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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, 2004
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to _____________
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(g) of the Act:
None.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. (X) Yes ( ) No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). ( ) Yes (X) No
The aggregate market value of the voting and non-voting stock held by
non-affiliates was zero as of December 31, 2003.
As of August 15, 2004, 1,000 shares of common stock of AKI, Inc., $0.01 par
value, were outstanding.
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
ITEM 1. BUSINESS
General
Our Company is a leading global marketer and manufacturer of multi-sensory
marketing, interactive advertising and sampling systems which utilize various
technologies to engage the senses of touch, sight and olfactory. Our marketing
vehicles and sampling systems are widely recognized in the fine fragrance,
cosmetics and personal care industries, as well as other consumer products
industries including the household products and food and beverage industries. We
offer an extensive portfolio of proprietary, patented and patent-pending
technologies that can be incorporated into various marketing programs designed
to reach the consumer at home or in-store, such as magazine inserts, catalog
inserts, remittance envelopes, statement enclosures, blow-ins, direct mail,
direct sell and point-of-sale materials and gift-with-purchase / purchase-with-
purchase programs.
We are a fully integrated multi-sensory marketing and sampling company,
conducting our business under the Arcade Marketing name. We believe that we are
well positioned to provide complete, interactive advertising and sampling
programs to our customers, including creative content and product sample systems
and distribution.
We believe 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. We
believe that our introduction in 1979 of the ScentStrip(R) Sampler, the first
pull-apart, microencapsulated scent sampling system, transformed the fragrance
sampling industry. With the creation of a multi-sensory marketing program -
combining advertising with a sampling system - marketers are afforded a
cost-effective means to reach consumers in their homes on a mass scale. We have
a diverse portfolio of alternative scent sampling systems, all designed for
cost-effective mass distribution, and we continue to be a leading innovator in
sampling system technologies.
In recent years, we have expanded our sampling system business by
developing and acquiring new technologies in the olfactory and beauty sampling
system categories. 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. Many of 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.
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In December 1997, DLJ Merchant Banking Partners II, L.P. and other related
investors (collectively, "DLJMBII") and certain members of our 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 August 15, 2004, DLJMBII
owned approximately 98.8% of the outstanding common stock of AHC.
On November 6, 2000, Credit Suisse Group completed the merger of Diamond
Restructuring Corp., an indirect wholly owned subsidiary of Credit Suisse Group,
with and into Donaldson, Lufkin & Jenrette, Inc. ("DLJ"). As a result of the
merger, DLJ is now an indirect subsidiary of Credit Suisse First Boston, Inc.
("CSFB"). All references to DLJ in this annual report on Form 10-K refer to
entities now controlled by or affiliated with CSFB.
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 $4.5 million indebtedness of RetCom and its subsidiaries. The
acquired businesses of RetCom and its subsidiaries include a portfolio of
proprietary, patented and patent-pending sampling systems catering to the
fragrance, cosmetics and personal care industries, as well as microencapsulation
products and processes. The RetCom sampling systems include MicroSilk(TM),
MicroDot(TM) and AromaLacquer(TM). The acquired businesses also include a
creative service division that engages in marketing communications and catalogs.
On December 18, 2001, we acquired, through a newly formed subsidiary, IST,
Corp., the business including certain assets and assumed certain liabilities of
Color Prelude, Inc. (such business referred to hereafter as "CP"). CP
manufactures interactive advertising and sampling products for cosmetic and
consumer products companies. The acquired business offers proprietary, patented
and patent-pending sampling systems including the ShadeSeal(R) family of
products primarily for lipstick and powder sampling, BeautiPak(TM) for sampling
certain lipstick products, Liqi-Seal(R) for sampling skin care and foundation
products in a unique clear packette, PowdaScent(TM) for the sampling of
fragrance products and SelectaShade(R) which is a unique beauty tool for shade
selection for foundation.
On July 21, 2004, AHC entered into an Agreement and Plan of Merger (the
"Fusion Merger Agreement") with Fusion Acquisition LLC ("Fusion"), a
newly-formed entity owned by investment funds managed by Kohlberg, Kravis,
Roberts & Co. ("KKR") and AHC Merger, Inc. ("AHC Merger"), a wholly-owned
subsidiary of Fusion formed for the purpose of effecting the Fusion Merger (as
defined below), pursuant to which AHC Merger will merge with and into AHC such
that AHC will be the surviving corporation (the "Fusion Merger") and, at the
effective time of the Fusion Merger, will become a wholly-owned subsidiary of
Fusion. Immediately upon the effectiveness of the Fusion Merger, Fusion will
contribute AHC to Jostens Holding Corp. ("JHC") in exchange for capital stock of
JHC. Following the contribution, JHC intends to contribute AHC to its direct
subsidiary, Jostens IH Corp., and as a result, AHC will be a wholly- owned
subsidiary of Jostens IH Corp.
Pursuant to the Fusion Merger Agreement, each issued and outstanding share
of AHC's common stock will be cancelled and retired and shall cease to exist,
and no consideration shall
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be delivered in exchange therefore; and each issued and outstanding share of
AHC's outstanding preferred stock shall be converted into the right to receive
cash merger consideration. The cash merger consideration payable per share of
preferred stock will be determined based upon a total enterprise value of $250.0
million, as adjusted based upon the working capital of our Company at closing.
Upon consummation of the Fusion Merger and the contributions, our Company shall
be a wholly-owned subsidiary of Jostens IH Corp.
The Fusion Merger Agreement and subsequent contribution are subject to
certain conditions to closing including, among others: (i) the consummation of
the Fusion Merger and certain other concurrent transactions, including the
contribution and the merger of Von Hoffmann Holdings Inc. with and into a
subsidiary of Fusion; (ii) the repayment, repurchase or redemption of certain
indebtedness and preferred stock of Jostens, Inc., JHC, Von Hoffmann Holdings
Inc., Von Hoffmann Corporation, AHC and AKI; (iii) that Jostens IH Corp. obtains
financing for such concurrent transactions on the terms and conditions set forth
in the financing commitment provided by an affiliate of Credit Suisse First
Boston LLC, Banc of America Securities LLC and Deustche Bank Securities Inc.;
and (iv) that Marc Reisch, CEO of Fusion, shall have made an investment in the
common stock of JHC.
In connection with the Fusion Merger and subsequent contribution, we will
refinance our existing credit facility. In addition, upon the consummation of
the contribution, we intend to use new financing by Jostens IH Corp. to fund
certain tender payments due to holders of AKI, Inc.'s 10 1/2% Senior Notes due
2008 who elect to tender their notes pursuant to the tender offer and consent
solicitation commenced on August 19, 2004. It is a condition to the closing of
the Fusion Merger and the contribution and new financing described above that
the notes be repurchased or redeemed.
Products
We offer a broad and diversified portfolio of innovative, interactive
sampling systems and advertising formats for the fragrance, cosmetics and
personal care markets as well as other consumer products markets including
household products and food and beverage markets. Our major technologies are
described below, including a description of the patent protection of each
product technology. Each of our sample systems is generally sold to the same
category of manufacturers of the product being advertised.
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 annual sales. While ScentStrip(R) continues to be a
widely used technology for sampling products for the fine fragrance industry,
management believes that our new and recently acquired sampling systems have
enabled us to maintain a competitive advantage and affirm our position as an
innovator in the sampling industry. In recent years, our products have been used
in many major new fine fragrance launches that have utilized sampling systems.
Almost all of these sampling systems have been designed to meet U.S. Postal
Service ("USPS") approval for subscription magazine periodical rates.
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o ScentStrip(R): A proprietary technology introduced by our Company in
1979, ScentStrip(R) is microencapsulated essential oil deposited
between two layers of paper which "snap" open to release a quality
fragrance rendition. ScentStrip(R) can deliver quality aroma
renditions of fine fragrance, personal care, sun care and consumer
products. ScentStrip(R) is available in many formats, including
magazine and catalogue inserts, blow-ins, enclosures and remittance
envelopes, among others, all of which can be customized to include
multiple fragrances in ScentStrip(R) form.
o ScentStrip(R) Plus: Combines the traditional ScentStrip(R) format with
perfume "pearls" in a proprietary technology wherein fine
microencapsulated essential oil is deposited between two layers of
paper that "snap" open to deliver an olfactory sample and wearable
on-skin trial when "pearls" are touched.
o MicroDot(TM): A proprietary technology, MicroDot(TM) uses
microencapsulated fragrance oil, delivered in ultra-fine capsule size
form, deposited between two layers of paper which pull apart to
deliver superior on-skin fragrance trial. The technology is available
as a stand alone product, as pressure sensitive labels or as pressure
sensitive labels on perforated sheets.
o PowdaScent(TM): A patented technology in which an encapsulated
fragrance oil, in a printable form, is hygienically sealed between a
board stock and a see-thru layer of transparent film. This transparent
film displays the encapsulated fragrance which can be produced in any
size, shape and color. Once peeled open, and the capsules are touched,
an aroma rendition is delivered.
o AromaLacquer(TM): A proprietary 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(TM) releases the aroma rendition.
o AromaTouch(TM): A proprietary scented microencapsulated coating that
delivers a superior aroma rendition of nearly any fragrance, personal
care, household, food, beverage, pharmaceutical or novelty product.
