-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RranJztpRmnWNaf59zNySSOGTmkU4qfRWl8dy3JUC0CdufnRV4ZWmf7+V+s/4OMw IKGUywGS3Kmv9pUIcLtYBQ== 0000921530-99-000186.txt : 19991227 0000921530-99-000186.hdr.sgml : 19991227 ACCESSION NUMBER: 0000921530-99-000186 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990928 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AKI HOLDING CORP CENTRAL INDEX KEY: 0001067550 STANDARD INDUSTRIAL CLASSIFICATION: PERFUMES, COSMETICS & OTHER TOILET PREPARATIONS [2844] IRS NUMBER: 742883163 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-60991 FILM NUMBER: 99718551 BUSINESS ADDRESS: STREET 1: 1815 EAST MAIN STREET CITY: CHATTANOOGA STATE: TN ZIP: 37404 BUSINESS PHONE: 4236243301 MAIL ADDRESS: STREET 1: 1815 EAST MAIN STREET CITY: CHATTANOOGA STATE: TN ZIP: 37404 10-K 1 ANNUAL REPORT RE AKI HOLDING CORP 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, 1999 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to _____________ AKI HOLDING CORP. (Exact name of registrant as specified in its charter) Commission File Number: 333-60991 Delaware 74-288316 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) AKI, INC. (Exact name of registrant as specified in its charter) Commission File Number: 333-60989 Delaware 13-3785856 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1815 East Main Street Chattanooga, TN 37404 (423) 624-3301 (Address, including zip code and telephone number, including area code, of principal executive offices) Securities Registered Pursuant to Section 12(b) of the Act: None. Securities Registered Pursuant to Section 12(b) of the Act: None. Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. (X) Yes ( ) No As of September 27, 1999, 1,000 shares of common stock of AKI Holding Corp., $0.01 par value, were outstanding and 1,000 shares of common stock of AKI, Inc., $0.01 par value, were outstanding. Indicate by check mark if disclosure of delinquent filers is not contained herein, and will not be contained, to the best of registrants' knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( X) AKI, Inc. meets the requirements set forth in General Instruction I 1(a) and (b) of Form 10-K and is therefore filing this form with reduced disclosure format. DOCUMENTS INCORPORATED BY REFERENCE: None. As used within this report, the term "company" refers to AKI Holding Corp., a Delaware corporation, and its subsidiaries including AKI, Inc., a Delaware corporation ("AKI"), and the term "Holding" refers solely to AKI Holding Corp. PART I ITEM 1. BUSINESS Part I is presented with respect to both registrants submitting this filing, Holding and AKI. General Our company is a leading global marketer and manufacturer of multi-sensory, interactive sampling systems that engage the senses of touch, sight, sound and olfactory. Our sampling systems are widely recognized in the fragrance, cosmetics and personal care industries, as well as the household products and food and beverage industries. We offer an extensive portfolio of proprietary, patented and patent-pending sampling systems that can be incorporated into various media which is designed to reach the consumer at home, such as magazine inserts, catalog inserts, remittance envelopes, statement enclosures and blow-ins. Our company is a fully integrated sampling company and is positioned to provide complete, interactive advertising programs to our customers, including creative content and sample product and distribution. Product sampling is one of the most effective, widely used and fastest growing forms of promotional activity. Product sampling is particularly crucial to the fragrance and cosmetics industries where consumers traditionally "try before they buy" due to the highly personal nature of the products. Our company's introduction in 1979 of the ScentStrip(R) Sampler, the first pull-apart, microencapsulated scent sampling system, transformed the fragrance sampling industry. By combining advertising with a sampling system, marketers were afforded the first cost-effective means to reach consumers in their homes on a mass scale. Though the microencapsulated fragrance sampling system remains the most widely used product throughout the fragrance industry, our company has developed and/or acquired a portfolio of alternative scent sampling systems, all designed for cost-effective mass distribution, and continues to be the leading innovator in the sampling industry. In recent years, our company has expanded our sampling business by developing new technologies specifically for the skincare, makeup and consumer products markets. Although product sampling is critical to the success of these markets, sampling programs for these products historically have been too costly for mass production and incapable of efficiently being incorporated into magazines, catalogs, direct mail and other printed vehicles. Our innovative sampling systems are designed to fill the needs of these marketers by providing a cost-effective means of reaching consumers in their homes on a mass scale with quality renditions of skincare products, foundation, lipstick and cosmetic 1 powders. Management believes that our new sampling systems have altered the economics and efficiencies of product sampling in the cosmetics market. In December 1997, DLJ Merchant Banking Partners II, L.P. and certain related investors (collectively, "DLJMBII") and certain members of our company's prior management organized AHC I Acquisition Corp., a Delaware corporation ("Acquisition Corp."), to acquire all of the outstanding equity interests of AKI. Holding was formed as a holding company in 1998 and its only significant asset is the capital stock of AKI. Holding conducts all of its business through AKI. As of September 27, 1999, DLJMBII owned approximately 98.8% of the outstanding common stock of Acquisition Corp. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--The Acquisition." On September 15, 1999, we acquired all of the issued and outstanding shares of capital stock of RetCom Holdings Ltd. and refinanced working capital indebtedness of RetCom and its subsidiaries. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--RetCom Acquisition." The acquired businesses of RetCom and its subsidiaries include a portfolio of sampling systems catering to the fragrance, cosmetics and personal care industries, as well as microencapsulation products and processes. The acquired businesses also include a creative service division that engages in marketing communications and catalogs, and a multi-media division for merchandising at point-of-sale. The acquired businesses offer proprietary, patented and patent-pending sampling systems that include MicroSilk(TM), MicroDot(TM), Snap and Powder(TM), ColorDot(TM) and Ascent(TM). Products Our company offers a broad and diversified portfolio of innovative, interactive sampling systems for the fragrance, cosmetics and consumer products markets. Our major technologies are described below, including a description of the patent protection of each such product technology. Each of our products is a cosmetic, fragrance or consumer product sample delivery system, generally designed to perform the same basic function, and generally sold to the same category of customers.
- ----------------------- ------------------- ---------------------- --------------------- -------------------- Year of Patent Protection Product Introduction Origin Target Market - ----------------------- ------------------- ---------------------- --------------------- -------------------- - ----------------------- ------------------- ---------------------- --------------------- -------------------- ScentStrip 1979 Internally developed None Fragrance, consumer products ScentStrip Plus mid 1980's Internally developed None Fragrance DiscCover 1994 Licensed Patented Fragrance, consumer markets Scent Seal 1995 Acquired Patented Fragrance LiquaTouch 1997 Internally developed Patent Pending Fragrance, skin care 2 Fragrance Burst and 1989 Acquired Patented Fragrance Pearls Fragrance Burst 1989 Acquired Patented Fragrance Microfragrance Acquired Trade secret Fragrance, Scratch `n Sniff consumer markets BeautiSeal 1997 Internally developed Patented Cosmetics PowdaTouch 1997 Internally developed Patent Pending Cosmetics LipSeal 1998 Internally developed Patented Cosmetics TouchDown Nail Color 1999 Internally developed Patent Application Cosmetics Sampler Pending BeautiTouch 1999 Internally developed Patent Pending Cosmetics Multi-well Sampler - ----------------------- ------------------- ---------------------- --------------------- --------------------
Fragrance Sampling Systems Our company's portfolio of seven traditional fragrance sampling systems has historically accounted for substantially all of our company's sales. While the ScentStrip technology continues to be the most widely used technology throughout the fragrance industry, management believes that our company's new and recently acquired sampling systems have maintained our company's competitive position as an innovator in the industry. These sampling systems have enabled our company to participate in almost every major new fragrance launch in recent years. * ScentStrip: Our company's original pull-apart, microencapsulated fragrance sampling system continues to deliver the most cost-effective, quality fragrance rendition. * ScentStrip Plus: The classic, pull-apart, microencapsulated fragrance format with the added feature of silky-to-the-touch, powdery texture. * DiscCover: A peel-and-reveal, non-encapsulated sampling system that opens and reseals, delivering a quality aroma rendition up to 25 times. This technology is color-printable, affixable to nearly any surface, including plastic and glass, and can be die-cut in nearly any shape and size. * Scent Seal: A heat-sealed, pouch-like, pressure-sensitive format that peels open to reveal a moist, wearable gel rendition that offers both an olfactory and on-skin experience. 3 * Fragrance Burst Perfume Pearls: A multi-sensory sampling system that features silky-to-the-touch, pearlized perfume pearls - formulated of 85% liquid perfume oil - that release a wearable fragrance rendition when "pearls" are touched. * Fragrance Burst and Pearls: Combines the wearable, visible and tangible properties of Perfume Pearls with the classic, pull-apart fragrance burst format, delivering an olfactory and on-skin experience. * Microfragrance Scratch `n Sniff: Microfragrance capsules are applied to paper or stickers which affix to nearly any surface, delivering an accurate aroma rendition when the sampling system is scratched, then sniffed. New Products Our company has recently introduced six innovative new products which management believes can account for a significant portion of our company's future sales. All of these sampling systems have been designed for U.S. Postal Service approval for subscription magazine periodical rates. * BeautiSeal: A heat-sealed, pouch-like, pressure-sensitive format peels open to deliver quality renditions of cream and lotion treatments and liquid foundations. BeautiSeal is hygienic and spillproof and less expensive and more versatile than existing skincare/foundation sampling alternatives. For example, a two-sided, printed insert incorporating a BeautiSeal sampling system generally costs less than half that of the manufacture and magazine distribution of an equivalent sample packet. * PowdaTouch: Applies up to four different powders on a single carrier and is ideal for trial of a single item shade range or a complete color story. Delivers a superior rendition of the shade, texture, finish and application of eye shadow, powder blush, face powder, bronzer or body powder. Management estimates that PowdaTouch sampling systems can be produced approximately ten times faster than currently competing products and at a reduced production rate. * LiquaTouch: Delivers a rendition of finished fragrance product (e.g., eau de parfum, eau de toilette or after shave), any liquid treatment or personal care product and contains an applicator. Available in a pressure sensitive format designed for U.S. Postal Service approval for subscription magazine periodical rates, LiquaTouch is also available in a stand-alone version, which is a cost-effective alternative to fragrance vials. In an independent study recently conducted among male consumers of fragrance products, LiquaTouch was shown to be preferred among sampling systems and was also a finalist for the Fragrance Foundation's 1997 "Innovation of The Year" award. * LipSeal: A pressure-sensitive sampling system peels open to deliver a superior rendition of lipstick shade, finish and texture in any formula including volatile silicones. 4 * TouchDown Nail Color Sampler: A pressure-sensitive, die-cut sticker that temporarily "touches down" on the nail, demonstrating superior rendition of nail enamel shades without marring a manicure. * BeautiTouch Multi-Well Sampler: A pressure-sensitive technology featuring multiple, individually-sealed wells on a common backing, which peel open to deliver renditions of liquid foundations, cream and lotion treatment and personal care items, lipstick and fragrance ancillaries. Formats Our company produces a wide and versatile range of formats designed for U.S. Postal Service approval for subscription magazine periodical rates and which can be incorporated into almost any print media. The most common formats for the our company's products are described below. Magazine Inserts: Magazine inserts are available in half-, full-, two- and four-page formats, can be die-cut, can contain any of our company's sampling systems and are the most commonly produced among our company's formats, accounting for approximately 44% of fiscal 1999 sales. Catalog Inserts: Full color formats can be produced in a variety of sizes and inserted into retail or mail order catalogs. Catalog inserts can be produced with or without an attached envelope, which may be provided to facilitate the return of merchandise order forms to the store. Our company has the ability to create and produce special formats, to custom imprint with store information and to incorporate most of our company's sampling systems. Remittance Envelopes: Remittance envelopes, which are inserted into store statement mailings, can be customized with a store logo and can accommodate may of our company's sampling systems. Our company is the only company in the sampling industry that can produce remittance envelopes in-house. Remittance envelopes can be produced with or without our company's sampling systems. Remittance envelope production, which is a highly customized service business, reinforces our company's position as a fully-integrated enterprise. Statement Enclosures: Statement enclosures are available in various formats and sizes. Fragrance statement enclosures may contain a single scent in their fold, one or two scents under the fragrance panel, or they may be die-cut so that the fragrance can be sampled by removing the desired die shape. Enclosures are normally imprinted with store logo and product pricing information. The six inch format is our company's design and has become the industry standard. Blow-ins: Blow-ins, which are available in all formats and sizes, can accommodate nearly all of our company's sampling systems and are loosely inserted (blown in) rather than bound into store catalogues, newspapers and magazines. In-Store Handouts: Our company has made significant advances in replacing and expanding current methods of in-store cosmetic and fragrance 5 sampling. Due to the lower cost and design flexibility of our company's products, marketers have expanded the number and type of in-store vehicles. Working in partnership with our customers, new and creative formats have been developed. These formats incorporate many of our company's sampling systems and items such as postcards, stickers, wrist bands, bookmarks and CD inserts. Our company is also experiencing significant in-store business with the LiquaTouch sampling system, as an alternative to vials, and expects increases for the BeautiSeal and PowdaTouch sampling systems for trial of shade ranges and formulae. Patents and Proprietary Technology Our company currently holds patents covering the proprietary processes used to produce six of its products and has submitted applications for three additional manufacturing processes. Our company has six trademarks registered in the United States and eight trademarks filed and awaiting registration. Our company has also filed and registered trademarks in over 15 countries around the world, including Europe, Australia, Japan and Brazil. See "--Products." Our company has ongoing research efforts and expects to seek additional patents in the future covering patentable results of such research. There can be no assurance that any pending patent applications filed by our company: * 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, * will not be infringed upon or designed around by others or * will not be challenged by others and held to be invalid or unenforceable. In addition, many of our company's manufacturing processes are not covered by any patent or patent application. As a result, the business of our company may be adversely affected by competitors who independently develop technologies substantially equivalent to those employed by our company. Customers Our company sells its products to prestige and mass cosmetic, fragrance, consumer products companies, department stores and specialty retailers including Avon Products, Inc., Calvin Klein Cosmetics (Unilever Plc), Chanel, Inc., Coty, Inc., Cosmair/L'Oreal S.A., Elizabeth Arden (Unilever Plc), Estee Lauder, Inc., Giorgio Beverly Hills and The Procter & Gamble Company. Our company's top ten customers accounted for approximately 57% of sales in fiscal 1999. None of our company's customers, other than Estee Lauder, accounted for 10% or more of net sales in fiscal 1999. Our company believes that its technical expertise, manufacturing reliability and customer support capabilities have enabled it to develop strong relationships with its customers. Our company employs sales and marketing personnel who possess the requisite technical backgrounds to communicate effectively with both prospective customers and our company's manufacturing personnel. Historically, our company has had long-term relationships with its major customers. 6 Sales and Marketing Our company's sales and marketing efforts are organized geographically. Our company currently has a total of ten sales executives. The U.S. sales group consists of seven sales executives who are supervised by the Senior Vice President of Sales & Marketing. The European sales executives are based in Paris, France and London, England and are managed by the Senior Vice President, International, who is based in Paris, France. Each sales executive is dedicated to a certain number of identified customers. In addition, these sales efforts are supported by 15 production managers/customer service representatives which are based in Chattanooga, Tennessee and Paris, France. A portion of the compensation for sales executives is commission-based. Our company's marketing activities include direct contact with senior executives in the cosmetic and fragrance industry, major support of industry events, extensive joint marketing programs with magazines, retailers and oil houses, press coverage in industry trade publications, trade shows and seminars, advertising in trade publications and promotional pieces. In addition, our company focuses its sales efforts toward three principal groups within its customers' organizations that management believes influence the customers' purchasing decisions: * marketing, which selects the sampling system technology and controls the promotional budget; * product development, which approves our company's sampling system rendition and approves stability testing; and * purchasing, which buys the sampling system pieces and controls quality. Management believes that as the pressure for creativity increases with each new product introduction, fragrance marketers are increasingly looking for their vendors to contribute to the overall strategy-building effort for a new fragrance. Our company's executives routinely introduce new sampling system formats and ideas based on our company's technologies to the marketing departments of its customers. Our company's in-house creative and marketing expertise and complete product line provides customers with maximum flexibility in designing promotional programs. Manufacturing Our company's manufacturing processes are highly technical and largely proprietary. Our company's sampling systems must meet demanding performance specifications regarding fidelity to the product being sampled, shelf-life, resistance to pressure and temperature variations and various other requirements. The manufacturing processes can be broken into three phases: * formulation of cosmetic and fragrance product renditions in our company's slurry laboratories for use in sampling systems; 7 * manufacturing the sampler, which consists of either printing an encapsulated slurry onto paper or producing sampling labels that contain fragrance or other cosmetic product renditions; and * labeling technologies (DiscCover, Scent Seal, BeautiSeal, LiquaTouch), affixing the labels onto a piece preprinted by our company or a third party contract supplier. Management believes that our company's formulation capabilities are the best in the cosmetics sampling industry. The formulation process is highly complex because our company is trying to replicate the fragrance of a product in a bottle containing an alcohol solution using primarily essential oils and paper. Formulation approval is an interactive process between our company and its customers. Our company has more than 125 different, proprietary formulations that it utilizes in replicating different characteristics of over 500 fragrances to obtain a customer-approved rendition. Certain of these formulations are patented and the majority of the formulation process is based on unique and proprietary methods. Formulation of the fragrance and cosmetic product rendition is performed under very strict tolerances and in complete conformity to the formula that the customer has preapproved. Formulation is conducted in our company's specially designed formulation laboratories by trained specialists. The artwork for all printed pieces has typically been furnished by the customer or its advertising agency. Our company's prepress department is currently being converted to state-of -the-art technology by utilizing the receipt of customer-supplied computer disks and producing this material directly on to plates. Our company has the capability to produce high quality printed materials, including the covers of major fashion magazines, in connection with fragrance sampling systems. Our company has two different sampling component manufacturing processes: (1) for its formulated offset paper samplers (ScentStrip, ScentStrip Plus, PowdaTouch) and (2) for its formulated letterpress or flexo label samplers (DiscCover, Scent Seal, BeautiSeal, LiquaTouch). Formulated paper samplers are produced in our company's primary facility where our company carefully applies microencapsulated slurry onto the paper during the printing process and, in a continuous in-line operation, folds, cuts and trims the samplers for packing. A 24-hour quality control function and hourly accountability provide significant value to the product development personnel at our company's customers, who are responsible for sample quality. All sampling in a label form is produced on specially modified label and finishing equipment in our company's second facility. In addition to the patents pending on certain of its manufacturing processes, our company uses a number of proprietary techniques in producing label samplers. Similar to the formulated paper operation, sampling quality control personnel evaluate all samples by roll and provide full accountability for our company's production. Our company also has agreements with certain European and Australian printers and labelers which produce some quantities for global customers that require foreign distribution. Each of these arrangements are protected by non-competition agreements. 8 Our company was recently awarded The Proctor & Gamble Pinnacle Award which is presented to companies as recognition for having met certain quality requirements and having demonstrated outstanding quality assurance. Our company is currently pursuing U.S. Food and Drug Administration approval required by other potential new customers. Sources and Availability of Raw Materials Generally, the raw materials used by our company in the manufacturing of its products have been readily available from numerous suppliers and have been purchased by our company at prices that our company believes are competitive. Our company's encapsulated paper products utilize specific grades of paper that are subject to comprehensive evaluation and certification by our company for quality, consistency and fit. Our company has not experienced any material supply shortages in the past, nor are any anticipated. Competition Our company's competitors, some of whom have substantially greater capital resources than our company, are actively engaged in manufacturing certain products similar to, or in competition with, those of our company. Competition in our company's markets is based upon product quality, product technologies, customer relationships, price and customer service. Our company's principal competitors in the printed fragrance sampler market are Webcraft, a subsidiary of Big Flower Holdings, Inc., Orlandi Inc., Nord'est, Marietta Corp., Klocke, Color Prelude, Rotocon, Ascent and Appliquesence. Our company also competes with numerous manufacturers of miniatures, vials, packets, sachets, blisterpacks and scratch and sniff products. In addition, certain cosmetics companies produce sampling products for their own cosmetic products. Environmental and Safety Regulation Our company's operations are subject to extensive laws and regulations relating to the storagage, handling, emission, transportation and discharge of materials into the environment and the maintenance of safe conditions in the workplace. Our company's policy is to comply with all legal requirements of applicable environmental, health and safety laws and regulations. Our company believes that it is in general compliance with such requirements and has adequate professional staff and systems in place to remain in compliance, although there can be no assurances that this is the case. Our company considers costs for environmental compliance to be a normal cost of doing business and includes such costs in pricing decisions. Employees As of August 31, 1999, our company employed 377 persons, which included 240 hourly and 137 salaried and management personnel. Substantially all of our company's hourly employees are represented by the Graphics Communications International Union (GCIU) local 197-M. Management considers its relations with the union to be good. The current union contract was signed in April 1999 and will be in effect through March 31, 2003. 