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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-16431
APPLIED GRAPHICS TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 13-3864004
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
450 WEST 33RD STREET 10001
NEW YORK, NY (Zip Code)
(Address of principal executive offices)
212-716-6600
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
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 whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The number of shares of the registrant's common stock outstanding as of
July 31, 2003, was 9,147,565.
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APPLIED GRAPHICS TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER-SHARE AMOUNTS)
JUNE 30, DECEMBER 31,
2003 2002
--------- ------------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 6,431 $ 4,724
Trade accounts receivable (net of allowances of $6,200 in
2003 and $8,273 in 2002)............................... 82,793 89,661
Due from affiliates....................................... 363 405
Inventory................................................. 18,501 16,608
Prepaid expenses.......................................... 9,280 4,629
Deferred income taxes..................................... 14,104 14,104
Other current assets...................................... 1,005 2,830
--------- ---------
Total current assets................................... 132,477 132,961
Property, plant, and equipment -- net....................... 53,260 56,906
Other intangible assets -- net.............................. 1,586 1,364
Deferred income taxes....................................... 1,616 1,753
Other assets................................................ 685 7,110
--------- ---------
Total assets........................................... $ 189,624 $ 200,094
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable.......................................... $ 12,329 $ 14,932
Accrued expenses.......................................... 45,887 56,936
Current portion of long-term debt and obligations under
capital leases......................................... 131,081 14,050
Due to affiliates......................................... 189 442
Restructuring liabilities................................. 8,229 10,585
Other current liabilities................................. 17,928 23,722
--------- ---------
Total current liabilities.............................. 215,643 120,667
Long-term debt.............................................. 46,233 150,008
Subordinated notes.......................................... 30,700 29,894
Obligations under capital leases............................ 100 204
Other liabilities........................................... 7,433 8,638
--------- ---------
Total liabilities...................................... 300,109 309,411
--------- ---------
Commitments and contingencies
Minority interest -- Redeemable Preference Shares issued by
subsidiary................................................ 43,651 42,045
--------- ---------
Stockholders' Deficit:
Preferred stock (no par value, 10,000,000 shares
authorized; no shares outstanding).....................
Common stock ($0.01 par value, 150,000,000 shares
authorized; 9,147,565 shares issued and outstanding in
2003 and 2002)......................................... 92 92
Additional paid-in capital................................ 390,773 390,768
Accumulated other comprehensive loss...................... (1,524) (653)
Retained deficit.......................................... (543,477) (541,569)
--------- ---------
Total stockholders' deficit............................ (154,136) (151,362)
--------- ---------
Total liabilities and stockholders' deficit............ $ 189,624 $ 200,094
========= =========
See Notes to Interim Consolidated Financial Statements
1
APPLIED GRAPHICS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)
FOR THE SIX MONTHS FOR THE THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
2003 2002 2003 2002
-------- --------- -------- ---------
Revenues........................................... $196,832 $ 204,454 $99,086 $105,933
Cost of revenues................................... 130,106 139,004 65,141 71,339
-------- --------- ------- --------
Gross profit....................................... 66,726 65,450 33,945 34,594
-------- --------- ------- --------
Selling, general, and administrative expenses...... 60,102 60,622 29,104 30,066
Amortization of intangibles........................ 203 174 112 93
Loss (gain) on disposal of property and
equipment........................................ (4) 119 71 234
Restructuring charges.............................. 99 99
Impairment of goodwill............................. 1,440 1,440
-------- --------- ------- --------
Operating income................................... 6,326 3,095 4,559 2,761
Interest expense................................... (8,975) (9,238) (4,698) (5,149)
Interest income.................................... 118 125 53 69
Other income (expense) -- net...................... (723) (117) (729) (22)
-------- --------- ------- --------
Loss from continuing operations before provision
for income taxes and minority interest........... (3,254) (6,135) (815) (2,341)
Provision (benefit) for income taxes............... (1,139) (486) (285) 29
-------- --------- ------- --------
Loss from continuing operations before minority
interest......................................... (2,115) (5,649) (530) (2,370)
Minority interest.................................. (1,327) (1,190) (667) (602)
-------- --------- ------- --------
Loss from continuing operations.................... (3,442) (6,839) (1,197) (2,972)
Income (loss) from discontinued operations......... 1,534 (5,846) 1,534 348
Cumulative effect of change in accounting
principle........................................ (327,875)
-------- --------- ------- --------
Net income (loss).................................. (1,908) (340,560) 337 (2,624)
Other comprehensive income (loss).................. (871) 44 (1,446) (270)
-------- --------- ------- --------
Comprehensive loss................................. $ (2,779) $(340,516) $(1,109) $ (2,894)
======== ========= ======= ========
Basic income (loss) per common share:
Loss from continuing operations.................. $ (0.38) $ (0.75) $ (0.13) $ (0.33)
Income (loss) from discontinued operations....... 0.17 (0.64) 0.17 0.04
Cumulative effect of change in accounting
principle..................................... (36.00)
-------- --------- ------- --------
Total............................................ $ (0.21) $ (37.39) $ 0.04 $ (0.29)
======== ========= ======= ========
Diluted income (loss) per common share:
Loss from continuing operations.................. $ (0.38) $ (0.75) $ (0.13) $ (0.33)
Income (loss) from discontinued operations....... 0.17 (0.64) 0.17 0.04
Cumulative effect of change in accounting
principle..................................... (36.00)
-------- --------- ------- --------
Total............................................ $ (0.21) $ (37.39) $ 0.04 $ (0.29)
======== ========= ======= ========
Weighted average number of common shares:
Basic............................................ 9,148 9,108 9,148 9,148
Diluted.......................................... 9,148 9,108 9,148 9,148
See Notes to Interim Consolidated Financial Statements
2
APPLIED GRAPHICS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS OF DOLLARS)
FOR THE SIX MONTHS ENDED
JUNE 30,
------------------------
2003 2002
---------- -----------
Cash flows from operating activities:
Net loss.................................................... $ (1,908) $(340,560)
Adjustments to reconcile net loss to net cash from operating