AromaTouch(TM) is printable to paper or plastic substrates and is most
popular for use on product packaging. When rubbed or scratched,
AromaTouch(TM) releases the aroma rendition.
o Microfragrance(R) Scratch `n Sniff: Microfragrance(R) capsules are
applied to paper or stickers which affix to nearly any surface,
delivering an accurate aroma rendition of any product where scent is
part of the message such as flowers, shampoos, etc. When the sampling
system is scratched, capsules release a quality aroma rendition.
o AromaWindow (TM): A proprietary technology in which Microfragrance(R)
capsules are applied to a clear polyester film label, delivering an
accurate aroma rendition of any product, where scent is part of the
message, when scratched. This label technology is very effective for
application on packaging surfaces. The advantage of this
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technology is that the clarity of the label does not obscure the
graphics of the packaging as does a more traditional opaque label.
o DiscCover(R): A peel-and-reveal, non-encapsulated patented sampling
system label 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. This technology keeps
fragrance locked-in until "lift off" with no pre-release and is used
both in the fine fragrance and many other consumer products categories
including a variety of personal care products and food and beverage
products.
o DiscCover(R)More: This patented sampling system offers all of the
attributes of the original DiscCover(R) technology enhanced to offer a
single, wearable, on-skin trial of the fragrance.
o ScentSeal(R): A patented, pouch-like, pressure sensitive format that
incorporates a product rendition deposited between two layers of foil
laminate. When pulled open, ScentSeal(R) reveals a moist,
alcohol-based gel applicable to skin for wearable-trial. ScentSeal(R)
can contain quality fragrance, fragrance ancillary or personal care
product renditions. The product offers customers the opportunity to
deliver moist, on-skin trial via its "wet delivery system" and is
available in many shapes and sizes compatible with brand image and
creative design.
o LiquaTouch(R): This patented technology 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. LiquaTouch(R) is hermetically sealed with no
pre-release and delivers a spill proof trial of any alcohol formulated
fragrance product. The product is available in a single, or dual
chamber pressure-sensitive format and is also available in a
stand-alone version, which is a cost-effective alternative to
fragrance vials.
Beauty Sampling Systems
Our portfolio also includes non-fragrance sampling system products,
primarily for the beauty industry, which represent a growing percentage of our
sales. These sampling systems are utilized to sample cosmetics and beauty care
products including foundation, creams and lotions, lipstick and powders. Almost
all of these sampling systems have been designed to meet USPS approval for
subscription magazine periodical rates.
o BeautiSeal(R): A proprietary, patented technology, BeautiSeal(R) is a
sampling system for depositing quality renditions of creams, lotion or
gel products between the foil layers of a heat-sealed, pressure
sensitive well. BeautiSeal(R) is hermetically sealed, designed to
withstand significant pressure and is approved by the USPS for
subscription magazine periodical rates. BeautiSeal(R) can contain
renditions of liquid foundation, as well as creams, lotions and gel
treatment and personal care products such as moisturizers, eye
treatments, body, hand and foot lotions and hair gel, among
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others. BeautiSeal(R) is ideal for magazine and catalogue inserts,
bind-in cards, direct mailers, brochures and in-store handout and
regimen cards.
o ActiSeal(TM): A patented technology, with characteristics similar to
BeautiSeal(R), which is peeled open to reveal two adjacent wells, each
well containing a formula component which are blended together by the
consumer upon application.
o Liqi-Seal(R): A patented clear top packette which can be utilized to
sample liquid, cream, lotion or gel products. The patented clear
laminate has unique barrier characteristics which allow it to pass
stringent stability tests. The product sample can contain makeup, hair
care, skin care, fragranced ancillaries and body care, among other
products.
o PowdaTouch(R): A proprietary, patented technology wherein cosmetic
powder is deposited between two layers of paper, die-cut with a tab
that lifts up to reveal the powder rendition area. PowdaTouch(R) can
contain quality renditions of eye shadow, powder blush, face powder or
bronzer. PowdaTouch(R) is ideal for magazine and catalogue inserts,
blow-ins, and bind-in cards among others and is approved by the USPS
for subscription magazine periodical rates.
o ShadeSeal(R): This patented technology is used to sample renditions of
cosmetic powders or lip products. The product rendition is deposited
between two substrates which pull apart to offer a trial sample while
a transparent "window" displays the shade. This product can be
utilized in many different formats to accommodate either multiple
shades or a variety of cosmetic products including both long-lasting
and conventional lipsticks. Also very effective for sampling other
personal care powder products such as baby powder and foot care
powder.
o LipSeal(R): A patented technology with characteristics similar to
BeautiSeal(R), this product provides a sampling system wherein a
lipstick rendition is deposited into the well of a pressure-sensitive
format that easily pulls apart to offer user-friendly, hygienic trial.
LipSeal(R) offers trial of any lipstick shade, finish and texture in
any lipstick formula, including long-lasting formulas.
o BeautiPak(TM): A proprietary "windowed" sampling system for a variety
of lipstick formulations. Product is sealed into one well of a
thermoformed "tray" while a second well contains a flocked lipstick
applicator.
o BeautiTouch(R) Multi-Well Sampler: This proprietary technology is a
sampling system for cream, lotion, lipstick or gel product renditions
which are deposited into individually-sealed, foil laminate "pouches".
Heat-sealed "pouches" which share a common backing easily pull apart
to provide trial of multiple shades or formulas. BeautiTouch(R) offers
ideal, multiple shade demonstration by delivering trial of 8, 10, 12
or more foundation shades on a single carrier with no
cross-contamination. BeautiTouch(R) is also available in a stand alone
triple chamber format which is very effective as handouts or as a
sample at point of sale.
6
o SelectaShade(R): A proprietary beauty tool used to determine
foundation shades that precisely match consumers' skin tones. This
transparent strip of polyester film is printed with special inks that
replicate foundation shades exactly. When SelectaShade(R) is placed
against face or hand, the shade that best matches the users own skin
will become invisible on the chart to give each consumer an accurate
shade match.
Other Products & Services
o Arcade Direct: This full service division of our Company offers a full
range of creative services to our customers in the cosmetic and
fragrance industry and has established a niche presence in various
industries, including retail and specialty stores, fashion catalogues,
buying offices, direct marketers, hotels and spas. This dedicated
division offers complete turnkey marketing and creative services up to
and including electronic production.
o Arcade Product Technologies: This division employs proprietary
chemistries to manufacture and market microencapsulated ingredients
used in the formulation of various personal care products. Fragrance
oil, whether customer-supplied or selected from our Company's
extensive aroma library, can be encapsulated using these proprietary
systems and supplied in powder form, resulting in a scent that can be
renewed as the capsules are sheared. In addition, the technologies can
be used to encapsulate a wide range of cosmetic formulation materials
which provide consumers with additional, longer-lasting benefits due
to ingredients that re-release over time and which enhance texture,
application and overall product stability.
o Arcade Consumer Communications: This division specializes in
electronic, multi-media, multi-sensory devices primarily for use at
point-of-sale. Technologies offered in this division focus on
interaction with the consumer including the dispensing of samples.
Such interaction promotes sales at the point of sale.
Formats
Mail Formats
We produce a wide and versatile range of formats approved by the USPS for
subscription magazine periodical rates and which can be incorporated into almost
any print media. The most common formats for our products are described below.
Magazine Inserts: Magazine inserts are available in half-, full-, two- and
four-page formats, can be die-cut, can contain nearly all of our sampling
systems and are the most commonly produced among our sampling formats.
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
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envelope, provided to facilitate the return of merchandise order forms to the
store. We have the ability to create and produce special formats, to custom
imprint with store information and to incorporate most of our sampling systems.
Remittance Envelopes: Remittance envelopes, which are inserted into store
statement mailings, can be customized with a store logo and can be produced with
or without sampling systems. We believe that we are the only company in the
sampling industry that can produce remittance envelopes in-house. Remittance
envelope production, which is a highly customized service business, reinforces
our 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 design and has become the leading industry format.
Blow-ins: Blow-ins, which are available in all formats and sizes, can
accommodate nearly all of our sampling systems and are loosely inserted (blown
in) rather than bound into store catalogues, newspapers and magazines.
Direct Mail: Full color, direct mail formats can be produced in a variety
of sizes, weights and designs, including single, double and triple folds, as
well as standard and oversized postcards. Direct mailers can be customized with
store or manufacturer logo and can accommodate virtually all of our sampling
technologies.