9 RISK FACTORS Substantial Leverage; Restrictive Covenants - Our substantial indebtedness and restrictive covenants imposed by the terms of our indebtedness could adversely affect the financial health of our company and prevent us from fulfilling our obligations under our notes and debentures. Our company has substantial indebtedness and debt service obligations. As of June 30, 1999, Holding and AKI had total consolidated indebtedness of approximately $146.7 million and $117.0 million, respectively. In addition, Holding's and AKI's deficiency of earnings available to cover fixed charges for fiscal 1999, was $5.5 million and $1.7 million, respectively. As of September 20, 1999, AKI had letters of credit outstanding in the amount of $0.6 million and outstanding borrowings of $16.3 million under its revolving credit agreement with Heller Financial, Inc. In addition, as of such date, borrowings of up to approximately $3.1 million were available under the credit agreement, subject to specified conditions. The indenture governing Holding's 13 1/2% Senior Discount Debentures due 2009 and the indenture governing AKI's 10 1/2% Senior Notes due 2008 and the credit agreement permit our company and its Restricted Subsidiaries (as defined in the indentures), in each case, to incur additional indebtedness if we meet specified requirements. The level of our company's indebtedness could have important consequences to holders of the notes and the debentures, including, but not limited to, the following: * a substantial portion of cash flow from operations must be dedicated to debt service and will not be available for other purposes; * additional debt financing in the future for working capital, capital expenditures or acquisitions may be limited; * the level of indebtedness could limit flexibility in reacting to changes in the operating environment and economic conditions generally; * the level of indebtedness could restrict our company's ability to increase manufacturing capacity; * our company may face difficulties in satisfying its obligations with respect to its indebtedness; and * a portion of our company's borrowings bear interest at variable rates of interest, which could result in higher interest expense in the event of an increase in market interest rates. The indentures and the credit agreement contain covenants that, among other things, limit the ability of our company and its Restricted Subsidiaries to: * pay dividends or make certain restricted payments; 10 * incur additional indebtedness and issue preferred stock; * create liens; * incur dividend and other payment restrictions affecting subsidiaries; * enter into mergers, consolidations or sales of all or substantially all of the assets of our company; * enter into certain transactions with affiliates; and * sell certain assets. In addition, the credit agreement requires our company to maintain specified financial ratios and satisfy specified financial condition tests. Our company's ability to meet those financial ratios and tests can be affected by events beyond its control, and there can be no assurance that our company will meet those tests. Ability to Service Debt - To service our company's indebtedness we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control. The ability of our company to pay principal and interest on the notes or principal on the debentures and to satisfy its other debt obligations will depend upon AKI's future operating performance. AKI's future operating performance will be affected by prevailing economic conditions and financial, business and other factors, which factors may be beyond our company's control, as well as the availability of revolving credit borrowings under the credit agreement. Our company anticipates that its operating cash flow, together with borrowings under the credit agreement, will be sufficient to meet its operating expenses and to service its debt requirements as they become due. However, if our company is unable to service its indebtedness, our company may be required to take action such as reducing or delaying capital expenditures, selling assets, restructuring or refinancing its indebtedness or seeking additional equity capital. There can be no assurance that any of these remedies can be effected on satisfactory terms, if at all. Holding Company Structure - Holding's debentures are structurally subordinated to indebtedness of its subsidiaries. Holding is a holding company and does not have any material operations or assets other than ownership of all of the capital stock of AKI. Accordingly, its debentures will be effectively subordinated to all existing and future liabilities of Holding's subsidiaries, including indebtedness under the credit agreement and AKI's notes. As of June 30, 1999, Holding's subsidiaries had $117.0 million of indebtedness and $17.1 million of other outstanding liabilities (including trade payables, accrued liabilities and deferred taxes). As of September 20, 1999, AKI also had letters of credit outstanding in the amount of $0.6 million and outstanding borrowings of $16.3 million under the 11 credit agreement. In addition, as of such date, borrowings of up to approximately $3.1 million were available under the credit agreement, subject to specified conditions. All such indebtedness effectively ranks senior to the debentures. At June 30, 1999, Holding had no outstanding indebtedness other than the debentures. Holding and its subsidiaries may incur additional indebtedness in the future, subject to the limitations contained in the instruments governing their indebtedness. Any right of Holding to participate in any distribution of assets of its subsidiaries upon the liquidation, reorganization or insolvency of any such subsidiary (and the consequent right of the holders of the debentures to participate in the distribution of those assets) will be subject to the prior claims of the respective subsidiary's creditors. Limitation on the Payment of Funds to Holding by its Subsidiaries - Holding's ability to repay its debentures may depend on its ability to raise cash other than through its subsidiaries. Holding's cash flow, and consequently its ability to service debt, including its obligations under its debentures, is dependent upon the cash flows of its subsidiaries and the payment of funds by such subsidiaries to Holding in the form of loans, dividends or otherwise. Holding's subsidiaries have no obligations, contingent or otherwise, to pay any amounts due pursuant to the debentures or to make any funds available for payment of the debentures. In addition, AKI's credit agreement and its note indenture impose, and agreements entered into in the future may impose, significant restrictions on the payment of dividends and the making of loans by AKI and its subsidiaries to Holding. Accordingly, repayment of the debentures may depend upon the ability of Holding to effect an equity offering or to refinance the debentures. Effective Subordination; Assets Subject to Security Interest - Your right to receive payments on the notes and debentures is junior to our existing and future secured indebtedness. Under the terms of the 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 a default under the credit agreement, whether as a result of the failure to comply with a payment or other covenant, a cross-default or otherwise, such lender will have a prior secured claim on the capital stock of AKI and the encumbered assets of our company. As a result, the encumbered assets of our company would be available to pay obligations on the notes and the debentures only after borrowings under the credit agreement and any other secured indebtedness have been paid in full. If the lender should attempt to foreclose on its collateral, our company's financial condition and the value of the debentures and the notes will be materially adversely affected and could be eliminated. As of September 20, 1999, AKI had letters of credit outstanding in the amount of $0.6 million and outstanding borrowings of $16.3 million under the credit agreement. In addition, as of such date, borrowings of up to approximately $3.1 million were available under the credit agreement, subject to specified conditions. 12 Postal Regulation - Our results of operations could be adversely affected by a change in the U.S. Postal Service classification of our sampling systems or the sampling products of our competitors. Our company's sampling systems are approved by the U.S. Postal Service for inclusion in subscription magazines mailed at periodical postage rates. Our company's sampling systems have a significant cost advantage over certain competing sampling products, such as miniatures, vials, packettes, sachets and blisterpacks, because such competing products cause an increase from periodical postage rates to the higher third-class rates for the magazine's entire circulation. Subscription magazine sampling inserts delivered to consumers through the U.S. Postal Service accounted for approximately 36% of our company's net sales in fiscal 1999. There can be no assurance that the U.S. Postal Service will not approve other competing types of sampling systems for use in subscription magazines without requiring a postal surcharge, or that the U.S. Postal Service will not reclassify our company's sampling systems such that they would incur a postal surcharge. Any such action by the U.S. Postal Service could have a material adverse effect on our company's results of operations and financial condition. Reliance Upon Significant Customers - Our company relies on a small number of customers for a large portion of its revenues. Our company's top ten customers by sales revenue accounted for approximately 57% of our company's net sales in fiscal 1999. None of our company's customers other than Estee Lauder accounted for 10% or more of net sales in fiscal 1999. Although our company has long-established relationships with most of its major customers, our company does not have long-term contracts with any of its customers. Our company may be required by some customers to qualify its manufacturing operations under certain supplier standards. There can be no assurance that our company will be able to qualify under such supplier standards or that such customers will continue to purchase sampling systems from our company if our company's manufacturing operations are not so qualified. An adverse change in its relationships with significant customers, including Estee Lauder, could have a material adverse effect on our company's results of operations and financial condition. Competition - Our ability to compete with other companies depends, in part, on our ability to meet customer needs on a cost-effective and timely basis and to protect our proprietary technology. Our company's competitors, some of whom have substantially greater capital resources than our company, are actively engaged in manufacturing certain products similar to those of our company. Our company's principal competitors in the cosmetic sampling market are Webcraft, a subsidiary of Big Flower Holdings, Inc., Orlandi Inc., Nord'est, Marietta Corp., Klocke, Color Prelude, Rotocon, Ascent and Appliquessence. Our company also competes with numerous manufacturers of miniatures, vials, packettes, sachets, blisterpacks, and scratch and sniff products. In addition, certain cosmetic companies produce sampling products for their own cosmetic products. Competition in our company's market is based upon product quality, product technologies, customer relationships, price and customer service. The future success of our company's business will depend in large part upon its ability to market and manufacture products and services that meet customer needs on a cost-effective and timely 13 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 our company will be successful in generating sales on commercially favorable terms, if at all. In addition, our company's success, competitive position and revenues will depend, in part, upon its ability to protect its proprietary technologies and to operate without infringing on the proprietary rights of others. Although our company has certain patents and has filed, and expects to continue to file, other patent applications, there can be no assurance that our company's issued patents are enforceable or that its patent applications will mature into issued patents. The expense involved in litigation regarding patent protection or a challenge thereto has been and could be significant and any future expense, if any, cannot be estimated by our company. A portion of our company's manufacturing processes are not covered by any patent or patent application. As a result, the business of our company may be adversely affected by competitors who independently develop technologies substantially equivalent to those employed by our company. Dependence on Fragrance Industry; Seasonality - Our business is affected by the advertising budgets of our customers and is seasonal in nature. The advertising budgets of our company's customers, and therefore the revenues of our company, are susceptible to prevailing economic and market conditions that affect advertising expenditures, the performance of the products of our company's customers in the marketplace and certain other factors. There can be no assurance that reductions in advertising spending will not occur, which could have a material adverse effect on our company's results of operations and financial condition. In addition, our company's sales and operating results have historically reflected seasonal variations. Such seasonal variations are based on the timing of our company's customers' advertising campaigns, which have traditionally been concentrated prior to the Christmas and spring holiday seasons. As a result, a higher level of sales are reflected in our company's first two fiscal quarters ended December 31 when sales from such advertising campaigns are principally recognized while our company's fourth fiscal quarter ended June 30 typically reflects the lowest sales level of the fiscal year. These seasonal fluctuations require our company to accurately allocate its resources to manage our company's manufacturing capacity, which often operates at full capacity during peak seasonal demand periods. Availability of Raw Materials - Our results of operations and financial condition may be adversely affected by an increase in paper prices or a decrease in paper supply. Paper is the primary raw material utilized by our company in producing its sampling systems. Paper costs represented approximately 30% of our company's cost of goods sold in each of fiscal 1997, 1998 and 1999. Significant increases in paper costs could have a material adverse effect on our company's results of operations and financial condition to the extent that our company is unable to 14 price its products to reflect such increases. There can be no assurance that our company's customers would accept such price increases or the extent to which such price increases would impact their decision to utilize our company's sampling systems. All of our company's encapsulated sampling systems, which accounted for approximately 62% of our company's net sales in fiscal 1999, utilize specific grades of paper that are subject to comprehensive evaluation and certification by our company for quality, consistency and fit. Our company continues to research methods of replicating the advantages of these specific grades of paper with other available grades of paper. Until such methods are developed, a loss of such supply of paper could have a material adverse effect on our company's results of operations and financial condition to the extent that our company is unable to obtain such paper elsewhere. Risks of International Operations; Currency Fluctuations - Our company receives a portion of its revenue from foreign countries which is subject to foreign laws and regulations and political and economic events. Approximately 20% of our company's net sales in fiscal 1999 were generated outside the United States. Foreign operations are subject to certain risks inherent in conducting business abroad, including, among others, exposure to foreign currency fluctuations and devaluations or restrictions on money supplies, foreign and domestic export law and regulations, price controls, taxation, tariffs, import restrictions, and other political and economic events beyond our company's control. Our company has not experienced any material effects of these risks as of yet, but there can be no assurance that they will not have such an effect in the future. Control by DLJMBII; Conflicts of Interest - Our company is controlled by DLJMBII whose interests may conflict with the interests of the holders of the notes and debentures. DLJMBII has the power to elect a majority of the directors of Acquisition Corp. and generally exercises control over the business, policies and affairs of Acquisition Corp., Holding, AKI and its subsidiaries through its ownership of Acquisition Corp. DLJMBII may have interests that could be in conflict with those of the holders of notes or the debentures and may take actions that adversely affect the interests of the holders of the notes and debentures. Labor Relations; Expiration of Collective Bargaining Agreement - Our company's business may be adversely affected by a labor dispute. As of August 31, 1999, approximately 64% of our company's employees worked under a collective bargaining agreement that expires on March 31, 2003. While our company believes that its relations with its employees are good, there can be no assurance that our company's collective bargaining agreement will be renewed in the future. A prolonged labor dispute (which could include a work stoppage) could have a material adverse effect on our company's business, financial condition and results of operations. 15 Year 2000 Issues - Year 2000 problems could affect our day-to-day operations and cause significant economic liabilities. Our company evaluated its information technology systems and its non-information technology systems in order to assess its exposure to Year 2000 issues. Our company expects to make the necessary modifications or changes to its information systems to enable proper processing of transactions relating to the Year 2000 and beyond before January 1, 2000. While our company is not substantially dependent upon the proper function of its computer systems, a failure of its systems could cause, among other things, inaccurate or incomplete accounting, the inability to bill customers and the inability to process incoming orders which may cause business interruption or financial loss. If third parties with whom our company interacts have Year 2000 problems which are not resolved, our company could experience, among other things, the disruption of services including telecommunications and electrical power or financial or accounting difficulties. Our company currently estimates that the total cost of Year 2000 compliance will be less than $100,000. There can be no assurance that our company's Year 2000 program will be effective or that our company will not experience disruption or difficulties resulting from Year 2000 problems of third parties. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Year 2000 Issues." ITEM 2. PROPERTIES Our company owns land and buildings in Chattanooga, Tennessee that are used for production, administration and warehousing. Our company's executive offices and primary facility at 1815 East Main Street are located on 2.55 acres and encloses approximately 67,900 square feet. A second facility housing product development and additional manufacturing areas at 1600 East Main Street is located three blocks away on 2.49 acres and encloses approximately 36,700 square feet. Our company also leases a third facility at 3501 St. Elmo Avenue in Chattanooga, Tennessee which is used for production and warehousing. This facility is located on 1.875 acres and encloses approximately 29,500 square feet. Our company currently has a number of web printing presses with multi-color capability as well as envelope-converting machines and other ancillary equipment. Our company operates a fully equipped production lab for the manufacture of microcapsules and slurry and separate laboratories for our company's Encapsulated Products Division and our company's research and development facility. Our company also has a fully staffed and equipped label manufacturing facility, which includes state-of-the-art label manufacturing machines that have been specially modified to produce our company's products and a complete label attaching operation. Our company also leases sales offices in New York, New York, Paris, France and London, England. ITEM 3. LEGAL PROCEEDINGS Our company does not believe that there are any pending legal proceedings that, if adversely determined, would have a material adverse effect on the financial condition or results of operations of our company, taken as a whole. 16 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders of Holding during the fourth quarter of fiscal 1999. PART II ITEM 5. MARKET FOR REGISTRANT COMMON EQUITY AND RELATED STOCKHOLDER MATTERS There is no established public trading market for Holding's or AKI's common stock. As of September 27, 1999, Acquisition Corp. was the sole holder of record of Holding's common stock and Holding was the sole holder of record of AKI's common stock. Generally, neither Holding nor AKI pays dividends on its shares of common stock and neither expects to pay dividends on its shares of common stock in the foreseeable future. The debentures contain restrictions on Holding's ability to pay dividends on its common stock. The notes and the credit agreement contain restrictions on AKI's ability to pay dividends on its common stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." ITEM 6. SELECTED FINANCIAL DATA The selected historical consolidated financial data presented below as of June 30, 1995, 1996 and 1997, December 15, 1997, and for the fiscal years ended June 30, 1995, 1996 and 1997 and the periods from July 1, 1997 to December 15, 1997 have been derived from the historical consolidated financial statements of Arcade Holding Corporation, the predecessor to our company. The selected historical consolidated financial data presented below as of June 30, 1998 and 1999 and for the period from December 16, 1997 to June 30, 1998 and the year ended June 30, 1999 have been derived from the historical consolidated financial statements of our company. The information contained in this table should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," and our company's Consolidated Financial Statements and the notes thereto included elsewhere in this report. 17
Predecessor Holding ----------- ------- July 1, 1997 December Fiscal year ended June 30, to 16, 1997 to December 15, June 30, June 30, 1995 1996 1997 1997 1998 1999 ---- ---- ---- ---- ---- ---- Statement of Operations Data: Net sales $ 61,794 $ 73,486 $ 77,723 $ 35,186 $ 36,066 $ 85,967 Cost of goods sold 38,333 49,862 49,467 22,809 24,518 55,199 --------- ---------- ---------- ---------- ---------- -------- Gross profit 23,461 23,624 28,256 12,377 11,548 30,768 Selling, general and administrative expenses 8,483 10,635 13,333 5,703 5,587 14,500 Amortization of goodwill 1,113 1,234 1,234 568 2,101 4,606 --------- ----------- ---------- ---------- ---------- -------- Income from operations 13,865 11,755 13,689 6,106 3,860 11,662 Interest expense, net 6,170 6,762 6,203 2,646 11,327 16,740 Fees to stockholders 470 470 470 215 125 250 Other, net (22) 244 (101) 11 (47) 128 Income tax expense (benefit) 3,114 2,101 3,135 1,441 (2,052) (340) --------- ---------- ----------- ---------- ---------- -------- Net income (loss) $ 4,133 $ 2,178 $ 3,982 $ 1,793 $ (5,493) $ (5,116) ========= ========== ========== ========== ========== ======== Balance Sheet Data (at end of period): Cash and cash equivalents $ 4,196 $ 626 $ 303 $ 4,481 $ 3,842 $ 7,015 Working capital (deficit) 39 (4,685) (36,957) (4,959) 15,046 14,853 Total Assets 85,695 82,395 77,142 77,399 214,521 213,579 Total debt and redeemable preferred stock 64,655 60,736 54,964 55,408 144,448 146,688 Total stockholder's equity 6,572 7,932 11,225 12,716 57,084 49,797 Other Data: Capital expenditures 1,325 2,051 2,462 807 514 2,856 Ratio of earnings to fixed charges 2.2x 1.6x 2.1x 2.2x --- ---
_____________________ (1) For purposes of calculating the ratio of earnings to fixed charges, "earnings" represent income (loss) before income taxes plus fixed charges. "Fixed charges" consist of interest on all indebtedness and amortization of deferred financing costs. Earnings were not sufficient to cover fixed charges by $7,545 and $5,456 for the periods from December 16, 1997 to June 30, 1998 and the year ended June 30, 1999, respectively. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The sales of our company are derived from the sale of sampling systems to cosmetics and consumer products companies. Substantially all of our company's sales are made directly to its customers while a small portion are made through advertising agencies. Each customer's sampling program is unique and pricing is negotiated based on estimated costs plus a margin. While our company and its customers generally do not enter into long-term contracts, our company has had long-standing relationships with the majority of its customer base. The introduction of our company's new products, such as BeautiSeal, PowdaTouch and LiquaTouch, has affected our company's results of operations for certain of the periods discussed below. 18 The Acquisition DLJMBII and certain members of our company's 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 Acquisition Corp. 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) Acquisition Corp. 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." Acquisition Corp. then contributed $1 of cash and all of its ownership interest in AKI to Holding for 1,000 shares of Holding's common stock. The merger corporation's senior increasing rate notes were subsequently repaid on June 25, 1998 from the proceeds of AKI's issuance of $115.0 million of AKI's notes and from a capital contribution from Holding. On June 25, 1998, Holding issued and sold its debentures totaling $50.0 million in aggregate principal amount at maturity for gross proceeds of $26.0 million, the majority of which were used to fund Holding's equity contribution to AKI. The Acquisition was accounted for using the purchase method of accounting and resulted in the recognition of $153.9 million of goodwill and a significant increase in amortization expense. 3M Acquisition On June 22, 1998, we acquired the fragrance sampling business of the Industrial and Consumer Products division of Minnesota Mining and Manufacturing Company (3M) for $7.25 million in cash and the assumption of a liability of $182,000 to one of the customers of the business. Our company financed the 3M acquisition with borrowings under the credit agreement. Such borrowings were subsequently repaid. RetCom Acquisition On September 15, 1999, we acquired all of the issued and outstanding shares of capital stock of RetCom Holdings Ltd. at a purchase price of 19 approximately $12.2 million and refinanced working capital indebtedness of approximately $5.1 million of RetCom Holdings Ltd. and its subsidiaries. The purchase price and refinancing of indebtedness were initially financed by borrowings under the credit agreement. See "--Liquidity and Capital Resources." Results of Operations For purposes of the following discussion, the results of operations for the year ended June 30, 1998 reflect the combination of the results of operations of the predecessor corporation for the period July 1, 1997 through December 15, 1997, the date of the Acquisition, with the results of operations of our company for the period December 16, 1997 through June 30, 1998. Due to the effects of purchase accounting applied in the Acquisition and the additional interest expense associated with the debt incurred to finance the Acquisition, the results of operations of our company are not comparable in all respects to the results of operations of the predecessor corporation. Fiscal Year Ended June 30, 1999 Compared to Fiscal Year Ended June 30, 1998 Net Sales. Net sales for the fiscal year ended June 30, 1999 increased $14.7 million, or 20.6%, to $86.0 million as compared to $71.3 million for the fiscal year ended June 30, 1998. The increase was primarily attributable to a $9.1 million increase in domestic sales of cosmetic sampling products, the $5.7 million growth of our company's European revenues and increases in sales of consumer product samples, offset by decreases in sales to the domestic fragrance industry. Gross Profit. Gross profit for the fiscal year ended June 30, 1999 increased $6.9 million, or 28.9%, to $30.8 million as compared to $23.9 million for fiscal year ended June 30, 1998. Gross profit as a percentage of net sales increased to 35.8% in the fiscal year ended June 30, 1999, from 33.5% in the fiscal year ended June 30, 1998. The increase in gross profit and gross profit as a percentage of net sales is primarily attributable to the increase in net sales discussed above and reductions in raw material costs, offset by a decrease in certain fragrance samples pricing, changes in product sales mix, increased costs associated with the outsourcing of European production and increased costs associated with the initial production runs of certain customer products. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the fiscal year ended June 30, 1999 increased $3.2 million, or 28.3% to $14.5 million as compared to $11.3 million for the fiscal year ended June 30, 1998. The increase in selling, general and administrative expenses was primarily due to severance charges related to former executive officers, changes in executive compensation following the Acquisition and increased sales staffing and commissions related to the increase in net sales and costs associated with the transition of the 3M acquisition, offset partially by reduced advertising expenditures and staff reductions. As a result of these factors, selling, general and administrative expenses as a percent of net sales increased to 16.9% in the fiscal year ended June 30, 1999 from 15.8% in the fiscal year ended June 30, 1998. 20 Income from Operations. Income from operations for the fiscal year ended June 30, 1999 increased $1.7 million, or 17.0%, to $11.7 million as compared to $10.0 million for the fiscal year ended June 30, 1998. Income from operations as a percentage of net sales decreased to 13.6% in the fiscal year ended June 30, 1999 from 14.0% in the fiscal year ended June 30, 1998, principally as a result of the increase in amortization of goodwill and other intangibles resulting from the Acquisition and the 3M acquisition and the factors described above. Interest Expense. Interest expense for the fiscal year ended June 30, 1999 increased $2.7 million, or 19.3% to $16.7 million, as compared to $14.0 million for the fiscal year ended June 30, 1998. Interest expense as a percentage of net sales decreased to 19.4% in the fiscal year ended June 30, 1999 from 19.6% in the fiscal year ended June 30, 1998. The increase in interest expense is due to the increased indebtedness as a result of the recapitalization of our company in connection with the Acquisition, partially offset by the refinancing of the merger corporation's senior increasing rate notes with the notes and debentures. Interest expense for AKI for the fiscal year ended June 30, 1999 decreased $0.9 million, or 6.5%, to $13.0 million, as compared to $13.9 million for the fiscal year ended June 30, 1998. Interest expense as a percentage of net sales decreased to 15.1% in the fiscal year ended June 30, 1999 from 19.5% in the fiscal year ended June 30, 1998. The decrease in interest expense is due to the decreased indebtedness as a result of the refinancing of the merger corporation's senior increasing rate notes with the notes and Holding's equity contribution to AKI partially offset by the recapitalization of AKI. Management Fees and Other, Net. Management fees and other, net for the fiscal year ended June 30, 1999 were $0.4 million as compared to $0.3 million for the fiscal year ended June 30, 1998. Management fees and other, net as a percentage of net sales were relatively constant for the fiscal years ended June 30, 1999 and 1998. Income Tax Expense. The income tax benefit for the fiscal year ended June 30, 1999 decreased $0.3 million to ($0.3) million as compared to ($0.6) million for the fiscal year ended June 30, 1998. The decrease is due to the increase in non-deductible goodwill amortization and non-deductible portion of the interest expense on the debentures, offset partially by the increased net loss before income taxes as a result of the factors described above. Income tax expense for AKI for the fiscal year ended June 30, 1999 increased $1.4 million to $0.8 million as compared to ($0.6) million for the fiscal year ended June 30, 1998. The increase is due to the decrease in loss before income taxes as a result of the factors described above and increase in non-deductible goodwill amortization. EBITDA. EBITDA for the fiscal year ended June 30, 1999, increased $3.7 million, or 22.6%, to $20.1 million as compared to $16.4 million for the fiscal year ended June 30, 1998, principally as a result of the factors described above. EBITDA is income from operations plus depreciation and amortization of goodwill and other intangibles. 