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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2000
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to _____________
AKI HOLDING CORP.
(Exact name of registrant as specified in its charter)
Commission File Number: 333-60991
Delaware 74-288316
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
AKI, INC.
(Exact name of registrant as specified in its charter)
Commission File Number: 333-60989
Delaware 13-3785856
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1815 East Main Street
Chattanooga, TN 37404
(423) 624-3301
(Address, including zip code and telephone number, including area code, of
principal executive offices)
Securities Registered Pursuant to Section 12(b) of the Act:
None.
Securities Registered Pursuant to Section 12(b) of the Act:
None.
Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) have been subject to such
filing requirements for the past 90 days. (X) Yes ( ) No
As of September 27, 2000, 1,000 shares of common stock of AKI Holding Corp.,
$0.01 par value, were outstanding and 1,000 shares of common stock of AKI, Inc.,
$0.01 par value, were outstanding.
Indicate by check mark if disclosure of delinquent filers is not contained
herein, and will not be contained, to the best of registrants' knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. (X)
AKI, Inc. meets the requirements set forth in General Instruction I 1(a) and (b)
of Form 10-K and is therefore filing this form with reduced disclosure format.
DOCUMENTS INCORPORATED BY REFERENCE:
None.
As used within this report, the term "company" refers to AKI Holding Corp.,
a Delaware corporation, and its subsidiaries, including AKI, Inc., a Delaware
corporation ("AKI"). The term "Holding" refers solely to AKI Holding Corp.
PART I
Part I is presented with respect to both registrants submitting this
filing, Holding and AKI.
ITEM 1. BUSINESS
General
Our company is a leading global marketer and manufacturer of multi-sensory,
interactive advertising utilizing sampling systems that engage the senses of
touch, sight, sound and olfactory. Our sampling systems are widely recognized in
the fragrance, cosmetics and personal care industries, as well as the household
products and food and beverage industries. We offer an extensive portfolio of
proprietary, patented and patent-pending sampling systems that can be
incorporated into various advertising media which is designed to reach the
consumer at home or in-store, such as magazine inserts, catalog inserts,
remittance envelopes, statement enclosures, blow-ins and point-of-sale displays.
Our company is a fully integrated multi-sensory advertising company,
conducting its business under the Arcade Marketing Inc. name and is positioned
to provide complete, interactive advertising programs to our customers,
including creative content and product sample systems and distribution.
Product sampling is one of the most effective, widely used and fastest
growing forms of promotional activity. Product sampling is particularly crucial
to the fragrance and cosmetics industries where consumers traditionally "try
before they buy" due to the highly personal nature of the products. Our
company's introduction in 1979 of the ScentStrip(R) Sampler, the first
pull-apart, microencapsulated scent sampling system, transformed the fragrance
sampling industry. By combining advertising with a sampling system, marketers
were afforded the first cost-effective means to reach consumers in their homes
on a mass scale. Though the microencapsulated fragrance sampling system remains
the most widely used product throughout the fragrance industry, our company has
developed and/or acquired a portfolio of alternative scent sampling systems, all
designed for cost-effective mass distribution, and continues to be the leading
innovator in sampling system advertising.
In recent years, our company has expanded our sampling system business by
developing new technologies specifically for the skincare, makeup, food and
beverage and consumer products markets. Although product sampling is critical to
the success of these markets, sampling programs for these products historically
have been too costly for mass production and incapable of efficiently being
incorporated into magazines, catalogs, direct mail and other printed vehicles.
Our innovative sampling systems are designed to fill the needs of these
marketers by providing a cost-effective means of reaching consumers in their
homes on a mass scale with
quality renditions of skincare products, foundation, lipstick and cosmetic
powders. Management believes that our innovative sampling systems have altered
the economics and efficiencies of product sampling in the cosmetics market.
In December 1997, DLJ Merchant Banking Partners II, L.P. and certain
related investors (collectively, "DLJMBII") and certain members of our company's
prior management organized AHC I Acquisition Corp., a Delaware corporation
("AHC"), to acquire all of the outstanding equity interests of AKI. Holding was
formed as a holding company in 1998 and its only significant asset is the
capital stock of AKI. Holding conducts all of its business through AKI. As of
September 27, 2000, DLJMBII owned approximately 98.8% of the outstanding common
stock of AHC. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Acquisition" and "Item 12. Security
Ownership of Certain Beneficial Owners and Management."
On September 15, 1999, we acquired all of the issued and outstanding shares
of capital stock of RetCom Holdings Ltd. ("RetCom"), a Delaware corporation, and
refinanced working capital indebtedness of RetCom and its subsidiaries. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations--RetCom Acquisition." The acquired businesses of RetCom and its
subsidiaries include a portfolio of sampling systems catering to the fragrance,
cosmetics and personal care industries, as well as microencapsulation products
and processes. The acquired businesses also include a creative service division
that engages in marketing communications and catalogs, and a multi-media
division focused presently at merchandising at point-of-sale and through the
Internet. The acquired businesses offer proprietary, patented and patent-pending
sampling systems that include MicroSilk(TM), MicroDot(TM), Snap and Powder,
ColorDot(TM) and Ascent(TM).
Products
Our company offers a broad and diversified portfolio of innovative,
interactive sampling systems and advertising formats for the fragrance,
cosmetics and consumer products markets. Our major technologies are described
below, including a description of the patent protection of each product
technology. Each of our products is a cosmetic, fragrance or consumer product
sample system generally sold to the same category of manufacturers of the
product being advertised.
- --------------------------------------------------------------------------------
Year of Patent
Product Introduction Origin Protection Target Market
- --------------------------------------------------------------------------------
ScentStrip(R) 1979 Internally Proprietary Fragrance,
developed secret consumer products
- --------------------------------------------------------------------------------
ScentStrip(R)Plus mid 1980's Internally Proprietary Fragrance
developed secret
- --------------------------------------------------------------------------------
DiscCover(R) 1994 Licensed Patented Fragrance,
consumer products
- --------------------------------------------------------------------------------
Scent Seal(R) 1995 Acquired Patented Fragrance
- --------------------------------------------------------------------------------
LiquaTouch(R) 1997 Internally Patent Fragrance,
developed pending skin care
- --------------------------------------------------------------------------------
2
- --------------------------------------------------------------------------------
MicroDot(TM) 1993 Acquired Proprietary Fragrance
secret
- --------------------------------------------------------------------------------
Aromalacquer 1997 Acquired Proprietary Fragrance,
secret consumer product
- --------------------------------------------------------------------------------
Fragrance Burst and 1989 Acquired Patented Fragrance
Pearls
- --------------------------------------------------------------------------------
Fragrance Burst 1984 Acquired Patented Fragrance
- --------------------------------------------------------------------------------
Microfragrance Scratch Acquired Proprietary Fragrance,
`n Sniff 1978 secret consumer product
- --------------------------------------------------------------------------------
BeautiSeal(R) 1997 Internally Patented Cosmetics, skin
developed care and personal
care
- --------------------------------------------------------------------------------
PowdaTouch(R) 1997 Internally Patented Cosmetics
developed
- --------------------------------------------------------------------------------
LipSeal(TM) 1998 Internally Patented Cosmetics
developed
- --------------------------------------------------------------------------------
TouchDown(TM) 1999 Internally Patent Cosmetics
Nail Color Sampler developed application
pending
- --------------------------------------------------------------------------------
BeautiTouch(R) 1999 Internally Patent Cosmetics, skin
Multi-well Sampler developed pending care and personal
care
- --------------------------------------------------------------------------------
ColorDot(TM) 1999 Acquired Patented Cosmetics
- --------------------------------------------------------------------------------
Olfactory Sampling Systems
Our diverse portfolio of fragrance sampling systems, which uses a variety
of proprietary chemistries and processes, historically has represented a
significant portion of our utilized sales. While ScentStrip continues to be the
most widely used technology for sampling products for the fragrance industry,
management believes that our new and recently acquired sampling systems have
helped us maintain a competitive advantage and our position as an innovator in
the sampling industry. Our products have been used in substantially all major
new fragrance launches in recent years that have utilized sampling systems.
o ScentStrip(R): Our company's original pull-apart, microencapsulated
fragrance sampling system continues to deliver the most cost-effective,
quality fragrance rendition.
o ScentStrip(R) Plus: The classic, pull-apart, microencapsulated fragrance
format with the added feature of silky-to-the-touch, powdery texture.
o DiscCover(R): A peel-and-reveal, non-encapsulated sampling system that
opens and reseals, delivering a quality aroma rendition up to 25 times.
This technology is color-printable, affixable to nearly any surface,
including plastic and glass, and can be die-cut in nearly any shape and
size.
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o Scent Seal(R): A heat-sealed, pouch-like, pressure-sensitive format that
peels open to reveal a moist, wearable gel rendition that offers both an
olfactory and on-skin experience.
o LiquaTouch(R): Delivers a rendition of finished fragrance product (e.g.,
eau de parfum, eau de toilette or after shave), any liquid treatment or
personal care product and contains an applicator. Available in a
pressure-sensitive format designed for U.S. Postal Service approval for
subscription magazine periodical rates, LiquaTouch(R) is also available in
a stand-alone version, which is a cost-effective alternative to fragrance
vials. In an independent study recently conducted among male consumers of
fragrance products, LiquaTouch(R) was shown to be preferred among sampling
systems and was also a finalist for the Fragrance Foundation's 1997
"Innovation of The Year" award.
o MicroDot(TM): A peel away resealable label, which reveals pressure
sensitive microencapsulated fragrance oil delivered in a Microsilk(TM)
powder. When applied to the skin, the Microsilk(TM) powder delivers a
superior fragrance rendition.
o Aramalacquer: Scented varnish that delivers a superior aroma rendition of
nearly any fragrance, personal care, household, food, beverage,
pharmaceutical, or novelty product. When rubbed or scratched, Aromalacquer
releases the aroma rendition.
o Fragrance Burst Perfume Pearls: A multi-sensory sampling system that
features silky-to-the-touch, pearlized perfume pearls. These pearls are
formulated of 85% liquid perfume oil and release a wearable fragrance
rendition when touched.
o Fragrance Burst and Pearls: Combines the wearable, visible and tangible
properties of Perfume Pearls with the classic, pull-apart fragrance burst
format, delivering an olfactory and on-skin experience.
o Microfragrance Scratch `n Sniff: Microfragrance capsules are applied to
paper or stickers which affix to nearly any surface, delivering an accurate
aroma rendition when the sampling system is scratched, then sniffed.