activities:
Loss (income) from discontinued operations................ (1,534) 5,846
Depreciation and amortization............................. 8,075 8,981
Deferred taxes............................................ (1,089)
Loss (gain) on disposal of property and equipment......... (4) 119
Provision for bad debts................................... (101) (776)
Cumulative effect of change in accounting principle....... 328,529
Impairment of goodwill.................................... 1,440
Other..................................................... 1,545 1,580
Changes in operating assets and liabilities, net of effects
of dispositions:
Trade accounts receivable................................. 7,337 8,342
Due from/to affiliates.................................... (210) (979)
Inventory................................................. (1,841) (3,762)
Other assets.............................................. 5,016 (685)
Accounts payable and accrued expenses..................... (14,020) (2,378)
Other liabilities......................................... (6,980) (2,981)
Net cash provided by operating activities of discontinued
operations............................................. 795
-------- ---------
Net cash provided by (used in) operating activities......... (4,625) 2,422
-------- ---------
Cash flows from investing activities:
Property, plant, and equipment expenditures............... (4,628) (6,681)
Proceeds from sale of property and equipment.............. 442 286
Proceeds from the sale of a business...................... 33,503
Other..................................................... (720)
Net cash used in investing activities of discontinued
operations............................................. (93)
-------- ---------
Net cash provided by (used in) investing activities......... (4,186) 26,295
-------- ---------
Cash flows from financing activities:
Repayments of term loans.................................. (13,526) (31,500)
Borrowings under revolving credit line -- net............. 27,009 2,800
Repayments of notes and capital lease obligations......... (333) (581)
Payment of debt financing fees............................ (2,780) (1,025)
Net cash used in financing activities of discontinued
operations............................................. (279)
-------- ---------
Net cash provided by (used in) financing activities......... 10,370 (30,585)
-------- ---------
Net increase (decrease) in cash and cash equivalents........ 1,559 (1,868)
Effect of exchange rate changes on cash and cash
equivalents............................................... 148 27
Cash and cash equivalents at beginning of period............ 4,724 4,949
-------- ---------
Cash and cash equivalents at end of period.................. $ 6,431 $ 3,108
======== =========
See Notes to Interim Consolidated Financial Statements
3
APPLIED GRAPHICS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
(UNAUDITED)
(IN THOUSANDS OF DOLLARS)
FOR THE SIX MONTHS ENDED JUNE 30, 2003
-----------------------------------------------
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN COMPREHENSIVE RETAINED
STOCK CAPITAL LOSS DEFICIT
------ ---------- ------------- ---------
Balance at January 1, 2003...................... $92 $390,768 $ (653) $(541,569)
Compensation cost of vested stock options issued
to non-employees.............................. 5
Reclassification adjustment for losses realized
in net income................................. 19
Reclassification of cumulative effect of change
in accounting principle....................... 2
Unrealized loss from foreign currency
translation adjustments....................... (892)
Net loss........................................ (1,908)
--- -------- ------- ---------
Balance at June 30, 2003........................ $92 $390,773 $(1,524) $(543,477)
=== ======== ======= =========
4
APPLIED GRAPHICS TECHNOLOGIES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS OF DOLLARS)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Applied Graphics Technologies, Inc., and its subsidiaries (the "Company"), which
have been prepared in accordance with the instructions to Form 10-Q and,
therefore, do not include all information and footnotes necessary for a fair
presentation of financial position, results of operations, and cash flows in
conformity with generally accepted accounting principles, should be read in
conjunction with the notes to consolidated financial statements contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 2002. In
the opinion of the management of the Company, all adjustments (consisting
primarily of normal recurring accruals) necessary for a fair presentation have
been included in the financial statements. The operating results of any quarter
are not necessarily indicative of results for any future period.
Certain prior-period amounts in the accompanying financial statements have
been reclassified to conform with the 2003 presentation.
2. TENDER OFFER AND RECAPITALIZATION
On August 4, 2003, KAGT Acquisition Corp., a wholly-owned subsidiary of
KAGT Holdings, Inc., an affiliate of funds managed by Kohlberg & Co., LLC
("Kohlberg"), completed a tender offer for the Company with 6,081,145 shares of
the Company's outstanding common stock, or approximately 66% of the total shares
outstanding, being validly tendered and accepted for payment. Concurrent with
the closing of the tender offer, the Company completed a restructuring and
extinguishment of its existing credit facility. The tender offer and the
extinguishment of the existing credit facility are part of an overall
recapitalization in which the Company also redeemed all of its outstanding
subordinated notes and all of the outstanding preference shares of a subsidiary
of the Company. KAGT Acquisition Corp. plans to acquire the Company's remaining
outstanding shares of common stock through a second-step merger, which is
expected to be consummated within the next several months.
The overall recapitalization is being funded with $52,000 from KAGT
Acquisition Corp., of which $44,200 will initially be subordinated debt of the
Company (the "KAGT Note") and all of which will be converted into equity upon
completion of the second-step merger, and approximately $72,500 of debt under a
new credit facility entered into by the Company with a new lender group. Of the
total funding, approximately $97,700 was used to fully repay $176,097 of
borrowings outstanding under the Company's old credit facility at the closing of
the tender offer, and approximately $7,800 will be paid directly to holders of
the Company's common stock by KAGT Acquisition Corp., of which approximately
$5,200 was paid upon the closing of the tender offer and approximately $2,600
will be paid upon completion of the second-step merger. The $5,200 that was paid
upon the closing of the tender offer was provided to KAGT Acquisition Corp. as
equity financing by funds managed by Kohlberg and another investor. In addition,
approximately $9,000 was paid to fully redeem the outstanding subordinated
notes, including accrued interest, and approximately $6,300 was paid to fully
redeem the outstanding preference shares, of which $1,800 is committed to be
reinvested in the Company by certain holders of the preference shares in the
form of a subordinated note. The remaining funding of $3,700 will be paid to
cover fees and expenses of the transaction, including bank fees. Additional fees
totaling approximately $4,000, including approximately $3,000 to be paid to
Kohlberg, were deferred at the time of the closing of the tender offer and will
be paid from working capital or borrowings under the Company's new credit
facility.