21 Fiscal Year Ended June 30, 1998 Compared to Fiscal Year Ended June 30, 1997 Net Sales. Net Sales for fiscal year ended June 30, 1998 decreased $6.4 million, or 8.2%, to $71.3 million as compared to $77.7 million for fiscal year ended June 30, 1997. The majority of this decrease was attributable to three core customers' advertising decreases on new product launches and existing products as a result of a management restructuring at two of these customers and the sale of one of them. In addition there was a decrease in domestic sales of products for fragrance sampling. These decreases were partially offset by increased domestic and European sales of sampling products to other categories of the cosmetics industry as well as increased sales to the consumer products market. Gross Profit. Gross profit for fiscal year ended June 30, 1998 decreased $4.4 million, or 15.5%, to $23.9 million as compared to $28.3 million for fiscal year ended June 30, 1997. Gross profit as a percentage of nets sales decreased to 33.5% in fiscal year ended June 30, 1998 from 36.4% in fiscal year ended June 30, 1997. The gross profit decline was primarily attributable to the absorption of fixed overhead, depreciation costs and equipment reconfiguration costs created by shorter production runs due to lower volume and the increase in cost of goods sold in the period subsequent to the Acquisition from the write-up of inventory in purchase accounting. Selling, General and Administrative Expenses. Selling, general and administrative expenses for fiscal year ended June 30, 1998 decreased $2.1 million or 15.7%, to $11.3 million as compared to $13.4 million for fiscal year ended June 30, 1997. The decrease in selling, general and administrative expenses was primarily attributable to a decrease in sales commissions resulting from the decreased level of sales and a decrease in legal costs related to our company's pursuit of a patent infringement claim in fiscal year ended June 30, 1997. In addition, our company also had decreased expenses in fiscal year ended June 30, 1998 versus fiscal year ended June 30, 1997 related to the consolidation of certain acquired technologies and certain expenses relating to reorganizing the management structure at our company's European subsidiary. As a result of these factors, selling, general and administrative expenses as a percentage of net sales decreased to 15.8% in fiscal year ended June 30, 1998 from 17.2% in fiscal year ended June 30, 1997. Income from Operations. Income from operations for fiscal year ended June 30, 1998 decreased $3.7 million, or 27.0%, to $10.0 million as compared to $13.7 million for fiscal year ended June 30, 1997. Income from operations as a percentage of net sales decreased to 14.0% in fiscal year ended June 30, 1998 from 17.6% in fiscal year ended June 30, 1997 principally as a result of the factors described above and the increase in amortization of goodwill resulting from the Acquisition. Interest Expense. Interest expense for fiscal year ended June 30, 1998 increased $7.8 million, or 125.8% to $14.0 million as compared to $6.2 million for fiscal year ended June 30, 1997. Interest expense as a percentage of net sales increased to 19.6% in fiscal year ended June 30, 1998 from 8.0% in fiscal year ended June 30, 1997. The increase in interest expense is a result of the refinancing of our company in connection with the Acquisition. 22 Interest expense for AKI for fiscal year ended June 30, 1998 increased $7.7 million, or 124.2% to $13.9 million as compared to $6.2 million for fiscal year ended June 30, 1997. Interest expense as a percentage of net sales increased to 19.5% in fiscal year ended June 30, 1998 from 8.0% in fiscal year ended June 30, 1997. The increase in interest expense is a result of the refinancing of our company in connection with the Acquisition. Other Income/Expense and Management Fees. Other income/expense and management fees for fiscal year ended June 30, 1998 decreased $0.1 million, or 25.0% to $0.3 million as compared to $0.4 million for fiscal year ended June 30, 1997. Other income/expense and management fees as a percentage of net sales decreased to 0.4% in fiscal year ended June 30, 1998 from 0.5% in fiscal year ended June 30, 1997. The decrease in other income/expense and management fees is related to the decrease in management/advisory fees subsequent to the sale of our company. Income Tax Expenses. Income tax expense for fiscal year ended June 30, 1998 decreased $3.7 million or 119.4% to $(0.6) million as compared to $3.1 million for fiscal year ended June 30, 1997. The Company's effective tax rate was 36.8% in 1998 and 37.6% in 1997. EBITDA. EBITDA for fiscal year ended June 30, 1998 decreased $2.4 million, or 12.8% to $16.4 million as compared to $18.8 million for fiscal year ended June 30, 1997, principally as a result of the factors described above. Liquidity and Capital Resources Our company has substantial indebtedness and significant debt service obligations. As of June 30, 1999, our company had consolidated indebtedness in an aggregate amount of $146.7 million (excluding trade payables, accrued liabilities and deferred taxes), of which (1) approximately $29.7 million was a direct obligation of Holding relating to its debentures and (2) approximately $117.0 million was a direct obligation of AKI relating to its notes and capital leases. At June 30, 1999, AKI also had $17.1 million in additional outstanding liabilities (including trade payables, accrued liabilities and deferred taxes) and letters of credit outstanding under the credit agreement in the amount of $0.6 million. As of September 20, 1999, AKI had letters of credit outstanding in the amount of $0.6 million and outstanding borrowings of $16.3 million under the credit agreement. Borrowings under the credit agreement are limited to a maximum amount equal to $20.0 million. At June 30, 1999 and September 27, 1999, AKI had borrowings of approximately $19.4 million and $3.1 million, respectively, available, subject to a borrowing base calculation and the achievement of specified financial ratios and compliance with specified conditions. The interest rate for borrowings under the credit agreement are determined from time to time based on our company's choice of formulas, plus a margin. The credit agreement will mature on December 31, 2002. The indentures and the credit agreement permit Holding and its Restricted Subsidiaries to incur additional indebtedness, subject to specified 23 limitations. In addition, the indentures contains restrictive covenants that, among other things, limit the ability of Holding and its Restricted Subsidiaries to: * pay dividends or make certain restricted payments; * incur additional indebtedness and issue preferred stock; * create liens; * incur dividend and other payment restrictions affecting subsidiaries; * enter into mergers, consolidations or sales of all or substantially all of the assets of our company; * enter into certain transactions with affiliates; and * sell certain assets. Payment of Holding's debentures is not guaranteed by AKI or any of its subsidiaries. Because Holding is a holding company with no substantive operations, it is dependent upon the cash flows of AKI and its subsidiaries and the payment of funds by AKI and its subsidiaries to Holding in the form of loans, dividends or otherwise to pay its obligations. See "Risk Factors--Holding Company Structure." Holding's principal liquidity requirements are for debt service requirements under the debentures. AKI's principal liquidity requirements are for debt service requirements and fees under the notes and the credit agreement. Historically, our company has funded its capital, debt service and operating requirements with a combination of net cash provided by operating activities, which was $9.8 million for fiscal 1999, together with borrowings under revolving credit facilities. In fiscal 1998, cash totaling $3.9 million was used by operating activities primarily due to the assumption, and subsequent settlement, of a $5.8 million current liability arising from, and directly attributable to the Acquisition. Net cash provided by operating activities during fiscal 1999 resulted from net income before depreciation and amortization, the collection of an income tax refund receivable and increases in accounts payable and accrued expenses. These factors were partially offset by increased accounts receivable and inventory levels. In fiscal 1998 and fiscal 1999, our company had capital expenditures of approximately $1.3 million and $2.9 million, respectively. These capital expenditures consisted primarily of the purchase and maintenance of manufacturing equipment and furniture and fixtures and maintaining and upgrading its computer systems. On September 15, 1999, we acquired all of the issued and outstanding shares of capital stock of RetCom Holdings Ltd. at a purchase price of approximately $12.2 million and refinanced working capital indebtedness of approximately $5.1 million of RetCom Holdings Ltd. and its subsidiaries. The 24 purchase price and refinancing of indebtedness were initially financed by borrowings under the credit agreement. Our company is exploring options for the longer-term financing of a portion of the borrowings incurred in connection with the acquisition. Our company may from time to time evaluate additional potential acquisitions. There can be no assurance that additional capital sources will be available to our company to fund additional acquisitions on terms that our company finds acceptable, or at all. In August 1998, Acquisition Corp. repurchased from Roger Barnett 80,000 shares of preferred stock of Acquisition Corp. for approximately $2.0 million in cash pursuant to the exercise by Mr. Barnett of a put option on July 30, 1998 with the proceeds of a dividend from Holding. At June 30, 1999, Acquisition Corp. had outstanding (1) $30 million of Floating Rate Notes which bear interest at approximately 15% per annum and mature on December 15, 2009, and (2) approximately $50.8 million of Senior Preferred Stock which accrue dividends at 15% per annum and must be redeemed by December 15, 2012. Interest on the floating rate 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 Acquisition Corp. and are not obligations of, or guaranteed by Holding, AKI or any of its subsidiaries. Acquisition Corp. is a holding company and is dependant upon the cash flows of its subsidiaries and the payment to it of funds by its subsidiaries. The indenture relating to the debentures restricts the payment of dividends or the making of other restricted payments by Holding to Acquisition Corp. In September 1999, Acquisition Corp. consummated a private placement to DLJMBII of 15,000,000 shares of its common stock at a purchase price of $1.00 per share. A portion of the proceeds may become available to the Company to reduce outstanding indebtedness of Holding or AKI or for working capital or other general corporate purposes, but there is no obligation on the part of Acquisition Corp. to make any of these funds available. Capital expenditures for the fiscal year ending June 30, 2000 are budgeted to be approximately $4.0 million. Based on borrowings outstanding (other than pursuant to the credit agreement) as of June 30, 1999 and borrowings outstanding under the credit agreement as of September 20, 1999, our company expects total cash payments for debt service in fiscal 2000 to be approximately $14.0 million, consisting of $12.1 million in interest payments on the notes, $0.9 million in capital lease obligations and $1.0 million in interest and fees under the credit agreement. Our company also expects to make royalty payments of approximately $1.1 million during fiscal 2000. * Our company believes that, in the absence of future acquisitions, cash flows from existing operations and available borrowings will be sufficient to fund budgeted capital expenditures, working capital requirements and interest and principal payments on its indebtedness, including the debentures and the notes for fiscal 2000. In the event our company consummates any additional acquisitions it may seek additional debt or equity financings subject to compliance with the terms of the indentures. 25 At June 30, 1999, our company's cash and cash equivalents and net working capital were $7.0 million and $14.9 million, respectively, representing an increase in cash and cash equivalents of $3.2 million and a decrease in net working capital of $0.2 million from June 30, 1998. Account receivables, net, at June 30, 1999 increased 20.2% or $2.7 million over the June 30, 1998 amount, primarily due to increased sales and an increase in days sales outstanding. Seasonality Our company's sales and operating results have historically reflected seasonal variations. Such seasonal variations are based on the timing of our company's customers' advertising campaigns, which have traditionally been concentrated prior to the Christmas and spring holiday seasons. As a result, a higher level of sales are reflected in our company's first two fiscal quarters ended December 31 when sales from such advertising campaigns are principally recognized while our company's fourth fiscal quarter ended June 30 typically reflects the lowest sales level of the fiscal year. These seasonal fluctuations require our company to accurately allocate its resources to manage our company's manufacturing capacity, which often operates at full capacity during peak seasonal demand periods. Recently Issued Accounting Standards In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" which is effective for fiscal years beginning after June 15, 1999. SFAS No. 133 established accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities Deferral of Effective Date" which is effective for fiscal years beginning after June 15, 2000. Our company has only utilized derivative financial instruments to hedge our company's exposure to certain foreign currencies. Such hedging activity has historically been minor and, as a result, adoption of this Statement is not expected to have a material impact on our company's financial condition or results of operations. Our company will adopt the provisions of this Statement on July 1, 2000. Year 2000 Issues Our company is currently working to resolve the potential impact of the Year 2000 on its information technology systems and its non-information technology systems so they will properly recognize and utilize dates beyond December 31, 1999. Our company has in place a Year 2000 program which is being executed by an internal project team. The objective of the Year 2000 program is to determine and assess the risks of the Year 2000 issue and to plan and institute mitigating actions to minimize those risks to acceptable levels. To date, all of our company's systems have been assessed for Year 2000 compliance. Our company relies on five computerized systems all of which required remediation, two of which are maintained internally and the others are maintained by third party 26 vendors. Our company believes that all of these systems are currently Year 2000 compliant. Upon review of our company's non-information technology systems our company believes that none of its manufacturing equipment is date sensitive. Of the remaining non-information technology systems, our company believes all such systems are Year 2000 compliant. If, however, all necessary actions are not taken on a timely basis to ensure Year 2000 compliance, the Year 2000 issue could have a material adverse effect on our company. See "Risk Factors--Year 2000 Issues." To date, our company has spent approximately $80,000 on Year 2000 compliance. Although our company expects the above referenced expenditures will be sufficient to ensure our company is Year 2000 compliant, our company has budgeted an additional $20,000 for any unforeseen problems which may arise with respect to Year 2000 compliance between July 1, 1999 and the Year 2000. All expenditures with respect to Year 2000 compliance will be funded from working capital. Our company is communicating with its significant customers and vendors to understand their Year 2000 issues and how they might prepare themselves to manage those issues as they relate to our company. To date, no significant customers or vendors have informed our company that a material Year 2000 issue exists which will have a material effect on our company. Our company has not formulated a contingency plan in the event it or its significant customers or vendors are not Year 2000 compliant. Forward-Looking Statements The information provided in this document contains forward-looking statements that involve a number of risks and uncertainties. A number of factors could cause actual results, performance, achievements of our company or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These factors include, but are not limited to: o the competitive environment in the sampling industry in general and in our company's specific market areas; * changes in prevailing interest rates; * inflation; * changes in cost of goods and services; * economic conditions in general and in our company's specific market areas; * changes in or failure to comply with postal regulations or other federal, state and/or local government regulations; * liability and other claims asserted against our company; * changes in operating strategy or development plans; 27 * the ability to attract and retain qualified personnel; * the significant indebtedness of our company; * labor disturbances; * changes in our company's capital expenditure plans; * 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 such forward-looking statements. Our company disclaims any obligations to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained in this document to reflect future events or developments. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Our company generates approximately 20% of its sales from customers outside the United States, principally in Europe. International sales are made mostly from our company's foreign subsidiary located in France and are primarily denominated in the local currency. Our company's foreign subsidiary also incurs the majority of its expenses in the local currency and uses the local currency as its functional currency. Our company's major principal cash balances are held in U.S. dollars. Cash balances in foreign currencies are held to minimum balances for working capital purposes and therefore have a minimum risk to currency fluctuations. Our company periodically enters into forward foreign currency exchange contracts to hedge certain exposures related to selected transactions that are relatively certain as to both timing and amount and to hedge a portion of the production costs expected to be denominated in foreign currencies. The purpose of entering into these hedge transactions is to minimize the impact of foreign currency fluctuations on the results of operations and cash flows. Gains and losses on the hedging activities are recognized concurrently with the gains and losses from the underlying transactions. At June 30, 1999, our company's forward exchange contracts consisted of forward contracts to sell Euros at an exchange rate of 1.0461 per U.S. dollar and to buy British pound sterling at an exchange rate of 1.6123 per U.S. dollar. The notational principal amounts under these foreign exchange contracts were $1.1 million and $0.7 million, respectively. 28 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to the Consolidated Financial Statements of each of Holding and AKI, the related notes and the Report of Independent Accountants for each of Holding and AKI commencing at page F-1 of this report, which financial statements, notes and reports are incorporated by reference into this report. ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE None. 29 PART III ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS OF REGISTRANT The following table sets forth certain information with respect to the directors and executive officers of Holding. Name Age Position - ---- --- -------- Thompson Dean 40 Chairman of the Board and Director William J. Fox 43 President, Chief Executive Officer and Director Kenneth A. Budde 50 Chief Financial Officer Hugh R. Kirkpatrick 62 Director Mark P. Michaels 39 Director David M. Wittels 35 Director Roger L. Barnett 35 Director Thompson Dean has served as Chairman of the Board and a Director of Holding since December 1997. Mr. Dean is the Managing Partner of DLJ Merchant Banking II, Inc. ("DLJ Merchant Banking") and the general partner of DLJ Merchant Banking Partners II, L.P. Mr. Dean serves as a director of Commvault Inc., Von Hoffman Press, Inc., Manufacturers' Services Limited and Phase Metrics, Inc. William J. Fox has served as President, Chief Executive Officer and a Director of Holding and as Chairman, President and Chief Executive Officer and a Director of AKI, Inc. since February 1999. Mr. Fox was President, Strategic and Corporate Development of Revlon Worldwide, Senior Executive Vice President of Revlon, Inc. and Revlon Consumer Products Corporation ("RCPC") (and 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 a Director and Vice Chairman of the Board of The Hain Food Group, Inc. (NASDAQ: HAIN). Kenneth A. Budde has served as Chief Financial Officer of Holding since November 1994. From October 1988 to June 1994, Mr. Budde served as Controller and Chief Financial Officer of Southwestern Publishing Company. Prior to that, Mr. Budde spent 12 years with KPMG Peat Marwick. Hugh R. Kirkpatrick has served as a director of Holding since June 1998. Mr. Kirkpatrick is a former director of International Flavors & Fragrances, Inc. where he served as Senior Vice President and President, Worldwide Fragrance Division, from 1991 through his retirement in 1996. 30 Mark P. Michaels has served as a director of Holding since June 1998. Mr. Michaels has been a Principal of DLJ Merchant Banking since 1997. Prior thereto, Mr. Michaels was a consultant with McKinsey & Company, Inc. from 1987 to 1996. David M. Wittels has served as a director of Holding since December 1997. Mr. Wittels is a Principal of DLJ Merchant Banking and has served in various capacities with DLJ Merchant Banking since 1986. Mr. Wittels serves as a director of Wilson Greatbatch Limited. Roger L. Barnett has served as director of our company (or its predecessor) since November 1993. Mr. Barnett is the chief executive officer of Beauty.Com. From 1995 to February 1999, Mr. Barnett served as President and Chief Executive Officer of our company and from 1994 to 1995, he served as Senior Vice President and Vice President of our company. Compensation of Directors Except for Messrs. Kirkpatrick and Barnett, directors of Holding will not receive compensation for services rendered in that capacity, but will be reimbursed for out-of-pocket expenses incurred by them in connection with their travel to and attendance at board meetings and committees of the board. Messrs. Kirkpatrick and Barnett will receive an annual fee of $20,000 per year plus reasonable out-of-pocket expenses in connection with travel to and attendance at meetings of the board of directors and committees of the board. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth certain information for the three most recently completed fiscal years with respect to the compensation of (1) each person who served as our company's chief executive officer in fiscal 1999, (2) our other most highly compensated executive officer whose total annual compensation exceeded $100,000 and (3) our other most highly compensated executive officer whose total annual compensation exceed $100,000 but was not an employee of our company at June 30, 1999 (collectively, the "named executive officers"). 31
Summary Compensation Table Long Term Annual Compensation Compensation ------------------- ------------ Fiscal Securities All Other Name and Principal Position Year Salary Bonus Underlying Options Compensation(1) --------------------------- ---- ------ ----- ------------------ --------------- William J. Fox(2) 1999 $242,308 $250,000 ------(3) ------ President, Chief Executive Officer 1998 ------ ------ ------ ------ And Director 1997 ------ ------ ------ ------ Roger L. Barnett(2) 1999 309,711 ------(4) ------ $3,577 President, Chief Executive Officer 1998 367,083 ------ 32,500(5) 3,670 And Director 1997 210,000 275,000 ------ 5,700 Kenneth A. Budde 1999 154,327 80,625 ------ 9,077 Chief Financial Officer 1998 120,000 75,000 ------ ------ 1997 100,000 50,000 ------ ------ Barry Miller(6) 1999 219,153 ------ ------ 120 Chief Operating Officer 1998 23,692 ------ ------ ------ 1997 ------ ------ ------ ------
(1) Represents amounts contributed on behalf of the named executive to our company's 401(k) retirement savings plan. (2) On February 1, 1999, Mr. Barnett resigned as president and chief executive officer of our company and Mr. Fox was engaged as president and chief executive officer. (3) Pursuant to the terms of his employment agreement, Mr. Fox is entitled to receive options to acquire 5% of Acquisition Corp.'s issued and outstanding common stock on a fully diluted basis, which options have not yet been granted. See "--Equity Based Compensation" and "--Fox Employment Agreement." (4) Does not include $353,275 to which Mr. Barnett is entitled in connection with his resignation from our company. See "Certain Relationships and Related Transactions--Employment Arrangements." (5) These options were forfeited upon Mr. Barnett's resignation from our company. (6) Mr. Miller's employment with our company commenced in May 1998 and was terminated in May 1999. Equity-Based Compensation No options were granted by Acquisition Corp., Holding or AKI in fiscal 1999. Pursuant to the terms of his employment agreement, Mr. Fox is entitled to receive options to acquire 5% of Acquisition Corp.'s issued and outstanding common stock on a fully diluted basis, which options have not yet been granted. See "--Fox Employment Agreement." In addition, no options for shares of capital stock of Acquisition Corp., Holding or AKI were exercised in fiscal 1999. Acquisition Corp. adopted the 1998 Stock Option Plan for certain key employees and directors of Acquisition Corp. and any parent or subsidiary 32 corporation of Acquisition Corp. The objectives of the option plan are (1) to retain the services of persons holding key positions and to secure the services of persons capable of filling such positions and (2) to provide persons responsible for the future growth of Acquisition Corp. an opportunity to acquire a proprietary interest in our company and thus create in such key employees an increased interest in and a greater concern for the welfare of our company. The option plan authorizes the issuance of options to acquire up to 100,000 shares of common stock of Acquisition Corp. The option plan will be administered by the board of directors or a compensation committee to be designated by the board of directors. Pursuant to the option plan, Acquisition Corp. may grant options, including options that become exercisable as performance standards determined by the committee are met, to key employees and directors of Acquisition Corp. and any parent or subsidiary corporation. The terms of any such grant will be determined by the committee and set forth in a separate grant agreement. The exercise price will be at least equal to the fair market value per share of Acquisition Corp. common stock on the date of grant, provided that the exercise price shall not be less than $1.00 per share. Options may be exercisable for up to ten years. The committee has the right to accelerate the right to exercise any option granted under the option plan without effecting the expiration date thereof. Upon the occurrence of a change in control (as defined in the option plan) of Acquisition Corp., each option may, at the discretion of the committee, be terminated upon notice to the holder and each such holder will receive, in respect of each share of Acquisition Corp. common stock for which such option is then exercisable, an amount equal to the excess of the then fair market value of such share of Acquisition Corp. common stock over the per share exercise price. Fox Employment Agreement On January 27, 1999, William J. Fox entered into an employment agreement with our company effective February 1, 1999. The term of the agreement began on the effective date and will end on the third anniversary of the effective date, provided, that beginning on the first anniversary of the effective date, the term shall automatically be extended for one additional day each day, unless either party provides notice not to extend. Pursuant to his employment agreement, Mr. Fox's base salary is $600,000 and he will be eligible to receive a performance-based bonus of 25%, 100% or 200% of his base salary upon achievement of targeted goals, and other incentive payments. Pursuant to the terms of his employment agreement, Mr. Fox is entitled to receive options to acquire 5% of Acquisition Corp.'s issued and outstanding common stock on a fully diluted basis, subject to anti-dilution protection, which options have not yet been granted. Once granted, these options will vest at specified dates and upon the occurrence of specified conditions. In addition, upon a change in control (as defined in the employment agreement), all time vested options vest and all performance vested options vest if the DLJ Entities (as defined in the employment agreement) achieve certain levels of return on their equity investments. If Mr. Fox's employment is terminated by our company without cause or by Mr. Fox for good reason, our company will pay Mr. Fox two times his base salary, 50% of such amount on termination of employment and 50% paid in equal monthly installments over a twelve month period following the date of 33 termination. In addition, Mr. Fox will receive a pro-rata bonus for the year of termination if he would have been entitled to such a bonus had he remained employed during the year of termination. If such termination occurs within 6-months of a time where a tranche of time vested options would otherwise become exercisable, then a pro-rata portion of such tranche will become exercisable. The employment agreement contains confidentiality, noncompetition and nonsolicitation provisions. The restricted period for the noncompetition provisions upon termination of employment is two years if Mr. Fox's employment is terminated by our company without cause or by our company for good reason, and one year if Mr. Fox's employment is terminated for any other reason. Compensation Committee Interlocks and Insider Participation None of Acquisition Corp., Holding or AKI had a compensation committee during fiscal 1999. No executive officer participated in deliberations regarding executive compensation. Each of William J. Fox and Roger L. Barnett were executive officers during fiscal 1999 and served on the board of directors. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT All of AKI's issued and outstanding capital stock is owned by Holding. All of Holding's issued and outstanding capital stock is owned by Acquisition Corp. The following table sets forth certain information as of September 27, 1999 with respect to the beneficial ownership of Acquisition Corp. common stock by (1) owners of more than five percent of such Acquisition Corp. common stock, (2) each director and named executive officer of Holding and (3) all directors and executive officers of Holding, as a group.