Other Formats
Direct Sell: Many of our Company's sampling systems are widely used in
direct sales campaigns. Beauty companies, whose treatment, cosmetic and
fragrance products are sold directly to the consumer by representatives, use our
sampling technologies to promote their product offerings.
Point-of-Sale Materials: We have 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 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 sampling systems and items such as postcards, stickers,
wristbands, bookmarks and CD inserts. Many of our other technologies, including
LiquaTouch(R), BeautiSeal(R), BeautiPak(TM), BeautiTouch(R), MicroDot(TM),
Liqi-Seal(R), ShadeSeal(R) and PowdaTouch(R) are becoming more widely accepted
for point-of-sale handouts as an alternative to more traditional sampling
methods and for salable unit doses.
Gift-with-Purchase/Purchase-with-Purchase Programs: Many of our fragrance
and cosmetic customers promote new product offerings with our sampling systems.
LiquaTouch(R) stand alones and DiscCover(R)More offer single, long-lasting
wearable fragrance trial samples.
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BeautiPak(TM) gives the consumer a full application of a lipstick formula or
shade, and LiquiSeal(TM) can be used to offer a full application of up to four
foundation or treatment product samples.
Company-Sponsored Research and Development Activities
We engage in various company-sponsored research and development activities.
Research and development expenditures consist of salaries and benefits,
occupancy costs, and test materials and related production costs, and are
charged to selling, general and administrative expenses in the period incurred.
Research and development expenses totaled approximately $2.2 million, $2.1
million and $2.1 million for the years ended June 30, 2004, 2003 and 2002,
respectively, including expenditures related to the improvement of existing
products, services and techniques totaled approximately $1.8 million, $1.7
million and $1.7 million, respectively.
Intellectual Property
We currently hold patents covering the proprietary processes used to
produce many of our products in both the United States and abroad and have
submitted applications for many of our manufacturing processes. We have
trademarks registered in the United States and we have also filed and registered
trademarks in over 15 countries around the world, including countries in the
European Union, Australia, Japan and Brazil.
We have ongoing research efforts and expect to seek additional patents in
the future covering results of our research. We cannot assure you 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 or held to be invalid or
unenforceable.
In addition, many of our manufacturing processes are not covered by any
patent or patent application. As a result, our business may be adversely
affected by competitors who independently develop technologies substantially
equivalent to those employed by our Company.
Customers
We sell our products to prestige and mass cosmetic, fragrance and consumer
products companies, department stores, home shopping retailers and specialty
retailers including Avon Products, Inc., Unilever plc, Chanel, Inc., Coty, Inc.,
L'Oreal S.A., Elizabeth Arden, Estee Lauder, Inc., Mary Kay, Victoria's Secret
Beauty and The Procter & Gamble Company. Our top ten customers accounted for
approximately 76% of sales in fiscal 2004. Estee Lauder, L'Oreal and Mary Kay
were the only customers that accounted for 10% or more of net sales in fiscal
2004. We believe that our technical expertise, manufacturing reliability and
customer support capabilities have enabled us to develop strong relationships
with our customers. We employ sales and marketing personnel who possess the
requisite technical backgrounds to communicate
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effectively with both prospective customers and our manufacturing personnel.
Historically, we have had long-term relationships with our major customers.
Sales and Marketing
Our sales and marketing efforts are organized geographically. The U.S.
sales group is supervised by our Senior Vice President of U.S. Sales, while our
European sales executives are based in Paris, France and London, England and are
managed by an executive based in Paris, France. We also have representatives in
Australia, Brazil, Canada, Mexico and Japan. Each sales executive is dedicated
to a certain number of identified customers. In addition, these sales efforts
are supported by production managers/customer service representatives, which are
based in Chattanooga, Tennessee, Baltimore, Maryland and Paris, France. A
portion of the compensation for sales executives is commission and/or
bonus-based.
Our marketing activities include direct contact with senior executives in
the cosmetic and fragrance industry, major support of industry events and
extensive joint marketing programs with magazines, retailers and fragrance
houses. We also receive press coverage in industry trade publications, attend
industry seminars, advertise in trade publications and sponsor promotional
pieces. In addition, we focus our sales efforts toward three principal groups
within our customers' organizations that management believes influence our
customers' purchasing decisions:
o marketing, which selects the sampling system technology and typically
controls the promotional budget;
o product development, which approves our sampling system rendition and
conducts stability testing; and
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, cosmetic and fragrance marketers are increasingly
looking for their vendors to contribute to the overall strategy-building effort
to introduce a new product. Our executives routinely introduce new sampling
system formats and ideas based on our technologies to the marketing departments
of our customers. Our in-house creative and marketing know-how, as well as our
complete product line of sampling technologies, provides customers with maximum
flexibility in designing promotional programs.
Geographic Revenues
Revenues generated from customers in the United States for the years ended
June 30, 2004, 2003 and 2002 were approximately $101.4 million, $87.6 million
and $95.5 million, respectively. Revenues including export shipments from the
United States, generated by foreign customers, principally in Europe, for the
years ended June 30, 2004, 2003 and 2002 were approximately $32.0 million, $27.7
million and $25.4 million, respectively.
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Manufacturing
Our manufacturing processes are highly technical and largely proprietary.
Our 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. Our manufacturing
processes are composed of one or more of the following:
o formulating cosmetic and fragrance product renditions in our in-house
laboratories;
o printing advertising pages and other media;
o manufacturing the sampling product, which consists of either applying
an encapsulated slurry onto paper or producing sampling labels that
contain fragrance or other cosmetic product renditions; and
o affixing our label products onto a preprinted advertising carrier.
ISO 9001 Registration: During 2001, the International Organization for
Standardization awarded three of our Company's manufacturing facilities in
Chattanooga, Tennessee with ISO 9001:1994 Registration. In December 2003, these
facilities and a fourth manufacturing facility located in Baltimore, Maryland
were awarded ISO 9001:2000 Registration. These facilities produce many of our
Company's proprietary, patented and patent-pending products, as well as several
of our other sampling systems. The registration was awarded following an
extensive examination of our Company's quality management system which contains
five process groups; each with elements and sub-elements that outline the
requirements for documenting and implementing our Company's overall philosophy
as it pertains to quality, our policies, systems and procedures. The ISO
standards serve as guidelines for businesses interested in assuring that their
processes result in products that reflect the highest level of quality. The ISO
9001:2000 standard applies to organizations that design, develop and produce
products while assuring and controlling quality through continuous improvement.
Both of our Chattanooga and Baltimore operations have been awarded The
Procter & Gamble Triple Pinnacle Award, which is presented to companies as
recognition for having met certain quality requirements and having demonstrated
outstanding quality assurance. Both operations are also registered with the Food
and Drug Administration for the packaging of regulated cosmetic products and we
maintain environmentally controlled cGMP (current good manufacturing practice)
compliant facilities.
Management believes that our formulation capabilities are the best in the
cosmetics and fragrance sampling industry. The formulation process is highly
complex because we strive to replicate the fragrance of a product in a bottle
containing an alcohol solution. Formulation approval is an interactive process
between our Company and our customers. We have more than 125 different
proprietary formulations that we utilize in replicating different
characteristics of over 500 fragrances to obtain a customer-approved rendition.
A number 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
11
strict tolerances and in complete conformity to the formula that the customer
has pre-approved. Formulation is conducted in our specially designed formulation
laboratories by trained specialists.
The artwork for substantially all printed pieces is typically furnished by
the customer or its advertising agency. Our digital prepress department utilizes
state-of-the-art technology to receive customer-supplied computer disks and
transfers this material directly to our printing plates. We have the capability
to produce high quality printed materials, including the covers of major fashion
magazines, in connection with fragrance sampling systems.
Our formulated offset paper samplers (ScentStrip(R), ScentStrip(R) Plus,
PowdaTouch(R)) are produced in our primary facility in Chattanooga, Tennessee in
a continuous in-line operation. Our formulated letterpress or flexo label
samplers (DiscCover(R), BeautiSeal(R), LipSeal(R), LiquaTouch(R) and
ScentSeal(R) ) are produced on specially modified label and finishing equipment
in our second Chattanooga facility, while the Microfragrance(R) Scratch `n Sniff
operation is conducted in a third facility in Chattanooga, Tennessee. Our
specialized screen printing manufacturing process which produces our
ShadeSeal(R) and PowdaScent(TM) technologies takes place in our facility in
Baltimore, Maryland. In addition BeautiPak(TM), our proprietary thermoformed
technology for sampling lipstick, and Liqi-Seal(R), our patented clear top
packette to sampler liquid, cream, lotion or gel products, are produced in our
Baltimore, Maryland facility. At each facility, a 24-hour quality control
function and hourly accountability provide significant value to our customers'
product development personnel, who are typically responsible for sample system
quality. In addition to the patents pending on a number of our manufacturing
processes, we use 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 production.