5
APPLIED GRAPHICS TECHNOLOGIES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amounts outstanding at June 30, 2003, for the Company's various
obligations impacted by the recapitalization, and the amounts outstanding for
such obligations upon the closing of the tender offer and assuming the
completion of all transactions contemplated by the recapitalization, including
the second-step merger and the conversion of the KAGT Note into equity, are as
follows:
JUNE 30, AFTER TENDER AFTER
2003 OFFER CLOSING SECOND-STEP MERGER
-------- ------------- ------------------
Credit facility debt......................... $175,697 $ 72,469 $70,669
Subordinated notes (including $1,279 of
accrued interest).......................... 31,979 -- --
Preference shares issued by subsidiary....... 43,651 -- --
Other subordinated debt...................... -- 44,200 1,800
-------- -------- -------
Total........................................ $251,327 $116,669 $72,469
======== ======== =======
3. 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
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:
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
------------------- ------------------
2003 2002 2003 2002
------- --------- ------- --------
Net income (loss) as reported................. $(1,908) $(340,560) $ 337 $(2,624)
Stock-based compensation expense, net of tax,
included in net income (loss) as reported... -- -- -- --
Stock-based compensation expense, net of tax,
under fair value method..................... (624) (934) (314) (470)
------- --------- ------ -------
Pro forma net income (loss)................... $(2,532) $(341,494) $ 23 $(3,094)
======= ========= ====== =======
Basic and diluted net income (loss) per share
as reported................................. $ (0.21) $ (37.39) $ 0.04 $ (0.29)
Pro forma basic and diluted net income (loss)
per share................................... $ (0.28) $ (37.49) $ -- $ (0.34)
Upon the closing of the tender offer, the Company repurchased 923,000
in-the-money stock options held by employees and non-employee directors for
approximately $400. The amount paid to repurchase each in-the-money stock option
was the difference between the price paid per share in connection with the
tender offer and the exercise price of such stock option. All remaining stock
options were cancelled without further payment.
4. RESTRUCTURING
The Company initiated and completed a plan during the second quarter of
2003 (the "2003 Second Quarter Plan") to close its Rochester, New York, facility
and move its operations to existing facilities in New York City and Nashua, New
Hampshire. In connection with the "2003 Second Quarter Plan" the Company
incurred a charge of $99, which consisted of $95 for a lease termination
payment, $3 for severance related to the termination of one employee, and $1 for
future rental obligations on abandoned equipment.
6
APPLIED GRAPHICS TECHNOLOGIES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In addition, the Company initiated various restructuring plans in prior
periods (the "2002 Third Quarter Plan," the "2001 Fourth Quarter Plan," the
"2001 Second Quarter Plan," the "2000 Second Quarter Plan," and the "1999 Fourth
Quarter Plan," respectively) under which it continues to make certain payments.
During the six months ended June 30, 2003, the Company paid $2,454 related to
all of its various restructuring plans, and the Company had a liability of
$8,229 for the future payments associated with the various restructuring plans
as of June 30, 2003. The remaining liability for future payments and the amounts
charged against the respective restructuring liabilities during the six months
ended June 30, 2003, were as follows:
2003 SECOND 2002 THIRD 2001 FOURTH
QUARTER PLAN QUARTER PLAN QUARTER PLAN
------------ ------------ ------------
Balance at January 1, 2003....................... $1,725 $ 8,170
Restructuring charge............................. $ 99
Facility closure costs........................... (95) (305) (1,673)
Employee termination costs....................... (3) (7) (159)
Abandoned leased equipment....................... (1) (68) (45)
---- ------ -------
Balance at June 30, 2003......................... $ -- $1,345 $ 6,293
==== ====== =======
2001 SECOND 2000 SECOND 1999 FOURTH
QUARTER PLAN QUARTER PLAN QUARTER PLAN
------------ ------------ ------------
Balance at January 1, 2003....................... $269 $409 $ 12
Facility closure costs........................... (87)
Abandoned leased equipment....................... (12)
---- ---- ----
Balance at June 30, 2003......................... $269 $322 $ --
==== ==== ====
The number of employees paid during the six months ended June 30, 2003,
that resulted in a reduction of the restructuring plans' liabilities for
employee termination costs were one for the 2003 Second Quarter Plan, one for
the 2002 Third Quarter Plan, and two for the 2001 Fourth Quarter Plan.
5. DISCONTINUED OPERATIONS
In connection with the sale of the Company's publishing business in April
2002, a portion of the proceeds were originally held in escrow under the terms
of the sale to satisfy any claims related to contractual warranties. The Company
received $500 from the escrow in November 2002, and received the remaining
$1,534 in April 2003. Additionally, in the second quarter of 2003, the Company
recognized $1,534 of income from discontinued operations from the reversal of
liabilities originally established to cover such contingencies.
6. INVENTORY
The components of inventory were as follows:
JUNE 30, DECEMBER 31,
2003 2002
-------- ------------
Work-in-process............................................. $17,059 $14,554
Raw materials............................................... 1,442 2,054
------- -------
Total....................................................... $18,501 $16,608
======= =======
7
APPLIED GRAPHICS TECHNOLOGIES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. LONG TERM DEBT
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. 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, would
constitute an event of default. In July 2003, the Company and its senior lenders
entered into amendments to the Amended Credit Agreement extending the deadline
for the restructuring or recapitalization to July 31, 2003.
On August 4, 2003, in connection with the tender offer and the
recapitalization (see Note 2 to the Interim Consolidated Financial Statements),
the Company settled all amounts outstanding under the Amended Credit Agreement,
which totaled $176,097, and entered into a Loan and Security Agreement with a
new lender group that matures in August 2008 (the "Loan Agreement"). The Loan
Agreement provides for two term loans totaling $22,000 and $27,000 ("Term Loan
A" and "Term Loan B," respectively) and a revolving credit line with a maximum
availability of $58,000, subject to a borrowing base limitation based on
receivables. Borrowings under the Loan Agreement will be secured by all of the
receivables, inventory, and real and personal property of the Company and
certain of its subsidiaries. The interest rate on funds borrowed under the
revolving credit line of the Loan Agreement is either LIBOR plus 3.00% or the
prime rate plus 1.50%. The interest rates on Term Loan A and Term Loan B are the
prime rate plus 2.00% and 8.25%, respectively.
Initial borrowings on August 4, 2003, under the Loan Agreement totaled
$72,469, a portion of which were used to partially settle the amounts
outstanding under the Amended Credit Agreement. The non-current portion of the
amounts borrowed under the Loan Agreement are therefore reflected as non-current
in the Company's Consolidated Balance Sheet at June 30, 2003.
Under the terms of the Loan Agreement, the Company will have to comply with
certain quarterly covenants related to minimum EBITDA (as defined in the Loan
Agreement), fixed charge ratios, leverage ratios, and capital spending.