Percentage of Shares Outstanding Beneficially Acquisition Corp. Owned Common Stock Beneficial Owner DLJ Merchant Banking Partners, II, L.P. and related investors (1) (2) 15,921,111 98.8% William J. Fox --- --- Thompson Dean (3) --- --- Roger L. Barnett (2) 134,325 * Hugh R. Kirpatrick --- --- Mark Michaels (3) --- --- David M. Wittels (3) --- --- Kenneth A. Budde --- --- All directors and executive officers as a group (2) (3) 134,325 *
34 - ------------- * Less than one percent. (1) Consists of shares held directly by the following affiliated investors: DLJ Merchant Banking Partners II, L.P; DLJ Merchant Banking Partners II-A, LP ("DLJMBII-A); DLJ Offshore Partners II, C.V. ("Offshore Partners II"); DLJ Diversified Partners, L.P. ("Diversified Partners"); DLJ Diversified Partners-A, L.P ("Diversified Partners-A"); DLJMB Funding II, Inc. ("DLJ Funding II"); DLJ Millennium Partners, L.P. ("Millennium Partners"); DLJ Millennium Partners-A, L.P, ("Millennium Partners-A"); DLJ EAB Partners, L.P ("EAB Partners"); UK Investment Plan 1997 Partners ("UK Partners"); and DLJ First ESC L.P ("First ESC"). See "Certain Relationships and Related Transactions-Transactions with DLJMBII, and their Affiliates." The address of each of DLJMBII, DLJMBII-A, Diversified Partners, Diversified Partners-A, DLJ Funding II, Millennium Partners, Millennium Partners-A, EAB Partners and First ESC is 277 Park Avenue, New York, New York 10172. The address of Offshore Partners 11 is John B. Gorsiraweg 14, Willemstad, Curacao, Netherlands Antilles. The address of UK Partners is 2121 Avenue of the Stars, Fox Plaza, Suite 3000, Los Angeles, California 90067. Does not include 18,000 shares of Acquisition Corp. Common Stock held directly by the Scratch & Sniff Funding, Inc., an affiliate of DLJMBII. (2) See "Certain Relationships and Related Transactions." (3) Messrs. Dean, Michaels and Wittels are officers of DLJ Merchant Banking, an affiliate of DLJMBII. Share data shown for such individuals excludes shares shown as held by DLJMBII, as to which such individuals disclaim beneficial ownership. The address of each of Messrs. Dean, Michaels and Wittels is 277 Park Avenue, New York, New York 10172. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Transactions with DLJMBII and their Affiliates Messrs. Dean, Michaels and Wittels, who are directors of AKI and officers and directors of Holding and Acquisition Corp., are officers of DLJ Merchant Banking. DLJ Merchant Banking, together with DLJMBII, beneficially own, in the aggregate, approximately 98.8% of the outstanding common stock of Acquisition Corp. Pursuant to an agreement between Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") and Acquisition Corp., DLJ will receive an annual fee of $250,000 for acting as the exclusive financial and investment banking advisor to our company ending December 31, 2002. Our company has agreed to indemnify DLJ in connection with its acting as financial advisor. Stockholders Agreement In connection with the Acquisition, Acquisition Corp., DLJMBII, certain investors in our company prior to the Acquisition, including Roger L. Barnett and certain other signatories thereto, entered into a Stockholders Agreement, dated as of December 15, 1997, that sets forth certain rights and restrictions relating to the ownership of the capital stock of Acquisition Corp. (including securities exercisable for or convertible or exchangeable into capital stock of Acquisition Corp.) and agreements among the parties thereto as to the governance of Acquisition Corp. and, indirectly, Holding and AKI. Pursuant to the stockholders agreement, the board of directors of Acquisition Corp. consists of six members. DLJMBII has the right to nominate 35 four of the directors of Acquisition Corp. and the prior investors have the right to nominate one director of Acquisition Corp., provided that DLJMBII and the prior investors maintain a specified minimum level of equity investment in Acquisition Corp. In addition, the stockholders agreement provides that the Chief Executive Officer of Acquisition Corp. be nominated as a director of Acquisition Corp. The stockholders agreement contains restrictions on the ability of each holder of capital stock of Acquisition Corp. to transfer any capital stock of Acquisition Corp. to any person designated by the board of directors of Acquisition Corp. to be an "Adverse Person." In addition, the prior investors are restricted in their ability to transfer capital stock of Acquisition Corp. prior to the date that is the earlier of (1) the consummation of a qualifying initial public offering or (2) December 15, 2002, except to DLJMBII or a party who is a prior investor, or pursuant to an offering of equity securities registered under the Securities Act. The other material provisions of the stockholders agreement provide, subject to specified exceptions, (1) certain preemptive rights to the holders of capital stock of Acquisition Corp., (2) "drag along" rights to DLJMBII to require the remaining holders of capital stock of Acquisition Corp. to sell a percentage of their ownership and (3) "tag along" rights to the holders of capital stock of Acquisition Corp., other than DLJMBII, with respect to sales of capital stock of Acquisition Corp. by DLJMBII. Pursuant to the stockholders agreement, DLJMBII was granted the right to demand up to three registrations on Form S-1 or the equivalent to sell Acquisition Corp. common stock (or if Acquisition Corp. is eligible to use Form S-3, the number of demand rights is unlimited) and all holders of capital stock of Acquisition Corp. were granted certain customary "piggyback" registration rights to register their common stock in any registration statement filed by Acquisition Corp. Employment Arrangements On June 17, 1998, Roger Barnett was retained as president and chief executive officer of our company pursuant to the terms of his employment agreement. On February 1, 1999, Mr. Barnett resigned as president and chief executive officer and our company engaged William J. Fox as president and chief executive officer. Under the terms of his employment agreement, Mr. Barnett was entitled to receive payments aggregating $500,000, of which $353,275 was required to be paid in fiscal 1999 and the remainder of which will be paid in fiscal 2000. Put Option In August 1998, Acquisition Corp. repurchased from Roger Barnett 80,000 shares of preferred stock of Acquisition Corp. for approximately $2.0 million in cash pursuant to the exercise by Mr. Barnett of a put option on July 30, 1998 with the proceeds of a dividend from Holding. 36 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements The financial statements listed on the accompanying index to such financial statements are filed as part of this report. 2. Financial Statement Schedule None. 3. Exhibits and Exhibit Index. 3.1 Certificate of Incorporation of Holding.* 3.2 Certificate of Incorporation of AKI.** 3.3 Bylaws of Holding.* 3.4 Bylaws of AKI.** 4.1 Indenture dated as of June 25, 1998 between Holding and State Street Bank and Trust Company, as Trustee.* 4.2 Indenture dated as of June 25, 1998 between AKI and IBJ Schroder Trust Company, as Trustee.** 4.3 Form of 13 1/2% Senior Discount Debentures due July 1, 2009 (included in Exhibit 4.1(a)). 4.4 Form of 10 1/2% Senior Discount Debentures due July 1, 2008 (included in Exhibit 4.1(b)). 4.5 Registration Rights Agreement of Holding, dated as of June 25, 1998 between Holding and Donaldson, Lufkin and Jenrette ("DLJ").* 4.6 Registration Rights Agreement of AKI, dated as of June 25, 1998, between AKI and DLJ.** 10.1 Acquisition Corp. Stock Option Plan.* 10.2 Option Letter Agreement relating to the Time Vesting Options dated as of June 17, 1998 between Acquisition Corp. and Roger L. Barnett.* 10.3 Option Letter Agreement relating to the Standard Option dated as of June 17, 1998 between Acquisition Corp. and Roger L. Barnett.* 10.4 Employment Agreement dated as of June 17, 1998 between Holding and Roger L. Barnett.* 38 10.5 Employment Agreement dated as of May 12, 1998 between Holding and Barry Miller.* 10.6 Employment Agreement dated as of February 1, 1999 between Holding and William J. Fox.*** 10.7 Stockholders Agreement dated as of December 15, 1997 between Acquisition Corp., DLJMBII and certain other investors including Roger L. Barnett.* 10.8 Credit Agreement, dated as of April 30, 1996, as amended by Amendment No. 1, dated December 12, 1997, and as further amended by Amendment No. 2, dated October 30, 1998, between the Company and Heller Financial, Inc.* 10.9 Amendment No. 3 to the Credit Agreement, dated August 30, 1999, between the Company and Heller Financial.+ 10.10 Amendment No. 4 to the Credit Agreement, dated September 21, 1999, between the Company and Heller Financial, Inc.+ 10.11 Securities Purchase Agreement dated as of December 15, 1997 between Holding and Scratch & Sniff Funding, Inc.* 10.12 Asset Purchase Agreement dated as of May 28, 1998 between AKI and Minnesota, Mining and Manufacturing Company.* 10.13 Stock Purchase Agreement dated as of November 14, 1997, as amended on December 2, 1997 and December 12, 1997 among the Company and DLJMBII and certain related investors.* 10.14 Financial Advisory Agreement dated as of December 12, 1997 between Acquisition Corp. and DLJ.* 10.15 Replacement Stock Option Agreement dated as of December 15, 1997 between Acquisition Corp. and Roger L. Barnett.* 10.16 Option Substitution Agreement dated as of December 15, 1997 among Holding, Acquisition Corp., and Roger L. Barnett.* 10.17 Put and Call Agreement dated as of December 15, 1997, as amended on February 2, 1998 and April 1, 1998, among Roger L. Barnett, Acquisition Corp., and DLJMBII.* 10.18 Termination of Put and Call Agreement dated June 17, 1997 among DLJMBII, Barnett, and Acquisition Corp.* 10.19 Stock Purchase Agreement, by and among AKI and each of Michael Berman, Paul Pearl, Stuart Fleischer, Jay Gartlan, Retail TCA Corporation, a New York corporation, Retail TCB Corporation, a New York corporation, and Sleepeck Printing Company, an Illinois corporation, dated as of September 2, 1999.+ 12.1 Computation of Ratio of Earnings to Fixed Charges.+ 21.1 Subsidiaries of Holding.+ 23.1 Consent of PricewaterhouseCoopers LLP.+ 23.2 Consent of PricewaterhouseCoopers LLP.+ 39 27.1 Financial Data Schedule.+ 27.2 Financial Data Schedule.+ - -------------- * Incorporated by reference from Registrant's Registration Statement on Form S-4, File No. 333-60991 filed with the Securities and Exchange Commission on August 7, 1998. ** Incorporated by reference from Registrant's Registration Statement on Form S-4, File No. 333-60989 filed with the Securities and Exchange Commission on August 7, 1998. *** Incorporated by reference from Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on February 4, 1999. + Filed herewith. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the three months ended June 30, 1999. 40 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, AKI Holding Corp. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 28th day of September, 1999. AKI HOLDING CORP. (Registrant) By: /S/ WILLIAM J. FOX _________________________________ William J. Fox President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated on the 28th day of September, 1999. SIGNATURE TITLE /S/ THOMPSON DEAN Chairman and Director - ------------------------ Thompson Dean /S/ WILLIAM J. FOX President, Chief Executive Officer and Director - ------------------------ (Principal Executive Officer) William J. Fox /S/ KENNETH BUDDE Chief Financial Officer (Principal Financial and - ------------------------ Accounting Officer) Kenneth Budde /S/ DAVID WITTELS Director - ------------------------ David Wittels /S MARK MICHAELS Director - ------------------------ Mark Michaels /S/ HUGH KIRKPATRICK Director - ------------------------ Hugh Kirkpatrick Director - ------------------------ Roger L. Barnett 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, AKI, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 28th day of September, 1999. AKI, INC. (Registrant) By: /S/ WILLIAM J. FOX _________________________________ William J. Fox President, Chief Executive Officer and Chairman Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated on the 28th day of September, 1999. SIGNATURE TITLE /S/ WILLIAM J. FOX President, Chief Executive Officer, Chairman and - ------------------------ Director (Principal Executive Officer) William J. Fox /S/ KENNETH BUDDE Chief Financial Officer (Principal Financial and - ------------------------ Accounting Officer) Kenneth Budde /S/ DAVID WITTELS Director - ------------------------ David Wittels /S/ THOMPSON DEAN Director - ------------------------ Thompson Dean /S MARK MICHAELS Director - ------------------------ Mark Michaels /S/ HUGH KIRKPATRICK Director - ------------------------ Hugh Kirkpatrick Director - ------------------------ Roger L. Barnett 42 SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT. No annual report or proxy material has been or is expected to be sent to security holders of the registrants. 43 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED FINANACIAL STATEMENTS OF AKI HOLDING CORP.: Report of Independent Accountants........................................... F-2 Report of Independent Accountants........................................... F-3 Consolidated Balance Sheets at June 30, 1998 and 1999....................... F-4 Consolidated Statements of Operations for the year ended June 30, 1997 and for the period from July 1, 1997 through December 15, 1997 and for the period from December 16, 1997 through June 30, 1998 and for the year ended June 30, 1999.............. F-5 Consolidated Statements of Changes in Stockholder(s) Equity for the year ended June 30, 1997 and for the period from July 1, 1997 through December 15, 1997 and for the period from December 16, 1997 through June 30, 1998 and for the year ended June 30, 1999........................................................... F-6 Consolidated Statements of Cash Flows for the year ended June 30, 1997 and for the period from July 1, 1997 through December 15, 1997 and for the period from December 16, 1997 through June 30, 1998 and for the year ended June 30, 1999.............. F-7 Notes to Consolidated Financial Statements.................................. F-8 CONSOLIDATED FINANACIAL STATEMENTS OF AKI, INC.: Report of Independent Accountants...........................................F-31 Report of Independent Accountants...........................................F-32 Consolidated Balance Sheets at June 30, 1998 and 1999.......................F-33 Consolidated Statements of Operations for the year ended June 30, 1997 and for the period from July 1, 1997 through December 15, 1997 and for the period from December 16, 1997 through June 30, 1998 and for the year ended June 30, 1999..............F-34 Consolidated Statements of Changes in Stockholder(s) Equity for the year ended June 30, 1997 and for the period from July 1, 1997 through December 15, 1997 and for the period from December 16, 1997 through June 30, 1998 and for the year ended June 30, 1999.....................................................F-35 Consolidated Statements of Cash Flows for the year ended June 30, 1997 and for the period from July 1, 1997 through December 15, 1997 and for the period from December 16, 1997 through June 30, 1998 and for the year ended June 30, 1999..............F-36 Notes to Consolidated Financial Statements..................................F-37 F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholder of AKI Holding Corp. and Subsidiaries In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in stockholder's equity and of cash flows present fairly, in all material respects, the financial position of AKI Holding Corp. (a wholly-owned subsidiary of AHC I Acquisition Corp.) and Subsidiaries (the "Successor"), at June 30, 1998 and 1999, and the results of their operations and their cash flows for the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999 in conformity with generally accepted accounting principles. These financial statements are the responsibility of management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Nashville, Tennessee July 31, 1999 except for Note 19 which is as of September 15, 1999 F-2 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholder of AKI Holding Corp. and Subsidiaries In our opinion, the accompanying consolidated statements of operations, of changes in stockholders' equity and of cash flows of Arcade Holding Corporation and Subsidiaries (the "Predecessor") present fairly, in all material respects, the results of their operations and their cash flows for the year ended June 30, 1997 and the period from July 1, 1997 through December 15, 1997 in conformity with generally accepted accounting principles. These financial statements are the responsibility of management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Nashville, Tennessee July 31, 1998 F-3
AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) CONSOLIDATED BALANCE SHEETS (dollars in thousands, except share information) The accompanying notes are an integral part of these consolidated financial statements. Successor --------- June 30, 1998 June 30, 1999 ------------- ------------- ASSETS Current assets Cash and cash equivalents..................................... $ 3,842 $ 7,015 Accounts receivable, net...................................... 13,550 16,287 Inventory..................................................... 2,078 5,109 Income tax refund receivable.................................. 5,155 32 Prepaid expenses.............................................. 379 452 Deferred income taxes......................................... 827 400 ----------- ----------- Total current assets.................................... 25,831 29,295 Property, plant and equipment, net............................ 18,936 18,511 Goodwill, net ................................................ 151,842 147,990 Deferred charges, net......................................... 6,535 6,839 Other intangible assets, net.................................. 7,289 6,560 Deferred income taxes......................................... 3,888 4,338 Other assets.................................................. 200 46 ----------- ----------- Total assets............................................ $ 214,521 $ 213,579 =========== =========== LIABILITIES AND STOCKHOLDER'S EQUITY Current liabilities Current portion of capital lease obligations.................. $ 609 $ 688 Current portion of other notes payable........................ 1,330 - Accounts payable, trade....................................... 4,293 3,400 Accrued income taxes.......................................... 100 497 Accrued compensation.......................................... 2,497 2,527 Accrued interest.............................................. 167 6,047 Accrued expenses.............................................. 1,789 1,283 ----------- ----------- Total current liabilities............................... 10,785 14,442 Long-term portion of capital lease obligations................ 1,489 1,349 Senior notes.................................................. 115,000 115,000 Senior discount debentures.................................... 26,020 29,651 Deferred income taxes......................................... 4,143 3,340 ----------- ----------- Total liabilities....................................... 157,437 163,782 Commitments and contingencies (see Note 14) Stockholder's equity Common stock, $0.01 par, 1,000 shares authorized; 1,000 shares issued and outstanding at June 30, 1998 and June 30, 1999 - - Additional paid-in capital.................................... 78,364 78,364 Accumulated deficit........................................... (5,493) (12,472) Accumulated other comprehensive loss.......................... (57) (365) Carryover basis adjustment.................................... (15,730) (15,730) ----------- ------------ Total stockholder's equity.............................. 57,084 49,797 ----------- ----------- Total liabilities and stockholder's equity.............. $ 214,521 $ 213,579 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. F-4
AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands) Predecessor Successor ----------- --------- July 1, December 16, 1997 1997 Year Ended through through Year Ended June 30, December 15, June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Net sales................................. $ 77,723 $ 35,186 $ 36,066 $ 85,967 Cost of goods sold........................ 49,467 22,809 24,518 55,199 --------- --------- --------- --------- Gross profit......................... 28,256 12,377 11,548 30,768 Selling, general and administrative expenses 13,333 5,703 5,587 14,500 Amortization of goodwill and other intangible assets............ 1,234 568 2,101 4,606 --------- --------- --------- --------- Income from operations............... 13,689 6,106 3,860 11,662 Other expenses (income): Interest expense to stockholder(s) and affiliate........................... 5,196 2,143 10,785 - Interest expense, other................ 1,007 503 542 16,740 Management fees to stockholders........ and affiliate........................ 470 215 125 250 Other, net............................. (101) 11 (47) 128 --------- --------- --------- --------- Income (loss) before income taxes.... 7,117 3,234 (7,545) (5,456) Income tax expense (benefit).............. 3,135 1,441 (2,052) (340) --------- --------- --------- ---------- Net income (loss).................... $ 3,982 $ 1,793 $ (5,493) $ (5,116) ========= ========= ========= =========
F-5
AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER(S) EQUITY (dollars in thousands, except share information) Retained Accumulated Additional Stock Earnings Other Carryover Common Stock Paid-in Purchase (Accumulated Comprehensive Basis Shares Amount Capital Warrants Deficit) Loss Adjustment Total ------ ------ ---------------- ------- ---- ---------- ----- Predecessor ----------- Balances, June 30, 1996....... 48,000 $ 1 $4,889 $1,923 $ 1,199 $ (80) $ - $ 7,932 Net Income.................... - - - - 3,982 - - 3,982 Other comprehensive income, net of tax: Foreign currency translation adjustment.............. - - - - - (73) - (73) ---------- Comprehensive income.......... 3,909 Preferred stock dividend...... - - - - (616) - - (616) ------- ------- ------ ------ -------- -------- --------- --------- Balances, June 30, 1997....... 48,000 1 4,889 1,923 4,565 (153) - 11,225 Net income.................... - - - - 1,793 - - 1,793 Other comprehensive income, net of tax : Foreign currency translation adjustment.............. - - - - - (19) - (19) ---------- Comprehensive income.......... 1,774 Preferred stock dividend...... - - - - (283) - - (283) ------- ------- ------ ------ -------- -------- --------- --------- Balances, December 15, 1997... 48,000 $ 1 $4,889 $1,923 $ 6,075 $ (172) $ - $ 12,716 ======= ======= ====== ====== ======== ======== ========= ========= ___________________________________________________________________________________________________________________ Successor --------- Balances, December 16, 1997... - $ - $ - $ - $ - $ - $ - $ - Initial capitalization 1,000 - 78,364 - - - - 78,364 (see Note 13)............... Carryover basis adjustment.... - - - - - - (15,730) (15,730) Net loss...................... - - - - (5,493) - - (5,493) Other comprehensive loss, net of tax: Foreign currency translation adjustment.............. - - - - - (57) - (57) ---------- Comprehensive loss............ (5,550) ------- ------- ------ ------ -------- -------- --------- --------- Balances, June 30, 1998....... 1,000 - 78,364 - (5,493) (57) (15,730) 57,084 Net loss...................... - - - - (5,116) - - (5,116) Other comprehensive loss, net of tax: Foreign currency translation adjustment.............. - - - - - (308) - (308) ---------- Comprehensive loss............ (5,424) Dividend to AHC I Acquisition Corp. - - - - (1,863) - - (1,863) --- --- ---- ------ -------- -------- --------- ---------- Balances, June 30, 1999....... 1,000 $ - $78,364 $ - $(12,472) $ (365) $ (15,730) $ 49,797 ======= ======= ======= ====== ======== ========= ========= ========= The accompanying notes are an integral part of these consolidated financial statements.
F-6
AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands) Predecessor Successor ----------- --------- July 1, December 16, Year 1997 1997 Year ended through through ended June 30, December 15, June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Cash flows from operating activities: Net income (loss)..................... $ 3,982 $ 1,793 $ (5,493) $ (5,116) Adjustment to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization of goodwill and other intangibles............. 5,084 2,456 3,954 8,487 Amortization of debt discount....... 560 233 139 3,631 Amortization of loan closing costs.. 258 101 3,808 727 Deferred income taxes............... (297) (460) (2,035) (544) Gain on sale of equipment...... - - - (50) Other............................... (138) (18) (57) (308) Changes in operating assets and liabilities: Accounts receivable............... 2,546 1,153 (4,562) (2,737) Inventory......................... (550) 69 543 (3,031) Prepaid expenses, deferred charges and other assets.................... (101) (62) (453) (975) Income taxes...................... (1,163) 699 767 5,238 Accounts payable and accrued expenses (1,239) (1,036) (5,432) 4,511 --------- --------- ------ ------ Net cash provided by (used in) operating activities...................... 8,942 4,928 (8,821) 9,833 --------- --------- --------- --------- Cash flows from investing activities: Purchases of equipment................ (2,462) (807) (514) (2,856) Proceeds from sale of equipment....... 38 - - 50 Payments for acquisitions, net of cash acquired - - (141,403) - ------- --------- --------- --------- Net cash used in investing activities (2,424) (807) (141,917) (2,806) --------- --------- --------- --------- Cash flows from financing activities: Payments under capital leases for equipment (2,359) (249) (308) (661) Net proceeds (repayments) on line of credit 4,338 2,362 (6,700) - Proceeds from issuance of senior increasing rate notes, net of offering costs....... - - 119,735 - Payments on senior increasing rate notes - - (123,500) - Proceeds from issuance of senior notes, net of offering costs................... - - 110,158 - Proceeds from issuance of senior discount debentures, net of offering costs... - - 24,699 - Proceeds from issuance of common stock - - 76,001 - Redemption of preferred stock......... - - (8,678) - Repayment of loans payable to stockholder (7,004) (1,851) (36,649) - Repayment of other notes payable...... (1,200) (50) (50) (1,330) Dividends paid on preferred stock..... (616) (155) (128) - Dividend paid to AHC I Acquisition Corp. - - - (1,863) ---------- -------- --------- --------- Net cash provided by (used in) financing activities.............. (6,841) 57 154,580 (3,854) --------- --------- --------- --------- Net increase (decrease) in cash and cash equivalents (323) 4,178 3,842 3,173 Cash and cash equivalents, beginning of period 626 303 - 3,842 --------- -------- --------- --------- Cash and cash equivalents, end of period. $ 303 $ 4,481 $ 3,842 $ 7,015 ========= ========= ======== ========= Supplemental information: Cash paid (received) during the period for: Interest to stockholder(s)...... $ 4,559 $ 1,146 $ 11,503 $ - Interest, other..................... 917 459 214 6,512 Income taxes........................ 4,594 1,222 (784) (5,123) Significant non-cash activities: Assets acquired under capital lease... $ - $ - $ - $ 600
F-7 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 1. ORGANIZATION AND BUSINESS Arcade Holding Corporation (the "Predecessor") was organized for the purpose of acquiring all the issued and outstanding capital stock of Arcade, Inc. ("Arcade") on November 4, 1993. Arcade is engaged in interactive advertising for consumer products companies and has a specialty in the design, production and distribution of sampling systems from its Chattanooga, Tennessee facilities, and distributes its products in Europe through its French subsidiary, Arcade Europe S.A.R.L. As more fully described in Note 3, DLJ Merchant Banking Partners II, L.P. and certain related investors (collectively, "DLJMBII") and certain members of the Predecessor organized AHC I Acquisition Corp. ("Acquisition Corp.") and AHC I Merger Corp. ("Merger Corp.") for purposes of acquiring the Predecessor. On December 15, 1997, Merger Corp. acquired all of the equity interests of the Predecessor and then merged with and into the Predecessor and the combined entity assumed the name AKI, Inc. and Subsidiaries ("AKI"). Subsequent to the Acquisition, Acquisition Corp. contributed $1 and all of its ownership interest in AKI to AKI Holding Corp. ("Holding," the "Successor" or the "Company") for all of the outstanding equity of Holding. Unless otherwise indicated, all references to years refer to the Predecessor's, AKI's and Holding's fiscal year, June 30. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated. Reclassification Certain prior year amounts have been reclassified to conform with the current year presentation. Cash and Cash Equivalents For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents. Concentration of Credit Risk The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts; in addition, the Company believes it is not exposed to any significant credit risk on cash and cash equivalents. The Company grants credit terms in the normal course of business to its customers and as part of its ongoing procedures, the Company monitors the credit worthiness of its customers. The Company does not believe that it is subject to any unusual credit risk beyond the normal credit risk attendant in its business. F-8 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Two customers accounted for 23.5% and 35.3% of the Predecessor's net sales during the year ended June 30, 1997 and the period from July 1, 1997 through December 15, 1997, respectively. One customer accounted for 13.3% of net sales during the period from December 16, 1997 through June 30, 1998. Two customers accounted for 26.8% of net sales during the year ended June 30, 1999. Concentration of Purchasing Products accounting for a majority of the Company's net sales utilize specific grades of paper that are produced exclusively for the Company by one domestic supplier. The Company does not have a purchase agreement with the supplier and is not aware of any other suppliers of these specific grades of paper. These products can be manufactured using other grades of paper; however, the Company believes these specific grades of paper provide the Company with an advantage over its competitors. The Company is currently researching methods of replicating the advantages of these specific grades of paper with other grades of paper available from multiple suppliers. Until such methods are developed, a loss of supply of these specific grades of paper and the resulting competitive advantage could cause a possible loss of sales which could adversely affect operating results. Revenue Recognition and Accounts Receivable Product sales are recognized upon shipment, net of estimated discounts. Accounts receivable are accounted for net of allowances for doubtful accounts. Inventory Paper inventory is stated at the lower of cost or market using the last-in, first-out (LIFO) method; all other inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method. Property, Plant and Equipment Property, plant and equipment are stated at cost. Expenditures that extend the economic lives or improve the efficiency of equipment are capitalized. The costs of maintenance and repairs are expensed as incurred. Upon retirement or disposal, the related cost and accumulated depreciation are removed from the respective accounts and any gain or loss is recorded. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets as indicated in Note 6 for financial reporting purposes and accelerated methods for tax purposes. Leasehold improvements are depreciated over the shorter of their estimated useful lives or the lease term. F-9 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Goodwill The aggregate purchase price of business acquisitions was allocated to the assets and liabilities of the acquired companies based on their respective fair values as of the acquisition dates. Goodwill represents the excess purchase price paid over the fair value of net identifiable assets acquired and is amortized over forty years using the straight-line method. Accumulated amortization was $2,087 and $5,939 at June 30, 1998 and June 30, 1999, respectively. Management periodically reviews the value of its goodwill and other long-lived assets to determine if an impairment has occurred. The potential impairment of recorded goodwill and other long-lived assets is measured by the undiscounted value of expected future operating cash flows in relation to its net capital investment. Based on its review, management does not believe that an impairment of its goodwill or its other long-lived assets has occurred. Deferred Charges Deferred charges are primarily comprised of debt issuance costs which are being amortized using the effective interest method over the terms of the related debt. Such costs are included in the accompanying consolidated balance sheets, net of accumulated amortization. Other Intangible Assets Other intangible assets include a covenant not to compete and other intangible assets resulting from the acquisition of the fragrance sampling business of Minnesota Mining and Manufacturing Company ("3M") (see Note 3) in June 1998 and are being amortized over ten years using the straight-line method. Accumulated amortization related to these intangibles was $729 at June 30, 1999. Fair Value of Financial Instruments SFAS No. 107, "Disclosures About Fair Values of Financial Instruments," requires the disclosure of the fair value of financial instruments, for assets and liabilities recognized and not recognized on the balance sheet, for which it is practicable to estimate fair value. The fair value of the Company's Senior Notes and Senior Discount Debentures, as determined from quoted market prices, was $112,000 and $22,508, respectively, at June 30, 1999 compared to a carrying value of $115,000 and $29,651, respectively, as of the same date. The carrying value of the Senior Notes and Senior Discount Debentures approximated fair value at June 30, 1998. The carrying value of all other financial instruments approximated fair value at June 30, 1998 and June 30, 1999. F-10 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Foreign Currency Transactions Gains and losses on foreign currency transactions with third parties have been included in the determination of net income in accordance with SFAS No. 52, "Foreign Currency Translation." Foreign currency losses and (gains) amounted to $387, $(44), $(52) and $91 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Research and Development Expenses Research and development expenditures are charged to selling, general and administrative expenses in the period incurred. Research and development expenses totaled $1,263, $664, $717 and $1,136 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and for the year ended June 30, 1999, respectively. Income Taxes Income taxes are provided in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Accordingly, deferred tax assets and liabilities are recognized at the applicable income tax rates based upon future tax consequences of temporary differences between the tax bases and financial reporting bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax assets are reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Comprehensive Income (Loss) The Company adopted the provisions of Statement of Financial Accounting Standards No. 130 ("SFAS No. 130") on July 1, 1998. This statement establishes standards for reporting and displaying comprehensive income and its components in the financial statements. This statement also requires that comparative information for earlier periods be reclassified. As the Company only has two items of comprehensive income, net income and foreign currency translations, adoption of this statement did not have a material effect upon the Company's financial position or results of operations. F-11 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 3. SIGNIFICANT ACQUISITIONS DLJMBII and certain members of the Predecessor organized Acquisition Corp. and Merger Corp. for purposes of acquiring the Predecessor. Merger Corp. was a wholly-owned subsidiary of Acquisition Corp. and was initially capitalized by Acquisition Corp. with an equity contribution of $78,363, comprised of $76,000 of cash (see Note 12) and $2,363 of non-cash consideration in the form of an option to purchase Senior Preferred Stock of Acquisition Corp. (see Note 17). Immediately following this equity contribution, Merger Corp. issued $123,500 of senior increasing rate notes (the "Bridge Loans") to an entity with an ownership interest in Acquisition Corp. The Bridge Loans had a stated maturity of December 15, 1998 and had an interest rate equal to the greater of (i) 10.0% per annum and (ii) a daily floating rate of prime plus 2.25% plus an additional percentage amount equal to (a) 1.0% from and including the interest payment date on June 15, 1998 or (b) 1.5% from and including the interest payment date on September 15, 1998. Merger Corp. received cash proceeds from the issuance of the Bridge Loans of $119,735, net of $3,765 of associated debt issuance costs. On December 15, 1997, Merger Corp. acquired all of the equity interests of the Predecessor (the "Acquisition") for a total cost of $197,730 which consisted of $138,634 cash paid for equity interests and direct acquisitions costs, $2,363 in non-cash consideration in the form of an option to purchase Senior Preferred Stock of Acquisition Corp. (see Note 17) and the assumption of $56,733 in debt, preferred stock and related interest and dividends, including a capital lease obligation. Included in the amount of direct acquisition costs was approximately $2,022 paid to an entity that has an ownership interest in Acquisition Corp. Merger Corp. then merged with and into the Predecessor and the combined entity assumed the name AKI. Subsequent to the Acquisition, Acquisition Corp. contributed $1 of cash and all of its ownership interest in AKI to Holding for all of the outstanding equity of Holding. Since all companies are under common control and since Holding and Acquisition Corp. have no operations other than those related to AKI, the contribution was accounted for as if it were a pooling of interests. The Acquisition was accounted for using the purchase method of accounting. In accordance with the consensus reached by the Emerging Issues Task Force of the Financial Accounting Standards Board in Issue 88-16, "Basis in Leveraged Buyout Transactions," the purchase price allocation required an adjustment for the continuing interest attributable to management's ownership interest in the Predecessor carried over in connection with the Acquisition. As a result, a reduction in stockholders' equity of $15,730 was recorded which represents the difference between the fair value of the Company's assets and the related book value attributable to the interest of the continuing shareholders' investment in the Predecessor. The remaining purchase price has been allocated to assets and liabilities based upon estimates of their respective fair value as determined by management and third-party appraisals with respect to property, plant and equipment. In connection with the Acquisition, the Company repaid the outstanding balance and related interest of the Predecessor's loans payable to a shareholder of $37,374, the outstanding balance and related interest of the Predecessor's line of credit of $6,278 and the outstanding balance and related dividends on the Predecessor's preferred stock of $8,806. F-12 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 3. SIGNIFICANT ACQUISITIONS (Continued) The following shows the acquisition costs and the allocation of the purchase price: Acquisition costs Cash paid for stock.......................................... $ 134,403 Direct acquisition costs..................................... 