We also have agreements with North American, European and Australian
printers and label manufacturers that we contract with to produce some materials
for our customers. These arrangements are typically utilized when foreign
distribution is required or demand exceeds our internal capacity. Each of these
arrangements is protected by non-competition agreements.
Sources and Availability of Raw Materials
Generally, the raw materials used by our Company in the manufacturing of
our products have been readily available from numerous suppliers and have been
purchased by our Company at prices that we believe are competitive. However, our
encapsulated paper products utilize specific grades of paper which we purchase
primarily from one manufacturer. These paper products are subject to
comprehensive evaluation and certification by us for quality, consistency and
fit. Some of our laminates are purchased from single sources under certain
specifications. We have not experienced any significant material supply
shortages in the past, nor are any anticipated.
12
Competition
Our competitors, some of whom have substantially greater capital resources
than our Company, are actively engaged in manufacturing products similar to, or
in competition with, our products. Competition in our markets is based upon
product quality, product technologies, customer relationships, price and
customer service. Our principal competitors in fragrance and cosmetic sampling
market are the fragrance divisions of Vertis, Inc., Orlandi, Inc., Delta
Graphics, Inc., Nord'est, Marietta Corp., Sampling Dimensions, LLC, Klocke,
Rotakon GmbH, Follmann & Co., Manka Creations and Appliquesence. We also compete
with numerous manufacturers of miniatures, vials, packets, sachets, blister
packs and scratch and sniff products. In addition, some cosmetics companies
produce sampling products for their own cosmetic products. We also compete 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 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
policy is to comply with all legal requirements of applicable environmental,
health and safety laws and regulations. We believe that we are in general
compliance with such requirements and have adequate professional staff and
systems in place to remain in compliance, although there can be no assurances
that this is the case. We consider costs for environmental compliance to be a
normal cost of doing business and include such costs in pricing decisions.
Employees
As of July 31, 2004, we employed 490 persons, which included 288 hourly and
202 salaried and management personnel. A substantial number of our hourly
employees are represented by the Graphics Communications International Union
(GCIU) local 197-M. Management considers our relations with the union to be
good. The current union contract was signed March 11, 2004 and will be in effect
through March 31, 2007.
Available Information
We are subject to the informational requirements of the Securities Exchange
Act of 1934. We therefore file periodic reports and other information with the
Securities and Exchange Commission. Since we are not a listed company, we do not
make such annual reports or other information available on our website and do
not provide electronic or paper copies of these reports free of charge. Such
reports may be obtained by visiting the Public Reference Room of the SEC at 450
Fifth Street, NW, Washington, D.C. 20549, or by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an internet site
(http://www.sec.gov) that contains reports, proxy and information statements and
other information regarding issuers that file electronically. Our Internet
website address is www.arcadeinc.com. Information contained on our website is
not part of this report.
13
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.
We have substantial indebtedness and debt service obligations. As of June
30, 2004, AKI had total indebtedness of approximately $105.0 million. As of July
31, 2004, AKI had outstanding borrowings of $4.0 million under its revolving
credit agreement with Heller Financial, Inc. In addition, as of such date,
additional borrowings of up to approximately $15.7 million were available under
the revolving loan commitment of the credit agreement, subject to specified
conditions. 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 indenture, in each case, to incur additional indebtedness if we meet
specified requirements.
The level of our indebtedness could have negative consequences to holders
of the notes, 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 our level of indebtedness could limit flexibility in reacting to
changes in the operating environment and economic conditions
generally;
o our level of indebtedness could restrict our ability to increase
manufacturing capacity;
o we may face difficulties in satisfying our obligations with respect to
our indebtedness; and
o a portion of our 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 indenture 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;
o incur additional indebtedness and issue preferred stock;
o create liens;
o incur dividend and other payment restrictions affecting subsidiaries;
14
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 us to maintain specified
financial ratios and satisfy specified financial condition tests. Our ability to
meet those financial ratios and tests can be affected by events beyond our
control, and there can be no assurance that we will meet those tests in the
future. As of June 30, 2004, we were in compliance with all debt covenants.
To service our 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 and
to satisfy our 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 control. We anticipate that our operating cash flow, together with
available borrowings under the credit agreement, will be sufficient to meet our
operating expenses and to service our debt requirements as they become due.
However, if we are unable to service our indebtedness, we may be required to
take action such as reducing or delaying capital expenditures, selling assets,
restructuring or refinancing our 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 we are 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.
An investor's right to receive payments on the notes 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, the lender will have a prior secured
claim on the capital stock of AKI and our encumbered assets. As a result, our
encumbered assets would be available to pay obligations on the notes 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 financial condition would be materially adversely affected and the value of
the notes could be eliminated. As of July 31, 2004, AKI had outstanding
borrowings under the credit agreement consisting of, $4.0 million revolving loan
and could borrow an additional $15.7 million under the revolving loan commitment
of the credit agreement, subject to specified conditions.
15
Our results of operations could be adversely affected if the USPS reclassifies
our sampling systems or the sampling products of our competitors.
Most of our sampling systems are approved by the USPS for inclusion in
subscription magazines mailed at periodical postage rates. USPS approved
sampling systems have a significant cost advantage over other competing sampling
products, such as miniatures, vials, packettes, sachets and blister packs,
because these 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 USPS
accounted for approximately 22% of our net sales in fiscal 2004. There can be no
assurance that the USPS will not approve other competing types of sampling
systems for use in subscription magazines without requiring a postal surcharge,
or that the USPS will not reclassify our sampling systems such that they would
incur a postal surcharge. Any such action by the USPS could have a material
adverse effect on our results of operations and financial condition.
We rely on a small number of customers for a large portion of our revenues.
Our top ten customers by sales revenue accounted for approximately 76% of
our net sales in fiscal 2004. None of our customers, other than Estee Lauder,
L'Oreal and Mary Kay, accounted for 10% or more of net sales in fiscal 2004.
Although we have long-established relationships with most of our major
customers, we generally do not have long-term contracts with any of our
customers. We do have an exclusive three year contract, expiring in August 2007,
to provide Mary Kay certain lipstick samples. We may also be required by some
customers to qualify our manufacturing operations under specified supplier
standards. There can be no assurance that we will be able to qualify under any
supplier standards or that our customers will continue to purchase sampling
systems from us if our manufacturing operations are not so qualified. An adverse
change in our relationship with significant customers, including Estee Lauder,
L'Oreal or Mary Kay, would have a material adverse effect on our 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.
Our competitors, some of whom have substantially greater financial
resources than our Company, are actively engaged in manufacturing products
similar to those of our Company. Our principal competitors in the fragrance and
cosmetic sampling market are the fragrance division of Vertis, Inc., Orlandi
Inc., Delta Graphics, Inc., Nord'est, Marietta Corp, Sampling Dimensions LLC,
Klocke, Rotakon GmbH, Follmann & Co., Manka Creations and Appliquesence. We also
compete with numerous manufacturers of miniatures, vials, packettes, sachets,
blister packs and scratch and sniff products. In addition, certain cosmetic
companies produce sampling products for their own cosmetic products. We also
compete 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.
Competition in our market is primarily based upon price, product quality,
product technologies, customer relationships and customer service. The future
success of our business will depend in large part upon our ability to market and
manufacture products and services that meet customer needs on a
16
cost-effective and timely basis. There can be no assurance that capital will be
available for these purposes, that investments in new technology will result in
commercially viable products or that we will be successful in generating sales
on commercially favorable terms, if at all.
We must protect our intellectual property to be successful.
Our success, competitive position and revenues will depend, in part, upon
our ability to protect our proprietary and patented technologies and to operate
without infringing on the proprietary rights of others. Although we have certain
patents and have filed, and expect to continue to file, other patent
applications, there can be no assurance that our issued patents are enforceable
or that our 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 we cannot estimate any future expense. A
portion of our manufacturing processes are not covered by any patent or patent
application. As a result, our business may be adversely affected by competitors
who independently develop technologies substantially equivalent to those
employed by us.
Our business is affected by the advertising budgets of our customers and is
cyclical and seasonal in nature.
The advertising and marketing budgets of our customers, and therefore our
revenues, are susceptible to prevailing economic cycles and market conditions
that affect advertising and marketing expenditures, the performance of the
products of our customers in the marketplace and other related factors. There
can be no assurance that reductions in advertising spending will not occur,
which could have a material adverse effect on our results of operations and
financial condition.
In addition, our sales and operating results have historically reflected
seasonal variations. These seasonal variations are based on the timing of our
customers' advertising and marketing campaigns, which have traditionally been
concentrated prior to the Christmas and spring holiday seasons. These seasonal
fluctuations require us to accurately allocate our resources to manage our
manufacturing capacity, which often operates at full capacity during peak
seasonal demand periods. If we fail to adequately plan for our seasonal
fluctuations, our business may be adversely affected.
Our results of operations and financial condition may be adversely affected by
an increase in raw material prices or a decrease in raw material supply.