8. DERIVATIVES
The fair value of the Company's interest rate swaps was a net loss of $279
and $1,954 at June 30, 2003 and 2002, respectively. The Company recognized as a
component of interest expense a non-cash benefit of $1,088 and $63 for the six
months ended June 30, 2003 and 2002, respectively, and a non-cash benefit of
$586 and a non-cash charge of $289 for the three months ended June 30, 2003 and
2002, respectively, which consisted of the following:
SIX MONTHS THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------- --------------
2003 2002 2003 2002
------- ----- ------ -----
Change in fair market value of swaps not designated
as hedges......................................... $(1,124) $(281) $(586) $181
Reclassification of loss in "Accumulated other
comprehensive income (loss)"...................... 33 198 99
Reclassification of cumulative effect recorded upon
adoption of SFAS No. 133.......................... 3 20 9
------- ----- ----- ----
Total charge (benefit).............................. $(1,088) $ (63) $(586) $289
======= ===== ===== ====
8
APPLIED GRAPHICS TECHNOLOGIES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the restructuring of its credit facility and settlement
of amounts outstanding under the Amended Credit Agreement, the Company
terminated the two interest rate swap agreements and paid $576, which
approximated the accrued interest through maturity.
9. RELATED PARTY TRANSACTIONS
Sales to, purchases from, and administrative charges incurred with related
parties during the six and three months ended June 30, 2003 and 2002, were as
follows:
SIX MONTHS THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------- ---------------
2003 2002 2003 2002
------ ------ ----- -------
Affiliate sales..................................... $1,444 $3,118 $734 $1,507
Affiliate purchases................................. $ 267 $ 231 $128 $ 166
Administrative charges.............................. $ 853 $ 802 $401 $ 441
Administrative charges include charges for rent incurred for leases with
affiliates and for certain legal, administrative, and computer services provided
by affiliates.
10. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Payments of interest and income taxes for the six months ended June 30,
2003 and 2002, were as follows:
2003 2002
------- ------
Interest paid............................................... $10,176 $8,965
Income taxes paid -- net of refunds......................... $ 845 $ 739
Noncash investing and financing activities for the six months ended June
30, 2003 and 2002, were as follows:
2003 2002
---- ----
Compensation cost of vested stock options issued to
non-employees............................................. $5 $ 6
Additions to goodwill for contingent payments............... $720
Fair value of warrants issued to banks...................... $404
9
APPLIED GRAPHICS TECHNOLOGIES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. SEGMENT INFORMATION
Segment information relating to results of operations for the six and the
three months ended June 30, 2003 and 2002, was as follows:
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
------------------- ------------------
2003 2002 2003 2002
-------- -------- ------- --------
Revenue:
Content Management Services................. $181,515 $190,979 $91,353 $ 98,969
Other operating segments.................... 15,317 13,475 7,733 6,964
-------- -------- ------- --------
Total....................................... $196,832 $204,454 $99,086 $105,933
======== ======== ======= ========
Operating Income (Loss):
Content Management Services................. $ 15,121 $ 18,495 $ 8,210 $ 11,237
Other operating segments.................... 1,780 1 1,006 46
-------- -------- ------- --------
Total....................................... 16,901 18,496 9,216 11,283
Other business activities................... (10,277) (13,668) (4,375) (6,755)
Amortization of intangibles................. (203) (174) (112) (93)
Gain (loss) on disposal of property and
equipment................................. 4 (119) (71) (234)
Restructuring charges....................... (99) (99)
Impairment of goodwill...................... (1,440) (1,440)
Interest expense............................ (8,975) (9,238) (4,698) (5,149)
Interest income............................. 118 125 53 69
Other income (expense)-net.................. (723) (117) (729) (22)
-------- -------- ------- --------
Consolidated loss before provision for
income taxes and minority interest........ $ (3,254) $ (6,135) $ (815) $ (2,341)
======== ======== ======= ========
Segment information relating to the Company's assets as of June 30, 2003,
and December 31, 2002, was as follows:
JUNE 30, DECEMBER 31,
2003 2002
-------- ------------
Total Assets:
Content Management Services................................. $146,628 $157,297
Other operating segments.................................... 9,659 11,833
Other business activities................................... 33,337 30,964
-------- --------
Total....................................................... $189,624 $200,094
======== ========
12. RECENTLY ADOPTED ACCOUNTING STANDARDS
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 were effective for periods ending after December 15, 2002, and the
recognition criteria of FIN 45 were effective for guarantees issued or modified
after December 31, 2002. The Company adopted the recognition criteria of FIN 45
on January 1,
10
APPLIED GRAPHICS TECHNOLOGIES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2003. The adoption of the recognition criteria of FIN 45 did not have a material
impact on the Company's financial condition or results of operations.
Statement of Financial Accounting Standards (SFAS) No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity," was issued in May 2003, and is effective for financial instruments
entered into or modified after May 31, 2003, or at the beginning of the first
interim period beginning after June 15, 2003. SFAS No. 150 establishes standards
for reporting and measuring certain financial instruments with characteristics
of both liabilities and equity. The Company does not expect the adoption of SFAS
No. 150 to have a material effect on its financial condition or results of
operations.
13. LITIGATION
As previously reported, Kmart Corporation ("Kmart") filed for protection
under Chapter 11 of the United States Bankruptcy Code on January 22, 2002, with
the United States Bankruptcy Court for the Northern District of Illinois (the
"Bankruptcy Court"). Meridian Retail, Inc. ("Meridian"), an indirect wholly
owned subsidiary of the Company, is a provider of services to Kmart. On January
25, 2002, Kmart obtained an order from the Bankruptcy Court authorizing it to
pay pre-Chapter 11 amounts to designated categories of vendors whom Kmart deemed
critical (the "Critical Vendor Order"). Pursuant to the Critical Vendor Order,
Meridian was paid substantially all of its accounts receivable for services
rendered to Kmart prior to its bankruptcy filing. By a decision dated April 8,
2003, the United States District Court for the Northern District of Illinois
(the "District Court") reversed the Critical Vendor Order as it applies to all
of Kmart's critical vendors. Kmart has appealed that decision to the United
States Court of Appeals for the Seventh Circuit. On May 5, 2003, Kmart filed a
complaint in the Bankruptcy Court against Meridian, which was amended on June
27, 2003, to include the Company as a defendant, claiming that Kmart did not
intend to treat Meridian as a critical vendor and that Meridian was erroneously
paid approximately $10,800 as a critical vendor in the postpetition period.
