(IN THOUSANDS OF DOLLARS)

- ---------------
(1) Represents amounts written off.

62