Paper is the primary raw material utilized by our Company in producing our
sampling systems. Paper costs represented approximately 18% of our cost of goods
sold in each of fiscal 2004, 2003 and 2002. Significant increases in paper costs
could have a material adverse effect on our results of operations and financial
condition to the extent that we are unable to price our products to reflect such
increases. There can be no assurance that our customers would accept such price
increases or the extent to which such price increases would impact their
decision to utilize our sampling systems.
17
Substantially all of our ScentStrip(R) sampling systems, which accounted
for approximately 39% of our net sales in fiscal 2004, utilize specific grades
of paper that are subject to comprehensive evaluation and certification by us
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. We continue to research methods of replicating the
advantages of these specific grades of paper with other available grades of
paper. Until alternative methods are developed, a loss of our supply of paper
and the resulting competitive advantage could have a material adverse effect on
our results of operations and financial condition to the extent that we are
unable to obtain such paper elsewhere.
Certain of our label sampling systems, which accounted for approximately
27% of our net sales in fiscal 2004, utilize component materials that are
sourced from one qualified vendor. Although alternative sources are being sought
for the component materials, there can be no assurance that we will be
successful in locating another vendor. A loss of supply of materials could have
a material adverse effect on our results of operations and financial condition
to the extent we are unable to obtain materials elsewhere.
We receive a portion of our revenue from foreign countries and are subject to
foreign laws and regulations and political and economic events.
Approximately 24% of our net sales, including export shipments from the
United States, in fiscal 2004 was generated outside the United States. Foreign
operations are subject to 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 control. We have 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.
We are controlled by DLJMBII whose interests may conflict with the interests of
the holders of the notes.
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 AHC's outstanding common stock. DLJMBII
may have interests that could be in conflict with those of the holders of the
notes and may take actions that adversely affect the interests of the holders of
the notes.
Our business may be adversely affected by a labor dispute.
As of July 31, 2004, approximately 47% of our employees worked under a
collective bargaining agreement that expires on March 31, 2007. While we believe
that our relations with our employees are good, there can be no assurance that
our collective bargaining agreement will
18
be renewed in the future. A prolonged labor dispute (which may include a work
stoppage) could have a material adverse effect on our business, financial
condition and results of operations.
ITEM 2. PROPERTIES
We own land and buildings in Chattanooga, Tennessee, that are used for
production, administration and warehousing. Our executive offices and primary
facility at 1815 East Main Street are located on 2.55 acres and encloses
approximately 67,900 square feet. A second facility housing product development
and additional manufacturing areas at 1600 East Main Street is located three
blocks away on 2.49 acres and encloses approximately 36,700 square feet. We have
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.
We lease buildings in Baltimore, Maryland that are used for production and
warehousing. The production facility at 7600 Energy Parkway encloses
approximately 60,000 square feet, and its lease expires in August, 2007 with an
option to purchase the facility for $4.2 million. The warehouse facility at 7525
Perryman Court encloses approximately 13,000 square feet and its lease expires
in January, 2005.
We also lease sales offices in New York, New York, Paris, France and
London, England.
ITEM 3. LEGAL PROCEEDINGS
Other than as discussed below, we do not believe that there are any pending
legal proceedings other than ordinary routine litigation incidental to our
business.
The Beautiful Bouquet Company, Ltd. (the "Licensor") filed suit in
Tennessee state court on October 30, 2003 against our Company alleging breaches
of a Patent and Know-How License agreement, as amended (the "License
Agreement"). Under the License Agreement, our Company licenses certain
intellectual property related to one of our products for which we are obligated
to pay the Licensor a royalty based on sales of the product and a minimum annual
royalty. The Licensor alleges our Company committed a number of breaches,
including a breach of the License Agreement and a breach of fiduciary duty owed
to the Licensor, and is seeking to recover unspecified amounts under the terms
of the License Agreement and all amounts due it because of our Company's alleged
unjust enrichment of the Licensor's intellectual property rights.
We believe that we did not breach any provisions of the License Agreement
and intend to vigorously defend ourself.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
There is no established public trading market for AKI's common stock. As of
August 15, 2004, 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
notes and the credit agreement contain restrictions on AKI's ability to pay
dividends on its common stock.
20
ITEM 6. SELECTED FINANCIAL DATA
The selected historical consolidated financial data presented below as of
June 30, 2004, 2003, 2002, 2001 and 2000 and the years ended June 30, 2004,
2003, 2002, 2001 and 2000 have been derived from the historical consolidated
financial statements of 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 Consolidated
Financial Statements and the notes thereto included elsewhere in this report.
June 30, June 30, June 30, June 30, June 30,
(dollars in thousands) 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Statement of Operations Data:
Net sales $ 133,372 $ 115,308 $ 120,893 $ 115,395 $ 99,811
Cost of goods sold 85,770 73,883 73,888 71,336 61,552
--------- --------- --------- --------- ---------
Gross profit 47,602 41,425 47,005 44,059 38,259
Selling, general and
administrative expenses 20,795 17,971 18,943 18,199 16,980
Amortization of intangibles
including goodwill 1,143 1,143 6,451 5,757 5,336
Gain from settlement, net - - (992) - (858)
--------- --------- --------- --------- ---------
Income from operations 25,664 22,311 22,603 20,103 16,801
Interest expense, net 12,575 12,674 12,528 13,212 13,668
Management fees 400 325 250 250 250
(Gain) from early
retirement of debt (1) - - - (748) (704)
Other, net (105) 33 - - -
Income tax expense 4,418 3,446 5,674 4,950 3,092
--------- --------- --------- --------- ---------
Net income $ 8,376 $ 5,833 $ 4,151 $ 2,439 $ 495
========= ========= ========= ========= =========
Balance Sheet Data (at end
of period):
Cash and cash equivalents $ 1,369 $ 1,470 $ 1,875 $ 4,654 $ 1,158
Working capital 12,643 10,677 11,525 10,288 14,182
Goodwill, net 152,438 152,994 153,277 157,334 162,472
Total assets 212,203 215,547 224,906 213,378 222,050
Senior notes 103,510 103,510 103,510 103,510 107,510
Total debt 105,010 121,635 115,760 104,013 117,859
Total stockholder's equity 84,225 72,090 83,407 85,670 83,526
Other Data:
Capital expenditures $ 1,349 $ 2,345 $ 1,338 $ 3,015 $ 2,782
Ratio of earnings to fixed
charges (2) 2.0x 1.7x 1.8x 1.6x 1.3x
- ------------
(1) Extraordinary gains in fiscal 2001 and 2000 have been reclassed to conform
with current year presentation, in accordance with the provisions of SFAS
145.
(2) 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.
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
Our sales are primarily derived from the sale of sampling systems to
cosmetics, fragrance and consumer products companies. Substantially all of our
sales are made directly to our 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 our
customers generally do not enter into long-term contracts, we have had
long-standing relationships with the majority of our customer base.
The Acquisition
DLJMBII and certain members of our 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. All of these
debentures have been repurchased by our Company as of June 30, 2003.
The Acquisition was accounted for using the purchase method of accounting
and resulted in the recognition of $153.9 million of goodwill.
22
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 $7.3 million in cash and the assumption of a liability of
$0.2 million to one of the customers of the business. We financed the 3M
acquisition with borrowings under the credit agreement. These borrowings were
subsequently repaid.
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 financed by borrowings under the credit agreement.
Color Prelude Acquisition
On December 18, 2001, we acquired the CP business for $19.4 million. We
financed the CP acquisition with borrowings under our credit agreement.
Fusion Merger
On July 21, 2004, AHC entered into the Fusion Merger Agreement with Fusion,
a newly-formed entity owned by investment funds managed by KKR, and AHC Merger,
Inc., a wholly-owned subsidiary of Fusion formed for the purpose of effecting
the Fusion Merger, pursuant to which AHC Merger will merge with and into AHC
such that AHC will be the surviving corporation and, at the effective time of
the Fusion Merger, will become a wholly-owned subsidiary of Fusion. Immediately
upon the effectiveness of the Fusion Merger, Fusion will contribute AHC to JHC
in exchange for capital stock of JHC. Following the contribution, JHC intends to
contribute AHC to its direct subsidiary, Jostens IH Corp., and as a result AHC
will be a wholly-owned subsidiary of Jostens IH Corp.
Pursuant to the Fusion Merger Agreement, each issued and outstanding share
of AHC's common stock will be cancelled and retired and shall cease to exist,
and no consideration shall be delivered in exchange therefore; and each issued
and outstanding share of AHC's outstanding preferred stock shall be converted
into the right to receive cash merger consideration. The cash merger
consideration payable per share of preferred stock will be determined based upon
a total enterprise value of $250.0 million, as adjusted based upon the working
capital of our Company at closing. Upon consummation of the Fusion Merger and
the contributions, AHC shall be a wholly-owned subsidiary of Jostens IH Corp.