Kmart's complaint also refers to the District Court's reversal of the Critical
Vendor Order. In addition, Kmart's complaint alleges that virtually all payments
received by Meridian during the ninety days preceding Kmart's bankruptcy filing
totaling approximately $13,200 are recoverable as preferential payments under
the applicable provision of the Bankruptcy Code. Accordingly, Kmart is seeking
to recover amounts totaling approximately $24,000. The Company believes it has
meritorious defenses to these claims and intends to vigorously defend its
position, although there can be no assurances as to the final outcome of this
action.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements made in this Quarterly Report on Form 10-Q are
"forward-looking" statements (within the meaning of the Private Securities
Litigation Reform Act of 1995, as amended). Such statements involve known and
unknown risks, uncertainties, and other factors that may cause actual results,
performance, or achievements of the Company to be materially different from any
future results, performance, or achievements expressed or implied by such
forward-looking statements. Although the Company believes that the expectations
reflected in such forward-looking statements are based upon reasonable
assumptions, the Company's actual results could differ materially from those set
forth in the forward-looking statements. Certain factors that might cause such a
difference include the following: the ability of the Company to retain
customers; the ability of the Company to maintain compliance with the covenant
requirements under its credit facility; the ability of the Company 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 credit facility
and cash flows to fund cash needs.
The following discussion and analysis (in thousands of dollars) should be
read in conjunction with the Company's Interim Consolidated Financial Statements
and notes thereto.
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.
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 an impairment charge, net of taxes,
relating to its goodwill of $327,875 upon the adoption of SFAS No. 142 on
January 1, 2002. Such impairment charge was reported as a cumulative effect of a
change in accounting principle. 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 that estimated. 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 June 30, 2003, and December 31, 2002, resulting in net deferred tax assets of
$15,720 at June 30, 2003 and $15,857 at December 31, 2002. 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
12
Company, and therefore will result in an adjustment to the valuation allowance
established at June 30, 2003. 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 $6,200 was established at June 30, 2003, compared to an allowance of
$8,273 at December 31, 2002. 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 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
$8,229 at June 30, 2003, as compared to $10,585 at December 31, 2002. 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
SIX MONTHS ENDED JUNE 30, 2003, COMPARED WITH 2002
Revenues in the first six months of 2003 were $7,622, or 3.7%, lower than
in the comparable period in 2002. Revenues in the 2003 period decreased by
$9,464 from content management services and $291 from digital services, and were
partially offset by increased revenues of $2,133 from broadcast media
distribution services. Decreased revenues from content management services
primarily resulted from the continued weakness in the advertising market in the
first six months of 2003 that adversely impacted the Company's operations
servicing advertising agencies, retailers, and magazine publishers. Increased
revenues from broadcast media distribution services resulted from additional
volume of premium services provided for which the Company receives higher rates.
Gross profit increased by $1,276 in the first six months of 2003. The gross
profit percentage in the first six months of 2003 was 33.9% as compared to 32.0%
in the 2002 period. The increase in the gross profit percentage primarily
resulted from improved operating efficiencies and cost cutting in the Company's
content management services business related to the Company's operational
restructuring and integration efforts that were completed in the second quarter
of 2002. The gross profit percentage also increased due to the additional volume
of premium services provided by the Company's broadcast media distribution
services.
Selling, general, and administrative expenses in the first six months of
2003 were $520 lower than in the 2002 period. Selling, general, and
administrative expenses as a percent of revenue increased to 30.5% in the 2003
period from 29.7% in the 2002 period. This increase in the percentage was due
primarily to additional costs incurred to support the higher volumes of revenue
achieved in the latter part of 2002, with such costs not being reduced
commensurately with the decline in revenue.
The results of operations for the six months ended June 30, 2003, include a
restructuring charge of $99 related to a plan initiated and completed by the
Company during the second quarter of 2003 (the "2003 Second Quarter Plan").
Under the 2003 Second Quarter Plan, the Company closed its Rochester, New York,
facility and moved its operations to existing facilities in New York City and
Nashua, New Hampshire. The
13
Company terminated one employee as part of the 2003 Second Quarter Plan. The
restructuring charge of $99 consisted of $95 for facility closure costs, $3 for
employee termination costs, and $1 for future rental obligations on abandoned
equipment.
Interest expense in the first six months of 2003 was $263 lower than in the
2002 period due primarily to a larger non-cash benefit recognized in the 2003
period related to the accounting for the Company's interest rate swap
arrangements, partially offset by $580 of interest allocated to discontinued
operations in 2002 with no comparable allocation in 2003 and higher borrowings
outstanding and interest rates under the Company's credit facility in the 2003
period.
Other expense of $723 for the six months ended June 30, 2003, includes a
charge of $923 for costs incurred in connection with the recapitalization of the
Company (see Note 2 to the Interim Consolidated Financial Statements). This
charge was partially offset by income of $250 associated with the settlement of
certain contingent obligations, which were assumed by the Company in connection
with the acquisition of Wace Group Limited ("Wace") in May 1999, for amounts
less than originally estimated at the time of acquisition.
In connection with the sale of the Company's publishing business in April
2002, a portion of the proceeds were originally held in escrow under the terms
of the sale to satisfy any claims related to contractual warranties. The Company
received $500 from the escrow in November 2002, and received the remaining
$1,534 in April 2003. Additionally, in the second quarter of 2003, the Company
recognized $1,534 of income from discontinued operations from the reversal of
liabilities originally established to cover such contingencies.
Revenues from business transacted with affiliates for the six months ended
June 30, 2003 and 2002, totaled $1,444 and $3,118, respectively, representing
0.7% and 1.5%, respectively, of the Company's revenues.
THREE MONTHS ENDED JUNE 30, 2003, COMPARED WITH 2002
Revenues in the second quarter of 2003 were $6,847, or 6.5%, lower than in
the comparable period in 2002. Revenues in the 2003 period decreased by $7,616
from content management services and $194 from digital services, and were
partially offset by increased revenues of $963 from broadcast media distribution
services. Decreased revenues from content management services primarily resulted
from the continued weakness in the advertising market in the second quarter of
2003 that adversely impacted the Company's operations servicing advertising
agencies, retailers, and magazine publishers. 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 $649 in the second quarter of 2003. The gross
profit percentage in the second quarter of 2003 was 34.3% as compared to 32.7%
in the 2002 period. The increase in the gross profit percentage primarily
resulted from improved operating efficiencies and cost cutting in the Company's
content management services business related to the Company's operational
restructuring and integration efforts that were completed in the second quarter
of 2002. The gross profit percentage also increased due to the additional volume
of premium services provided by the Company's broadcast media distribution
services.