Other Sampling Systems
Our company also has in its portfolio non-fragrance sampling system
products which represent a growing percentage of our company's sales. All of
these sampling systems except ColorDot(TM) have been designed for U.S. Postal
Service approval for subscription magazine periodical rates.
o BeautiSeal(R): A heat-sealed, pouch-like, pressure-sensitive format peels
open to deliver quality renditions of cream and lotion treatments and
liquid foundations. BeautiSeal(R) is hygienic and spillproof and less
expensive and more versatile than existing skincare/foundation sampling
alternatives. For example, a two-sided, printed
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insert incorporating a BeautiSeal(R) sampling system generally costs less
than half that of the manufacture and magazine distribution of an
equivalent sample packet. BeautiSeal(R) was a finalist for the Fragrance
Foundation's 1998 "Marketing Innovation of The Year" award.
o PowdaTouch(R): Applies up to four different powders on a single carrier and
is ideal for trial of a single item shade range or a complete color story.
Delivers a superior rendition of the shade, texture, finish and application
of eye shadow, powder blush, face powder, bronzer or body powder.
Management estimates that PowdaTouch(R) sampling systems can be produced
approximately ten times faster than currently competing products and at a
reduced production rate.
o LipSeal(TM): A pressure-sensitive sampling system peels open to deliver a
superior rendition of lipstick shade, finish and texture in any formula
including volatile silicones.
o TouchDown(TM) Nail Color Sampler: A pressure-sensitive, die-cut sticker
that temporarily "touches down" on the nail, demonstrating superior
rendition of nail enamel shades without marring a manicure.
o BeautiTouch(R) Multi-Well Sampler: A pressure-sensitive technology
featuring multiple, individually-sealed wells on a common backing, which
peel open to deliver renditions of liquid foundations, cream and lotion
treatment and personal care items, lipstick and fragrance ancillaries.
o ColorDot(TM): A pressure sensitive label which peels away to reveal a
microencapsulated color cosmetic sampling system containing up to four
cosmetic colors laid down in parallel rows.
Formats
Our company produces a wide and versatile range of formats designed for
U.S. Postal Service approval for subscription magazine periodical rates and
which can be incorporated into almost any print media. The most common formats
for our company's products are described below.
Magazine Inserts: Magazine inserts are available in half-, full-, two- and
four-page formats, can be die-cut, can contain any of our company's sampling
systems and are the most commonly produced among our company's formats,
accounting for approximately 39% of fiscal 2000 sales.
Catalog Inserts: Full color formats can be produced in a variety of sizes
and inserted into retail or mail order catalogs. Catalog inserts can be produced
with or without an attached envelope, which may be provided to facilitate the
return of merchandise order forms to the store. Our company has the ability to
create and produce special formats, to custom imprint with store information and
to incorporate most of our company's sampling systems.
5
Remittance Envelopes: Remittance envelopes, which are inserted into store
statement mailings, can be customized with a store logo and can accommodate many
of our company's sampling systems. Our company is the only company in the
sampling industry that can produce remittance envelopes in-house. Remittance
envelopes can be produced with or without our company's sampling systems.
Remittance envelope production, which is a highly customized service business,
reinforces our company's position as a fully-integrated enterprise.
Statement Enclosures: Statement enclosures are available in various formats
and sizes. Fragrance statement enclosures may contain a single scent in their
fold, one or two scents under the fragrance panel, or they may be die-cut so
that the fragrance can be sampled by removing the desired die shape. Enclosures
are normally imprinted with store logo and product pricing information. The
six-inch format is our company's design and has become the industry standard.
Blow-ins: Blow-ins, which are available in all formats and sizes, can
accommodate nearly all of our company's sampling systems and are loosely
inserted (blown in) rather than bound into store catalogues, newspapers and
magazines.
In-Store Handouts: Our company has made significant advances in replacing
and expanding current methods of in-store cosmetic and fragrance sampling. Due
to the lower cost and design flexibility of our company's products, marketers
have expanded the number and type of in-store vehicles. Working in partnership
with our customers, new and creative formats have been developed. These formats
incorporate many of our company's sampling systems and items such as postcards,
stickers, wrist bands, bookmarks and CD inserts. Our company is also
experiencing significant in-store business with the LiquaTouch(R) sampling
system, as an alternative to vials, and expects increases for the BeautiSeal(R)
and PowdaTouch(R) sampling systems for trial of shade ranges and formulae.
Patents and Proprietary Technology
Our company currently holds patents covering the proprietary processes used
to produce eight of its products and has submitted applications for three
additional manufacturing processes. Our company has six trademarks registered in
the United States and eight trademarks filed and awaiting registration. Our
company has also filed and registered trademarks in over 15 countries around the
world, including Europe, Australia, Japan and Brazil. See "--Products."
Our company has ongoing research efforts and expects to seek additional
patents in the future covering patentable results of such research. There can be
no assurance that any pending patent applications filed by our company:
o will result in patents being issued or that any patents now or hereafter
owned by our company will afford protection against competitors with
similar technology,
o will not be infringed upon or designed around by others or
o will not be challenged by others and held to be invalid or unenforceable.
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In addition, many of our company's manufacturing processes are not covered by
any patent or patent application. As a result, the business of our company may
be adversely affected by competitors who independently develop technologies
substantially equivalent to those employed by our company.
Customers
Our company sells its products to prestige and mass cosmetic, fragrance,
consumer products companies, department stores, home shopping retailers and
specialty retailers including Avon Products, Inc., Calvin Klein Cosmetics
(Unilever Plc), Chanel, Inc., Coty, Inc., Cosmair/L'Oreal S.A., Elizabeth Arden
(Unilever Plc), Estee Lauder, Inc., Giorgio Beverly Hills, Colgate, Victoria
Secret Beauty and The Procter & Gamble Company. Our company's top ten customers
accounted for approximately 58% of sales in fiscal 2000. None of our company's
customers, other than Estee Lauder, accounted for 10% or more of net sales in
fiscal 2000. Our company believes that its technical expertise, manufacturing
reliability and customer support capabilities have enabled it to develop strong
relationships with its customers. Our company employs sales and marketing
personnel who possess the requisite technical backgrounds to communicate
effectively with both prospective customers and our company's manufacturing
personnel. Historically, our company has had long-term relationships with its
major customers.
Sales and Marketing
Our company's sales and marketing efforts are organized geographically. Our
company currently has a total of twelve sales executives. The U.S. sales group
consists of seven sales executives who are supervised by the Senior Vice
President of Sales. The European sales executives are based in Paris, France and
London, England and are managed by the Senior Vice President, International, who
is based in Paris, France. Each sales executive is dedicated to a certain number
of identified customers. In addition, these sales efforts are supported by
eighteen production managers/customer service representatives, which are based
in Chattanooga, Tennessee and Paris, France. A portion of the compensation for
sales executives is commission-based.
Our company's marketing activities include direct contact with senior
executives in the cosmetic and fragrance industry, major support of industry
events, extensive joint marketing programs with magazines, retailers and oil
houses, press coverage in industry trade publications, tradeshows and seminars,
advertising in trade publications and promotional pieces. In addition, our
company focuses its sales efforts toward three principal groups within its
customers' organizations that management believes influence the customers'
purchasing decisions:
o marketing, which selects the sampling system technology and controls the
promotional budget;
o product development, which approves our company's sampling system rendition
and approves stability testing; and
7
o purchasing, which buys the sampling system pieces and controls quality.
Management believes that as the pressure for creativity increases with each new
product introduction, fragrance marketers are increasingly looking for their
vendors to contribute to the overall strategy-building effort for a new
fragrance. Our company's executives routinely introduce new sampling system
formats and ideas based on our company's technologies to the marketing
departments of its customers. Our company's in-house creative and marketing
expertise and complete product line provides customers with maximum flexibility
in designing promotional programs.
Manufacturing
Our company's manufacturing processes are highly technical and largely
proprietary. Our company's sampling systems must meet demanding performance
specifications regarding fidelity to the product being sampled, shelf-life,
resistance to pressure and temperature variations and various other
requirements. The manufacturing processes can be divided into three phases:
o formulating cosmetic and fragrance product renditions in our company's
slurry laboratories for use in sampling systems;
o manufacturing the sampler, which consists of either applying an
encapsulated slurry onto paper or producing sampling labels that contain
fragrance or other cosmetic product renditions as well as printing the
advertising page; and
o labeling technologies (DiscCover(R), Scent Seal(R), BeautiSeal(R),
LiquaTouch(R)), affixing the labels onto a piece preprinted by our company
or a third-party contract supplier.
Management believes that our company's formulation capabilities are the
best in the cosmetics sampling industry. The formulation process is highly
complex because our company is trying to replicate the fragrance of a product in
a bottle containing an alcohol solution using primarily essential oils and
paper. Formulation approval is an interactive process between our company and
its customers. Our company has more than 125 different, proprietary formulations
that it utilizes in replicating different characteristics of over 500 fragrances
to obtain a customer-approved rendition. Certain of these formulations are
patented and the majority of the formulation process is based on unique and
proprietary methods. Formulation of the fragrance and cosmetic product rendition
is performed under very strict tolerances and in complete conformity to the
formula that the customer has pre-approved. Formulation is conducted in our
company's specially designed formulation laboratories by trained specialists.
The artwork for substantially all printed pieces has typically been
furnished by the customer or its advertising agency. Our company's prepress
department is currently being converted to state-of-the-art technology by
utilizing the receipt of customer-supplied computer disks and producing this
material directly on to plates. Our company has the capability to produce high
quality printed materials, including the covers of major fashion magazines, in
connection with fragrance sampling systems.
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Our company has two different sampling component manufacturing processes:
(1) for its formulated offset paper samplers (ScentStrip(R), ScentStrip(R) Plus,
PowdaTouch(R)) and (2) for its formulated letterpress or flexo label samplers
(DiscCover(R), Scent Seal(R), BeautiSeal(R), LiquaTouch(R)). Formulated paper
samplers are produced in our company's primary facility where our company
carefully applies microencapsulated slurry onto the paper during the printing
process and, in a continuous in-line operation, folds, cuts and trims the
samplers for packing. A 24-hour quality control function and hourly
accountability provide significant value to the product development personnel at
our company's customers, who are responsible for sample system quality.
All sampling systems in label form are produced on specially modified label
and finishing equipment in our company's second facility. In addition to the
patents pending on certain of its manufacturing processes, our company uses a
number of proprietary techniques in producing label samplers. Similar to the
formulated paper operation, sampling quality control personnel evaluate all
sample systems by roll and provide full accountability for our company's
production.
Our company also has agreements with certain European and Australian
printers and labelers, which produce some quantities for global customers that
require foreign distribution. Each of these arrangements is protected by
non-competition agreements.