The Fusion Merger Agreement and subsequent contribution are subject to
certain conditions to closing including, among others: (i) the consummation of
the Fusion Merger and certain other concurrent transactions, including the
contribution and the merger of Von Hoffmann Holdings Inc. with and into a
subsidiary of Fusion; (ii) the repayment, repurchase or redemption of certain
indebtedness and preferred stock of Jostens, Inc., JHC, Von Hoffmann
23
Holdings Inc., Von Hoffmann Corporation, AHC and AKI; (iii) that Jostens IH
Corp. obtains financing for such concurrent transactions on the terms and
conditions set forth in the financing commitment provided by an affiliate of
Credit Suisse First Boston LLC, Banc of America Securities LLC and Deustche Bank
Securities Inc.; and (iv) that Marc Reisch, CEO of Fusion, shall have made an
investment in the common stock of JHC.
In connection with the Fusion Merger and subsequent contribution, we will
refinance our existing credit facility. In addition, upon the consummation of
the contributions, JHC intends to use new financing by Jostens IH Corp. to fund
certain tender payments due to holders of AKI's 10 1/2% Senior Notes due 2008
who elect to tender their notes pursuant to tender offers and consent
solicitations commenced on August 19, 2004.
Results of Operations
Fiscal Year Ended June 30, 2004 Compared to Fiscal Year Ended June 30, 2003
Net Sales. Net sales for the fiscal year ended June 30, 2004 increased
$18.0 million, or 15.6%, to $133.3 million as compared to $115.3 million for the
fiscal year ended June 30, 2003. The increase in net sales was primarily
attributable to an increase in sales of sampling technologies for advertising
and marketing of domestic fragrance products and international cosmetic products
and favorable foreign exchange rates.
Gross Profit. Gross profit for the fiscal year ended June 30, 2004
increased $6.2 million, or 15.0%, to $47.6 million as compared to $41.4 million
for fiscal year ended June 30, 2003. Gross profit as a percentage of net sales
decreased to 35.7% in the fiscal year ended June 30, 2004, from 35.9% in the
fiscal year ended June 30, 2003. The increase in gross profit is primarily due
to the increase in sales volume and favorable foreign exchange rates. The
decrease in gross profit as a percentage of net sales is primarily due to
changes in product and format mix and the reduction in prices of certain
fragrance sampling products in order to maintain and grow market share.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2004 increased $2.8
million, or 15.6% to $20.8 million as compared to $18.0 million for the fiscal
year ended June 30, 2003. Selling, general and administrative expenses as a
percent of net sales were 15.6% in the fiscal years ended June 30, 2004 and
2003. The increase in selling, general and administrative expenses is primarily
related to an increase in advisory services related to customs and duties
matters and consulting services related to marketing initiatives, incentive
compensation expense, and the impact of foreign exchange rates.
Income from Operations. Income from operations for the fiscal year ended
June 30, 2004 increased $3.4 million, or 15.2%, to $25.7 million as compared to
$22.3 million for the fiscal year ended June 30, 2003. Income from operations as
a percentage of net sales was 19.3% in the fiscal years ended June 30, 2004 and
2003. The increase in income from operations is principally the result of the
factors described above.
24
Interest Expense. Interest expense for the fiscal year ended June 30, 2004
decreased $0.1 million, or 0.8%, to $12.6 million, as compared to $12.7 million
for the fiscal year ended June 30, 2003. Interest expense as a percentage of net
sales decreased to 9.5% in the fiscal year ended June 30, 2004 from 11.0% in the
fiscal year ended June 30, 2003. The decrease in interest expense, including the
amortization of deferred financing costs, is primarily due to the repayment of
the term loan.
Income Tax Expense. The income tax expense for the fiscal year ended June
30, 2004 increased $1.0 million to $4.4 million as compared to $3.4 million for
the fiscal year ended June 30, 2003. The increase is due to the increase in
income before income taxes and non-deductible expenses principally as a result
of the factors described above.
Fiscal Year Ended June 30, 2003 Compared to Fiscal Year Ended June 30, 2002
Net Sales. Net sales for the fiscal year ended June 30, 2003 decreased $5.6
million, or 4.6%, to $115.3 million as compared to $120.9 million for the fiscal
year ended June 30, 2002. The decrease in net sales was primarily attributable
to a decrease in sales of sampling technologies for advertising and marketing of
domestic cosmetic products and international fragrance products partially offset
by an increase in the sales of sampling technologies for advertising and
marketing of domestic consumer products and international cosmetic products and
favorable foreign exchange rates.
Gross Profit. Gross profit for the fiscal year ended June 30, 2003
decreased $5.6 million, or 11.9%, to $41.4 million as compared to $47.0 million
for fiscal year ended June 30, 2002. Gross profit as a percentage of net sales
decreased to 35.9% in the fiscal year ended June 30, 2003, from 38.9% in the
fiscal year ended June 30, 2002. The decrease in gross profit and gross profit
as a percentage of net sales is primarily due to the decrease in sales volume
and changes in product mix and increased fixed costs associated with a full-year
operation of CP partially offset by favorable foreign exchange rates.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2003 decreased $0.9
million, or 4.8% to $18.0 million as compared to $18.9 million for the fiscal
year ended June 30, 2002. Selling, general and administrative expenses as a
percent of net sales was 15.6% in the fiscal years ended June 30, 2003 and 2002.
The decrease in selling, general and administrative expenses is primarily
related to a decrease in legal services related to a patent infringement lawsuit
initiated by our Company and incentive compensation expense partially offset by
increased expenses associated with a full-year operation of CP.
Amortization of Goodwill. Amortization of goodwill for the fiscal year
ended June 30, 2003 decreased $4.8 million, or 100%, to $0, as compared to $4.8
million for the fiscal year ended June 30, 2002. The decrease in amortization of
goodwill resulted from the adoption of FASB Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets". We completed our
initial and first annual tests of the carrying value of goodwill which resulted
in no impairment.
25
Income from Operations. Income from operations for the fiscal year ended
June 30, 2003 decreased $0.3 million, or 1.3%, to $22.3 million as compared to
$22.6 million for the fiscal year ended June 30, 2002. Income from operations as
a percentage of net sales increased to 19.3% in the fiscal year ended June 30,
2003 from 18.7% in the fiscal year ended June 30, 2002. The increase in income
from operations and income from operations as a percentage of net sales is
principally the result of the factors described above.
Interest Expense. Interest expense for the fiscal year ended June 30, 2003
increased $0.2 million, or 1.6%, to $12.7 million, as compared to $12.5 million
for the fiscal year ended June 30, 2002. Interest expense as a percentage of net
sales increased to 11.0% in the fiscal year ended June 30, 2003 from 10.3% in
the fiscal year ended June 30, 2002. The increase in interest expense, including
the amortization of deferred financing costs, is primarily due to a full year of
interest payable on the term loan incurred in connection with the CP
acquisition.
Income Tax Expense. Income tax expense for the fiscal year ended June 30,
2003 decreased $2.3 million to $3.4 million as compared to $5.7 million for the
fiscal year ended June 30, 2002. The decrease is due to the decrease in income
before income taxes and non-deductible expenses principally as a result of the
factors described above.
Liquidity and Capital Resources
We have substantial indebtedness and significant debt service obligations.
As of June 30, 2004, we had indebtedness in an aggregate amount of $105.0
million (excluding trade payables, accrued liabilities and deferred taxes),
which is a direct obligation of AKI relating to its notes and revolving credit
line. At June 30, 2004, AKI had $23.0 million in accrued liabilities (including
trade payables, accrued liabilities, deferred taxes and other liabilities). As
of July 31, 2004, AKI had outstanding borrowings of $4.0 million under the
revolving loan commitment of the credit agreement.
Borrowings under the revolving credit line are limited to a maximum amount
equal to $20.0 million. At June 30, 2004 and July 31, 2004, AKI had borrowing
availability of approximately $18.2 million and $15.7 million, respectively,
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 choice of certain formulas set forth in the credit agreement, plus a margin.
The credit agreement will mature on December 31, 2006.
The indenture governing the notes and the credit agreement permit AKI to
incur additional indebtedness, subject to specified limitations. In addition,
the indenture contains restrictive covenants that, among other things, limit the
ability of AKI to: (1) pay dividends or make certain restricted payments; (2)
incur additional indebtedness and issue preferred stock; (3) create liens; (4)
incur dividend and other payment restrictions affecting subsidiaries; (5) enter
into mergers, consolidations or sales of all or substantially all of the assets
of our company; (6) enter into certain transactions with affiliates; and (7)
sell certain assets. We were in compliance with all such covenants as of June
30, 2004.
26
In connection with the Fusion Merger and subsequent contribution, we will
refinance our existing credit facility. In addition, upon the consummation of
the contribution, we intend to use new financing by Jostens IH Corp. to fund
certain tender payments due to holders of AKI's 10 1/2% Senior Notes due 2008
who tender their notes pursuant to the tender offer and consent solicitation
commenced on August 19, 2004. It is a condition to the closing of the Fusion
Merger and the contribution and new financing described above that the notes be
repurchased or redeemed.