4,231 ----------- 138,634 Non-cash consideration for stock in the form of an option to purchase Senior Preferred Stock of Acquisition Corp. (see Note 17)......... 2,363 ----------- Total....................................................... 140,997 Less--Carryover basis adjustment............................ (15,730) ----------- Purchase price to be allocated.............................. $ 125,267 =========== Summary allocation of purchase price Cash........................................................ $ 4,481 Other current assets........................................ 17,782 Property, plant and equipment............................... 20,132 Deferred income taxes....................................... 2,953 Other assets................................................ 329 Goodwill.................................................... 153,929 ----------- Total allocation to assets.................................. $ 199,606 =========== Current liabilities......................................... $ 13,190 Long-term debt (including current portion) and related interest 47,927 Deferred income taxes.......................................... 4,416 Preferred stock and related dividends.......................... 8,806 ----------- Total liabilities assumed..................................... $ 74,339 =========== Included in cash paid for stock of $134,403 is $19,342 related to the purchase and retirement of 11,201 options of the Predecessor. In addition, the non-cash consideration for stock of $2,363 was incurred to acquire and retire the remaining 1,370 options of the Predecessor (see Note 17). On June 22, 1998, the Company acquired (the "3M Acquisition") the fragrance sampling business of the Industrial and Consumer Products division of 3M for approximately $7,250 in cash and the assumption of liabilities of approximately $182. The only tangible assets acquired were approximately $143 of equipment. The acquisition was accounted for using the purchase method of accounting and resulted in assigning value to certain intangible assets, including a covenant not to compete, totaling approximately $7,289 which are being amortized on a straight line basis over a period of 10 years. F-13 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 3. SIGNIFICANT ACQUISITIONS (Continued) Unaudited pro forma results for the Company assuming the Acquisition, the 3M Acquisition and the Refinancing had occurred as of the beginning of each applicable fiscal year are presented below: Unaudited Pro Forma Results for the Year Ended ------------------ June 30, June 30, 1997 1998 ---- ---- Net sales....................... $ 87,771 $ 81,831 Income from operations.......... 9,565 5,838 Interest expense, net........... 16,640 16,730 Net loss........................ (6,102) (8,573) On June 25, 1998, the Bridge Loans were repaid, without penalty, with the proceeds from the Senior Note offering (see Note 9) and the Senior Discount Debenture offering (see Note 10) (collectively, the "Refinancing"). Contemporaneous with the repayment of the Bridge Loans, the Company wrote-off the unamortized balance of debt issuance costs associated with the Bridge Loans of $1,795 to interest expense. 4. ACCOUNTS RECEIVABLE The following table details the components of accounts receivable: June 30, June 30, 1998 1999 ---- ---- Trade accounts receivable.............. $ 13,782 $ 16,349 Allowance for doubtful accounts........ (277) (251) ---------- --------- 13,505 16,098 Other accounts receivable.............. 45 189 --------- -------- $ 13,550 $ 16,287 ========= ======== F-14 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 5. INVENTORY The following table details the components of inventory: June 30, June 30, 1998 1999 ---- ---- Raw materials Paper.................................... $ 556 $ 1,088 Other raw materials...................... 1,024 2,328 --------- -------- Total raw materials................... 1,580 3,416 Work in process............................ 498 1,693 --------- -------- Total inventory............................ $ 2,078 $ 5,109 ========= ======== The difference between the carrying value of paper inventory using the FIFO method as compared to the LIFO method was not significant at June 30, 1998 or June 30, 1999. 6. PROPERTY, PLANT AND EQUIPMENT The following table details the components of property, plant and equipment as well as their estimated useful lives: Estimated June 30, June 30, Useful Lives 1998 1999 ------------ ---- ---- Land........................... $ 256 $ 258 Building....................... 7 - 15 years 1,048 1,648 Leasehold improvements......... 1 - 3 years 153 579 Machinery and equipment........ 5 - 7 years 17,146 19,483 Furniture and fixtures......... 3 - 5 years 1,634 2,084 Construction in progress....... 552 193 --------- -------- 20,789 24,245 Accumulated depreciation....... (1,853) (5,734) --------- --------- $ 18,936 $ 18,511 ========= ========= Depreciation expense amounted to $3,850, $1,888, $1,853 and $3,881 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. F-15 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 6. PROPERTY, PLANT AND EQUIPMENT (Continued) Property held under capital lease is included in the respective property, plant and equipment category as follows: June 30, June 30, 1999 1998 ---- ---- Machinery and equipment.................. $ 3,000 $ 3,000 Building................................. - 600 --------- -------- 3,000 3,600 Less accumulated depreciation............ (275) (790) --------- --------- $ 2,725 $ 2,810 ========= ======== Depreciation of assets under capital lease totaled $633, $232, $275 and $515 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Future minimum lease payments under the remaining lease are as follows: Payment Interest 2000...................... $ 884 $ 197 2001...................... 948 100 2002...................... 529 27 --------- -------- $ 2,361 $ 324 ========= ======== 7. LINE OF CREDIT On April 30, 1996, the Predecessor entered into a line of credit agreement (the "Credit Agreement"), which was amended on December 12, 1997, in connection with the Acquisition, and amended again on September 30, 1998. The Credit Agreement provides for a revolving loan commitment up to a maximum of $20,000 and expires on December 31, 2002. Borrowings are limited to a borrowing base consisting of accounts receivable, inventory and property, plant and equipment which serve as collateral for the borrowings. As of June 30, 1999, the Company's borrowing base was approximately $17,500. Interest on amounts borrowed accrue at a floating rate based upon either prime or LIBOR (9.25% and 8.50% at June 30, 1998 and June 30, 1999, respectively). The weighted average interest rate on the outstanding balance under the Credit Agreement was 9.31%, 9.50%, 9.25% and 8.51% for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. F-16 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 7. LINE OF CREDIT (Continued) The Company is required to pay commitment fees on the unused portion of the revolving loan commitment at a rate of approximately 0.5% per annum. In addition, the Company is required to pay fees equal to 2.5% of the average daily outstanding amount of lender guarantees. The Company had $600 of lender guarantees outstanding at June 30, 1998 and June 30, 1999. These fees totaled $109, $30, $59 and $111 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. The Credit Agreement contains certain financial covenants and other restrictions including restrictions on additional indebtedness and restrictions on the payment of dividends. As of June 30, 1999, the Company was in compliance with all debt covenants. However, the Company expects to be in violation of certain loan covenants in Fiscal 2000. Management expects to obtain loan amendments and/or waivers in Fiscal 2000 with respect to such covenants. If management is unable to obtain loan amendments and/or waivers in Fiscal 2000, the Company may need to seek additional sources of financing. 8. LOANS PAYABLE TO STOCKHOLDER The Predecessor entered into a Senior Loan Agreement and two Subordinated Loan Agreements (collectively, the "Loan Agreements") with a party that had owned the Predecessor's preferred stock and a significant portion of its common stock. The Loan Agreements were collateralized by substantially all the assets of the Predecessor. The Loan Agreements limited the Predecessor's ability to incur additional indebtedness, pay dividends and purchase fixed assets. Additionally, the Loan Agreements required that certain financial covenants be maintained. The Predecessor was not in compliance with all such covenants at June 30, 1997. However, this debt was subsequently retired upon the acquisition of the Predecessor as discussed in Note 3. All amounts borrowed under the Senior Loan Agreement bore interest at prime plus 1.50%. The Predecessor borrowed $30,000 under the Subordinated Loan Agreements, of which $23,000 was designated as Loan I and $7,000 was designated as Loan II. Loan I bore interest, payable quarterly, at 12% until November 4, 1998, and then would have converted to prime plus 4%. Loan II bore interest, payable quarterly, at 7%. The outstanding amount of the subordinated loans was net of unamortized debt discounts, which were being amortized over the term of the related loan. In connection with Loan II, the Predecessor issued a warrant to purchase 19,233 shares of common stock at $0.05 per share. The warrant was exercisable until November 4, 2003. The Predecessor valued the warrants at $100 each based on the fair market value of a share of the underlying common stock resulting from a sale with a third party. In connection with the warrant issued, the Predecessor recorded a debt discount of $1,923. In connection with the sale of the Predecessor on December 15, 1997 (see Note 3), all outstanding warrants were purchased from the holder by the buyer of the Predecessor and retired. F-17 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 9. SENIOR NOTES On June 25, 1998, AKI completed a private placement of $115,000 of Senior Notes (the "Senior Notes"). The Senior Notes are general unsecured obligations of AKI and bear interest at 10.5% per annum, payable semi-annually on January 1 and July 1. The Senior Notes mature on July 1, 2008 and may be redeemed at the option of AKI, in whole or in part, at any time on or after July 1, 2003 at a price equal to 105.25% of the outstanding principal balance plus accrued and unpaid interest. The placement of the Senior Notes yielded AKI net proceeds of $110,158 after deducting offering expenses of $4,842, including $3,450 of underwriting fees paid to an affiliate of the stockholder. The Senior Notes are redeemable at the option of the Company, in whole or part, at any time after July 1, 2003 at a price of up to 105.25% of the outstanding principal balance plus accrued and unpaid interest. Prior to July 1, 2003, AKI is permitted to repurchase up to 35% of the Senior Notes at a redemption price equal to 110.5% of the aggregate principal amount plus accrued and unpaid interest with the net proceeds of one or more public equity offerings. The Senior Notes contain certain customary covenants including restrictions on the declaration and payment of dividends by AKI to Holding and limitations on the incurrence of additional indebtedness. On December 22, 1998, AKI completed the registration of its Senior Notes with the Securities and Exchange Commission. 10. SENIOR DISCOUNT DEBENTURES On June 25, 1998, Holding completed a private placement of Senior Discount Debentures (the "Debentures") with a stated value of $50,000. The Debentures are general unsecured obligations of Holding and mature on July 1, 2009. The Debentures do not accrue or pay interest until July 1, 2003 and were issued with an original issuance discount of $24,038. The placement of the Debentures yielded the Company net proceeds of $24,699 after deducting offering expenses of $1,263, including $1,038 of underwriting fees paid to an affiliate of the stockholder. The original issuance discount of $24,038 on the Debentures is being accreted from issuance through July 1, 2003 at an effective rate of 13.5% per annum. The unamortized balance of the original issuance discount was $23,980 and $20,349 at June 30, 1998 and June 30, 1999, respectively. After July 1, 2003, the Debentures will accrue interest at a rate of 13.5% per annum, payable semi-annually, commencing January 1, 2004. The Debentures are redeemable at the option of Holding, in whole or in part, at any time on or after July 1, 2003 at a price up to 106.75% of the outstanding principal balance plus accrued and unpaid interest. Prior to July 1, 2003, Holding is permitted to repurchase up to 35% of the aggregate principal amount at maturity of the Debentures originally issued at a redemption price equal to 113.5% of the accreted value of the Debentures with the net proceeds of one or more public equity offerings. The Debentures contain certain customary covenants including restrictions on the declaration and payment of dividends and limitations on the incurrence of additional indebtedness. On December 22, 1998, the Company completed the registration of its Senior Discount Debentures with the Securities and Exchange Commission. F-18 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 11. OTHER NOTES PAYABLE On June 9, 1995, the Predecessor acquired all of the issued and outstanding stock of Scent Seal Inc. ("Scent Seal"). The acquisition of Scent Seal did not have a material impact on the financial position or results of operations of the Predecessor and was accounted for as a purchase transaction whereby the purchase cost was allocated to the fair value of the net assets acquired. In connection with the acquisition of Scent Seal, the Predecessor issued $3,627 in noninterest bearing promissory notes (the "Notes") to an employee of the Predecessor who was previously a Scent Seal stockholder. The Predecessor recorded a debt discount of $649 in connection with the issuance of the Notes to reflect an effective interest rate of 10%. The discount was being amortized over the term of the Notes. Under certain provisions of the Scent Seal acquisition agreement, the Company was permitted to reduce the outstanding principal balance of the Notes based upon the ultimate realization of assets acquired and settlement of liabilities assumed. In June 1998, the Company reached a settlement with the holder of the Notes under these provisions which resulted in the reduction of the outstanding principal balance of the Notes of $120. The remaining principal balance of the Notes of $1,330 was repaid in July 1998 in accordance with the terms of the Notes. 12. REDEEMABLE PREFERRED STOCK OF THE PREDECESSOR In connection with the 1993 acquisition of Arcade, the Predecessor authorized and issued 8,000 shares of 7% cumulative, $1 par value redeemable preferred stock at $1,000 per share. The redeemable preferred stock prohibited the Predecessor from acquiring its common stock as long as the preferred stock was outstanding and restricted the payment of common stock dividends. Accrued and unpaid dividends of $678 accrued through December 31, 1994, were added to the outstanding balance. The redeemable preferred stock would have been redeemable on December 31, 2001, at liquidation value of $1,000 per share plus accrued and unpaid dividends. In conjunction with the sale of the Predecessor on December 15, 1997 (see Note 3), all outstanding redeemable preferred stock was redeemed at $1,000 per share plus accrued and unpaid dividends. 13. INITIAL CAPITALIZATION In conjunction with the Acquisition, Acquisition Corp. issued $30,000 of Floating Rate Notes, $50,279 of Manditorily Redeemable Senior Preferred Stock (the "Senior Preferred Stock") and $1,111 of its Common Stock. The Floating Rate Notes were issued with an original issuance discount of $5,389 and bear interest at a rate equal to the rate in effect on the Bridge Loans (see Note 3) plus 2.50%. After the completion of the Refinancing (see Note 3) on June 25, 1998, the Floating Rate Notes bear interest at 15% per annum. Interest is payable quarterly and can be settled through the issuance of additional Floating Rate Notes through maturity at the discretion of Acquisition Corp. The original issuance discount of $5,389 is being amortized using the effective interest method over the life of the Floating Rate Notes. The unamortized balance of the original issuance discount was $5,152 and $4,470 at June 30, 1998 and June 30, 1999, respectively. The Floating Rate Notes mature on December 15, 2009 and are held by affiliates of the primary shareholder of Acquisition Corp. The Senior Preferred Stock accretes in value at 15% per annum and must be redeemed by December 15, 2012. The Floating Rate Notes and Senior Preferred Stock are general unsecured obligations of Acquisition Corp. F-19 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 13. INITIAL CAPITALIZATION (Continued) The cash proceeds from the issuance of the Floating Rate Notes, Senior Preferred Stock and Common Stock of approximately $76,000 and a Manditorily Redeemable Senior Preferred Stock Option of $2,363 (see Note 17) were contributed by Acquisition Corp. to AKI in exchange for 1,000 shares of AKI's Common Stock. Subsequent to the capitalization of AKI, Acquisition Corp. contributed $1 of cash and all of its ownership interest in AKI to Holding for all of the outstanding equity of Holding. Acquisition Corp. has no other operations other than the Company. Absent addition financing by Acquisition Corp., the Company's operations represent the only current source of funds available to service the Floating Rate Notes and Manditorily Redeemable Senior Preferred Stock; however, the Company is not obligated to pay or otherwise guarantee the Floating Rate Notes and Manditorily Redeemable Senior Preferred Stock. 14. COMMITMENTS AND CONTINGENCIES Operating Leases Equipment and office, warehouse and production space under operating leases expire at various dates. Rent expense was $443, $192, $198 and $338 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Future minimum lease payments under these leases are as follows: 2000.............. $ 162 2001.............. 138 -------- $ 300 ======== Royalty Agreements Royalty agreements are maintained for certain technologies used in the manufacture of certain products. Under the terms of one royalty agreement, payments are required based on a percentage of net sales of those products manufactured with the specific technology, or a minimum of $500 per year. This agreement expires in 2003 or when a total of $12,500 in cumulative royalty payments has been paid. The Company expensed $761, $437, $516 and $500 under this agreement for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. The Company has paid $4,576 in cumulative royalty payments under this agreement through June 30, 1999. Under the terms of another agreement, royalty payments are required based on the number of products sold that were manufactured with the specific licensed technology, or a minimum payment per year. These minimum payments for years after fiscal 1999 are $625 through the expiration of the agreement in 2012. The Company expensed $475, $241, $284 and $575 under this agreement for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. F-20 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 14. COMMITMENTS AND CONTINGENCIES (Continued) Employment Agreements The Company has employment agreements with certain officers with terms through February 1, 2002. Such agreements provide for base salaries totaling $825 per year. One officer has an incentive bonus of up to 200% of base salary which is payable if certain financial and management goals are attained and certain other incentive payments. One of the employment agreements also provides severance benefits of up to two years of base salary if the officer's services are terminated under certain conditions. During fiscal 1999, two executive officers employment was terminated with the Company. In accordance with the terms of former officers' employment agreements, the Company was obligated for severance benefits of approximately $610. The Company had paid approximately $457 of these benefits by June 30, 1999. The remaining balance of $153 is included in accrued compensation at June 30, 1999. Litigation The Company is a party to litigation arising in the ordinary course of business which, in the opinion of management, will not have a material adverse effect on the Company's financial condition, results of operations or cash flows. 15. RETIREMENT PLANS A 401(k) defined contribution plan (the "Plan") is maintained for substantially all full-time salaried employees. Applicable employees who have six months of service and have attained age 21 are eligible to participate in the Plan. Employees may elect to contribute a percentage of their earnings to the Plan in accordance with limits prescribed by law. Contributions to the Plan are determined annually by the Company and generally are a matching percentage of employee contributions. Costs associated with the Plan totaled $180, $95, $113 and $201 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Certain hourly employees are covered under a multiemployer defined benefit plan administered under a collective bargaining agreement. Costs (determined by union contract) under the defined benefit plan were $143, $80, $81 and $204 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, from December 16, 1997 through June 30, 1998 and for the year ended June 30, 1999, respectively. F-21 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 16. INCOME TAXES The Company is included in the consolidated federal income tax return filed by Acquisition Corp. for periods subsequent to December 15, 1997. Income taxes related to the Company for the period from December 16, 1997 through June 30, 1999 were determined on a separate entity basis. The Company files separate state income tax returns and calculates its state tax provision on a separate company basis. Any income taxes payable or receivable by the consolidated group are settled or received by AKI. The Predecessor was not part of a consolidated group. For financial reporting purposes, income (loss) before income taxes includes the following components:
July 1, December 16, 1997 1997 Year Ended through through Year Ended June 30, December 15, June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Income (loss) before income taxes: United States.................... $ 7,609 $ 3,298 $ (8,227) $ (5,978) Foreign.......................... (492) (64) 682 522 ---------- ---------- --------- --------- $ 7,117 $ 3,234 $ (7,545) $ (5,456) ========== ========== ========= ========= Significant components of the provision (benefit) for income taxes are as follows: July 1, December 16, 1997 1997 Year Ended through through Year Ended June 30, December 15 June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Current expense (benefit): Federal.......................... $ 2,880 $ 1,623 $ - $ - Foreign.......................... - - 104 204 State............................ 552 278 (121) - --------- --------- ---------- --------- 3,432 1,901 (17) 204 --------- --------- ---------- --------- Deferred expense (benefit): Federal.......................... (90) (376) (1,916) (481) Foreign.......................... (165) (25) 162 - State............................ (42) (59) (281) (63) ---------- --------- ---------- ---------- (297) (460) (2,035) (544) ---------- --------- --------- ---------- $ 3,135 $ 1,441 $ (2,052) $ (340) ========== ========= ========= =========
F-22 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 16. INCOME TAXES (Continued) The significant components of deferred tax assets and deferred tax liability at June 30, 1998 and 1999, were as follows:
June 30, 1998 June 30, 1999 ---------------------- --------------------- Current Noncurrent Current Noncurrent ---------------------- --------------------- Deferred income tax assets: Accrued expenses........................ $ 719 $ - $ 308 $ - Allowance for doubtful accounts......... 108 - 92 - Net operating loss carryforwards........ - 2,966 - 4,338 Preferred stock option.................. - 922 - - --------- --------- --------- --------- 827 3,888 400 4,338 Deferred income tax liability: Property, plant and equipment......... - 4,143 - 3,340 --------- --------- --------- --------- $ 827 $ (255) $ 400 $ 998 ========= ========== ========= ========= The income tax provision recognized by the Predecessor for the year ended June 30, 1997 and the period from July 1, 1997 through December 15, 1997 and by the Company for the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999 differs from the amount determined by applying the applicable U.S. statutory federal income tax rate to pretax income as a result of the following: July 1, December 16, 1997 1997 Year Ended through through Year Ended June 30, December 15, June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Computed tax provision (benefit) at the statutory rate................... $ 2,420 $ 1,100 $ (2,565) $ (1,855) State income tax provision (benefit), net of federal effect................... 335 145 (265) (152) Nondeductible expenses.................... 455 193 723 1,655 Other, net................................ (75) 3 55 12 ---------- --------- ---------- ---------- $ 3,135 $ 1,441 $ (2,052) $ (340) ========= ========= ========== ========== In conjunction with the Acquisition, the Company recognized an income tax benefit of $7,327 related to the excess of the redemption price over the strike price of certain non-qualified options of the Predecessor redeemed and retired by the Company. This benefit was recorded as a reduction to goodwill.
F-23 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 16. INCOME TAXES (continued) Due to the Company's current year losses and certain transactions made in conjunction with the Acquisition, the Company has recorded a long-term deferred tax asset of $4,338 reflecting cumulative net operating loss carryforwards available to offset future federal taxable income of approximately $10,000 and future state taxable income of approximately $17,500 at June 30, 1999. These cumulative net operating loss carryforwards expire in varying amounts through 2019. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes that it is more likely than not that all of the deferred tax asset will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. 17. STOCK OPTIONS The Predecessor sponsored a key employee stock option plan under which a maximum of 12,571 shares of the Predecessor's common stock could be reserved for nonqualified options; all stock options were granted with an exercise price equal to the fair market value of $100 per share. All options vested ratably over five years and would have expired ten years from the grant date. The Predecessor accounted for its employee stock options under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"). Under APB 25, because the exercise price of the Predecessor's employee stock options equaled the market value of the underlying stock on the date of grant, no compensation expense was recognized. A summary of the Predecessor's stock option activity and related information follows: June 30, 1997 Weighted Average Exercise Options Price Outstanding, beginning of year...... 12,571 $ 100 Granted........................... - - Exercised......................... - - Forfeited......................... - - -------- ------- Outstanding, end of year............ 12,571 $ 100 ======== ======= Exercisable, end of year............ 5,866 $ 100 ======== ======= Weighted average remaining contractual life.................. 7.3 years F-24 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 17. STOCK OPTIONS (Continued) Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"), requires disclosure of pro forma information regarding net income for option grants subsequent to December 15, 1995. Because all of the Predecessor's options were granted prior to that date, no pro forma adjustments to net income or disclosure of information would apply under SFAS 123. As a result of the sale of the Predecessor on December 15, 1997 (see Note 3), all outstanding options became immediately vested and exercisable under the terms of the original individual stock option agreements. In connection with the Acquisition, the Company purchased and retired 11,201 options of the Predecessor for $19,342. The remaining 1,370 options of the Predecessor, which had a cumulative exercise price of $137, were exchanged at fair value for an option to purchase 100,000 shares of Acquisition Corp.'s Senior Preferred Stock with a cumulative stated valued of $2,500 ("the Preferred Stock Option"). The 1,370 options were subsequently retired. The Preferred Stock Option had an exercise price of $137. The total consideration of $21,705 used to purchase and retire the outstanding options of the Predecessor was included in the cost of the Acquisition (see Note 3). The Preferred Stock Option was issued with a Put and Call Option (the "Put and Call Option") which granted the officer the right to compel DLJMBII to purchase the 100,000 shares of Senior Preferred Stock obtainable under the Preferred Stock Option, together with certain common equity interests in Acquisition Corp. held by the officer, for $2,590. The Put and Call Option also granted DLJMBII the right to purchase the equity interests, both common and preferred, of the officer for the same amount. The Put and Call Option had a stated termination of June 30, 1998. The officer agreed to terminate the Put and Call Option and enter into a new put option (the "Put Option") dated June 17, 1998. The Put Option granted the officer an irrevocable option to require Acquisition Corp. to purchase 80,000 shares of the Senior Preferred Stock obtainable under the Preferred Stock Option, for $2,000 in cash. As the terms of the Put Option were generally more restrictive than the Put and Call Option, no compensation expense was recognized as a result of the transaction. On July 30, 1998, the officer exercised the Preferred Stock Option and Put Option. To provide Acquisition Corp. the funds to redeem the 80,000 shares of Senior Preferred Stock, Holding issued Acquisition Corp. a dividend of $1,863 in cash on such date. Subsequent to the Acquisition, Acquisition Corp. adopted the 1998 Stock Option Plan ("Option Plan") for certain key employees and directors of Acquisition Corp. and any parent or subsidiary of Acquisition Corp. The Option Plan authorizes the issuance of options to acquire up to 100,000 shares of Acquisition Corp. Common Stock. The terms of each individual options grant are determined by the Board of Directors. The exercise price for each grant is required to be set at least equal to the fair market value per share of Acquisition Corp. provided that the exercise price shall not be less than $1.00 per share. Options may be exercisable for up to ten years. F-25 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 17. STOCK OPTIONS (Continued) On June 17, 1998, Acquisition Corp. granted an officer of the Company options to purchase 32,500 shares of Acquisition Corp. Common Stock. All options have an exercise price of $1.00 per share and a term of 10 years. These options were forfeited during 1999 upon the resignation of the officer. The Company has elected to account for its stock based compensation with employees under the intrinsic value method as permitted under FAS 123. Under the intrinsic value method, because the stock price of the Company's employee stock options equaled the fair value of the underlying stock on the date of grant, no compensation expense was recognized. If the Company had elected to recognize compensation expense based on the fair value of the options at grant date as prescribed by FAS 123, the net loss for the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999 would have been $(5,494) and $(5,119), respectively. In making this determination, fair value was estimated on the date of grant using the minimum value method and a risk-free interest rate of 5.4%. The weighted average fair value at date of grant of options granted during 1998 was approximately $0.41 per option. 18. RELATED PARTY TRANSACTIONS The Predecessor made payments to a company controlled by a stockholder of the Predecessor of $612 for the year ended June 30, 1997 and $160 for the period from July 1, 1997 through December 15, 1997, for management fees, bonuses and expense reimbursements. The Predecessor made payments to another stockholder of $120 for the year ended June 30, 1997 and $55 for the period from July 1, 1997 through December 15, 1997, for management fees. The Successor made payments to an affiliate of DLJMBII of $125 and $250 for the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively, for financial advisory fees. In addition, the Company had approximately $2,401 of cash on deposit with a financial institution affiliated with DLJMBII as of June 30, 1998. 19. SUBSEQUENT EVENT On September 15, 1999, AKI acquired all of the equity interests in RetCom Holdings Ltd. and its subsidiaries for a total cost of approximately $12,000 and refinanced working capital indebtedness of approximately $4,500 of RetCom Holdings Ltd. and its subsidiaries. The purchase price and refinancing of indebtedness were initially financed by borrowings under the credit agreement. F-26 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 20. GEOGRAPHIC INFORMATION The following table illustrates geographic information for revenues and long-lived assets. Revenues are attributed to countries based on the receipt of sales orders, and long-lived assets are based upon the country of domicile.