Our company was recently awarded The Proctor & Gamble Pinnacle Award, which
is presented to companies as recognition for having met certain quality
requirements and having demonstrated outstanding quality assurance. Our company
is also registered with the Food and Drug Administration for the packaging of
regulated cosmetic products.
Sources and Availability of Raw Materials
Generally, the raw materials used by our company in the manufacturing of
its products have been readily available from numerous suppliers and have been
purchased by our company at prices that our company believes are competitive.
Our company's encapsulated paper products utilize specific grades of paper that
are subject to comprehensive evaluation and certification by our company for
quality, consistency and fit. Our company has not experienced any material
supply shortages in the past, nor are any anticipated.
Competition
Our company's competitors, some of whom have substantially greater capital
resources than our company, are actively engaged in manufacturing certain
products similar to, or in competition with, those of our company. Competition
in our company's markets is based upon product quality, product technologies,
customer relationships, price and customer service. Our company's principal
competitors in the printed fragrance sampler market are Webcraft, a subsidiary
of Big Flower Holdings, Inc., Orlandi, Inc., Nord'est, Marietta Corp., Klocke,
Color Prelude, Rotocon, Ascent and Appliquesence. Our company also competes with
numerous manufacturers of miniatures, vials, packets, sachets, blisterpacks and
scratch and sniff products.
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In addition, certain cosmetics companies produce sampling products for their own
cosmetic products. Our company also competes with numerous other marketing and
advertising venues for marketing dollars our customers allocate to various types
of advertising, marketing and promotional efforts such as print, television and
in-store promotions.
Environmental and Safety Regulation
Our company's operations are subject to extensive laws and regulations
relating to the storage, handling, emission, transportation and discharge of
materials into the environment and the maintenance of safe conditions in the
workplace. Our company's policy is to comply with all legal requirements of
applicable environmental, health and safety laws and regulations. Our company
believes that it is in general compliance with such requirements and has
adequate professional staff and systems in place to remain in compliance,
although there can be no assurances that this is the case. Our company considers
costs for environmental compliance to be a normal cost of doing business and
includes such costs in pricing decisions.
Employees
As of August 31, 2000, our company employed 403 persons, which included 237
hourly and 166 salaried and management personnel. Substantially all of our
company's hourly employees are represented by the Graphics Communications
International Union (GCIU) local 197-M. Management considers its relations with
the union to be good. The current union contract was signed in April 1999 and
will be in effect through March 31, 2003.
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RISK FACTORS
Our substantial indebtedness and restrictive covenants imposed by the terms of
our indebtedness could adversely affect our cash flow and prevent us from
fulfilling our obligations under our notes and debentures.
Our company has substantial indebtedness and debt service obligations. As
of June 30, 2000, Holding and AKI had total consolidated indebtedness of
approximately $145.7 million and $117.9 million, respectively. In addition,
Holding's deficiency of earnings available to cover fixed charges for fiscal
2000, was $0.8 million. As of September 20, 2000, AKI had letters of credit
outstanding in the amount of $0.6 million and outstanding borrowings of $9.5
million under its revolving credit agreement with Heller Financial, Inc. and
$4.8 million under promissory note with AHC. In addition, as of such date,
borrowings of up to approximately $9.9 million were available under the credit
agreement, subject to specified conditions. The indenture governing Holding's 13
1/2% Senior Discount Debentures due 2009 and the indenture governing AKI's 10
1/2% Senior Notes due 2008 and the credit agreement permit our company and its
Restricted Subsidiaries (as defined in the indentures), in each case, to incur
additional indebtedness if we meet specified requirements.
The level of our company's indebtedness could have negative consequences to
holders of the notes and the debentures, including, but not limited to, the
following:
o a substantial portion of cash flow from operations must be dedicated to
debt service and will not be available for other purposes;
o additional debt financing in the future for working capital, capital
expenditures or acquisitions may be limited;
o the level of indebtedness could limit flexibility in reacting to changes in
the operating environment and economic conditions generally;
o the level of indebtedness could restrict our company's ability to increase
manufacturing capacity;
o our company may face difficulties in satisfying its obligations with
respect to its indebtedness; and
o a portion of our company's borrowings bear interest at variable rates of
interest, which could result in higher interest expense in the event of an
increase in market interest rates.
The indentures and the credit agreement contain covenants that, among other
things, limit the ability of our company and its Restricted Subsidiaries to:
o pay dividends or make certain restricted payments;
11
o incur additional indebtedness and issue preferred stock;
o create liens;
o incur dividend and other payment restrictions affecting subsidiaries;
o enter into mergers, consolidations or sales of all or substantially all of
the assets of our company;
o enter into certain transactions with affiliates; and
o sell certain assets.
In addition, the credit agreement requires our company to maintain specified
financial ratios and satisfy specified financial condition tests. Our company's
ability to meet those financial ratios and tests can be affected by events
beyond its control, and there can be no assurance that our company will meet
those tests.
To service our company's indebtedness we will require a significant amount of
cash. Our ability to generate cash depends on many factors beyond our control.
The ability of our company to pay principal and interest on the notes or
principal on the debentures and to satisfy its other debt obligations will
depend upon AKI's future operating performance. AKI's future operating
performance will be affected by prevailing economic conditions and financial,
business and other factors, which factors may be beyond our company's control,
as well as the availability of revolving credit borrowings under the credit
agreement. Our company anticipates that its operating cash flow, together with
borrowings under the credit agreement, will be sufficient to meet its operating
expenses and to service its debt requirements as they become due. However, if
our company is unable to service its indebtedness, our company may be required
to take action such as reducing or delaying capital expenditures, selling
assets, restructuring or refinancing its indebtedness or seeking additional
equity capital. There can be no assurance that any of these remedies can be
effected on satisfactory terms, if at all. If the company is unable to maintain
the specified financial ratios or generate sufficient cash flow or otherwise
obtain funds necessary to make required payments, we would be in default under
the terms of our indebtedness, which would permit the holders of such
indebtedness to accelerate the maturity of the indebtedness.
Holding Company Structure - Holding's debentures are structurally subordinated
to indebtedness of its subsidiaries.
Holding is a holding company and does not have any material operations or
assets other than ownership of all of the capital stock of AKI. Accordingly, its
debentures are effectively subordinated to all existing and future liabilities
of Holding's subsidiaries, including indebtedness under the credit agreement and
AKI's notes. As of June 30, 2000, Holding's subsidiaries had $117.8 million of
indebtedness and $21.4 million of other outstanding liabilities (including trade
payables, accrued liabilities and deferred taxes). As of September 20, 2000, AKI
had letters of credit outstanding in the amount of $0.6 million and outstanding
borrowings
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of $9.5 million under the credit agreement and $4.8 million under a promissory
note with AHC. In addition, as of September 20,2000, borrowings of up to
approximately $9.9 million were available under the credit agreement, subject to
specified conditions. All such indebtedness effectively ranks senior to the
debentures. At June 30, 2000, Holding had $0.4 million of accrued liabilities
and no outstanding indebtedness other than the debentures. Holding and its
subsidiaries may incur additional indebtedness in the future, subject to the
limitations contained in the instruments governing their indebtedness.
Any right of Holding to participate in any distribution of assets of its
subsidiaries upon the liquidation, reorganization or insolvency of any such
subsidiary (and the consequent right of the holders of the debentures to
participate in the distribution of those assets) will be subject to the prior
claims of the respective subsidiary's creditors.
Holding's ability to repay its debentures may depend on its ability to raise
cash other than through its subsidiaries.
Holding's cash flow, and consequently its ability to service debt,
including its obligations under its debentures, is dependent upon the cash flows
of its subsidiaries and the payment of funds by such subsidiaries to Holding in
the form of loans, dividends or otherwise. Holding's subsidiaries have no
obligations, contingent or otherwise, to pay any amounts due pursuant to the
debentures or to make any funds available for payment of the debentures. In
addition, AKI's credit agreement and its note indenture impose, and agreements
entered into in the future may impose, significant restrictions on the payment
of dividends and the making of loans by AKI and its subsidiaries to Holding.
Accordingly, repayment of the debentures may depend upon the ability of Holding
to effect an equity offering or to refinance the debentures.
Your right to receive payments on the notes and debentures is junior to our
existing and future secured indebtedness.
Under the terms of our credit agreement, Heller Financial, Inc., the lender
under the credit agreement, has a security interest in substantially all of the
current and future assets of AKI. In the event of default under the credit
agreement, whether as a result of the failure to comply with a payment or other
covenant, a cross-default or otherwise, such lender will have a prior secured
claim on the capital stock of AKI and the encumbered assets of our company. As a
result, the encumbered assets of our company would be available to pay
obligations on the notes and the debentures only after borrowings under the
credit agreement and any other secured indebtedness have been paid in full. If
the lender should attempt to foreclose on its collateral, our company's
financial condition and the value of the debentures and the notes will be
materially adversely affected and could be eliminated. As of September 20, 2000,
AKI had letters of credit outstanding in the amount of $0.6 million and
outstanding borrowings of $9.5 million under the credit agreement and $4.8
million under promissory note with AHC. In addition, as of such date, borrowings
of up to approximately $9.9 million were available under the credit agreement,
subject to specified conditions.
13
Our results of operations could be adversely affected if the U.S. Postal Service
reclassifies our sampling systems or the sampling products of our competitors.
Our company's sampling systems are approved by the U.S. Postal Service for
inclusion in subscription magazines mailed at periodical postage rates. Our
company's sampling systems have a significant cost advantage over certain
competing sampling products, such as miniatures, vials, packettes, sachets and
blisterpacks, because such competing products cause an increase from periodical
postage rates to the higher third-class rates for the magazine's entire
circulation. Subscription magazine sampling inserts delivered to consumers
through the U.S. Postal Service accounted for approximately 32% of our company's
net sales in fiscal 2000. There can be no assurance that the U.S. Postal Service
will not approve other competing types of sampling systems for use in
subscription magazines without requiring a postal surcharge, or that the U.S.
Postal Service will not reclassify our company's sampling systems such that they
would incur a postal surcharge. Any such action by the U.S. Postal Service could
have a material adverse effect on our company's results of operations and
financial condition.
Our company relies on a small number of customers for a large portion of its
revenues.
Our company's top ten customers by sales revenue accounted for
approximately 58% of our company's net sales in fiscal 2000. None of our
company's customers other than Estee Lauder accounted for 10% or more of net
sales in fiscal 2000. Although our company has long-established relationships
with most of its major customers, our company does not have long-term contracts
with any of its customers. Our company may be required by some customers to
qualify its manufacturing operations under certain supplier standards. There can
be no assurance that our company will be able to qualify under such supplier
standards or that such customers will continue to purchase sampling systems from
our company if our company's manufacturing operations are not so qualified. An
adverse change in its relationships with significant customers, including Estee
Lauder, could have a material adverse effect on our company's results of
operations and financial condition.