AKI's principal liquidity requirements are for operating working capital,
debt service requirements and fees under the notes and the credit agreement.
Historically, we have funded our capital, debt service and operating
requirements with a combination of net cash provided by operating activities,
which was $14.7 million and $14.2 million for fiscal 2004 and 2003,
respectively, together with borrowings under revolving credit facilities. Net
cash provided by operating activities during fiscal 2004 resulted primarily from
net income before depreciation and amortization and an increase in accounts
payable and accrued expenses, partially offset by increases in accounts
receivable and inventories.
We define Adjusted EBITDA (also referred to as EBITDA in our credit
agreement) as net income or loss plus income and franchise taxes, interest
expense, loss from early retirement of debt, depreciation, amortization and
impairment loss of goodwill and amortization of other intangibles less gain from
early retirement of debt and sale and disposal of fixed assets plus non-
capitalized acquisitions costs. Adjusted EBITDA is not a measure of financial or
operating performance, cash flow or liquidity under accounting principles
generally accepted in the United States and should not be used by itself or in
the place of net income, cash flows from operating activities or other income or
cash flow statement data prepared in accordance with generally accepted
accounting principles as a financial or liquidity measure.
We use Adjusted EBITDA to manage and evaluate our business operations. Our
management evaluates Adjusted EBITDA because it excludes certain cash and
non-cash items that are either beyond our immediate control or that we believe
are not characteristic of our underlying business operation for the period in
which they are recorded, or both. We believe the presentation of Adjusted EBITDA
is relevant because Adjusted EBITDA is a measurement that we and our lenders use
to comply with our debt covenants and establish our interest rate on a portion
of our debt. Investors should be aware that the way by which we calculate
Adjusted EBITDA may not be comparable with similarly titled measures presented
by other companies and comparisons of such amounts could be misleading unless
all companies and analysts calculate such measures in the same manner.
27
The calculation of adjusted EBITDA for the years ended June 30, 2004, 2003
and 2002 is as follows (dollars in millions):
2004 2003 2002
---- ---- ----
Net income........................ $ 8.4 $ 5.8 $ 4.1
Income and franchise tax
expense......................... 4.7 3.7 5.9
Interest expense.................. 12.6 12.7 12.5
Depreciation and amortization
of goodwill and other
intangibles..................... 7.1 7.3 12.1
Gain from sale and disposal of
fixed assets.................... (0.1) - -
Non-capitalized acquisitions
costs........................... - - 0.2
-------- -------- --------
Adjusted EBITDA................... $ 32.7 $ 29.5 $ 34.8
======== ======== ========
In fiscal 2004 and fiscal 2003, we had capital expenditures of
approximately $1.3 million and $2.3 million, respectively. These capital
expenditures consisted primarily of the purchase and maintenance of
manufacturing equipment and furniture and fixtures and maintaining and upgrading
our 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 financed by borrowings under the credit agreement. In fiscal 2002 we
received $1.0 million as a result of the purchase price reduction from the
sellers of RetCom.
On December 18, 2001, we acquired the CP business for $19.4 million. We
financed the CP acquisition with borrowings under our credit agreement.
We may from time to time evaluate additional potential acquisitions. There
can be no assurance that additional capital sources will be available to us to
fund additional acquisitions on terms that we find acceptable, or at all.
At June 30, 2004, AHC had outstanding $73.4 million of notes payable to
stockholders which bear interest at approximately 16% per annum and mature on
December 15, 2009, and approximately $133.0 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,
28
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.
During the year ended June 30, 2003, Holding purchased, with proceeds from
distributions from AKI, its 13.5% Senior Discount Debentures due 2009 with an
accreted value of $17.5 million for $18.0 million. The purchase caused there to
be outstanding no Debentures as of such date. AKI funded the distribution
through borrowings under its credit agreement.
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.
Substantially all of the proceeds were used in fiscal 2001 and 2000 to reduce
outstanding indebtedness of Holding and AKI. The balance of the proceeds may
become available to us 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, 2005 are budgeted
to be approximately $3.0 million. Based on borrowings outstanding (other than
pursuant to the revolving credit agreement) as of June 30, 2004 and borrowings
outstanding under the revolving credit agreement as of July 31, 2004, we expect
total cash payments for debt service in fiscal 2005 to be approximately $11.3
million, consisting of $10.9 million in interest payments on the notes and $0.4
million in interest and fees under the credit agreement. We also expect to make
royalty payments of approximately $1.2 million during fiscal 2005.
We believe 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 our indebtedness, including the notes for fiscal 2005. In the event
we consummate any additional acquisitions, we may seek additional debt or equity
financings subject to compliance with the terms of the indenture.
At June 30, 2004, AKI's consolidated cash and cash equivalents and net
working capital were $1.4 million and $12.6 million, respectively, representing
a decrease in cash and cash equivalents of $0.1 million and an increase in net
working capital of $2.0 million from June 30, 2003. Account receivables, net, at
June 30, 2004 increased 9.4% or $1.9 million over the June 30, 2003 amount,
primarily due to an increase in fourth quarter sales.
29
The following table summarizes our contractual obligations and other
contingencies as of June 30, 2004 (dollars in thousands):
Payments due by fiscal year
--------------------------------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total
---- ---- ---- ---- ---- ---------- -----
Debt obligations:
Principal................. $ - $ - $ 1,500 $ - $ 103,510 $ - $ 105,010
Interest*................. 11,169 11,169 11,019 10,869 5,435 - 49,661
Standby letter of credit...... - - 87 - - 291 378
Operating leases.............. 1,506 1,502 1,291 756 683 1,728 7,466
Minimum royalties**........... 1,200 1,200 1,200 1,200 1,200 3,206 9,206
Unconditional raw material
purchase obligations.......... 5,804 - - - - - 5,804
Other long-term obligations... 750 - - - - - 750
----------- ----------- ----------- ----------- ----------- ---------- -----------
Total................... $ 20,429 $ 13,871 $ 15,097 $ 12,825 $ 110,828 $ 5,225 $ 178,275
=========== =========== =========== =========== =========== ========== ===========
* Interest for floating rate obligations has been calculated using the
rates in effect as of June 30, 2004.
** Minimum royalties which are subject to consumer price index ("CPI")
adjustment have been calculated based on the CPI as of June 30, 2004.
Seasonality
Our sales of sampling technologies for advertising and marketing of
fragrance products have historically reflected seasonal variations. Such
seasonal variations are based on the timing of our 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 generally
reflected in our first and third fiscal quarters ended September 30 and March 31
when sales from such advertising campaigns are principally recognized. These
seasonal fluctuations require us to allocate our resources to manage our
manufacturing capacity, which often operates at full capacity during peak
seasonal demand periods. The severity of our seasonal sales variations has
decreased over time as we have developed and acquired other sampling
technologies for advertising and marketing of cosmetic and consumer products.
Off-Balance Sheet Arrangements
As of June 30, 2004 we did not have any significant off-balance sheet
arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.
Recently Issued Accounting Standards
Financial Accounting Standards Board ("FASB") Statement of Financial
Accounting Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142")
was issued in June 2001. SFAS 142 changes the accounting and reporting for
acquired goodwill and other
30
intangible assets. SFAS 142 is effective for fiscal years beginning after
December 15, 2001 and was applied at the beginning of our 2003 fiscal year. The
adoption of SFAS 142 eliminated the amortization of goodwill, approximately $4.8
million in fiscal year 2002, while requiring annual tests for impairment of
goodwill. We completed our initial and annual tests of the carrying value of
goodwill all of which resulted in no impairment.
FASB Interpretation No. 45 "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" ("FIN 45") was issued in November 2002. FIN 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also requires the guarantor to recognize, at the inception of the guarantee, a
liability for the fair value of obligation undertaken in issuing the guarantee.
The disclosure requirements are effective for quarters ending after December 15,
2002 and the liability recognition is in effect for guarantees initiated after
December 31, 2002. We do not anticipate that the provisions of this statement
will have a material impact on our reported results of operations, financial
positions or cash flows.
FASB Interpretation No. 46 "Consolidation of Variable Interest Entities"
("FIN 46") was issued in January 2003. FIN 46 requires an investor with a
majority of the variable interests in a variable interest entity ("VIE") to
consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A VIE is an entity in which
the equity investor does not have a controlling interest, or the equity
investment risk is insufficient to finance the entity's activities without
receiving additional subordinated financial support from the other parties. For
arrangements entered into with VIEs created prior to January 31, 2003, the
provisions of FIN 46 are required to be adopted at the beginning of the first
interim or annual period beginning after December 15, 2003. Provisions of this
interpretation did not have any material impact on our reported results of
operations, financial position or cash flows.