United States France Total Predecessor ----------- Net sales: Year ended June 30, 1997............. $ 70,660 $ 7,063 $ 77,723 Period from July 1, 1997 through December 15, 1997.......... 32,600 2,586 35,186 Successor --------- Net sales: Period from December 16, 1997 through June 30, 1998.............. $ 29,162 $ 6,904 $ 36,066 Year ended June 30, 1999............. 71,056 14,911 85,967 Long-lived assets: June 30, 1998........................ 188,532 158 188,690 June 30, 1999........................ 184,177 107 184,284
F-27 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 21. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS The following condensed balance sheet at June 30, 1998 and June 30, 1999 and condensed statement of operations, changes in stockholder's equity and cash flows for the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999 for Holding should be read in conjunction with the consolidated financial statements and notes thereto.
BALANCE SHEETS June 30, June 30, 1998 1999 ---- ---- Assets Cash.............................................................. $ 2,201 $ - Investment in subsidiaries........................................ 95,408 92,817 Deferred charges.................................................. 1,263 1,520 Deferred income taxes............................................. 19 1,206 ---------- ----------- Total assets.................................................... $ 98,891 $ 95,543 ========== =========== Liabilities Senior Discount Debentures........................................ $ 26,020 $ 29,651 Stockholder's equity Common Stock, $0.01 par value, 1,000 shares authorized; 1,000 shares issued and outstanding............................. - - Additional paid-in capital........................................ 78,364 78,364 Accumulated deficit............................................... (5,493) (12,472) ---------- ----------- Total stockholder's equity...................................... 72,871 65,892 ---------- ----------- Total liabilities and stockholder's equity...................... $ 98,891 $ 95,543 ========== =========== STATEMENT OF OPERATIONS December 16, 1997 through Year ended June 30, June 30 1998 1999 ---- ---- Equity in losses of subsidiaries.................................. $ (5,454) $ (2,591) Interest expense, net............................................. (58) (3,712) ---------- ------------ Loss before income taxes........................................ (5,512) (6,303) Income tax benefit................................................ (19) (1,187) ---------- ----------- Net loss........................................................ $ (5,493) $ (5,116) ========== ============
F-28 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 21. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)
STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY Additional Common Stock Paid-in Accumulated Shares Amount Capital Deficit Total ------ ------ ------- ------- ----- Balances, December 16, 1997...... - $ - $ - $ - $ - Initial capitalization........... 1,000 - 78,364 - 78,364 Net loss......................... - - - (5,493) (5,493) ------- ------- ----------- ----------- ------------ Balances, June 30, 1998.......... 1,000 - 78,364 (5,493) 72,871 Net loss......................... - - - (5,116) (5,116) Dividend to AHC I Acquisition Corp............... - - - (1,863) (1,863) ------- ------- ----------- ---------- ----------- Balances, June 30, 1999.......... 1,000 $ - $ 78,364 $ (12,472) $ 65,892 ======= ======= =========== ========== =========== STATEMENT OF CASH FLOWS December 16, 1997 through Year ended June 30, June 30, 1998 1999 ---- ---- Cash flows from operating activities: Net loss............................................................ $ (5,493) $ (5,116) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Net change in investment in subsidiaries.......................... 5,454 2,591 Amortization of original issuance discount and loan closing costs. 58 3,722 Deferred income taxes............................................. (19) (1,187) Increase in deferred charges...................................... - (348) ---------- ----------- Net cash provided by (used in) operating activities............. - (338) ---------- ------------ Cash flows from investing activities: Capital contributed to subsidiary................................... (22,499) - ---------- ----------- Cash flows from financing activities: Proceeds from issuance of stock..................................... 1 - Proceeds from issuance of Senior Discount Debentures................ 24,699 - Dividend paid to AHC I Acquisition Corp............................. - (1,863) ---------- ----------- Net cash provided by (used in) financing activities............. 24,700 (1,863) ---------- ------------ Net increase (decrease) in cash and cash equivalents.............. 2,201 (2,201) Cash and cash equivalents, beginning of period.................... - 2,201 ---------- ----------- Cash and cash equivalents, end of period.......................... $ 2,201 $ - ========== ===========
F-29 AKI HOLDING CORP. AND SUBSIDIARIES (a wholly-owned subsidiary of AHC I Acquisition Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 22. UNAUDITED QUARTERLY RESULTS OF OPERATIONS The following is a summary of the unaudited quarterly results of operations for Fiscal 1998 and Fiscal 1999.
Predecessor Successor October 1, December 16, 1997 1997 Quarter Ended through through Quarter Ended Quarter Ended September 30, December 15, December 31, March 31, June 30, Full Fiscal 1998 1997 1997 1997 1998 1998 Year ---- ---- ---- ---- ---- ---- Net sales............. $ 21,928 $ 13,258 $ 2,791 $ 19,191 $ 14,084 $ 71,252 Gross profit.......... 8,306 4,071 813 7,256 3,479 23,925 Income from operations 4,680 1,426 153 3,603 104 9,966 Interest expense, net. 1,451 1,195 759 4,404 6,164 13,973 Net income (loss)..... 1,796 (3) (443) (887) (4,163) (3,700) Successor Quarter Ended Quarter Ended Quarter Ended Quarter Ended September 30, December 31, March 31, June 30, Full Fiscal 1999 1998 1998 1999 1999 Year ---- ---- ---- ---- ---- Net sales............. $ 24,024 $ 20,437 $ 24,518 $ 16,988 $ 85,967 Gross profit.......... 8,603 6,777 9,691 5,697 30,768 Income from operations 4,337 2,331 4,616 378 11,662 Interest expense, net. 4,096 4,149 4,258 4,237 16,740 Net loss.............. (324) (1,579) (364) (2,849) (5,116)
F-30 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholder of AKI, Inc. and Subsidiaries In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in stockholder's equity and of cash flows present fairly, in all material respects, the financial position of AKI, Inc. (a wholly-owned subsidiary of AKI Holding Corp.) and Subsidiaries (the "Successor"), formerly known as Arcade Holding Corporation (the "Predecessor"), at June 30, 1998 and 1999 and the results of their operations and their cash flows for the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999 in conformity with generally accepted accounting principles. These financial statements are the responsibility of management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Nashville, Tennessee July 31, 1999 except for Note 18 which is as of September 15, 1999 F-31 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholder of AKI, Inc. and Subsidiaries In our opinion, the accompanying consolidated statements of operations, of changes in stockholders' equity and of cash flows of Arcade Holding Corporation and Subsidiaries present fairly, in all material respects, the results of their operations and their cash flows for the year ended June 30, 1997 and the period from July 1, 1997 through December 15, 1997 in conformity with generally accepted accounting principles. These financial statements are the responsibility of management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Nashville, Tennessee July 31, 1998 F-32
AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) CONSOLIDATED BALANCE SHEETS (dollars in thousands, except share information) Successor --------- June 30, 1998 June 30, 1999 ------------- ------------- ASSETS Current assets Cash and cash equivalents..................................... $ 1,641 $ 7,015 Accounts receivable, net...................................... 13,550 16,287 Inventory..................................................... 2,078 5,109 Income tax refund receivable.................................. 5,155 32 Prepaid expenses.............................................. 379 452 Deferred income taxes......................................... 827 400 --------- --------- Total current assets.................................... 23,630 29,295 Property, plant and equipment, net............................ 18,936 18,511 Goodwill, net ................................................ 151,842 147,990 Deferred charges, net......................................... 5,272 5,319 Other intangible assets, net.................................. 7,289 6,560 Deferred income taxes......................................... 3,869 3,132 Other assets.................................................. 200 46 --------- --------- Total assets............................................ $ 211,038 $ 210,853 ========= ========= LIABILITIES AND STOCKHOLDER'S EQUITY Current liabilities Current portion of capital lease obligation................... $ 609 $ 688 Current portion of other notes payable........................ 1,330 - Accounts payable, trade....................................... 4,293 3,400 Accrued income taxes.......................................... 100 497 Accrued compensation.......................................... 2,497 2,527 Accrued interest.............................................. 167 6,047 Accrued expenses.............................................. 1,789 1,283 --------- --------- Total current liabilities............................... 10,785 14,442 Long-term portion of capital lease obligation................. 1,489 1,349 Senior notes.................................................. 115,000 115,000 Deferred income taxes......................................... 4,143 3,340 --------- --------- Total liabilities....................................... 131,417 134,131 Commitments and contingencies (see Note 13) Stockholder's equity Preferred stock, $0.01 par, 8,700 shares authorized; no shares issued or outstanding at June 30, 1998 and June 30, 1999.. - - Common stock, $0.01 par, 100,000 shares authorized; 1,000 shares issued and outstanding at June 30, 1998 and June 30, 1999 - - Additional paid-in capital.................................... 100,862 100,862 Accumulated deficit........................................... (5,454) (8,045) Accumulated other comprehensive loss.......................... (57) (365) Carryover basis adjustment.................................... (15,730) (15,730) --------- --------- Total stockholder's equity.............................. 79,621 76,722 --------- --------- Total liabilities and stockholder's equity.............. $ 211,038 $ 210,853 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-33 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands)
Predecessor Successor July 1, December 16, 1997 1997 Year Ended through through Year Ended June 30, December 15, June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Net sales.......................................... $ 77,723 $ 35,186 $ 36,066 $ 85,967 Cost of goods sold................................. 49,467 22,809 24,518 55,199 ----------- ------------ ---------- --------- Gross profit.................................. 28,256 12,377 11,548 30,768 Selling, general and administrative expenses....... 13,333 5,703 5,587 14,500 Amortization of goodwill and other intangibles............................... 1,234 568 2,101 4,606 ----------- ------------ ---------- --------- Income from operations........................ 13,689 6,106 3,860 11,662 Other expenses (income): Interest expense to stockholder(s) and affiliate.................................... 5,196 2,143 10,785 - Interest expense, other......................... 1,007 503 484 13,028 Management fees to stockholders and affiliate................................. 470 215 125 250 Other, net...................................... (101) 11 (47) 128 ----------- ------------ ---------- --------- Income (loss) before income taxes............. 7,117 3,234 (7,487) (1,744) Income tax expense (benefit)....................... 3,135 1,441 (2,033) 847 ----------- ------------ ---------- --------- Net income (loss)............................. $ 3,982 $ 1,793 $ (5,454) $ (2,591) =========== ============ ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-34
AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER(S) EQUITY (dollars in thousands, except share information) Retained Accumulated Addititonal Stock Earnings Other Carryover Common Stock Paid-in Purchase (Accumulated Comprehensive Basis Shares Amount Capital Warrants Deficit) Loss Adjustment Total ------ ------ ------ -------- ------- ---- ---------- ----- Predecessor ----------- Balances, June 30, 1996...... 48,000 $ 1 $ 4,889 $1,923 $ 1,199 $ (80) $ - $ 7,932 Net income................... - - - - 3,982 - - 3,982 Other comprehensive income, net of tax: Foreign currency translation adjustment.............. - - - - - (73) - (73) -------- Comprehensive income......... 3,909 Preferred stock dividend..... - - - - (616) - - (616) ------- ------- --------- ------ ---------- --------- -------- --------- Balances, June 30, 1997...... 48,000 1 4,889 1,923 4,565 (153) - 11,225 Net income................... - - - - 1,793 - - 1,793 Other comprehensive income, net of tax: Foreign currency translation adjustment.............. - - - - - (19) - (19) -------- Comprehensive income......... 1,774 Preferred stock dividend..... - - - - (283) - - (283) ------- ------- --------- ------ ---------- --------- -------- --------- Balances, December 15, 1997.. 48,000 $ 1 $ 4,889 $1,923 $ 6,075 $ (172) $ - $ 12,716 ======= ======= ========= ====== ========= ========= ======== ======== - ------------------------------------------------------------------------------------------------------------------- Successor --------- Balances, December 16, 1997.. - $ - $ - $ - $ - $ - $ - $ - Initial capitalization 1,000 - 78,363 - - - - 78,363 (see Note 12) Carryover basis adjustment... - - - - - - (15,730) (15,730) Equity contribution by Holding - - 22,499 - - - - 22,499 Net loss..................... - - - - (5,454) - - (5,454) Other comprehensive loss, net of tax: Foreign currency translation adjustment.............. - - - - - (57) - (57) -------- Comprehensive loss........... (5,511) ------- ------- --------- ------ --------- --------- -------- -------- Balances, June 30, 1998...... 1,000 - 100,862 - (5,454) (57) (15,730) 79,621 Net loss..................... - - - - (2,591) - - (2,591) Other comprehensive loss, net of tax: Foreign currency translation adjustment.............. - - - - - (308) - (308) -------- Comprehensive loss........... (2,899) ------- ------- --------- ------ --------- --------- -------- -------- Balances, June 30, 1999...... 1,000 $ - $ 100,862 $ - $ (8,045) $ (365) $(15,730) $ 76,722 ======= ======= ========= ====== ========= ========= ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-35 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
Predecessor Successor July 1, December 16, 1997 1997 Year Ended through through Year Ended June 30, December 15, June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Cash flows from operating activities: Net income (loss)........................... $ 3,982 $ 1,793 $ (5,454) $ (2,591) Adjustment to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization of goodwill and other intangibles................... 5,084 2,456 3,954 8,487 Amortization of debt discount............. 560 233 81 - Amortization of loan closing costs........ 258 101 3,808 636 Deferred income taxes..................... (297) (460) (2,016) 643 Gain on sale of equipment................. - - - (50) Other..................................... (138) (18) (57) (308) Changes in operating assets and liabilities: Accounts receivable..................... 2,546 1,153 (4,562) (2,737) Inventory............................... (550) 69 543 (3,031) Prepaid expenses, deferred charges and other assets.......................... (101) (62) (453) (627) Income taxes............................ (1,163) 699 767 5,238 Accounts payable and accrued expenses... (1,239) (1,036) (5,432) 4,511 --------- --------- --------- --------- Net cash provided by (used in) operating activities............................ 8,942 4,928 (8,821) 10,171 --------- --------- --------- --------- Cash flows from investing activities: Purchases of equipment...................... (2,462) (807) (514) (2,856) Proceeds from sale of equipment............. 38 - - 50 Payments for acquisitions, net of cash acquired - - (141,403) - --------- --------- ---------- ---------- Net cash used in investing activities... (2,424) (807) (141,917) (2,806) --------- --------- --------- --------- Cash flows from financing activities: Payments under capital leases for equipment. (2,359) (249) (308) (661) Net proceeds (repayments) on line of credit. 4,338 2,362 (6,700) - Proceeds from issuance of senior increasing rate notes, net of offering costs............. - - 119,735 - Payments on senior increasing rate notes.... - - (123,500) - Proceeds from issuance of senior notes, net of offering costs......................... - - 110,158 - Proceeds from issuance of common stock...... - - 98,499 - Redemption of preferred stock............... - - (8,678) - Repayment of loans payable to stockholder... (7,004) (1,851) (36,649) - Repayment of other notes payable............ (1,200) (50) (50) (1,330) Dividends paid on preferred stock........... (616) (155) (128) - --------- --------- ---------- --------- Net cash provided by (used in) financing activities.................... (6,841) 57 152,379 (1,991) --------- --------- --------- --------- Net increase (decrease) in cash and cash equivalents (323) 4,178 1,641 5,374 Cash and cash equivalents, beginning of period 626 303 - 1,641 --------- --------- --------- --------- Cash and cash equivalents, end of period...... $ 303 $ 4,481 $ 1,641 $ 7,015 ========= ========= ========= ========= Supplemental information: Cash paid (received) during the period for: Interest to stockholder(s)................ $ 4,559 $ 1,146 $ 11,503 $ - Interest, other........................... 917 459 214 6,512 Income taxes.............................. 4,594 1,222 (784) (5,123) Significant non-cash activities: Assets acquired under capital lease......... $ - $ - $ - $ 600
The accompanying notes are an integral part of these consolidated financial statements. F-36 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 1. ORGANIZATION AND BUSINESS Arcade Holding Corporation (the "Predecessor") was organized for the purpose of acquiring all the issued and outstanding capital stock of Arcade, Inc. ("Arcade") on November 4, 1993. Arcade is engaged in interactive advertising for consumer products companies and has a specialty in the design, production and distribution of sampling systems from its Chattanooga, Tennessee facilities, and distributes its products in Europe through its French subsidiary, Arcade Europe S.A.R.L. As more fully described in Note 3, DLJ Merchant Banking Partners II, L.P. and certain related investors (collectively, "DLJMBII") and certain members of the Predecessor organized AHC I Acquisition Corp. ("Acquisition Corp.") and AHC I Merger Corp. ("Merger Corp.") for purposes of acquiring the Predecessor. On December 15, 1997, Merger Corp. acquired all of the equity interests of the Predecessor then merged with and into the Predecessor and the combined entity assumed the name AKI, Inc. and Subsidiaries ("AKI," the "Successor" or the "Company"). Subsequent to the Acquisition, Acquisition Corp. contributed $1 of cash and all of its ownership interest in AKI to AKI Holding Corporation ("Holding") for all of the outstanding equity of Holding. Unless otherwise indicated, all references to years refer to the Predecessor's and AKI's fiscal year, June 30. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated. Reclassification Certain prior year amounts have been reclassified to conform with the current year presentation. Cash and Cash Equivalents For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents. Concentration of Credit Risk The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts; in addition, the Company believes it is not exposed to any significant credit risk on cash and cash equivalents. The Company grants credit terms in the normal course of business to its customers and as part of its ongoing procedures, the Company monitors the credit worthiness of its customers. The Company does not believe that it is subject to any unusual credit risk beyond the normal credit risk attendant in its business. F-37 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Two customers accounted for 23.5% and 35.3% of the Predecessor's net sales during the year ended June 30, 1997 and the period from July 1, 1997 through December 15, 1997, respectively. One customer accounted for 13.3% of net sales during the period from December 16, 1997 through June 30, 1998. Two customers accounted for 26.8% of net sales during the year ended June 30, 1999. Concentration of Purchasing Products accounting for a majority of the Company's net sales utilize specific grades of paper that are produced exclusively for the Company by one domestic supplier. The Company does not have a purchase agreement with the supplier and is not aware of any other suppliers of these specific grades of paper. These products can be manufactured using other grades of paper; however, the Company believes these specific grades of paper provide the Company with an advantage over its competitors. The Company is currently researching methods of replicating the advantages of these specific grades of paper with other grades of paper available from multiple suppliers. Until such methods are developed, a loss of supply of these specific grades of paper and the resulting competitive advantage could cause a possible loss of sales which could adversely affect operating results. Revenue Recognition and Accounts Receivable Product sales are recognized upon shipment, net of estimated discounts. Accounts receivable are accounted for net of allowances for doubtful accounts. Inventory Paper inventory is stated at the lower of cost or market using the last-in, first-out (LIFO) method; all other inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method. Property, Plant and Equipment Property, plant and equipment are stated at cost. Expenditures that extend the economic lives or improve the efficiency of equipment are capitalized. The costs of maintenance and repairs are expensed as incurred. Upon retirement or disposal, the related cost and accumulated depreciation are removed from the respective accounts and any gain or loss is recorded. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets as indicated in Note 6 for financial reporting purposes and accelerated methods for tax purposes. Leasehold improvements are depreciated over the shorter of their estimated useful lives or the lease term. F-38 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Goodwill The aggregate purchase price of business acquisitions was allocated to the assets and liabilities of the acquired companies based on their respective fair values as of the acquisition dates. Goodwill represents the excess purchase price paid over the fair value of net identifiable assets acquired and is amortized over forty years using the straight-line method. Accumulated amortization was $2,087 and $5,939 at June 30, 1998 and June 30, 1999, respectively. Management periodically reviews the value of its goodwill and other long-lived assets to determine if an impairment has occurred. The potential impairment of recorded goodwill and other long-lived assets is measured by the undiscounted value of expected future operating cash flows in relation to its net capital investment. Based on its review, management does not believe that an impairment of its goodwill or other long-lived assets has occurred. Deferred Charges Deferred charges are primarily comprised of debt issuance costs which are being amortized using the effective interest method over the terms of the related debt. Such costs are included in the accompanying consolidated balance sheets, net of accumulated amortization. Other Intangible Assets Other intangible assets include a covenant not to compete and other intangible assets resulting from the acquisition of the fragrance sampling business of Minnesota Mining and Manufacturing Company ("3M") (see Note 3) in June 1998 and are being amortized over ten years using the straight-line method. Accumulated amortization related to these intangible assets was $729 at June 30, 1999. Fair Value of Financial Instruments SFAS No. 107, "Disclosures About Fair Values of Financial Instruments," requires the disclosure of the fair value of financial instruments, for assets and liabilities recognized and not recognized on the balance sheet, for which it is practicable to estimate fair value. The fair value of the Company's Senior Notes, as determined from quoted market prices, was $112,000 at June 30, 1999 compared to a carrying value of $115,000 as of the same date. The carrying value of the Senior Notes approximated fair value at June 30, 1998. The carrying value of all other financial instruments approximates fair value at June 30, 1998 and June 30, 1999. F-39 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Foreign Currency Transactions Gains and losses on foreign currency transactions with third parties have been included in the determination of net income in accordance with SFAS No. 52, "Foreign Currency Translation." Foreign currency losses and (gains) amounted to $387, ($44), ($52) and $91 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Research and Development Expenses Research and development expenditures are charged to selling, general and administrative expenses in the period incurred. Research and development expenses totaled $1,263, $664, $717 and $1,136 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Income Taxes Income taxes are provided in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Accordingly, deferred tax assets and liabilities are recognized at the applicable income tax rates based upon future tax consequences of temporary differences between the tax bases and financial reporting bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax assets are reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Comprehensive Income (Loss) The Company adopted the provision of Statement of Financial Accounting Standards No. 130 ("SFAS No. 130") on July 1, 1998. This Statement establishes standards for reporting and displaying comprehensive income and its components in the financial statements. This Statement also requires that comparative information for earlier periods be reclassified. As the Company only has two items of comprehensive income, net income and foreign currency translations, adoption of this statement did not have a material effect upon the Company's financial position or results of operations. F-40 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 3. SIGNIFICANT ACQUISITIONS DLJMBII and certain members of the Predecessor organized Acquisition Corp. and Merger Corp. for purposes of acquiring the Predecessor. Merger Corp. was a wholly-owned subsidiary of Acquisition Corp. and was initially capitalized by Acquisition Corp. with an equity contribution of $78,363, comprised of $76,000 of cash (see Note 12) and $2,363 of non-cash consideration in the form of an option to purchase Senior Preferred Stock of Acquisition Corp. (see Note 16). Immediately following this equity contribution, Merger Corp. issued $123,500 of senior increasing rate notes (the "Bridge Loans") to an entity with an ownership interest in Acquisition Corp. The Bridge Loans had a stated maturity of December 15, 1998 and had an interest rate equal to the greater of (i) 10.0% per annum and (ii) a daily floating rate of prime plus 2.25% plus an additional percentage amount equal to (a) 1.0% from and including the interest payment date on June 15, 1998 or (b) 1.5% from and including the interest payment date on September 15, 1998. Merger Corp. received cash proceeds from the issuance of the Bridge Loans of $119,735, net of $3,765 of associated debt issuance costs. On December 15, 1997, Merger Corp. acquired all of the equity interests of the Predecessor (the "Acquisition") for a total cost of $197,730 which consisted of $138,634 cash paid for equity interests and direct acquisition costs, $2,363 in non-cash consideration in the form of an option to purchase Senior Preferred Stock of Acquisition Corp. (see Note 16) and the assumption of $56,733 in debt, preferred stock and related interest and dividends, including a capital lease obligation. Included in the amount of direct acquisition costs was approximately $2,022 paid to an entity that has an ownership interest in Acquisition Corp. Merger Corp. then merged with and into the Predecessor and the combined entity assumed the name AKI. Subsequent to the Acquisition, Acquisition Corp. contributed $1 of cash and all of its ownership interest in AKI to Holding for all of the outstanding equity of Holding. Since all companies are under common control and since Holding and Acquisition Corp. have no operations other than those related to the Company, the contribution was accounted for as if it were a pooling of interests. The Acquisition was accounted for using the purchase method of accounting. In accordance with the consensus reached by the Emerging Issues Task Force of the Financial Accounting Standards Board in Issue 88-16, "Basis in Leveraged Buyout Transactions," the purchase price allocation required an adjustment for the continuing interest attributable to management's ownership interest in the Predecessor carried over in connection with the Acquisition. As a result, a reduction in stockholders' equity of $15,730 was recorded which represents the difference between the fair value of the Company's assets and the related book value attributable to the interest of the continuing shareholders' investment in the Predecessor. The remaining purchase price has been allocated to assets and liabilities based upon estimates of their respective fair value as determined by management and third-party appraisals with respect to property, plant and equipment. In connection with the Acquisition, the Company repaid the outstanding balance and related interest of the Predecessor's loans payable to a shareholder of $37,374, the outstanding balance and related interest of the Predecessor's line of credit of $6,278 and the outstanding balance and related dividends on the Predecessor's preferred stock of $8,806. F-41 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 3. SIGNIFICANT ACQUISITIONS (Continued) The following shows the acquisition costs and the allocation of the purchase price:
Acquisition costs Cash paid for stock....................................................... $ 134,403 Direct acquisition costs.................................................. 4,231 ----------- 138,634 Non-cash consideration for stock in the form of an option to purchase Senior Preferred Stock of Acquisition Corp. (see Note 16)......................................... 2,363 ----------- Total..................................................................... 140,997 Less--Carryover basis adjustment........................................... (15,730) ----------- Purchase price to be allocated............................................ $ 125,267 =========== Summary allocation of purchase price Cash...................................................................... $ 4,481 Other current assets...................................................... 17,782 Property, plant and equipment............................................. 20,132 Deferred income taxes..................................................... 2,953 Other assets.............................................................. 329 Goodwill.................................................................. 153,929 ----------- Total allocation to assets................................................ $ 199,606 =========== Current liabilities....................................................... $ 13,190 Long-term debt (including current portion) and related interest........... 47,927 Deferred income taxes..................................................... 4,416 Preferred stock and related dividends..................................... 8,806 ----------- Total liabilities assumed................................................. $ 74,339 ===========