Our ability to compete with other companies depends, in part, on our ability to
meet customer needs on a cost-effective and timely basis and to protect our
proprietary technology.
Our company's competitors, some of whom have substantially greater
financial resources than our company, are actively engaged in manufacturing
certain products similar to those of our company. Our company's principal
competitors in the cosmetic sampling market are Webcraft, a subsidiary of Big
Flower Holdings, Inc., Orlandi Inc., Nord'est, Marietta Corp., Klocke, Color
Prelude, Rotocon, Ascent and Appliquessence. Our company also competes with
numerous manufacturers of miniatures, vials, packettes, sachets, blisterpacks,
and scratch and sniff products. In addition, certain cosmetic companies produce
sampling products for their own cosmetic products. Competition in our company's
market is primarily based upon product quality, product technologies, customer
relationships, price, and customer service. The future success of our company's
business will depend in large part upon its ability to market and manufacture
products and services that meet customer needs on a cost-effective and timely
basis. There can be no assurance that capital will be available for these
purposes, that investments in
14
new technology will result in commercially viable products or that our company
will be successful in generating sales on commercially favorable terms, if at
all.
In addition, our company's success, competitive position and revenues will
depend, in part, upon its ability to protect its proprietary technologies and to
operate without infringing on the proprietary rights of others. Although our
company has certain patents and has filed, and expects to continue to file,
other patent applications, there can be no assurance that our company's issued
patents are enforceable or that its patent applications will mature into issued
patents. The expense involved in litigation regarding patent protection or a
challenge thereto has been and could be significant and any future expense, if
any, cannot be estimated by our company. A portion of our company's
manufacturing processes are not covered by any patent or patent application. As
a result, the business of our company may be adversely affected by competitors
who independently develop technologies substantially equivalent to those
employed by our company.
Our business is affected by the advertising budgets of our customers and is
seasonal in nature.
The advertising budgets of our company's customers, and therefore the
revenues of our company, are susceptible to prevailing economic and market
conditions that affect advertising expenditures, the performance of the products
of our company's customers in the marketplace and certain other factors. There
can be no assurance that reductions in advertising spending will not occur,
which could have a material adverse effect on our company's results of
operations and financial condition.
In addition, our company's sales and operating results have historically
reflected seasonal variations. These seasonal variations are based on the timing
of our company's customers' advertising campaigns, which have traditionally been
concentrated prior to the Christmas and spring holiday seasons. As a result, a
higher level of sales are reflected in our company's first and third fiscal
quarters ended September 30 and March 31, respectively, when sales from such
advertising campaigns are principally recognized while our company's fourth
fiscal quarter ended June 30 typically reflects the lowest sales level of the
fiscal year. These seasonal fluctuations require our company to accurately
allocate its resources to manage our company's manufacturing capacity, which
often operates at full capacity during peak seasonal demand periods.
Our results of operations and financial condition may be adversely affected by
an increase in paper prices or a decrease in paper supply.
Paper is the primary raw material utilized by our company in producing its
sampling systems. Paper costs represented approximately 28% of our company's
cost of goods sold in each of fiscal 1998, 1999 and 2000. Significant increases
in paper costs could have a material adverse effect on our company's results of
operations and financial condition to the extent that our company is unable to
price its products to reflect such increases. There can be no assurance that our
company's customers would accept such price increases or the extent to which
such price increases would impact their decision to utilize our company's
sampling systems.
15
All of our company's encapsulated sampling systems, which accounted for
approximately 51% of our company's net sales in fiscal 2000, utilize specific
grades of paper that are subject to comprehensive evaluation and certification
by our company for quality, consistency and fit. These grades of paper are
produced exclusively for us by one domestic supplier. We do not have a purchase
agreement with the supplier and are not aware of any other suppliers of these
specific grades of paper. Although our products can be manufactured using other
grades of paper, we believe that the specific grades currently used provide us
with an advantage over our competitors. Our company continues to research
methods of replicating the advantages of these specific grades of paper with
other available grades of paper. Until such methods are developed, a loss of
such supply of paper and the resulting competitive advantage could have a
material adverse effect on our company's results of operations and financial
condition to the extent that our company is unable to obtain such paper
elsewhere.
Our company receives a portion of its revenue from foreign countries which is
subject to foreign laws and regulations and political and economic events.
Approximately 14% of our company's net sales in fiscal 2000 were generated
outside the United States. Foreign operations are subject to certain risks
inherent in conducting business abroad, including, among others, exposure to
foreign currency fluctuations and devaluations or restrictions on money
supplies, foreign and domestic export law and regulations, price controls,
taxation, tariffs, import restrictions, and other political and economic events
beyond our company's control. Our company has not experienced any material
effects of these risks as of yet, but there can be no assurance that they will
not have such an effect in the future.
Our company is controlled by DLJMBII whose interests may conflict with the
interests of the holders of the notes and debentures.
DLJMBII has the power to elect a majority of the directors of AHC and
generally exercises significant control over the business, policies and affairs
of AHC, Holding, AKI and its subsidiaries through its ownership of AHC. DLJMBII
currently owns approximately 98.8% of our outstanding common stock. DLJMBII may
have interests that could be in conflict with those of the holders of notes or
the debentures and may take actions that adversely affect the interests of the
holders of the notes and debentures.
Our company's business may be adversely affected by a labor dispute.
As of August 31, 2000, approximately 59% of our company's employees worked
under a collective bargaining agreement that expires on March 31, 2003. While
our company believes that its relations with its employees are good, there can
be no assurance that our company's collective bargaining agreement will be
renewed in the future. A prolonged labor dispute (which could include a work
stoppage) could have a material adverse effect on our company's business,
financial condition and results of operations.
ITEM 2. PROPERTIES
Our company owns land and buildings in Chattanooga, Tennessee, that are
used for production, administration and warehousing. Our company's executive
offices and primary facility at 1815 East Main Street are located on 2.55 acres
and encloses approximately 67,900
16
square feet. A second facility housing product development and additional
manufacturing areas at 1600 East Main Street is located three blocks away on
2.49 acres and encloses approximately 36,700 square feet. Our company also
leases a third facility at 3501 St. Elmo Avenue in Chattanooga, Tennessee, which
is used for production and warehousing. This facility is located on 1.875 acres
and encloses approximately 29,500 square feet.
Our company currently has a number of web printing presses with multi-color
capability as well as envelope-converting machines and other ancillary
equipment. Our company operates a fully equipped production lab for the
manufacture of microcapsules and slurry and separate laboratories for our
company's Encapsulated Products Division and our company's research and
development facility. Our company also has a fully staffed and equipped label
manufacturing facility, which includes state-of-the-art label manufacturing
machines that have been specially modified to produce our company's products and
a complete label attaching operation. Our company also leases sales offices in
New York, New York, Paris, France and London, England.
ITEM 3. LEGAL PROCEEDINGS
Our company does not believe that there are any pending legal proceedings
that, if adversely determined, would have a material adverse effect on the
financial condition or results of operations of our company, taken as a whole.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
17
PART II
ITEM 5. MARKET FOR REGISTRANT COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for Holding's or AKI's common
stock. As of September 27, 2000, AHC was the sole holder of record of Holding's
common stock and Holding was the sole holder of record of AKI's common stock.
Generally, neither Holding nor AKI pays dividends on its shares of common stock
and neither expects to pay dividends on its shares of common stock in the
foreseeable future. The debentures contain restrictions on Holding's ability to
pay dividends on its common stock. The notes and the credit agreement contain
restrictions on AKI's ability to pay dividends on its common stock. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
ITEM 6. SELECTED FINANCIAL DATA
The selected historical consolidated financial data presented below as of
June 30, 2000, 1999 and 1998 and the years ended June 30, 2000 and 1999 and for
the period from December 16, 1997 to June 30, 1998 have been derived from the
historical consolidated financial statements of our company. The selected
historical consolidated financial data presented below as of December 15, 1997,
June 30, 1997 and 1996, and for the period from July 1, 1997 to December 15,
1997 and the fiscal years ended June 30, 1997 and 1996 and have been derived
from the historical consolidated financial statements of Arcade Holding
Corporation, the predecessor to our company. The information contained in this
table should be read in conjunction with "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations," and our company's
Consolidated Financial Statements and the notes thereto included elsewhere in
this report.
18
Holding Predecessor
------- -----------
December 16, July 1, 1997
1997 to to
June 30, June 30, June 30, December 15, June 30, June 30,
2000 1999 1998 1997 1997 1996
--------- --------- --------- --------- --------- ---------
Statement of Operations
Data:
Net sales $ 98,563 $ 85,967 $ 36,066 $ 35,186 $ 77,723 $ 73,486
Cost of goods sold 60,304 55,199 24,518 22,809 49,467 49,862
--------- --------- --------- --------- --------- ---------
Gross profit 38,259 30,768 11,548 12,377 28,256 23,624
Selling, general and
administrative expenses 16,980 14,500 5,587 5,703 13,333 10,635
Amortization of goodwill 5,336 4,606 2,101 568 1,234 1,234
Gain from settlement, net (858) -- -- -- -- --
--------- --------- --------- --------- --------- ---------
Income from operations 16,801 11,662 3,860 6,106 13,689 11,755
Interest expense, net 17,401 16,740 11,327 2,646 6,203 6,762
Management fees 250 250 125 215 470 470
Other, net -- 128 (47) 11 (101) 244
Income tax expense (benefit) 1,596 (340) (2,052) 1,441 3,135 2,101
--------- --------- --------- --------- --------- ---------
Income (loss) (2,446) (5,116) (5,493) 1,793 3,982 2,178
Early retirement of debt, net 1,089 -- -- -- -- --
--------- --------- --------- --------- --------- ---------
Net income (loss) $ (1,357) $ (5,116) $ (5,493) $ 1,793 $ 3,982 $ 2,178
========= ========= ========= ========= ========= =========
Balance Sheet Data (at end
of period):
Cash and cash equivalents $ 1,158 $ 7,015 $ 3,842 $ 4,481 $ 303 $ 626
Working capital (deficit) 13,759 14,853 15,046 (4,959) (36,957) (4,685)
Total Assets 223,937 210,386 214,521 77,399 77,142 82,395
Total debt and redeemable
preferred stock 145,722 146,688 144,448 55,408 54,964 60,736
Total stockholder's equity 58,834 49,797 57,084 12,716 11,225 7,932
Other Data:
Capital expenditures 2,782 2,856 514 807 2,462 2,051
Ratio of earnings to fixed
charges -- -- -- 2.2x 2.1x 1.6x
- ---------
(1) For purposes of calculating the ratio of earnings to fixed charges,
"earnings" represent income (loss) before income taxes plus fixed charges.