Selling, general, and administrative expenses in the second quarter of 2003
were $962 lower than in the 2002 period. Selling, general, and administrative
expenses as a percent of revenue increased to 29.4% in the 2003 period from
28.4% in the 2002 period due primarily to additional costs incurred to support
the higher volumes of revenue achieved in the latter part of 2002, with such
costs not being reduced commensurately with the decline in revenue.
The results of operations in the second quarter of 2003 include a
restructuring charge of $99 related to the 2003 Second Quarter Plan.
Interest expense in the second quarter of 2003 was $451 lower than in the
2002 period due primarily to a larger non-cash benefit recognized in the 2003
period related to the accounting for the Company's interest rate swap
arrangements, partially offset by higher borrowings outstanding and interest
rates under the Company's credit facility in the 2003 period.
14
Other expense of $729 for the three months ended June 30, 2003, includes a
charge of $923 for costs incurred in connection with the recapitalization of the
Company (See Note 2 to the Interim Consolidated Financial Statements). This
charge was partially offset by income of $250 associated with the settlement of
certain contingent obligations, which were assumed by the Company in connection
with the acquisition of Wace in May 1999, for amounts less than originally
estimated at the time of acquisition.
In connection with the sale of the Company's publishing business in April
2002, a portion of the proceeds were originally held in escrow under the terms
of the sale to satisfy any claims related to contractual warranties. The Company
received $500 from the escrow in November 2002, and received the remaining
$1,534 in April 2003. Additionally, in the second quarter of 2003, the Company
recognized $1,534 of income from discontinued operations from the reversal of
liabilities originally established to cover such contingencies.
Revenues from business transacted with affiliates for the three months
ended June 30, 2003 and 2002, totaled $734 and $1,507, respectively,
representing 0.7% and 1.4%, respectively, of the Company's revenues.
FINANCIAL CONDITION
On August 4, 2003, KAGT Acquisition Corp., a wholly-owned subsidiary of
KAGT Holdings, Inc., an affiliate of funds managed by Kohlberg & Co., LLC
("Kohlberg"), completed a tender offer for the Company with 6,081,145 shares of
the Company's outstanding common stock, or approximately 66% of the total shares
outstanding, being validly tendered and accepted for payment. Concurrent with
the closing of the tender offer, the Company completed a restructuring and
extinguishment of its existing credit facility. The tender offer and the
extinguishment of the existing credit facility are part of an overall
recapitalization in which the Company also redeemed all of its outstanding
subordinated notes and all of the outstanding preference shares of a subsidiary
of the Company. KAGT Acquisition Corp. plans to acquire the Company's remaining
outstanding shares of common stock through a second-step merger, which is
expected to be consummated within the next several months.
The overall recapitalization is being funded with $52,000 from KAGT
Acquisition Corp., of which $44,200 will initially be subordinated debt of the
Company and all of which will be converted into equity upon completion of the
second-step merger, and approximately $72,500 of debt under a new credit
facility with a new lender group. Of the total funding, approximately $97,700
was used to fully repay $176,097 of borrowings outstanding under the Company's
old credit facility at the closing of the tender offer, and approximately $7,800
will be paid directly to holders of the Company's common stock by KAGT
Acquisition Corp., of which approximately $5,200 was paid upon the closing of
the tender offer and approximately $2,600 will be paid upon completion of the
second-step merger. The $5,200 that was paid upon the closing of the tender
offer was provided to KAGT Acquisition Corp. as equity financing by funds
managed by Kohlberg and another investor. In addition, approximately $9,000 was
paid to fully redeem the outstanding subordinated notes, including accrued
interest, and approximately $6,300 was paid to fully redeem the outstanding
preference shares, of which $1,800 is committed to be reinvested in the Company
by certain holders of the preference shares in the form of a subordinated note.
The remaining funding of $3,700 will be paid to cover fees and expenses of the
transaction, including bank fees. Additional fees totaling approximately $4,000,
including approximately $3,000 to be paid to Kohlberg, were deferred at the time
of the closing of the tender offer and will be paid from working capital or
borrowings under the Loan Agreement.
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. 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, would
constitute an event of default. In July 2003, the Company and its senior lenders
entered into amendments to the Amended Credit Agreement extending the deadline
for the restructuring or recapitalization to July 31, 2003.
On August 4, 2003, in connection with the closing of the tender offer and
the recapitalization (see Note 2 to the Interim Consolidated Financial
Statements), the Company settled all amounts outstanding under the Amended
Credit Agreement, which totaled $176,097, and entered into a Loan and Security
Agreement with a new lender group that matures in August 2008 (the "Loan
Agreement"). The Loan Agreement provides for two term loans totaling $22,000 and
$27,000 ("Term Loan A" and "Term Loan B," respectively) and a revolving credit
line with a maximum availability of $58,000, subject to a borrowing base
limitation based on receivables. Borrowings under the Loan Agreement will be
secured by all of the receivables, inventory, and
15
real and personal property of the Company and certain of its subsidiaries. The
interest rate on funds borrowed under the revolving credit line of the Loan
Agreement is either LIBOR plus 3.00% or the prime rate plus 1.50%. The interest
rates on Term Loan A and Term Loan B are the prime rate plus 2.00% and 8.25%,
respectively.
As previously disclosed, in connection with the Company's discussions with
third parties regarding a recapitalization of the Company, 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 the Amended Credit Agreement, the Company was required
to comply with certain quarterly covenants related to leverage ratios, interest
coverage ratios, fixed charge coverage ratios, and capital spending. In
addition, the Company was required to satisfy a monthly minimum cumulative
EBITDA (as defined in the Amended Credit Agreement) covenant. The Company was in
compliance with all covenants at June 30, 2003.
Under the terms of the Loan Agreement, the Company will have to comply with
certain quarterly covenants related to minimum EBITDA (as defined in the Loan
Agreement), fixed charge ratios, leverage ratios, and capital spending.
The Company had outstanding two interest rate swap agreements with an
aggregate notional amount of $50,000 that were scheduled to expire in August
2003. In connection with the restructuring of its credit facility and the
settlement of amounts outstanding under the Amended Credit Agreement, the
Company terminated the two interest rate swap agreements and paid $576, which
approximated the accrued interest through maturity. 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.