Included in cash paid for stock of $134,403 is $19,342 related to the purchase and retirement of 11,201 options of the Predecessor. In addition, the non-cash consideration for stock of $2,363 was incurred to acquire and retire the remaining 1,370 options of the Predecessor (see Note 16). On June 22, 1998, the Company acquired (the "3M Acquisition") the fragrance sampling business of the Industrial and Consumer Products division of 3M for approximately $7,250 in cash and the assumption of liabilities of approximately $182. The only tangible assets acquired were approximately $143 of equipment. The acquisition was accounted for using the purchase method of accounting and resulted in assigning value to certain intangible assets, including a covenant not to compete, totaling approximately $7,289 which are being amortized on a straight line basis over a period of 10 years. F-42 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 3. SIGNIFICANT ACQUISITIONS (Continued) Unaudited pro forma results for the Company assuming the Acquisition, the 3M Acquisition and the Refinancing had occurred as of the beginning of each applicable fiscal year are presented below: Unaudited Pro Forma Results for the Year Ended June 30, June 30, 1997 1998 ---- ---- Net sales..................... $ 87,771 $ 81,831 Income from operations........ 9,565 5,838 Interest expense, net......... 12,961 13,049 Net loss...................... (3,665) (6,091) On June 25, 1998, the Bridge Loans were repaid, without penalty, with the proceeds from the Senior Note offering (see Note 9) and the equity contribution from Holding (see Note 12) (collectively, the "Refinancing"). Contemporaneous with the repayment of the Bridge Loans, the Company wrote-off the unamortized balance of debt issuance costs associated with the Bridge Loans of $1,795 to interest expense. 4. ACCOUNTS RECEIVABLE The following table details the components of accounts receivable: June 30, June 30, 1998 1999 ---- ---- Trade accounts receivable........... $ 13,782 $ 16,349 Allowance for doubtful accounts..... (277) (251) --------- -------- 13,505 16,098 Other accounts receivable........... 45 189 --------- -------- $ 13,550 $ 16,287 ========= ======== F-43 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 5. INVENTORY The following table details the components of inventory: June 30, June 30, 1998 1999 ---- ---- Raw materials Paper................................. $ 556 $ 1,088 Other raw materials................... 1,024 2,328 --------- -------- Total raw materials................ 1,580 3,416 Work in process......................... 498 1,693 --------- -------- Total inventory......................... $ 2,078 $ 5,109 ========= ======== The difference between the carrying value of paper inventory using the FIFO method as compared to the LIFO method was not significant at June 30, 1998 or June 30, 1999. 6. PROPERTY, PLANT AND EQUIPMENT The following table details the components of property, plant and equipment as well as their estimated useful lives: Estimated June 30, June 30, Useful Lives 1998 1999 ------------ ---- ---- Land............................ $ 256 $ 258 Buildings....................... 7 - 15 years 1,048 1,648 Leasehold improvements.......... 1 - 3 years 153 579 Machinery and equipment......... 5 - 7 years 17,146 19,483 Furniture and fixtures.......... 3 - 5 years 1,634 2,084 Construction in progress........ 552 193 --------- -------- 20,789 24,245 Accumulated depreciation........ (1,853) (5,734) --------- -------- $ 18,936 $ 18,511 ========= ========== Depreciation expense amounted to $3,850, $1,888, $1,853 and $3,881 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. F-44 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 6. PROPERTY, PLANT AND EQUIPMENT (Continued) Property held under capital lease is included in the respective property, plant and equipment category as follows: June 30, June 30, 1998 1999 ---- ---- Machinery and equipment.................. $ 3,000 $ 3,000 Building................................. - 600 --------- -------- 3,000 3,600 Less accumulated depreciation............ (275) (790) --------- -------- $ 2,725 $ 2,810 ========= ======== Depreciation of the assets under capital lease totaled $633, $232, $275 and $515 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Future minimum lease payments under the remaining leases are as follows: Payment Interest 2000............................ $ 884 $ 197 2001............................ 948 100 2002............................ 529 27 --------- -------- $ 2,361 $ 324 ========= ======== 7. LINE OF CREDIT On April 30, 1996, the Predecessor entered into a line of credit agreement (the "Credit Agreement"), which was amended on December 12, 1997, in connection with the Acquisition, and amended again on September 30, 1998. The Credit Agreement provides for a revolving loan commitment up to a maximum of $20,000 and expires on December 31, 2002. Borrowings are limited to a borrowing base consisting of accounts receivable, inventory and property, plant and equipment which serve as collateral for the borrowings. As of June 30, 1999, the Company's borrowing base was approximately $17,500. Interest on amounts borrowed accrue at a floating rate based upon either prime or LIBOR (9.25% and 8.50% at June 30, 1998 and June 30, 1999, respectively). The weighted average interest rate on the outstanding balance under the Credit Agreement was 9.31%, 9.50%, 9.25% and 8.51% for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. F-45 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 7. LINE OF CREDIT (Continued) The Company is required to pay commitment fees on the unused portion of the revolving loan commitment at a rate of approximately 0.5% per annum. In addition, the Company is required to pay fees equal to 2.5% of the average daily outstanding amount of lender guarantees. The Company had $600 of lender guarantees outstanding at June 30, 1998 and June 30, 1999. These fees totaled $109, $30, $59 and $111 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. The Credit Agreement contains certain financial covenants and other restrictions including restrictions on additional indebtedness and restrictions on the payment of dividends. As of June 30, 1999, the Company was in compliance with all debt covenants. However, the Company expects to be in violation of certain loan covenants in Fiscal 2000. Management expects to obtain loan amendments and/or waivers in Fiscal 2000 with respect to such covenants. If management is unable to obtain loan amendments and/or waivers in Fiscal 2000, the Company may need to seek additional sources of financing. 8. LOANS PAYABLE TO STOCKHOLDER The Predecessor entered into a Senior Loan Agreement and two Subordinated Loan Agreements (collectively, the "Loan Agreements") with a party that had owned the Predecessor's preferred stock and a significant portion of its common stock. The Loan Agreements were collateralized by substantially all the assets of the Predecessor. The Loan Agreements limited the Predecessor's ability to incur additional indebtedness, pay dividends and purchase fixed assets. Additionally, the Loan Agreements required that certain financial covenants be maintained. The Predecessor was not in compliance with all such covenants at June 30, 1997. However, this debt was subsequently retired upon the acquisition of the Predecessor as discussed in Note 3. All amounts borrowed under the Senior Loan Agreement bore interest at prime plus 1.50%. The Predecessor borrowed $30,000 under the Subordinated Loan Agreements, of which $23,000 was designated as Loan I and $7,000 was designated as Loan II. Loan I bore interest, payable quarterly, at 12% until November 4, 1998, and then would have converted to prime plus 4%. Loan II bore interest, payable quarterly, at 7%. The outstanding amount of the subordinated loans was net of unamortized debt discounts, which were being amortized over the term of the related loan. In connection with Loan II, the Predecessor issued a warrant to purchase 19,233 shares of common stock at $0.05 per share. The warrant was exercisable until November 4, 2003. The Predecessor valued the warrants at $100 each based on the fair market value of a share of the underlying common stock resulting from a sale with a third party. In connection with the warrant issued, the Predecessor recorded a debt discount of $1,923. In connection with the sale of the Predecessor on December 15, 1997 (see Note 3), all outstanding warrants were purchased from the holder by the buyer of the Predecessor and retired. F-46 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 9. SENIOR NOTES On June 25, 1998, the Company completed a private placement of $115,000 of Senior Notes (the "Senior Notes"). The Senior Notes are general unsecured obligations of the Company and bear interest at 10.5% per annum, payable semi-annually on January 1 and July 1. The Senior Notes mature on July 1, 2008 and may be redeemed at the option of the Company, in whole or in part, at any time on or after July 1, 2003 at a price equal to 105.25% of the outstanding principal balance plus accrued and unpaid interest. The placement of the Senior Notes yielded the Company net proceeds of $110,158 after deducting offering expenses of $4,842, including $3,450 of underwriting fees paid to an affiliate of the stockholder. The Senior Notes are redeemable at the option of the Company, in whole or part, at any time after July 1, 2003 at a price of up to 105.25% of the outstanding principal balance plus accrued and unpaid interest. Prior to July 1, 2003, the Company is permitted to repurchase up to 35% of the Senior Notes at a redemption price of up to 110.5% of the aggregate principal amount plus accrued and unpaid interest with the net proceeds of one or more public equity offerings. The Senior Notes contain certain customary covenants including restrictions on the declaration and payment of dividends by the Company to Holding and limitations on the incurrence of additional indebtedness. On December 22, 1998, the Company completed the registration of its Senior Notes with the Securities and Exchange Commission. 10. OTHER NOTES PAYABLE On June 9, 1995, the Predecessor acquired all of the issued and outstanding stock of Scent Seal Inc. ("Scent Seal"). The acquisition of Scent Seal did not have a material impact on the financial position or results of operations of the Predecessor and was accounted for as a purchase transaction whereby the purchase cost was allocated to the fair value of the net assets acquired. In connection with the acquisition of Scent Seal, the Predecessor issued $3,627 in noninterest bearing promissory notes (the "Notes") to an employee of the Predecessor who was previously a Scent Seal stockholder. The Predecessor recorded a debt discount of $649 in connection with the issuance of the Notes to reflect an effective interest rate of 10%. The discount was being amortized over the term of the Notes. Under certain provisions of the Scent Seal acquisition agreement, the Company was permitted to reduce the outstanding principal balance of the Notes based upon the ultimate realization of assets acquired and settlement of liabilities assumed. In June 1998, the Company reached a settlement with the holder of the Notes under these provisions which resulted in the reduction of the outstanding principal balance of the Notes of $120. The remaining principal balance of the Notes of $1,330 was repaid in July 1998 in accordance with the terms of the Notes. F-47 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 11. REDEEMABLE PREFERRED STOCK OF PREDECESSOR In connection with the 1993 acquisition of Arcade, the Predecessor authorized and issued 8,000 shares of 7% cumulative, $1 par value redeemable preferred stock at $1,000 per share. The redeemable preferred stock prohibited the Predecessor from acquiring its common stock as long as the preferred stock was outstanding and restricted the payment of common stock dividends. Accrued and unpaid dividends of $678 accrued through December 31, 1994, were added to the outstanding balance. The redeemable preferred stock would have been redeemable on December 31, 2001, at liquidation value of $1,000 per share plus accrued and unpaid dividends. In conjunction with the sale of Predecessor on December 15, 1997 (see Note 3), all outstanding redeemable preferred stock was redeemed at $1,000 per share plus accrued and unpaid dividends. 12. INITIAL CAPITALIZATION In conjunction with the Acquisition, Acquisition Corp. issued $30,000 of Floating Rate Notes, $50,279 of Manditorily Redeemable Senior Preferred Stock (the "Senior Preferred Stock") and $1,111 of its Common Stock. The Floating Rate Notes were issued with an original issuance discount of $5,389 and bear interest at a rate equal to the rate in effect on the Bridge Loans (see Note 3) plus 2.50%. After the completion of the Refinancing (see Note 3) on June 25, 1998, the Floating Rate Notes bear interest at 15% per annum. Interest is payable quarterly and can be settled through the issuance of additional Floating Rate Notes through maturity at the discretion of Acquisition Corp. The original issuance discount of $5,389 is being amortized using the effective interest method over the life of the Floating Rate Notes. The unamortized balance of the original issue discount was $5,152 and $4,740 at June 30, 1998 and June 30, 1999, respectively. The Floating Rate Notes mature on December 15, 2009 and are held by affiliates of the primary shareholder of Acquisition Corp. The Senior Preferred Stock accretes in value at 15% per annum and must be redeemed by December 15, 2012. The Floating Rate Notes and Senior Preferred Stock are general unsecured obligations of Acquisition Corp. The cash proceeds from the issuance of the Floating Rate Notes, Senior Preferred Stock and Common Stock of approximately $76,000 and a Senior Preferred Stock option of $2,363 (see Note 16) were contributed by Acquisition Corp. to the Company in exchange for 1,000 shares of the Company's Common Stock. Subsequent to the initial capitalization of the Company, Acquisition Corp. contributed $1 and all of its ownership interest in the Company to Holding for all of the outstanding equity of Holding. F-48 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 12. INITIAL CAPITALIZATION (Continued) On June 25, 1998, Holding completed a private offering of $50,000 Senior Discount Debentures (the "Debentures"). The Debentures do not accrue or pay interest until July 1, 2003 and were issued with an original issuance discount of $24,038. The original issuance discount is being accreted from issuance through July 1, 2003 at an effective rate of 13.5% per annum. The unamortized balance of the original issuance discount was $23,980 and $20,349 at June 30, 1998 and June 30, 1999, respectively. After July 1, 2003, the Debentures will accrue interest at a rate of 13.5% per annum, payable semi-annually, commencing January 1, 2004. The Debentures are redeemable at the option of Holding, in whole or in part, at any time on or after July 1, 2003 at a price of up to 106.75% of the outstanding principal balance plus accrued and unpaid interest. Prior to July 1, 2003, Holding is permitted to repurchase up to 35% of the aggregate principal amount at maturity of the Debentures originally issued at a redemption price equal to 113.5% of the accreted value of the Debentures with the net proceeds of one or more public equity offerings. The Debentures are general unsecured obligations of Holding. With the proceeds of the Debenture offering, Holding contributed $22,499 of cash to the Company. No additional shares were issued to Holding as a result of this contribution. On December 22, 1998, Holding completed the registration of its Senior Discount Debentures with the Securities and Exchange Commission. Acquisition Corp. and Holding have no other operations other than the Company. Absent additional financing by Acquisition Corp. or Holding, the Company's operations represent the only current source of funds available to service the Floating Rate Notes, Senior Preferred Stock and Debentures; however, the Company is not obligated to pay or otherwise guarantee the Floating Rate Notes, Senior Preferred Stock and Debentures. 13. COMMITMENTS AND CONTINGENCIES Operating Leases Equipment and office, warehouse and production space under operating leases expire at various dates. Rent expense was $443, $192, $198 and $338 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Future minimum lease payments under these leases are as follows: 2000.............. $ 162 2001.............. 138 -------- $ 300 ======== F-49 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 13. COMMITMENTS AND CONTINGENCIES (Continued) Royalty Agreements Royalty agreements are maintained for certain technologies used in the manufacture of certain products. Under the terms of one royalty agreement, payments are required based on a percentage of net sales of those products manufactured with the specific technology, or a minimum of $500 per year. This agreement expires in 2003 or when a total of $12,500 in cumulative royalty payments has been paid. The Company expensed $761, $437, $516 and $500 under this agreement for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. The Company has paid $4,576 in cumulative royalty payments under this agreement through June 30, 1999. Under the terms of another agreement, royalty payments are required based on the number of products sold that were manufactured with the specific licensed technology, or a minimum payment per year. These minimum payments for years after fiscal 1999 are $625 per year through the expiration of the agreement in 2012. The Company expensed $475, $241, $284 and $575 under this agreement for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Employment Agreements The Company has employment agreements with certain officers with terms through February 1, 2002. Such agreements provide for base salaries totaling $825 per year. One officer has an incentive bonus of up to 200% of base salary which is payable if certain financial and management goals are attained and certain other incentive payments. One of the employment agreements also provides severance benefits of up to two years of base salary if the officer's services are terminated under certain conditions. During fiscal 1999, two executive officers employment was terminated with the Company. In accordance with the terms of former officers' employment agreements, the Company was obligated for severance benefits of approximately $610. The Company had paid approximately $457 of these benefits by June 30, 1999. The remaining balance of $153 is included in accrued compensation at June 30, 1999. Litigation The Company is a party to litigation arising in the ordinary course of business which, in the opinion of management, will not have a material adverse effect on the Company's financial condition, results of operations or cash flows. F-50 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 14. RETIREMENT PLANS A 401(k) defined contribution plan (the "Plan") is maintained for substantially all full-time salaried employees. Applicable employees who have six months of service and have attained age 21 are eligible to participate in the Plan. Employees may elect to contribute a percentage of their earnings to the Plan in accordance with limits prescribed by law. Contributions to the Plan are determined annually by the Company and generally are a matching percentage of employee contributions. Costs associated with the Plan totaled $180, $95, $113 and $201 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. Certain hourly employees are covered under a multiemployer defined benefit plan administered under a collective bargaining agreement. Costs (determined by union contract) under the defined benefit plan were $143, $80, $81 and $204 for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997, from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively. 15. INCOME TAXES The Company is included in the consolidated federal income tax return filed by Acquisition Corp. for periods subsequent to December 15, 1997. Income taxes related to the Company for the period from December 16, 1997 through June 30, 1999 were determined on a separate entity basis. The Company files separate state income tax returns and calculates its state tax provision on a separate company basis. Any income taxes payable or receivable by the consolidated group are settled or received by the Company. The Predecessor was not part of a consolidated group. For financial reporting purposes, income (loss) before income taxes includes the following components:
July 1, December 16, 1997 1997 Year Ended through through Year Ended June 30, December 15, June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Income (loss) before income taxes: United States................. $ 7,609 $ 3,298 $ (8,169) $ (2,266) Foreign....................... (492) (64) 682 522 --------- --------- ---------- --------- $ 7,117 $ 3,234 $ (7,487) $ (1,744) ======== ======== ========= =========
F-51 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 15. INCOME TAXES (Continued) Significant components of the provision (benefit) for income taxes are as follows:
July 1, December 16, 1997 1997 Year Ended through through Year Ended June 30, December 15, June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Current expense (benefit): Federal....................... $ 2,880 $ 1,623 $ - $ - Foreign....................... - - 104 204 State......................... 552 278 (121) - -------- ---------- ---------- --------- 3,432 1,901 (17) 204 -------- ---------- ---------- --------- Deferred expense (benefit): Federal....................... (90) (376) (1,900) 569 Foreign....................... (165) (25) 162 - State......................... (42) (59) (278) 74 -------- --------- ---------- --------- (297) (460) (2,016) 643 -------- --------- ---------- --------- $ 3,135 $ 1,441 $ (2,033) $ 847 ======== ========== ========== =========
The significant components of deferred tax assets and deferred tax liability at June 30, 1998 and 1999, were as follows:
June 30, 1998 June 30, 1999 ------------------------ ------------------------ Current Noncurrent Current Noncurrent ------------------------ ------------------------ Deferred income tax assets: Accrued expenses................... $ 719 $ - $ 308 $ - Allowance for doubtful accounts.... 108 - 92 - Net operating loss carryforwards... - 2,947 - 3,132 Preferred stock option............. - 922 - - --------- --------- --------- --------- 827 3,869 400 3,132 Deferred income tax liability: Property, plant and equipment...... - 4,143 - 3,340 --------- --------- --------- --------- $ 827 $ (274) $ 400 $ (208) ========= ========= ========= =========
F-52 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 15. INCOME TAXES (Continued) The income tax provision recognized by the Predecessor for the year ended June 30, 1997, the period from July 1, 1997 through December 15, 1997 and by the Company for the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, differs from the amount determined by applying the applicable U.S. statutory federal income tax rate to pretax income as a result of the following:
July 1, December 16, 1997 1997 Year Ended through through Year Ended June 30, December 15, June 30, June 30, 1997 1997 1998 1999 ---- ---- ---- ---- Computed tax provision (benefit) at statutory rate.................... $ 2,420 $ 1,100 $ (2,546) $ (593) State income tax provision (benefit),.. net of federal effect................ 335 145 (263) (49) Nondeductible expenses................. 455 193 720 1,477 Other, net............................. (75) 3 56 12 --------- --------- --------- --------- $ 3,135 $ 1,441 $ (2,033) $ 847 ========= ========= ========== =========
In conjunction with the Acquisition, the Company recognized an income tax benefit of $7,327 related to the excess of the redemption price over the strike price of certain non-qualified options of the Predecessor redeemed and retired by the Company. This benefit was recorded as a reduction to goodwill. Due to the Company's current year losses and certain transactions made in conjunction with the Acquisition, the Company has recorded a long-term deferred tax asset of $3,132 reflecting cumulative net operating loss carryforwards available to offset future federal taxable income of approximately $6,900 and future state taxable income of approximately $15,600 at June 30, 1999. These cumulative net operating loss carryforwards expire in varying amounts through 2019. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes that it is more likely than not that all of the deferred tax asset will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. F-53 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 16. STOCK OPTIONS The Predecessor sponsored a key employee stock option plan under which a maximum of 12,571 shares of the Predecessor's common stock could be reserved for nonqualified options; all stock options were granted with an exercise price equal to the fair market value of $100 per share. All options vested ratably over five years and would have expired ten years from the grant date. The Predecessor accounted for its employee stock options under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"). Under APB 25, because the exercise price of the Predecessor's employee stock options equaled the market value of the underlying stock on the date of grant, no compensation expense was recognized. A summary of the Predecessor's stock option activity and related information follows: June 30, 1997 Weighted Average Exercise Options Price Outstanding, beginning of year......... 12,571 $ 100 Granted........................... - - Exercised......................... - - Forfeited......................... - - -------- ------- Outstanding, end of year............... 12,571 $ 100 ======== ======= Exercisable, end of year............... 5,866 $ 100 ======== ======= Weighted average remaining contractual life.................. 7.3 years Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"), requires disclosure of pro forma information regarding net income for option grants subsequent to December 15, 1995. Because all of the Predecessor's options were granted prior to that date, no pro forma adjustments to net income or disclosure of information would apply under SFAS 123. As a result of the sale of the Predecessor on December 15, 1997 (see Note 3), all outstanding options became immediately vested and exercisable under the terms of the original individual stock option agreements. In connection with the Acquisition, the Company purchased and retired 11,201 options of the Predecessor for $19,342. The remaining 1,370 options of the Predecessor held by an officer, which had a cumulative exercise price of $137, were exchanged at fair value for an option to purchase 100,000 shares of Acquisition Corp.'s Senior Preferred Stock with a cumulative stated value of $2,500 (the "Preferred Stock Option"). The 1,370 options were subsequently retired. The Preferred Stock Option had an exercise price of $137. The total consideration of $21,705 used to purchase and retire the outstanding options of the Predecessor was included in the cost of the Acquisition (see Note 3). F-54 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 16. STOCK OPTIONS (Continued) The Preferred Stock Option was issued with a Put and Call Option (the "Put and Call Option") which granted the officer the right to compel DLJMBII to purchase the 100,000 shares of Senior Preferred Stock obtainable under the Preferred Stock Option, together with certain common equity interests in Acquisition Corp. held by the officer, for $2,590. The Put and Call Option also granted DLJMBII the right to purchase the equity interests, both common and preferred, of the officer for the same amount. The Put and Call Option had a stated termination on June 30, 1998. The officer agreed to terminate the Put and Call Option and enter into a new put option (the "Put Option") dated June 17, 1998. The Put Option granted the officer an irrevocable option to require Acquisition Corp. to purchase 80,000 shares of the Senior Preferred Stock obtainable under the Preferred Stock Option for $2,000 in cash. As the terms of the Put Option were generally more restrictive than the Put and Call Option, no compensation expense was recognized as a result of the transaction. On July 30, 1998, the officer exercised the Preferred Stock Option and Put Option. To provide Acquisition Corp. the funds to redeem the 80,000 shares of Senior Preferred Stock, Holding issued Acquisition Corp. a dividend of $1,863 in cash on such date. Subsequent to the Acquisition, Acquisition Corp. adopted the 1998 Stock Option Plan ("Option Plan") for certain key employees and directors of Acquisition Corp. and any parent or subsidiary of Acquisition Corp. The Option Plan authorizes the issuance of options to acquire up to 100,000 shares of Acquisition Corp. Common Stock. The terms of each individual options grant are determined by the Board of Directors. The exercise price for each grant is required to be set at least equal to the fair market value per share of Acquisition Corp. provided that the exercise price shall not be less than $1.00 per share. Options may be exercisable for up to ten years. On June 17, 1998, Acquisition Corp. granted an officer of the Company options to purchase 32,500 shares of Acquisition Corp. Common Stock. All options had an exercise price of $1.00 per share and a term of 10 years. These options were forfeited during 1999 upon the resignation of the officer. The Company has elected to account for its stock based compensation with employees under the intrinsic value method as permitted under SFAS 123. Under the intrinsic value method, because the stock price of the Company's employee stock options equaled the fair value of the underlying stock on the date of grant, no compensation expense was recognized. If the Company had elected to recognize compensation expense based on the fair value of the options at grant date as prescribed by SFAS 123, the net loss for the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999 would have been $(5,455) and $(2,593), respectively. In making this determination, fair value was estimated on the date of grant using the minimum value method and a risk-free interest rate of 5.4%. The weighted average fair value at date of grant of options granted during 1998 was approximately $0.41 per option. F-55 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 17. RELATED PARTY TRANSACTIONS The Predecessor made payments to a company controlled by a stockholder of the Predecessor of $612 for the year ended June 30, 1997 and $160 for the period from July 1, 1997 through December 15, 1997, for management fees, bonuses and expense reimbursements. The Predecessor made payments to another stockholder of $120 for the year ended June 30, 1997 and $55 for the period from July 1, 1997 through December 15, 1997, for management fees. The Successor made payments to an affiliate of DLJMBII of $125 and $250 for the period from December 16, 1997 through June 30, 1998 and the year ended June 30, 1999, respectively, for financial advisory fees. In addition, the Successor had approximately $200 of cash on deposit with a financial institution affiliated with DLJMBII as of June 30, 1998. 18. SUBSEQUENT EVENT On September 15, 1999, AKI acquired all of the equity interests in RetCom Holdings Ltd. and its subsidiaries for a total cost of approximately $12,000 and refinanced working capital indebtedness of approximately $4,500 of RetCom Holdings Ltd. and its subsidiaries. The purchase price and refinancing of indebtedness were initially financed by borrowings under the credit agreement. 19. GEOGRAPHIC INFORMATION The following table illustrates geographic information for revenues and long-lived assets. Revenues are attributed to countries based on the receipt of sales orders, and long-lived assets are based upon the country of domicile. United States France Total Predecessor ----------- Net sales: Year ended June 30, 1997...... $ 70,660 $ 7,063 $ 77,723 Period from July 1, 1997 through December 15, 1997... 32,600 2,586 35,186 ________________________________________________________________________ Successor --------- Net sales: Period from December 16, 1997 through June 30, 1998....... $ 29,162 $ 6,904 $ 36,066 Year ended June 30, 1999...... 71,056 14,911 85,967 Long-lived assets: June 30, 1998................. 187,250 158 187,408 June 30, 1999................. 181,451 107 181,558 F-56 AKI, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of AKI Holding Corp.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share information) 20. UNAUDITED QUARTERLY RESULTS OF OPERATIONS The following is a summary of the unaudited quarterly results of operations for Fiscal 1998 and Fiscal 1999.