"Fixed charges" consist of interest on all indebtedness and amortization of
deferred financing costs. Earnings were not sufficient to cover fixed
charges by $850, $5,456 and $7,545 for the years ended June 30, 2000 and
1999 and the period from December 16, 1997 to June 30, 1998, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
The sales of our company are primarily derived from the sale of sampling
systems to cosmetics and consumer products companies. Substantially all of our
company's sales are made directly to its customers while a small portion are
made through advertising agencies. Each customer's sampling program is unique
and pricing is negotiated based on estimated costs plus a margin. While our
company and its customers generally do not enter into long-term contracts, our
company has had long-standing relationships with the majority of its customer
base. The recent introduction of a number of our company's products, such as
BeautiSeal(R),
19
PowdaTouch(R), and LiquaTouch(R), has affected our company's results of
operations for certain of the periods discussed below.
The Acquisition
DLJMBII and certain members of our company's prior management organized AHC
I Merger Corp. for purposes of acquiring Arcade Holding Corporation, our
predecessor. On December 15, 1997, the merger corporation acquired all of the
equity interests of the predecessor corporation (the "Acquisition") for $205.7
million (including related fees, expenses and cash for working capital).
Included in the total cost of the Acquisition were approximately $6.2 million in
non-cash costs comprised of (1) the assumption of a promissory note issued by
the predecessor corporation in connection with the 1995 acquisition of Scent
Seal, Inc., and certain capital lease obligations and (2) the exchange of stock
options to acquire common stock in the predecessor corporation by the
predecessor corporation's chief executive officer for an option to acquire
preferred stock in AHC.
To provide the $199.5 million of cash necessary to fund the Acquisition,
including the equity purchase price and the retirement of all previously
existing preferred stock and debt of the predecessor corporation not assumed,
(1) the merger corporation issued $123.5 million of its Senior Increasing Rate
Notes to Scratch & Sniff Funding, Inc., an affiliate of DLJMBII, and (2) AHC
received $76.0 million from debt and equity (common and preferred) financings,
including equity investments by certain stockholders of the predecessor
corporation, which was contributed to the merger corporation. Immediately
following the Acquisition, the merger corporation merged with and into the
predecessor corporation and the combined entity assumed the name AKI, Inc. AHC
then contributed $1 of cash and all of its ownership interest in AKI to Holding
for 1,000 shares of Holding's common stock.
The merger corporation's senior increasing rate notes were subsequently
repaid on June 25, 1998 from the proceeds of AKI's issuance of $115.0 million of
AKI's notes and from a capital contribution from Holding. On June 25, 1998,
Holding issued and sold its debentures totaling $50.0 million in aggregate
principal amount at maturity for gross proceeds of $26.0 million, the majority
of which were used to fund Holding's equity contribution to AKI.
The Acquisition was accounted for using the purchase method of accounting
and resulted in the recognition of $153.9 million of goodwill and a significant
increase in amortization expense.
3M Acquisition
On June 22, 1998, we acquired the fragrance sampling business of the
Industrial and Consumer Products division of Minnesota Mining and Manufacturing
Company (3M) for $7.25 million in cash and the assumption of a liability of
$182,000 to one of the customers of the business. Our company financed the 3M
acquisition with borrowings under the credit agreement. These borrowings were
subsequently repaid.
20
RetCom Acquisition
On September 15, 1999, we acquired all of the issued and outstanding shares
of capital stock of RetCom at a purchase price of approximately $12.5 million
and refinanced working capital indebtedness of approximately $4.5 million of
RetCom and its subsidiaries. The purchase price and refinancing of indebtedness
were initially financed by borrowings under the credit agreement. See
"--Liquidity and Capital Resources."
Results of Operations
For purposes of the following discussion, the results of operations for the
year ended June 30, 1998 reflect the combination of the results of operations of
the predecessor corporation for the period July 1, 1997 through December 15,
1997, the date of the Acquisition, with the results of operations of our company
for the period December 16, 1997 through June 30, 1998. Due to the effects of
purchase accounting applied in the Acquisition and the additional interest
expense associated with the debt incurred to finance the Acquisition, the
results of operations of our company are not comparable in all respects to the
results of operations of the predecessor corporation.
Fiscal Year Ended June 30, 2000 Compared to Fiscal Year Ended June 30, 1999
Net Sales. Net sales for the fiscal year ended June 30, 2000 increased
$12.6 million, or 14.7%, to $98.6 million as compared to $86.0 million for the
fiscal year ended June 30, 1999. The increase was primarily attributable to
increases in domestic sales of sampling technologies for advertising and
marketing of cosmetics and consumer products, due partially to the timing of
completion and delivery of certain substantial orders which remained in process
at June 30, 1999, increases in international sales of sampling technologies for
advertising and marketing of fragrances and sales from the RetCom acquired
business, offset by changes in foreign exchange rates.
Gross Profit. Gross profit for the fiscal year ended June 30, 2000
increased $7.5 million, or 24.4%, to $38.3 million as compared to $30.8 million
for fiscal year ended June 30, 1999. Gross profit as a percentage of net sales
increased to 38.8% in the fiscal year ended June 30, 2000, from 35.8% in the
fiscal year ended June 30, 1999. The increase in gross profit and gross profit
as a percentage of net sales is primarily attributable to the increase in net
sales discussed above, changes in product mix and more efficient production
levels, offset partially by changes in foreign exchange rates.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2000 increased $2.5
million, or 17.2% to $17.0 million as compared to $14.5 million for the fiscal
year ended June 30, 1999. The increase in selling, general and administrative
expenses was primarily due to an increase staffing levels and compensation and
additional expenses associated with the acquisition and operation of RetCom. As
a result of these factors, selling, general and administrative expenses as a
percent of net sales increased to 17.2% in the fiscal year ended June 30, 2000
from 16.9% in the fiscal year ended June 30, 1999.
21
Income from Operations. Income from operations for the fiscal year ended
June 30, 2000 increased $5.1 million, or 43.6%, to $16.8 million as compared to
$11.7 million for the fiscal year ended June 30, 1999. Income from operations as
a percentage of net sales increased to 17.0% in the fiscal year ended June 30,
2000 from 13.6% in the fiscal year ended June 30, 1999, principally as a result
of the factors described above and an $0.8 million net gain from settlement of
litigation involving the Acquisition purchase price.
Interest Expense. Interest expense for the fiscal year ended June 30, 2000
increased $0.7 million, or 4.2% to $17.4 million, as compared to $16.7 million
for the fiscal year ended June 30, 1999. Interest expense as a percentage of net
sales decreased to 17.7% in the fiscal year ended June 30, 2000 from 19.4% in
the fiscal year ended June 30, 1999. The increase in interest expense, including
the amortization of deferred financing costs, is primarily due to use of the
credit line for working capital and the RetCom acquisition, offset partially by
a decrease in interest expense related to the repurchased and retired Senior
Discount Debentures and Senior Notes.
Interest expense for AKI for the fiscal year ended June 30, 2000 increased
$0.7 million, or 5.4%, to $13.7 million, as compared to $13.0 million for the
fiscal year ended June 30, 1999. Interest expense as a percentage of net sales
decreased to 13.9% in the fiscal year ended June 30, 2000 from 15.1% in the
fiscal year ended June 30, 1999. The increase in interest expense, including the
amortization of deferred financing costs, is primarily due to use of the credit
line for working capital and the RetCom acquisition, offset partially by a
decrease in interest expense related to the repurchased and retired Senior
Notes.
Income Tax Expense. The income tax expense for the fiscal year ended June
30, 2000 increased $1.9 million to $1.6 million as compared to a benefit of $0.3
million for the fiscal year ended June 30, 1999. The increase is due to the
increase in income before income taxes and extraordinary gain as a result of the
factors described above.
Income tax expense for AKI for the fiscal year ended June 30, 2000
increased $2.0 million to $2.8 million as compared to $0.8 million for the
fiscal year ended June 30, 1999. The increase is due to the increase in income
before income taxes and extraordinary gain as a result of the factors described
above.
Extraordinary gain from early retirement of debt. An extraordinary gain
from early retirement of debt of $1.1 million for the fiscal year ended June 30,
2000 resulted from the purchase and subsequent contribution of Senior Notes and
Senior Discount Debentures by AHC I Acquisition Corporation. The contributed
securities were subsequently retired.
An extraordinary gain from early retirement of debt for AKI of $0.4 million
for the fiscal year ended June 30, 2000 resulted from the purchase of Senior
Notes by AHC I Acquisition Corporation and subsequent contribution by AKI
Holding Corp. The contributed securities were subsequently retired.
22
EBITDA. EBITDA for the fiscal year ended June 30, 2000, increased $5.6
million, or 27.9%, to $25.7 million as compared to $20.1 million for the fiscal
year ended June 30, 1999. The increase principally reflects the increase in
income from operations discussed above. EBITDA as a percentage of net sales was
26.1% and 23.4% for the fiscal year ended June 30, 2000 and 1999, respectively.
EBITDA is income from operations plus depreciation and amortization of goodwill
and other intangibles less net gain from settlement of litigation.
Fiscal Year Ended June 30, 1999 Compared to Fiscal Year Ended June 30, 1998
Net Sales. Net sales for the fiscal year ended June 30, 1999 increased
$14.7 million, or 20.6%, to $86.0 million as compared to $71.3 million for the
fiscal year ended June 30, 1998. The increase was primarily attributable to a
$9.1 million increase in domestic sales of cosmetic sampling products, the $5.7
million growth of our company's European revenues and increases in sales of
consumer product samples, offset by decreases in sales to the domestic fragrance
industry.