As previously reported, Kmart Corporation ("Kmart") filed for protection
under Chapter 11 of the United States Bankruptcy Code on January 22, 2002, with
the United States Bankruptcy Court for the Northern District of Illinois (the
"Bankruptcy Court"). Meridian Retail, Inc. ("Meridian"), an indirect wholly
owned subsidiary of the Company, is a provider of services to Kmart. On January
25, 2002, Kmart obtained an order from the Bankruptcy Court authorizing it to
pay pre-Chapter 11 amounts to designated categories of vendors whom Kmart deemed
critical (the "Critical Vendor Order"). Pursuant to the Critical Vendor Order,
Meridian was paid substantially all of its accounts receivable for services
rendered to Kmart prior to its bankruptcy filing. By a decision dated April 8,
2003, the United States District Court for the Northern District of Illinois
(the "District Court") reversed the Critical Vendor Order as it applies to all
of Kmart's critical vendors. Kmart has appealed that decision to the United
States Court of Appeals for the Seventh Circuit. On May 5, 2003, Kmart filed a
complaint in the Bankruptcy Court against Meridian, which was amended on June
27, 2003, to include the Company as a defendant, claiming that Kmart did not
intend to treat Meridian as a critical vendor and that Meridian was erroneously
paid approximately $10,800 as a critical vendor in the postpetition period.
Kmart's complaint also refers to the District Court's reversal of the Critical
Vendor Order. In addition, Kmart's complaint alleges that virtually all payments
received by Meridian during the ninety days preceding Kmart's bankruptcy filing
totaling approximately $13,200 are recoverable as preferential payments under
the applicable provision of the Bankruptcy Code. Accordingly, Kmart is seeking
to recover amounts totaling approximately $24,000. The Company believes it has
meritorious defenses to these claims and intends to vigorously defend its
position, although there can be no assurances as to the final outcome of this
action.
During the first six months of 2003, other non-current assets decreased by
$6,425 due primarily to the release of approximately $6,600 from an escrow
account that was acquired in connection with the Wace acquisition in May 1999.
The escrow account was initially established in connection with a sale of a
business to satisfy any potential claims, all of which were satisfied in June
2003 with a payment of approximately $4,800. The remaining balance of
approximately $1,800 was received by the Company in June 2003.
16
Cash flows from operating activities of continuing operations during the
first six months of 2003 decreased by $6,252 as compared to the comparable
period in 2002 due primarily to the timing and amounts of payroll-related
payments and the timing of vendor payments, partially offset by the cash
received from escrow accounts and an increase in cash generated from operations.
During the first six months of 2003, the Company repaid $13,526 of term
loans, invested $4,628 in facility construction and new equipment, paid $2,780
in debt financing fees, and repaid $333 of notes and capital lease obligations.
Such amounts were primarily funded by borrowings under the Company's revolving
credit facility.
The Company expects to spend approximately $12,000 over the course of the
next twelve months for capital improvements, essentially all of which is for
modernization. The Company intends to finance these expenditures under leasing
arrangements, with working capital, or with borrowings under its credit
facility.
The Company believes that the cash flow from operations and available
borrowing capacity will provide sufficient cash flows to fund its cash needs
throughout 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary exposure to market risk is interest rate risk. The
Company had $175,697 outstanding under its credit facility at June 30, 2003.
Interest rates on funds borrowed under the Company's credit facility vary based
on changes to the prime rate or LIBOR. The Company partially managed its
interest rate risk through two interest rate swap agreements under which the
Company paid a fixed rate and was paid a floating rate based on the three month
LIBOR rate. The notional amounts of the two interest rate swaps totaled $50,000
at June 30, 2003. A change in interest rates of 1.0% would result in a change in
income before taxes of $1,257 based on the outstanding balance under the
Company's credit facility and the notional amounts of the interest rate swap
agreements at June 30, 2003.
On August 4, 2003, in connection with a tender offer and overall
recapitalization, the Company settled all amounts outstanding under its credit
facility and entered into a new credit facility under which the Company
initially borrowed $72,469. In addition, the Company terminated the two interest
swap agreements and paid $576, which approximated the accrued interest through
maturity.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management evaluated, with the participation of the Company's
principal executive and principal financial officers, the effectiveness of the
Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")), as of June 30, 2003. Based on their evaluation, the Company's principal
executive and principal financial officers concluded that the Company's
disclosure controls and procedures were effective as of June 30, 2003.
There has been no change in the Company's internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
that occurred during the Company's fiscal quarter ended June 30, 2003, that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
17
PART II. -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no material developments regarding legal proceedings
previously disclosed in the Company's quarterly report on Form 10-Q for the
quarterly period ended March 31, 2003.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In April 2003, pursuant to the terms of its credit agreement, the Company
issued warrants with an exercise price of $0.01 to its lenders to purchase
453,377 shares of the Company's common stock. Such warrants became exercisable
immediately upon their issuance. The issuance of such securities by the Company
were effected without registration based on reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act of 1933 for private
placements. Such warrants were cancelled in connection with the restructuring
and extinguishment of the Company's old credit facility.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As previously disclosed in its filings with the Securities and Exchange
Commission, a subsidiary of the Company, Wace Group Limited ("Wace"), is in
arrears on the dividend payments related to its 8% Cumulative Convertible
Redeemable Preference Shares (the "Preference Shares"). Wace had been prohibited
from making dividend payments due to its lack of distributable reserves, and had
not made a dividend payment since July 1999. The arrearage, which is included as
part of "Minority interest" in the Consolidated Balance Sheets, totaled
approximately $10,607,000 at August 12, 2003. Such arrearage was satisfied as
part of the redemption, at a significant discount, of the Preference Shares in
August 2003 in connection with a recapitalization of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of the stockholders of Applied Graphics Technologies,
Inc., was held on June 12, 2003. The stockholders voted on the following matter:
1. The election of the following eleven directors of the Company for
terms expiring at the 2004 annual meeting of stockholders:
SHARES SHARES
VOTED FOR WITHHELD
--------- ------------
Fred Drasner................................................ 7,170,934 422,828
John W. Dreyer.............................................. 7,180,871 412,891
Philip Guarascio............................................ 7,181,267 412,495
John R. Harris.............................................. 7,184,071 409,691
Martin D. Krall............................................. 7,181,971 411,791
Marne Obernauer, Jr. ....................................... 7,182,611 411,151
David R. Parker............................................. 7,183,791 409,971
Joseph D. Vecchiolla........................................ 7,172,605 421,157
John R. Walter.............................................. 7,181,571 412,191
John Zuccotti............................................... 7,178,971 414,791
Mortimer B. Zuckerman....................................... 7,277,671 316,091
As previously reported on a Current Report on Form 8-K, dated August 4,
2003, KAGT Acquisition Corp., a wholly-owned subsidiary of KAGT Holdings, Inc.,
an affiliate of funds managed by Kohlberg & Co., LLC, completed a tender offer
for the Company with 6,082,365 shares of the Company's outstanding common stock
being validly tendered and accepted for payment. Upon the closing of the tender
offer, and in accordance with an Agreement and Plan of Merger among KAGT
Holdings, Inc., KAGT Acquisition Corp., and the Company dated as of June 12,
2003, Fred Drasner, John Dreyer, Philip Guarascio, Martin Krall, Marne
18
Obernauer, Jr., Joseph Vecchiolla, John Walter, and Mortimer Zuckerman resigned,
and James Kohlberg, Samuel Frieder, Christopher Lacovara, and Gordon Woodward
were appointed as directors of the Company.