FASB Statement of Financial Accounting Standards No. 150 "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS 150") was issued in May 2003. SFAS 150 established guidance for
how certain financial instruments with characteristics of both liabilities and
equity are classified and requires that a financial instrument that is within
its scope be classified as a liability (or as an asset in some circumstances).
SFAS 150 is effective for fiscal years beginning after June 15, 2003. Our
Company has adopted SFAS 150, and it did not have a material impact on our
reported results of operations, financial position or cash flows.
Critical Accounting Policies
We have chosen accounting policies that we believe are appropriate to
accurately and fairly report our operating results and financial position, and
we apply those accounting policies in a consistent manner. The significant
accounting policies are summarized in Note 2 to the consolidated financial
statements.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires that we make
estimates and assumptions that
31
affect the reported amounts of assets, liabilities, revenues and expenses. These
estimates and assumptions are based on historical and other factors believed to
be reasonable under the circumstances. We evaluate these estimates and
assumptions on an ongoing basis and may retain outside professional advisors to
assist in our evaluation. We believe the following accounting policies are the
most critical because they involve the most significant judgments and estimates
used in preparation of our consolidated financial statements:
o Allowance for doubtful accounts. We maintain an allowance for doubtful
receivables for estimated losses resulting from the inability of our
trade customers to make required payments. We provide an allowance for
specific customer accounts where collection is doubtful and also
provide a general allowance for other accounts based on historical
collection and write-off experience. Judgment is necessary and if the
financial condition of our customers were to worsen, additional
allowances may be required.
o Inventories. Our inventories, which consist of raw materials and
work-in-process, are valued at the lower of cost or market value. We
evaluate all of our raw material inventory for slow moving product
based on recent usage, projections of future demand and market
conditions. For those units in inventory that are so identified, we
estimate their market value based on current realization trends. If
the projected net realizable value is less than cost, we provide a
provision to reflect the lower value of that inventory. This
methodology recognizes projected inventory losses at the time such
losses are evident.
o Intangible assets. When we acquire other companies or businesses, we
allocate the purchase price, including expenses and assumed
liabilities, to the assets and liabilities acquired including
intangible assets and goodwill. We estimate the useful lives of the
intangible assets by factoring in the characteristics of the related
products such as: existing sales contracts, patent protection,
estimated future introductions of competing products and other issues.
The factors that drive the estimate of the life of the asset are
inherently uncertain.
o Long-lived assets. We review our property, intangible assets and
goodwill for possible impairment whenever events or circumstances
indicate that the carrying amount of an asset may not be recoverable.
Assumptions and estimates used in the evaluation of impairment may
affect the carrying value of long-lived assets, which could result in
impairment charges in future periods. Such assumptions include
projections of future cash flows and, in some cases, the current fair
value of the asset. In addition, our depreciation and amortization
policies reflect judgments on the estimated useful lives of assets.
o Revenue recognition. Products are produced to customer specifications
based on purchase orders or signed quotations which include agreed
upon pricing. Product sales, net of estimated discounts and rebates,
are recognized at the time title and risk of ownership transfers upon
delivery to the customer. Products are shipped F.O.B. shipping point
and are not subject to any contractual right of return provisions.
32
o Deferred income tax assets. We have recorded deferred income tax
assets related to the temporary differences between the tax bases and
financial reporting bases of assets and liabilities. An adjustment to
income tax expense would be required in a future period if we
determine that the amount of deferred tax assets to be realized
differs from the net recorded amount.
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 or 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: (1) economic conditions in general and
in our specific market areas; (2) the significant indebtedness of our company;
(3) changes in operating strategy or development plans; (4) the competitive
environment in the sampling industry in general and in our specific market
areas; (5) changes in prevailing interest rates; (6) changes in or failure to
comply with postal regulations or other federal, state and/or local government
regulations; (7) changes in cost of goods and services; (8) changes in our
capital expenditure plans; (9) the ability to attract and retain qualified
personnel; (10) inflation; (11) liability and other claims asserted against us;
and (12) labor disturbances and other factors.
In addition, such forward-looking statements are necessarily dependent upon
assumptions, estimates and dates that may be incorrect or imprecise and involve
known and unknown risk, uncertainties and other factors. Accordingly, any
forward-looking statements included herein do not purport to be predictions of
future events or circumstances and may not be realized. Forward-looking
statements can be identified by, among other things, the use of forward-looking
terminology such as "believes," "expects," "may," "should," "seeks," "pro
forma," "anticipates," "intends" or the negative of any such word, or other
variations or comparable terminology, or by discussions of strategy or
intentions. Given these uncertainties, readers are cautioned not place undue
reliance on any forward-looking statements. We disclaim any obligations to
update any 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.
We are exposed to market risks from changes in foreign exchange rates. In
fiscal 2004, we generated approximately 24% of our sales, including export
shipments from the United States, from customers outside the United States,
principally in Europe. International sales are generated primarily from our
foreign subsidiary located in France and are primarily denominated in the local
currency. Our foreign subsidiary also incurs the majority of its expenses in the
local currency and uses the local currency as its functional currency.
33
Our 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.
We periodically enter 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, 2004, there were no forward
exchange contracts outstanding.
We are exposed to market risk from changes in interest rates. At June 30,
2004 we had $1.5 million outstanding in borrowings under our credit agreement at
variable rates. All of our remaining long-term debt is at fixed interest rates.
We believe that the effect, if any, of reasonably possible near term changes in
interest rates on our consolidated financial position, results of operations or
cash flows would not be significant.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Consolidated Financial Statements of AKI, the
related notes and the Report of Independent Registered Public Accounting Firm
for 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.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our chief executive
officer and chief financial officer have evaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Exchange Act Rule 13a-14(c)) as of the end of the period covered by this report.
Based on that evaluation, the chief executive officer and chief financial
officer have concluded as of the end of the period covered by this report that
our disclosure controls and procedures are effective.
(b) Changes in Internal Controls. There have not been any significant
changes in our internal controls or in other factors that could significantly
affect these controls during the period covered by this report.
34
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 AKI as of August 1, 2004.
Name Age Position
- ---- --- --------
William J. Fox * 47 President, Chief Executive Officer, Chairman of
the Board and Director
Kenneth A. Budde 55 Senior Vice President, Chief Financial Officer and
Secretary
A. Bruce Prashker 42 Senior Vice President and Assistant Secretary
David A. Durkin * 35 Director
Douglas B. Fox 56 Director
Hugh R. Kirkpatrick 67 Director
David M. Wittels * 40 Director
* Member of Executive Committee
William J. Fox has served as Chairman, President and Chief Executive
Officer and a Director of AKI 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. Mr. Fox is also
Co-Chairman of the Board and a Director of Loehmann's Holdings, Inc., a Director
of LQ Corporation Inc. and a Director nominee of Nephros, Inc. He also serves on
the Advisory Board of Barrington Companies Investors, LLC.
Kenneth A. Budde has served as Chief Financial Officer of AKI 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.
A. Bruce Prashker has served as Senior Vice President of AKI since April
2000. Prior to joining our Company, Mr. Prashker was Managing Principal of the
Capital Markets Company N.V. from April 1999 through April 2000. Mr. Prashker
served as Vice President & Controller of the International Division of RCPC from
January 1996 through April 1999, Vice President and Chief Financial Officer of
the Licensing Division of RCPC from August 1994 through
35
January 1996 and held various other executive positions at RCPC and MacAndrews
and Forbes Holding Inc. from April 1990 through August 1994.
David A. Durkin has served as a director of AKI since May 2002. Mr. Durkin
has been a Partner of DLJ Merchant Banking since July 2004 and a Principal since
March 2000. Prior to that, he served as a Vice President in the Leveraged
Finance Group and other roles in the Investment Banking Department of DLJ
Securities Corporation since 1996. Mr. Durkin also serves as a director of
Merrill Corporation/Merrill Communications LLC, Prometheus Laboratories, Inc.
and Seabulk International, Inc.
Douglas B. Fox has served as a director of the Corporation and as a
director of AKI since August 2003. Mr. Fox is a management consultant and
private investor. Since May 2001, he has served as the Chief Executive Officer
of Renaissance Brands LLC. Prior to that, he was Senior Vice President of
Marketing and Strategy for Compaq Computer Corporation from July 2000 to May
2001 and Chief Marketing Officer and Senior Vice President of Marketing for
International Paper Co. from April 1997 to December 1999. Mr. Fox also serves on
the board of directors of Bowne & Co., Inc., The Oreck Company and Advanstar
Communications Inc.
Hugh R. Kirkpatrick has served as a director of AKI 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.
David M. Wittels has served as a Director of AKI since December 1997. Mr.
Wittels was a Managing Director of DLJ Merchant Banking from January 2001 to
June 2004 and has served in various capacities with DLJ Merchant Banking during
the past six years. Mr. Wittels also serves as a director of Ziff Davis
Holdings, Inc.
Compensation of Directors
Except for Mr. Hugh Kirkpatrick, wh