Gross Profit. Gross profit for the fiscal year ended June 30, 1999
increased $6.9 million, or 28.9%, to $30.8 million as compared to $23.9 million
for fiscal year ended June 30, 1998. Gross profit as a percentage of net sales
increased to 35.8% in the fiscal year ended June 30, 1999, from 33.5% in the
fiscal year ended June 30, 1998. The increase in gross profit and gross profit
as a percentage of net sales is primarily attributable to the increase in net
sales discussed above and reductions in raw material costs, offset by a decrease
in certain fragrance samples pricing, changes in product sales mix, increased
costs associated with the outsourcing of European production and increased costs
associated with the initial production runs of certain customer products.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 1999 increased $3.2
million, or 28.3% to $14.5 million as compared to $11.3 million for the fiscal
year ended June 30, 1998. The increase in selling, general and administrative
expenses was primarily due to severance charges related to former executive
officers, changes in executive compensation following the Acquisition and
increased sales staffing and commissions related to the increase in net sales
and costs associated with the transition of the 3M acquisition, offset partially
by reduced advertising expenditures and staff reductions. As a result of these
factors, selling, general and administrative expenses as a percent of net sales
increased to 16.9% in the fiscal year ended June 30, 1999 from 15.8% in the
fiscal year ended June 30, 1998.
Income from Operations. Income from operations for the fiscal year ended
June 30, 1999 increased $1.7 million, or 17.0%, to $11.7 million as compared to
$10.0 million for the fiscal year ended June
23
30, 1998. Income from operations as a percentage of net sales decreased to 13.6%
in the fiscal year ended June 30, 1999 from 14.0% in the fiscal year ended June
30, 1998, principally as a result of the increase in amortization of goodwill
and other intangibles resulting from the Acquisition and the 3M acquisition and
the factors described above.
Interest Expense. Interest expense for the fiscal year ended June 30, 1999
increased $2.7 million, or 19.3% to $16.7 million, as compared to $14.0 million
for the fiscal year ended June 30, 1998. Interest expense as a percentage of net
sales decreased to 19.4% in the fiscal year ended June 30, 1999 from 19.6% in
the fiscal year ended June 30, 1998. The increase in interest expense is due to
the increased indebtedness as a result of the recapitalization of our company in
connection with the Acquisition, partially offset by the refinancing of the
merger corporation's senior increasing rate notes with the notes and debentures.
Interest expense for AKI for the fiscal year ended June 30, 1999 decreased
$0.9 million, or 6.5%, to $13.0 million, as compared to $13.9 million for the
fiscal year ended June 30, 1998. Interest expense as a percentage of net sales
decreased to 15.1% in the fiscal year ended June 30, 1999 from 19.5% in the
fiscal year ended June 30, 1998. The decrease in interest expense is due to the
decreased indebtedness as a result of the refinancing of the merger
corporation's senior increasing rate notes with the notes and Holding's equity
contribution to AKI partially offset by the recapitalization of AKI.
Income Tax Expense. The income tax benefit for the fiscal year ended June
30, 1999 decreased $0.3 million to a benefit of $0.3 million as compared to a
benefit of $0.6 million for the fiscal year ended June 30, 1998. The decrease is
due to the increase in non-deductible goodwill amortization and non-deductible
portion of the interest expense on the debentures, offset partially by the
increased net loss before income taxes as a result of the factors described
above.
Income tax expense for AKI for the fiscal year ended June 30, 1999
increased $1.4 million to $0.8 million as compared to a benefit of $0.6 million
for the fiscal year ended June 30, 1998. The increase is due to the decrease in
loss before income taxes as a result of the factors described above and increase
in non-deductible goodwill amortization.
EBITDA. EBITDA for the fiscal year ended June 30, 1999, increased $3.7
million, or 22.6%, to $20.1 million as compared to $16.4 million for the fiscal
year ended June 30, 1998, principally as a result of the factors described
above. EBITDA is income from operations plus depreciation and amortization of
goodwill and other intangibles.
Liquidity and Capital Resources
Our company has substantial indebtedness and significant debt service
obligations. As of June 30, 2000, our company had consolidated indebtedness in
an aggregate amount of $145.7 million (excluding trade payables, accrued
liabilities and deferred taxes), of which (1) approximately $27.9 million was a
direct obligation of Holding relating to its debentures and (2) approximately
$117.8 million was a direct obligation of AKI relating to its notes, revolving
credit line and capital leases. At June 30, 2000, Holding had $0.4 million of
accrued liabilities and AKI also had $21.4 million in additional outstanding
liabilities (including trade payables, accrued liabilities and deferred taxes)
and letters of credit outstanding under the credit agreement in the amount of
$0.6 million. As of September 20, 2000, AKI had letters of credit outstanding in
the amount of $0.6 million and outstanding borrowings of $9.5 million under the
credit agreement.
24
Borrowings under the credit agreement are limited to a maximum amount equal
to $20.0 million. At June 30, 2000 and September 20, 2000, AKI had borrowings of
approximately $10.4 million and $9.9 million, respectively, available, subject
to a borrowing base calculation and the achievement of specified financial
ratios and compliance with specified conditions. The interest rate for
borrowings under the credit agreement are determined from time to time based on
our company's choice of formulas, plus a margin. The credit agreement will
mature on December 31, 2002.
The indentures and the credit agreement permit Holding and its Restricted
Subsidiaries to incur additional indebtedness, subject to specified limitations.
In addition, the indentures contains restrictive covenants that, among other
things, limit the ability of Holding and its Restricted Subsidiaries to:
o pay dividends or make certain restricted payments;
o incur additional indebtedness and issue preferred stock;
o create liens;
o incur dividend and other payment restrictions affecting subsidiaries;
o enter into mergers, consolidations or sales of all or substantially
all of the assets of our company;
o enter into certain transactions with affiliates; and
o sell certain assets.
Payment of Holding's debentures is not guaranteed by AKI or any of its
subsidiaries. Because Holding is a holding company with no substantive
operations, it is dependent upon the cash flows of AKI and its subsidiaries and
the payment of funds by AKI and its subsidiaries to Holding in the form of
loans, dividends or otherwise to pay its obligations. See "Item 1. Business-Risk
Factors--Holding Company Structure."
Holding's principal liquidity requirements are for debt service
requirements under the debentures. AKI's principal liquidity requirements are
for debt service requirements and fees under the notes and the credit agreement.
Historically, our company has funded its capital, debt service and operating
requirements with a combination of net cash provided by operating activities,
which was $4.9 million and $9.8 million for fiscal 2000 and 1999, respectively,
together with borrowings under revolving credit facilities. Net cash provided by
operating activities during fiscal 2000 resulted from net income before
depreciation and amortization, partially offset by increased accounts receivable
and inventory levels and a decrease in accounts payable and accrued expenses.
In fiscal 2000 and fiscal 1999, our company had capital expenditures of
approximately $2.8 million and $2.9 million, respectively. These capital
expenditures consisted primarily of the
25
purchase and maintenance of manufacturing equipment and furniture and fixtures
and maintaining and upgrading its computer systems.
On September 15, 1999, we acquired all of the issued and outstanding shares
of capital stock of RetCom at a purchase price of approximately $12.5 million
and refinanced working capital indebtedness of approximately $4.5 million of
RetCom and its subsidiaries. The purchase price and refinancing of indebtedness
were initially financed by borrowings under the credit agreement. Our company is
exploring options for the longer-term financing of a portion of the borrowings
incurred in connection with the acquisition.
Our company may from time to time evaluate additional potential
acquisitions. There can be no assurance that additional capital sources will be
available to our company to fund additional acquisitions on terms that our
company finds acceptable, or at all.
At June 30, 2000, AHC had outstanding $35.5 million of Notes which bear
interest at approximately 16% per annum and mature on December 15, 2009, and
approximately $50.8 million of Senior Preferred Stock which accrue dividends at
15% per annum and must be redeemed by December 15, 2012. Interest on the notes
and dividends on the senior preferred stock may be settled through the issuance
of additional floating rate notes and senior preferred stock through maturity or
redemption, respectively. The floating rate notes are general, unsecured
obligations of AHC and are not obligations of, or guaranteed by Holding, AKI or
any of its subsidiaries. AHC is a holding company and is dependent upon the cash
flows of its subsidiaries and the payment to it of funds by its subsidiaries.
The indenture relating to the debentures restricts the payment of dividends or
the making of other restricted payments by Holding to AHC
In September 1999, AHC consummated a private placement to DLJMBII of
15,000,000 shares of its common stock at a purchase price of $1.00 per share. A
portion of the proceeds were used in fiscal 2000 to reduce outstanding
indebtedness of Holding and AKI. The balance of the proceeds may become
available to the Company to reduce outstanding indebtedness of Holding or AKI or
for working capital or other general corporate purposes, but there is no
obligation on the part of AHC. to make any of these funds available.
Capital expenditures for the fiscal year ending June 30, 2001 are budgeted
to be approximately $3.5 million. Based on borrowings outstanding (other than
pursuant to the credit agreement) as of June 30, 2000 and borrowings outstanding
under the credit agreement as of September 20, 2000, our company expects total
cash payments for debt service in fiscal 2001 to be approximately $13.2 million,
consisting of $11.3 million in interest payments on the notes, $0.9 million in
capital lease obligations and $1.0 million in interest and fees under the credit
agreement. Our company also expects to make royalty payments of approximately
$1.1 million during fiscal 2001.
Our company believes that, in the absence of future acquisitions, cash
flows from existing operations and available borrowings will be sufficient to
fund budgeted capital expenditures, working capital requirements and interest
and principal payments on its indebtedness, including the debentures and the
notes for fiscal 2001. In the event our company
26
consummates any additional acquisitions it may seek additional debt or equity
financings subject to compliance with the terms of the indentures.
At June 30, 2000, Holding's cash and cash equivalents and net working
capital were $1.2 million and $13.8 million, respectively, representing a
decrease in cash and cash equivalents of $5.8 million and a decrease in net
working capital of $1.1 million from June 30, 1999. Account receivables, net, at
June 30, 2000 increased 32.1% or $5.2 million over the June 30, 1999 amount,
primarily due to increased sales.
Seasonality
Our company's sales and operating results have historically reflected
seasonal variations. Such seasonal variations are based on the timing of our
company's customers' advertising campaigns, which have traditionally been
concentrated prior to the Christmas and spring holiday seasons. As a result, a
higher level of sales are reflected in our company's first and third fiscal
quarters ended September 30 and March 31 when sales from such advertising
campaigns are principally recognized while our company's fourth fiscal quarter
ended June 30 typically reflects the lowest sales level of the fiscal year.
These seasonal fluctuations require our company to accurately allocate its
resources to manage our company's manufacturing capacity, which often operates
at full capacity during peak seasonal demand periods.
Recently Issued Accounting Standards
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" which is
effective for fiscal years beginning after June 15, 1999. SFAS No. 133
established accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. In June 1999, the FASB issued Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging
Activities Deferral of Effective Date" which is effective for fiscal years
beginning after June 15, 2000. Our company has only utilized derivative
financial instruments to hedge our company's exposure to certain foreign
currencies. Such hedging activity has historically been minor and, as a result,
adoption of this Statement is not expected to have a material impact on our
company's financial condition or results of operations. Our company will adopt
the provisions of this Statement on July 1, 2000.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB
101"), which provides the Staff's views on applying generally accepted
accounting principles to revenue recognition issues. The Company does not
anticipate that the adoption of SAB 101 will have a material impact on the
consolidated financial statements and will continue to analyze the impact of SAB
101.