ITEM 5. OTHER INFORMATION
The Company appointed Nat Buonfiglio as Senior Vice President, Chief
Financial Officer, and Treasurer to be effective as of August 16, 2003.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
2.1 Agreement and Plan of Merger, dated as of February 13, 1998,
by and among Devon Group, Inc., Applied Graphics
Technologies, Inc., and AGT Acquisition Corp. (Incorporated
by reference to Exhibit No. 2.2 forming part of the
Registrant's 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).
2.3(a) Agreement and Plan of Merger, dated as of June 12, 2003,
among KAGT Holdings, Inc., KAGT Acquisition Corp., and
Applied Graphics Technologies, Inc. (Incorporated by
reference to Exhibit No. (d)(1) forming part of Schedule TO
of Tender Offer Statement filed by KAGT Acquisition Corp.
with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended, on June 20,
2003).
2.3(b) First Amendment to Agreement and Plan of Merger, dated as of
July 31, 2003, among KAGT Holdings, Inc., KAGT Acquisition
Corp., and Applied Graphics Technologies, Inc. (Incorporated
by reference to Exhibit No. (d)(10) forming part of Schedule
TO of Tender Offer Statement filed by KAGT Acquisition Corp.
with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended, on July 31,
2003).
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).
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).
19
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).
10.1 Loan and Security Agreement, dated as of August 4, 2003, by
and among Applied Graphics Technologies, Inc., the Lenders
that are signatories thereto, Wells Fargo Foothill, Inc.,
and Silver Point Finance, LLC
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) Employment Agreement dated as of January 16, 2003, by and
between the Registrant and Joseph D. Vecchiolla
(Incorporated by reference to Exhibit No. 10.6(a) 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, 2003).
10.6(b) Employment Agreement dated as of January 31, 2003, by and
between the Registrant and Fred Drasner (Incorporated by
reference to Exhibit No. 10.6(b) 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, 2003).
10.6(c)(i) Employment Agreement dated as of January 31, 2003, by and
between the Registrant and Martin D. Krall (Incorporated by
reference to Exhibit No. 10.6(c) 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, 2003).
10.6(c)(ii) Amendment #1, effective as of May 8, 2003, to Employment
Agreement by and between Registrant and Martin D. Krall.
10.6(d) Employment Agreement dated as of January 31, 2003, by and
between the Registrant and Kenneth G. Torosian (Incorporated
by reference to Exhibit No. 10.6(d) 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, 2003).
10.7 Form of Registration Rights Agreement (Incorporated by
reference to Exhibit No. 10.7 forming part of Amendment No.
3 to the Registrant's Registration Statement on Form S-1
(File No. 333-00478) filed with the Securities and Exchange
Commission under the Securities Act of 1933, as amended).
10.8 Applied Graphics Technologies, Inc., 1998 Incentive
Compensation Plan, as Amended and Restated (Incorporated by
reference to Exhibit No. 10.8 forming part of Registrant's
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).
20
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(a) 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 (Incorporated by reference to Exhibit
No. 10.9 forming part of 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,
2002).
10.9(b) First Amendment, dated as of July 3, 2003, to the Second
Amended and Restated Credit Agreement among Applied Graphics
Technologies, Inc., Other Institutional Lenders, and Fleet
National Bank as Administrative Agent.
10.9(c) Second Amendment, dated as of July 23, 2003, to the Second
Amended and Restated Credit Agreement among Applied Graphics
Technologies, Inc., Other Institutional Lenders, and Fleet
National Bank as Administrative Agent.
10.9(d) Lock-up Agreement, dated as of June 12, 2003, by and among
Applied Graphics Technologies, Inc., KAGT Holdings, Inc.,
Fleet National Bank as Administrative Agent, and the lenders
party to the Second Amended and Restated Credit Agreement,
dated as of April 15, 2003, among Applied Graphics
Technologies, Inc., Other Institutional Lenders, and Fleet
National Bank (Incorporated by reference to Exhibit No.
(d)(2) forming part of Schedule TO of Tender Offer Statement
filed by KAGT Acquisition Corp. with the Securities and
Exchange Commission under the Securities Exchange Act of
1934, as amended, on June 20, 2003).
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).
10.11 Management Agreement, dated as of August 4, 2003, by and
between Applied Graphics Technologies, Inc., and Kohlberg &
Company, L.L.C.
31.1 Certification of the principal executive officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended.
31.2 Certification of the principal financial officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended.
32.1 Certification of the principal executive officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the principal financial officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) The Registrant filed the following reports on Form 8-K during the
quarter ended June 30, 2003:
Current Report on Form 8-K filed on April 1, 2003, announcing the
Company's results of operations for the full year and three months ended
December 31, 2002.
Current Report on Form 8-K filed on May 16, 2003, announcing the
Company's results of operations for the three months ended March 31, 2003.
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
APPLIED GRAPHICS TECHNOLOGIES, INC.
(Registrant)
By: /s/ JOSEPH VECCHIOLLA
------------------------------------
Joseph Vecchiolla
President and Chief Operating
Officer
(Principal Executive Officer)
Date: August 14, 2003
/s/ KENNETH TOROSIAN
--------------------------------------
Kenneth Torosian
Senior Vice President and Chief
Financial Officer
(Principal Financial Officer)
Date: August 14, 2003
22