FASB Interpretation 44, Interpretation of APB Opinion 25 ("FIN 44"), was
issued in March 2000. FIN 44 provides an interpretation of APB Opinion 25 on
accounting for employee stock compensation and describes its application to
certain transactions. FIN 44 is effective on
27
July 1, 2000. It applies on a prospective basis to events occurring after that
date, except for certain transactions involving options granted to
non-employees, repriced fixed options, and modifications to add reload option
features, which apply to awards granted after December 31, 1998. The provisions
of FIN 44 are not expected to have a material effect on transactions entered
into through June 30, 2000.
Forward-Looking Statements
The information provided in this document contains forward-looking
statements that involve a number of risks and uncertainties. A number of factors
could cause actual results, performance, achievements of our company or industry
results to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. These
factors include, but are not limited to:
o the competitive environment in the sampling industry in general and in
our company's specific market areas;
o changes in prevailing interest rates;
o inflation;
o changes in cost of goods and services;
o economic conditions in general and in our company's specific market
areas;
o changes in or failure to comply with postal regulations or other
federal, state and/or local government regulations;
o liability and other claims asserted against our company;
o changes in operating strategy or development plans;
o the ability to attract and retain qualified personnel;
o the significant indebtedness of our company;
o labor disturbances;
o changes in our company's capital expenditure plans;
o and other factors.
In addition, such forward-looking statements are necessarily dependent upon
assumptions, estimates and dates that may be incorrect or imprecise and involve
known and unknown risk, uncertainties and other factors. Accordingly, any
forward-looking statements included herein do not purport to be predictions of
future events or circumstances and may not be realized. Forward-looking
statements can be identified by, among other things, the use of forward-looking
28
terminology such as "believes," "expects," "may," "should," "seeks," "pro
forma," "anticipates," "intends" or the negative of any such word, or other
variations or comparable terminology, or by discussions of strategy or
intentions. Given these uncertainties, readers are cautioned not place undue
reliance on such forward-looking statements. Our company disclaims any
obligations to update any such factors or to publicly announce the results of
any revisions to any of the forward-looking statements contained in this
document to reflect future events or developments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our company generates approximately 14% of its sales from customers outside
the United States, principally in Europe. International sales are made mostly
from our company's foreign subsidiary located in France and are primarily
denominated in the local currency. Our company's foreign subsidiary also incurs
the majority of its expenses in the local currency and uses the local currency
as its functional currency.
Our company's major principal cash balances are held in U.S. dollars. Cash
balances in foreign currencies are held to minimum balances for working capital
purposes and therefore have a minimum risk to currency fluctuations.
Our company periodically enters into forward foreign currency exchange
contracts to hedge certain exposures related to selected transactions that are
relatively certain as to both timing and amount and to hedge a portion of the
production costs expected to be denominated in foreign currencies. The purpose
of entering into these hedge transactions is to minimize the impact of foreign
currency fluctuations on the results of operations and cash flows. Gains and
losses on the hedging activities are recognized concurrently with the gains and
losses from the underlying transactions. At June 30, 2000, our company's forward
exchange contracts consisted of forward contracts to sell Euros at an exchange
rate of .8853 per U.S. dollar and to buy British pound sterling at an exchange
rate of 1.497 per U.S. dollar. The notional principal amounts under these
foreign exchange contracts were $0.7 million and $0.2 million, respectively.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Consolidated Financial Statements of each of
Holding and AKI, the related notes and the Report of Independent Accountants for
each of Holding and AKI commencing at page F-1 of this report, which financial
statements, notes and reports are incorporated by reference into this report.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
29
PART III
ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS OF REGISTRANT
The following table sets forth certain information with respect to the
directors and executive officers of Holding as of September 1, 2000.
Name Age Position
- ---- --- --------
Thompson Dean 42 Chairman of the Board and Director
William J. Fox 44 President, Chief Executive Officer and Director
Kenneth A. Budde 51 Chief Financial Officer
Hugh R. Kirkpatrick 63 Director
David M. Wittels 36 Director
Thompson Dean has served as Chairman of the Board and a Director of Holding
since December 1997. Mr. Dean has been a Managing Partner of DLJ Merchant
Banking, Inc. ("DLJ Merchant Banking") since November 1996. Previously, Mr. Dean
was a Managing Director of DLJ Merchant Banking and its predecessor since
January 1992. Mr. Dean also serves as a director of Von Hoffman Press, Inc.,
Manufacturers' Services Limited, Phase Metrics, Inc., Amatek Ltd., DeCrane
Aircraft Holdings Inc., Insilco Holding Corporation, Formica Corporation,
Mueller Group, Inc. and Charles River Laboratories International, Inc.
William J. Fox has served as President, Chief Executive Officer and a
Director of Holding and as Chairman, President and Chief Executive Officer and a
Director of AKI, Inc. since February 1999. Mr. Fox was President, Strategic and
Corporate Development of Revlon Worldwide, Senior Executive Vice President of
Revlon, Inc. and Revlon Consumer Products Corporation ("RCPC") (collectively,
"Revlon") and Chief Executive Officer, Revlon Technologies, a division of
Revlon, from January 1998 through January 1999. He was Executive Vice President
from 1991 through January 1997 and Senior Executive Vice President from January
1997 through January 1999 and Chief Financial Officer of Revlon from 1991 to
1997. Mr. Fox served as a director from November 1995 of Revlon, Inc. and from
September 1994 of RCPC, until April 1999. He was Senior Vice President of
MacAndrews and Forbes Holding Inc., the indirect majority shareholder of Revlon,
from August 1990 through January 1999.
Kenneth A. Budde has served as Chief Financial Officer of Holding since
November 1994. From October 1988 to June 1994, Mr. Budde served as Controller
and Chief Financial Officer of Southwestern Publishing Company. Prior to that,
Mr. Budde spent 12 years with KPMG Peat Marwick.
Hugh R. Kirkpatrick has served as a director of Holding since June 1998.
Mr. Kirkpatrick is a former director of International Flavors & Fragrances, Inc.
where he served as Senior Vice President and President, Worldwide Fragrance
Division, from 1991 through his retirement in 1996.
30
David M. Wittels has served as a director of Holding since December 1997.
Mr. Wittels has been a Principal of DLJ Merchant Banking since January 1997. For
the past five years, Mr. Wittels has served in various capacities with DLJ
Merchant Banking. Mr. Wittels also serves as a director of Mueller Holdings
(N.A.), Inc., Ziff Davis Holdings, Inc. and Wilson Greatbatch Technologies, Inc.
On September 8, 2000, Mr. James A. Quella was elected as a director of our
company. Mr. Quella is a Managing Director and Senior Operating Partner of DLJ
Merchant Banking since July, 2000. From January, 2000 to July, 2000 Mr. Quella
served as the Managing Director of GH Venture Partners. Mr. Quella served as the
Vice-Chairman: Market Development and Director of the Executive Committee of
Mercer Management Consulting from 1996 to 2000. Prior to that, Mr. Quella had
founded and managed the Financial Services Practice Group for four years.
Compensation of Directors
Except for Mr. Kirkpatrick, who receives an annual fee of $20,000,
directors of Holding will not receive compensation for services rendered but
will be reimbursed for out-of-pocket expenses incurred by them in connection
with their travel to and attendance at board meetings and committees of the
board. Mr. Kirkpatrick also received a grant of 5,000 stock options in fiscal
2000.
31
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information for the three most
recently completed fiscal years with respect to the compensation of our
President and Chief Executive Officer and our other most highly compensated
executive officer whose total annual compensation exceeded $100,000. We refer to
these individuals as our named executive officers.
Summary Compensation Table
Long Term
Annual Compensation Compensation
------------------- ------------
Fiscal Securities All Other
Name and Principal Position Year Salary Bonus Underlying Options Compensation(1)
--------------------------- ---- ------ ----- ------------------ ---------------
William J. Fox 2000 $ 650,000 $1,214,000 888,000(2) 5,462
President, Chief Executive Officer 1999 242,308 250,000 -- --
And Director 1998 -- -- -- --
Kenneth A. Budde 2000 175,000 102,500 160,000 7,090
Chief Financial Officer 1999 154,327 80,625 -- 9,077
1998 120,000 75,000 -- --
(1) Represents amounts contributed on behalf of the named executive to our
company's 401(k) retirement savings plan.
(2) Pursuant to the terms of his employment agreement, Mr. Fox is entitled to
receive options to acquire 5% of AHC's issued and outstanding common stock
on a fully diluted basis. As of June 30, 2000, 888,000 shares of common
stock represented 5% of AHC's issued and outstanding common stock on a
fully diluted basis. See "---Equity Based Compensation" and "---Fox
Employment Agreement."
32
Option Grants in Last Fiscal Year
The following table sets forth information regarding stock options granted
during fiscal 2000 to each of the executive officers named in the "Summary
Compensation Table" above, including the potential realizable value over the
term of the options, based on assumed rates of stock appreciation of 5% and 10%,
compounded annually. These assumed rates are mandated by the rules of the
Securities and Exchange Commission and do not represent our estimate of future
stock price performance. Actual gains, if any, on stock option exercises, will
be dependent on the future performance of our common stock.
Potential Realizable
Value at Assumed
Annual Rates of Stock
Price Appreciation for
Individual Grants Option Term
--------------------------------------------------------------------------------------------
Percent of
Number of Total
Securities Options/SARs
Underlying Granted to Exercise
Options/SARs Employees in Price
Name Granted (#) Fiscal Year ($/Share) Expiration Date 5% ($) 10% ($)
---- ----------- ----------- --------- --------------- ------ -------
William J. Fox 888,000 100% $ 1.00 December 15, 2009 $ 558,458 $ 1,415,243
President, Chief Executive Officer
And Director
Kenneth A. Budde 160,000 100% 1.00 December 15, 2009 100,623 254,999
Chief Financial Officer
Fiscal Year End Option Values
The following table sets forth information about the number and value of
options held by the executive officers named in the "Summary Compensation Table"
above as of June 30, 2000. In the absence of a regular, active public market for
our common stock, and based in part on consideration of comparable companies,
our management estimated the fair value of the stock options granted in fiscal
2000 to have been $0.27 per share as determined by the Minimum Value option
pricing model. The values of the in-the-money options have been calculated on
the basis of $1.00 per share fair market value of our common stock as of that
date less the applicable exercise price.
Year End Option Values
Number of securities
underlying unexercised options Value of unexercised in-the-money
at June 30, 2000 options at June 30, 2000
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
William J. Fox 222,000 666,000 -- --
President, Chief Executive Officer
And Director
Kenneth A. Budde 50,001 109,999 -- --
Chief Financial Officer
Equity-Based Compensation
AHC adopted the 1998 Stock Option Plan for certain employees and directors
of AHC and any parent or subsidiary corporation of AHC. The objectives of the
option plan are (1) to
33
retain the services of persons holding key positions and to secure the services
of persons capable of filling such positions and (2) to provide persons
responsible for the future growth of AHC an opportunity to acquire a proprietary
interest in our company and thus create in such key employees an increased
interest in and a greater concern for the welfare of our company.
The option plan authorizes the issuance of options to acquire up to
1,650,000 shares of common stock of AHC. The option plan will be administered by
the board of directors or a compensation committee to be designated by the board
of directors. Pursuant to the option plan, AHC may grant options, including
options that become exercisable as performance standards determined by the
committee are met, to key employees and directors of AHC and any parent or
subsidiary corporation. The terms of any grant will be determined by the
committee and set forth in a separate grant agreement. The exercise price will
be at least equal to the fair market value per share of AHC common stock on the
date of grant, provided that the exercise price shall not be less than $1.00 per
share. Options may be exercisable for up to ten years. The committee has the
right to accelerate the right to exercise any option granted under the option
plan without effecting the expiration date thereof. Upon the occurrence of a
change in control (as defined in the option plan) of AHC, each option may, at
the discretion of the committee, be terminated upon notice to the holder and
each such holder will receive, in respect of each share of AHC common stock for
which such option is then exercisable, an amount equal to the excess of the then
fair market value of such share of AHC common stock over the per share exercise
price.
AHC granted 1,519,917 options for shares of capital stock in fiscal 2000
and no options for shares of capital stock of AHC were exercised in fiscal 2000.
These options vest over periods ranging from three to eight years. Certain
options are eligible for accelerated vesting based on targeted EBITDA.
Employment Agreements
Fox Agreement
On January 27, 1999, William J. Fox entered into an employment agreement
with our company effective February 1, 1999. The agreement will end on February
1, 2002, the third anniversary of the effective date, subject to extension for
one additional day each day after February 1, 2000, unless either party provides
notice not to extend.
Mr. Fox's base salary is $700,000 and he is eligible to receive a
performance-based bonus of 25%, 100% or 200% of his base salary upon achievement
of targeted goals, and other incentive payments.
Pursuant to the terms of his employment agreement, Mr. Fox is entitled to
receive options to acquire 5% of AHC's issued and outstanding common stock on a
fully diluted basis, subject to anti-dilution protection. Once granted, these
options will vest at specified dates and upon the occurrence of specified
conditions. In addition, upon a change in control (as defined in the employment
agreement), all time vested options vest and all performance vested options vest
if the DLJ Entities (as defined in the employment agreement) achieve certain
levels of return on their equity investments.
34
If Mr. Fox's employment is terminated by our company without cause or by
Mr. Fox for good reason, our company will pay Mr. Fox two times his base salary,
50% of such amount on termination of employment and 50% paid in equal monthly
installments over a twelve-month period following the date of termination. In
addition, Mr. Fox will receive a pro-rata bonus for the year of termination if
he would have been entitled to such a bonus had he remained employed during the
year of termination. If such termination occurs within 6 months of a time where
a tranche of time-vested options would otherwise become exercisable, then a
pro-rata portion of such tranche will become exercisable.
The employment agreement contains confidentiality, noncompetition and
nonsolicitation provisions. The restricted period for the noncompetition
provisions upon termination of employment is two years if Mr. Fox's employment
is terminated by our company without cause or by our company for good reason,
and one year if Mr. Fox's employment is terminated for any other reason.
Budde Agreement
Mr. Budde is presently retained as Chief Financial Officer pursuant to an
employment agreement that provides for an annual base salary of $190,000 and
participation in our company's Salaried Employees Bonus Plan. The term of the
employment agreement with Mr. Budde, which expires on June 30, 2001,
automatically renews for additional twelve-month terms, unless either party
elects otherwise. If Mr. Budde is terminated by our company without cause or if
our company elects not to renew Mr. Budde's employment, our company will pay Mr.
Budde one times his base salary over a twelve-month period following the date of
termination.
Compensation Committee Interlocks and Insider Participation
None of AHC, Holding or AKI had a compensation committee during fiscal
2000. Certain members of our board of directors, other than Mr. Fox,
participated in deliberations regarding compensation to be paid to Mr. Fox.. Mr.
Fox determined the compensation to be paid to other executive officers.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
All of AKI's issued and outstanding capital stock is owned by Holding. All
of Holding's issued and outstanding capital stock is owned by AHC. The following
table sets forth certain information as of September 27, 2000 with respect to
the beneficial ownership of AHC common stock by (1) owners of more than 5% of
such AHC. common stock, (2) each director and named executive officer of Holding
and (3) all directors and executive officers of Holding, as a group.
35
Percentage of
Shares Outstanding AHC
Beneficially Common Stock
Beneficial Owner Owned ------------
---------------- -----
DLJ Merchant Banking Partners, II, L.P. 15,921,111 98.8%
and affiliated entities (1)
William J. Fox -- --
Thompson Dean (2) -- --
Hugh R. Kirpatrick -- --
James Quella (2) -- --
David M. Wittels (2) -- --
Kenneth A. Budde -- --
All directors and executive officers
as a group (2) -- --
- ----------
* Less than one percent.
(1) Consists of shares held directly by the following affiliated investors: DLJ
Merchant Banking Partners II, L.P; DLJ Merchant Banking Partners II-A, LP
("DLJMBII-A); DLJ Offshore Partners II, C.V. ("Offshore Partners II"); DLJ
Diversified Partners, L.P. ("Diversified Partners"); DLJ Diversified
Partners-A, L.P ("Diversified Partners-A"); DLJMB Funding II, Inc. ("DLJ
Funding II"); DLJ Millennium Partners, L.P. ("Millennium Partners"); DLJ
Millennium Partners-A, L.P, ("Millennium Partners-A"); DLJ EAB Partners,
L.P ("EAB Partners"); UK Investment Plan 1997 Partners ("UK Partners"); DLJ
First ESC L.P ("First ESC"); and Scratch & Sniff Funding, Inc. ("Scratch &
Sniff"). See "Certain Relationships and Related Transactions-Transactions
with DLJMBII, and their Affiliates." The address of each of DLJMBII,
DLJMBII-A, Diversified Partners, Diversified Partners-A, DLJ Funding II,
Millennium Partners, Scratch & Sniff, Millennium Partners-A, EAB Partners
and First ESC is 277 Park Avenue, New York, New York 10172. The address of
Offshore Partners 11 is John B. Gorsiraweg 14, Willemstad, Curacao,
Netherlands Antilles. The address of UK Partners is 2121 Avenue of the
Stars, Fox Plaza, Suite 3000, Los Angeles, California 90067. Does not
include 18,000 shares of AHC Common Stock held directly by the Scratch &
Sniff Funding, Inc., an affiliate of DLJMBII.
(2) Messrs. Dean, Quella and Wittels are officers of DLJ Merchant Banking, an
affiliate of DLJMBII. Share data shown for such individuals excludes shares
shown as held by DLJMBII, as to which such individuals disclaim beneficial
ownership. The address of each of Messrs. Dean, Quella and Wittels is 277
Park Avenue, New York, New York 10172.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Transactions with DLJMBII and their Affiliates
Messrs. Dean and Wittels, who are directors of AKI and officers and
directors of Holding and AHC, are officers of DLJ Merchant Banking. DLJ Merchant
Banking, together with DLJMBII, beneficially own, in the aggregate,
approximately 98.8% of the outstanding common stock of AHC.
36
Pursuant to an agreement between Donaldson, Lufkin & Jenrette Securities
Corporation ("DLJ") and AHC, DLJ receives an annual fee of $250,000 for acting
as the exclusive financial and investment banking advisor until December 31,
2002. Our company has agreed to indemnify DLJ in connection with its acting as
financial advisor.
Stockholders Agreement
In connection with the Acquisition, AHC, DLJMBII and certain investors in
our company prior to the Acquisition entered into a Stockholders Agreement,
dated as of December 15, 1997, that sets forth certain rights and restrictions
relating to the ownership of the capital stock of AHC (including securities
exercisable for or convertible or exchangeable into capital stock of AHC) and
agreements among the parties thereto as to the governance of AHC and,
indirectly, Holding and AKI.
Pursuant to the stockholders agreement, the board of directors of AHC
consists of six members, of which four may currently be nominated by DLJMBII.
The Chief Executive Officer of our company is also to be a member of the board.
The stockholders agreement contains (1) certain restrictions on the ability
of each holder of capital stock of AHC to transfer any capital stock of AHC, (2)
certain preemptive rights to the holders of capital stock of AHC, (3) "drag
along" rights to DLJMBII to require the remaining holders of capital stock of
AHC to sell a percentage of their ownership and (4) "tag along" rights to the
holders of capital stock of AHC, other than DLJMBII, with respect to sales of
capital stock of AHC by DLJMBII.
Pursuant to the stockholders agreement, DLJMBII was granted the right to
demand up to three registrations on Form S-1 or the equivalent to sell AHC
common stock (or if AHC is eligible to use Form S-3, the number of demand rights
is unlimited) and all holders of capital stock of AHC were granted certain
customary "piggyback" registration rights to register their common stock in any
registration statement filed by AHC.
Employment Arrangements
On February 1, 1999, Roger L. Barnett resigned as President and Chief
Executive Officer of our company. Under the terms of his employment agreement,
Mr. Barnett was entitled to receive payments aggregating $500,000 of which
$353,275 was paid in fiscal 1999 and the remainder of which was paid in fiscal
2000.
37
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The financial statements listed on the accompanying index to such
financial statements are filed as part of this report.
2. Financial Statement Schedule
None.
3. Exhibits and Exhibit Index.
3.1 Certificate of Incorporation of Holding.*
3.2 Certificate of Incorporation of AKI.**
3.3 Bylaws of Holding.*
3.4 Bylaws of AKI.**
4.1 Indenture dated as of June 25, 1998 between Holding and State Street
Bank and Trust Company, as Trustee.*
4.2 Indenture dated as of June 25, 1998 between AKI and IBJ Schroder Trust
Company, as Trustee.**
4.