Predecessor Successor October 1, December 16, 1997 1997 Quarter Ended through through Quarter Ended Quarter Ended September 30, December 15, December 31, March 31, June 30, Full Fiscal 1998 1997 1997 1997 1998 1998 Year ---- ---- ---- ---- ---- ---- Net sales............. $ 21,928 $ 13,258 $ 2,791 $ 19,191 $ 14,084 $ 71,252 Gross profit.......... 8,306 4,071 813 7,256 3,479 23,925 Income from operations 4,680 1,426 153 3,603 104 9,966 Interest expense, net. 1,451 1,195 759 4,404 6,106 13,915 Net income (loss)..... 1,796 (3) (443) (887) (4,124) (3,661) Successor Quarter Ended Quarter Ended Quarter Ended Quarter Ended September 30, December 31, March 31, June 30, Full Fiscal 1999 1998 1998 1999 1999 Year ---- ---- ---- ---- ---- Net sales............. $ 24,024 $ 20,437 $ 24,518 $ 16,988 $ 85,967 Gross profit.......... 8,603 6,777 9,691 5,697 30,768 Income from operations 4,337 2,331 4,616 378 11,662 Interest expense, net. 3,210 3,244 3,298 3,276 13,028 Net income (loss)..... 273 (970) 281 (2,175) (2,591)
EX-99 2 EXHIBIT 10.9 - THIRD AMENDMENT TO CREDIT AGREEMENT EXHIBIT 10.9 THIRD AMENDMENT TO CREDIT AGREEMENT This THIRD AMENDMENT TO CREDIT AGREEMENT ("Amendment") is made and entered into this 30th day of August, 1999 by and between AKI, Inc., formerly known as Arcade, Inc. ("Borrower") and Heller Financial, Inc. ("Lender"). WHEREAS, Lender and Borrower are parties to a certain Credit Agreement dated April 30, 1996 and all amendments thereto (as such agreement has from time to time been amended, supplemented or otherwise modified, the "Agreement"); and WHEREAS, the parties desire to amend the Agreement as hereinafter set forth; NOW THEREFORE, in consideration of the mutual conditions and agreements set forth in the Agreement and this Amendment, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. Definitions. Capitalized terms used in this Amendment, unless otherwise defined herein, shall have the meaning ascribed to such terms in the Agreement. 2. Amendments. Subject to the conditions set forth below, the Agreement is amended as follows: (a) Subsection 1.2 is amended by deleting the definition of "LIBOR" and inserting the following in lieu thereof: "LIBOR" means, for each Interest Period, a rate per annum equal to: (a) the offered rate for deposits in U.S. dollars in an amount comparable to the amount of the applicable Loan in the London interbank market which is published by the British Bankers' Association, and that currently appears on Telerate Page 3750, or any other source available to Lender, as of 11:00 a.m. (London time) on the day which is two (2) Business Days prior to the first day of the relevant Interest Period for a term comparable to such Interest Period; or if, for any reason, such a rate is not published by the British Bankers' Association on Telerate or any other source available to Lender, the rate per annum equal to the average rate (rounded upwards, if necessary, to the nearest 1/100 of 1%) at which Lender determines that U.S. dollars in an amount comparable to the amount of the applicable Loans are being offered to prime banks at approximately 11:00 a.m. (London time) on the day which is two (2) Business Days prior to the first day of such Interest Period for a term comparable to such Interest Period for settlement in immediately available funds by leading banks in the London interbank market selected by Lender; divided by (b) a number equal to 1.0 minus the aggregate (but without duplication) of the rates (expressed as a decimal fraction) of reserve requirements in effect on the day which is two (2) Business Days prior to the beginning of such Interest Period (including, without limitation, basic, supplemental, marginal and emergency reserves under any regulations of the Board of Governors of the Federal Reserve System or other governmental authority having jurisdiction with respect thereto, as now and from time to time in effect) for Eurocurrency funding (currently referred to as "Eurocurrency Liabilities" in Regulation D of such Board) which are required to be maintained by a member bank of the Federal Reserve System; such rate to be rounded upward to the next whole multiple of one-sixteenth of one percent (.0625%). (b) Subsection 4.3 is amended by deleting such subsection in its entirety and inserting the following in lieu thereof: "4.3 EBIDAT. Borrower shall not permit EBIDAT for the twelve month (12) ending on the last day of any month, during the periods set forth below to be less than the amount set forth below for such period: Period Amount July 1, 1999 through September 30, 1999 $20,000,000 October 1, 1999 through December 31, 1999 $25,500,000 January 1, 2000 through June 30, 2000 $27,800,000 July 1, 2000 through December 31, 2000 $28,800,000 January 1, 2001 through June 30, 2001 $29,800,000 July 1, 2001 through June 30, 2002 $32,000,000 July 1, 2002 and thereafter $34,300,000 "EBIDAT will be calculated as illustrated on Exhibit 4.6(C)." (c) Subsection 4.4 is amended by deleting such subsection in its entirety and inserting the following in lieu thereof: "4.4 Fixed Charge Coverage. Borrower shall not permit Fixed Charge Coverage for the twelve (12) month period ending on the last day of each month to be less than the amount set forth below for such period: Period Ratio July 1, 1999 through September 30, 1999 1.05 October 1, 1999 through June 30, 2002 1.10 July 1, 2002 and thereafter 1.15 " Fixed Charge Coverage will be calculated as illustrated on Exhibit 4.6(c)." (d) Subsection 4.5 is amended by deleting such subsection in its entirety and inserting the following in lieu thereof: "4.5 Total Indebtedness to Operating Cash Flow Ratio. Borrower shall not permit the ratio of Total Indebtedness calculated as of the last day of any month during the periods set forth below to Operating Cash Flow for the twelve (12) month period ending on such day to be greater than the amount set forth below for such period: 2 Period Ratio July 1, 1999 through September 30, 1999 7.9 October 1, 1999 through December 31, 1999 7.9 January 1, 2000 through June 30, 2000 7.2 July 1, 2000 through December 31, 2000 6.9 January 1, 2001 through June 30, 2001 6.7 July 1, 2001 through June 30, 2002 6.20 July 1, 2002 and thereafter 5.75 "Total Indebtedness, Operating Cash Flow, will be calculated as illustrated as Exhibit 4.6(C)." (e) Exhibit 4.6(C) is amended by deleting the portion of that Exhibit setting forth the calculations for determining compliance with covenant 4.5 Total Indebtedness to Operating Cash Flow Ratio in its entirety and substituting the calculations attached on Exhibit A. 3. Conditions. The effectiveness of this Amendment is subject to the following conditions precedent (unless specifically waived in writing by Lender): (a) Borrower shall have executed and delivered this Amendment, and such other documents and instruments as Lender may require shall have been executed and/or delivered to Lender; (b) All proceedings taken in connection with the transactions contemplated by this Amendment and all documents, instruments and other legal matters incident thereto shall be satisfactory to Lender and its legal counsel; (c) No Default or Event of Default shall have occurred and be continuing. 4. Representations and Warranties. To induce Lender to enter into this Amendment, Borrower represents and warrants to Lender: (a) that the execution, delivery and performance of this Amendment has been duly authorized by all requisite corporate action on the part of Borrower and that this Amendment has been duly executed and delivered by Borrower; (b) each of the representations and warranties set forth in Section 5 of the Agreement (Other than those which, by their terms, specifically are made as of certain date prior to the date hereof) are true and correct in all material respects as of the date hereof; (c) Borrower has made an assessment of the microchip and computer-based systems and the software used in its business, and based upon such assessment, believes that it will be "Year 2000 Compliant" by January 1, 2000. For purposes of this paragraph, "Year 2000 Compliant" means that all software, embedded microchips and other processing capabilities utilized by, and material to the business operations or financial condition of, Borrower are able to interpret, store, transmit, receive and manipulate data on and involving all calendar dates correctly and without causing any abnormal ending scenarios in relation to dates in and after the Year 2000. From time to time, at the request of Lender, Borrower shall provide to Lender such updated information as is requested regarding the status of its efforts to become Year 2000 Compliant. 3 5. Severability. Any provision of this Amendment held by a court of competent jurisdiction to be invalid or unenforceable shall not impair or invalidate the remainder of this Amendment and the effect thereof shall be confined to the provision so held to be invalid or unenforceable. 6. References. Any reference to the Agreement contained in any document, instrument or agreement executed in connection with the Agreement shall be deemed to be a reference to the Agreement as modified by this Amendment. 7. Counterparts. This Amendment may be executed in one or more counterparts, each of which shall constitute an original, but all of which taken together shall be one and the same instrument. 8. Ratification. The terms and provisions set forth in this Amendment shall modify and supersede all inconsistent terms and provisions of the Agreement and shall not be deemed to be a consent to the modification or waiver of any other term or condition of the Agreement. Except as expressly modified and superseded by this Amendment, the terms and provisions of the Agreement are ratified and confirmed and shall continue in full force and effect. 4 IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed under seal and delivered by their respective duly authorized officers on the date first written above. Heller Financial, Inc. AKI, INC. By: /S/ GEORGE F. KURTESON By /S/ KENNETH BUDDE ---------------------- ---------------------------- Title: Senior Vice President Title: Chief Financial Officer AKI HOLDING CORP. By: /S/ KENNETH BUDDE ---------------------------- Title: Chief Financial Officer 5 EXHIBIT A to EXHIBIT 4.6(C) COMPLIANCE CERTIFICATE AKI, INC. Date: _______________, 199__ Covenant 4.5 Total Indebtedness to Operating Cash Flow Ratio Total Indebtedness: Average daily principal balance of the Revolving Loans for the one month period ending on the date set forth above $---------- Plus: Outstanding principal balance of all other Indebtedness, excluding Subordinated Indebtedness held by SBA and Refinanced Subordinated Indebtedness ----------- Total Indebtedness $__________ Operating Cash Flow (defined in 4.4) $__________ Total Indebtedness to Operating Cash Flow Ratio ___________ Maximum Total Indebtedness to Operating Cash Flow Ratio ----------- In Compliance Yes/No EX-99 3 EXHIBIT 10.10 - FOURTH AMENDMENT TO CREDIT AGMT EXHIBIT 10.10 FOURTH AMENDMENT TO CREDIT AGREEMENT THIS FOURTH AMENDMENT TO CREDIT AGREEMENT is made and entered as of September 21, 1999 (this "Amendment") is between AKI, Inc., a Delaware corporation, formerly known as Arcade, Inc. ("Borrower") and HELLER FINANCIAL, INC., a Delaware corporation ("Lender"). W I T N E S S E T H: WHEREAS, Borrower and Lender are parties to that certain Credit Agreement dated as of April 30, 1996 and all amendments thereto (as amended and supplemented from time to time, the "Credit Agreement"); WHEREAS, pursuant to that certain Stock Purchase Agreement dated as of September __, 1999 (the "RetCom Purchase Agreement"), Borrower shall acquire all of the issued and outstanding capital stock of RetCom Holdings, Ltd., a Delaware corporation ("Target"); and WHEREAS, the parties wish to amend the Credit Agreement as provided herein; NOW, THEREFORE, the parties agree as follows: 1. Definitions. Capitalized terms used in this Amendment, unless otherwise defined herein, shall have the meanings ascribed to such terms in the Credit Agreement. 2. Amendments to the Credit Agreement. (a) Subsection 4.3(b) is amended by deleting all periods and amounts beginning with "July 1, 1999 through December 31, 1999 - $25,500,000" through the end of such subsection and substituting the following in lieu thereof: "July 1, 1999 through December 31, 1999 $20,000,000 January 1, 2000 through March 31, 2000 $21,000,000 April 1, 2000 through December 31, 2000 $22,000,000 January 1, 2001 through June 30, 2001 $23,000,000 July 1, 2001 through June 30, 2002 $24,000,000 July 1, 2002 through June 30, 2003 $25,000,000 July 1, 2003 through June 30, 2004 $26,000,000 July 1, 2004 and thereafter $27,000,000" (b) Subsection 4.4 is amended by deleting such subsection in its entirety and the following is inserted in lieu thereof: "4.4 Fixed Charged Coverage. Borrower shall not permit Fixed Charge Coverage for the twelve month period ending on any of July 31, 1999, August 31, 1999 and September 30, 1999 to be less than 1.05. Borrower shall not permit Fixed Charge Coverage for the twelve month period ending on the last day of each month thereafter to be less than 1.10. "Fixed Charge Coverage" will be calculated as illustrated on Exhibit 4.6(C)." (c) Subsection 4.5 is deleted in its entirety and the following is inserted in lieu thereof: "4.5 Total Indebtedness to Operating Cash Flow Ratio Borrower shall not permit the ratio of Total Indebtedness calculated as of the last day of any month during the periods set forth below to Operating Cash Flow for the twelve (12) month period ending on such day to be greater than the amount set forth below for such period: Period Ratio July 1, 1999 through December 31, 1999 7.90 January 1, 2000 through March 31, 2000 7.00 April 1, 2000 through June 30, 2000 6.80 July 1, 2000 through September 30, 2000 6.50 October 1, 2000 through December 31, 2000 6.30 January 1, 2001 through March 31, 2001 6.10 April 1, 2001 through June 30, 2001 5.90 July 1, 2001 and thereafter 5.75 "Total Indebtedness, Operating Cash Flow, will be calculated as illustrated on Exhibit 4.6(C)." 3. Representations and Warranties. To induce Lender to enter into this Amendment, Borrower represents and warrants to Lender that: (a) the execution, delivery and performance by Borrower of this Amendment are within its corporate power, have been duly authorized by all necessary corporate action and do not and will not contravene or conflict with any provision of law applicable to Borrower, the Certificate of Incorporation or By-laws of Borrower, or any order, judgment or decree of any court or other agency of government or any contractual obligation binding upon Borrower; (b) the Credit Agreement as amended as of the date hereof is the legal, valid and binding obligation of Borrower enforceable against Borrower in accordance with its terms; (c) each of the representations and warranties set forth in Section 5 of the Credit Agreement (other that those which, by their terms, specifically are made as of a certain date prior to the date hereof) are true and correct in all material respects as of the date hereof; (d) no Default or Event of Default has occurred and is continuing; and (e) all conditions precedent to the obligations of the parties to the consummate the purchase and sale of the stock of Target pursuant to the RetCom Purchase Agreement have been satisfied in all material respects. 4. Covenants. Borrower hereby covenants and agrees to, as soon as reasonably possible but in no event later than 10 Business Days after the date draft documentation is delivered to Borrower: (a) cause Target and each of its Subsidiaries to guarantee the Obligations and to secure such guarantee by granting a lien on substantially all of its and their assets, in each instance pursuant to documentation in form and substance reasonably satisfactory to Lender; (b) pledge and deliver to Lender all of the capital stock of Target and each of its Subsidiaries to secure the Obligations pursuant to documentation in form and substance reasonably satisfactory to Lender; (c) deliver to Lender a copy of the articles or certificate of incorporation of Borrower certified as of a recent date by the Secretary of State of Delaware and such other corporate organizational and authority documents as Lender may reasonably request; and (d) deliver to Lender such UCC financing statements and amendments thereto as Lender may reasonably require. 5. Conditions. The effectiveness of the amendments stated in this Amendment is subject to each of the following conditions precedent or concurrent: (a) No Default or Event of Default under the Credit Agreement, as amended hereby, shall have occurred and be continuing; (b) Borrower shall have executed and delivered this Amendment, and such other documents and instruments as Lender may require shall have been executed and/or delivered to Lender; and (c) All proceedings taken in connection with the transactions contemplated by this Amendment and all documents, instruments and other legal matters incident thereto, shall be satisfactory to Lender and its legal counsel. 6. Miscellaneous. (a) Captions. Section captions used in this Amendment are for convenience only, and shall not affect the construction of this Amendment. (b) Governing Law. This Amendment shall be a contract made under and governed by the laws of the State of New York, without regard to conflict of laws principals. Whenever possible each provision of this Amendment shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Amendment shall be prohibited by or invalid under such law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Amendment. (c) Counterparts. This Amendment may be executed in any number of counterparts, and each such counterpart shall be deemed to be an original, but all such counterparts shall together constituted but one and the same Agreement. (d) Successors and Assigns. This Amendment shall be binding upon Borrower and Lender and their respective successors and assigns, and shall inure to the sole benefit of Borrower and Lender and their respective successors and assigns. (e) References. Any reference to the Credit Agreement contained in any notice, request, certificate, or other document executed concurrently with or after the execution and delivery of this Amendment shall be deemed to include this Amendment unless the context shall otherwise require. (f) Continued Effectiveness. The Credit Agreement as amended hereby and each of the other Loan Documents remains in full force and effect. (g) Costs, Expenses and Taxes. Borrower affirms and acknowledges that subsection 1.3(B) of the Credit Agreement applies to this Amendment and the transactions and Agreements and document contemplated hereunder. Delivered at Chicago, Illinois, as of the day and year first above written. AKI, INC. By: /S/ WILLAIM J. FOX ------------------ Name Printed: William J. Fox Title: President HELLER FINANCIAL, INC., as Lender By: /S/ GEORGE F. KURTESON ---------------------- Name Printed: George F. Kurteson Title: Senior Vice President EX-99 4 EXHIBIT 10.19 - STOCK PURCHASE AGREEMENT EXECUTION COPY - -------------------------------------------------------------------------------- STOCK PURCHASE AGREEMENT BY AND AMONG AKI, INC. AND THE SELLERS LISTED ON THE SIGNATURE PAGES HEREOF Dated as of September 2, 1999 - --------------------------------------------------------------------------------
TABLE OF CONTENTS Page Article I SALE AND PURCHASE OF SHARES.............................................................................1 Section 1.1 Sale and Purchase of Shares.....................................................................1 Article II PURCHASE PRICE AND PAYMENT.............................................................................1 Section 2.1 Amount of Purchase Price........................................................................1 Section 2.2 Payment of Estimated Purchase Price.............................................................2 Section 2.3 Escrows.........................................................................................2 Section 2.4 Determination of Purchase Price.................................................................3 Article III CLOSING AND TERMINATION...............................................................................5 Section 3.1 Closing Date....................................................................................5 Section 3.2 Termination of Agreement........................................................................5 Section 3.3 Procedure Upon Termination......................................................................5 Section 3.4 Effect of Termination...........................................................................5 Article IV REPRESENTATIONS AND WARRANTIES OF THE SELLERS..........................................................6 Section 4.1 Organization and Good Standing..................................................................6 Section 4.2 Authorization of Agreement......................................................................6 Section 4.3 Capitalization..................................................................................7 Section 4.4 Subsidiaries....................................................................................7 Section 4.5 Conflicts; Certain Consents of Third Parties....................................................8 Section 4.6 Ownership and Transfer of Shares; Seller Consents...............................................8 Section 4.7 Financial Statements............................................................................9 Section 4.8 No Undisclosed Liabilities.....................................................................10 Section 4.9 Absence of Certain Developments................................................................10 Section 4.10 Taxes..........................................................................................11 Section 4.11 Real Property..................................................................................13 Section 4.12 Tangible Personal Property.....................................................................14 Section 4.13 Intellectual Property; Proprietary Information.................................................14 Section 4.14 Material Contracts.............................................................................16 Section 4.15 Employee Benefits..............................................................................16 Section 4.16 Labor..........................................................................................18 Section 4.17 Litigation.....................................................................................19 Section 4.18 Compliance with Laws; Permits..................................................................19 Section 4.19 Environmental Matters..........................................................................19 Section 4.20 Insurance......................................................................................20 Section 4.21 Inventories; Receivables; Payables.............................................................20 Section 4.22 Related Party Transactions.....................................................................21 Section 4.23 Banks..........................................................................................22 Section 4.24 Full Disclosure................................................................................22 i Section 4.25 Financial Advisors.............................................................................22 Section 4.26 Year 2000 Compliance...........................................................................22 Section 4.27 Representations and Warranties Exclusive.......................................................23 Article V REPRESENTATIONS AND WARRANTIES OF THE PURCHASER........................................................23 Section 5.1 Organization and Good Standing.................................................................23 Section 5.2 Authorization of Agreement.....................................................................23 Section 5.3 Conflicts; Consents of Third Parties...........................................................23 Section 5.4 Litigation.....................................................................................24 Section 5.5 Investment Intention...........................................................................24 Section 5.6 Financial Advisors.............................................................................24 Article VI COVENANTS.............................................................................................25 Section 6.1 Access to Information..........................................................................25 Section 6.2 Conduct of the Business Pending the Closing....................................................26 Section 6.3 Consents.......................................................................................27 Section 6.4 Other Actions..................................................................................27 Section 6.5 No Solicitation................................................................................27 Section 6.6 Preservation of Records........................................................................28 Section 6.7 Publicity......................................................................................29 Section 6.8 Termination of Agreements......................................................................29 Section 6.9 Intellectual Property..........................................................................29 Section 6.10 Collection of Accounts Receivable..............................................................29 Article VII OTHER AGREEMENTS.....................................................................................30 Section 7.1 Payment of Sleepeck Indebtedness...............................................................30 Section 7.2 Exercise of Options and Releases...............................................................30 Section 7.3 Employees......................................................................................31 Section 7.4 Certain Insurance Coverage.....................................................................31 Article VIII CONDITIONS TO CLOSING...............................................................................31 Section 8.1 Conditions Precedent to Obligations of the Purchaser...........................................31 Section 8.2 Conditions Precedent to Obligations of the Sellers.............................................34 Article IX CLOSING DELIVERIES....................................................................................35 Section 9.1 Documents to be Delivered by the Sellers.......................................................35 Section 9.2 Documents to be Delivered by the Purchaser.....................................................36 Section 9.3 Simultaneous Transactions......................................................................37 Article X INDEMNIFICATION........................................................................................37 Section 10.1 Non-Tax Indemnification........................................................................37 Section 10.2 Limitations on Indemnification for Breaches of Representations and Warranties...............................................................................39 Section 10.3 Non-Tax Indemnification Procedures.............................................................40 Section 10.4 Tax Matters....................................................................................41 Section 10.5 Tax Treatment of Indemnity Payments............................................................46 ii Article XI MISCELLANEOUS.........................................................................................46 Section 11.1 Certain Definitions............................................................................46 Section 11.2 Survival.......................................................................................51 Section 11.3 Expenses.......................................................................................51 Section 11.4 Specific Performance...........................................................................52 Section 11.5 Further Assurances.............................................................................52 Section 11.6 Arbitration....................................................................................52 Section 11.7 Entire Agreement; Amendments and Waivers.......................................................52 Section 11.8 Governing Law..................................................................................53 Section 11.9 Table of Contents and Headings.................................................................53 Section 11.10 Notices........................................................................................53 Section 11.11 Severability...................................................................................55 Section 11.12 Binding Effect; Assignment.....................................................................55 Section 11.13 Sellers'Representatives........................................................................56 Section 11.14 Disclaimer of Certain Kinds of Damages.........................................................56
iii SCHEDULES Schedule 1.1 - Sellers; Shares; Sharing Ratios Schedule 2.1 - 1998 Working Capital Schedule 2.3 - Accounts Receivable Schedule 4.1 - Organizations and Good Standing Schedule 4.3(a) - Owners of Stock Schedule 4.3(b) - Rights Holders/Exceptions Schedule 4.4 - Subsidiaries/Qualifications Schedule 4.5 - Consents of Third Parties Schedule 4.6 - Share Ownership Schedule 4.8 - Undisclosed Liabilities Schedule 4.7 - Financial Statements Schedule 4.9 - Certain Developments Schedule 4.10 - Taxes Schedule 4.11 - Real Property Leases Schedule 4.12(a) - Personal Property Leases Schedule 4.13 - Intellectual Property Schedule 4.14 - Material Contracts Schedule 4.15 - Employee Benefits Schedule 4.16 - Labor Schedule 4.17 - Litigation Schedule 4.19 - Environmental Matters Schedule 4.20 - Insurance Schedule 4.21 - Inventories; Receivables; Payables Schedule 4.22 - Related Party Transactions Schedule 4.23 - Banks Schedule 5.3(b) - Consents Required of Purchaser Schedule 6.8 - Termination of Agreements Schedule 8.1(r) - Employee Receivables Schedule 8.1(u) - Terminated Employees Schedule 10.1 - Indemnification Exceptions EXHIBITS Exhibit A - Form of Escrow Agreement Exhibit B - Form of Employment Agreement Exhibit C - Form of Consulting Agreement Exhibit D - Printing Services Agreement Exhibit E - Form of Non-Competition and Non-Solicitation Agreement Exhibit F - Form of Release iv STOCK PURCHASE AGREEMENT STOCK PURCHASE AGREEMENT, dated as of September 2, 1999 (the "Agreement"), by and among AKI, Inc., a Delaware corporation (the "Purchaser"), and the shareholders and rights holders of RetCom Holdings Ltd., a Delaware corporation (the "Company"), listed on the signature pages hereof (collectively, the "Sellers"). W I T N E S S E T H: - - - - - - - - - - WHEREAS, the Sellers own as specified in Schedule 1.1 all of the issued and outstanding shares of the Company's common stock, no par value (the "Common Stock"), and all of the issued and outstanding options and other rights to purchase capital stock of and all of the other equity rights of the Company (collectively, the "Options"); and WHEREAS, the Sellers desire to sell to Purchaser, and the Purchaser desires to purchase from the Sellers, the Common Stock and Options set forth on Schedule 1.1 (collectively, the "Shares") for the purchase price and upon the terms and conditions hereinafter set forth; and WHEREAS, certain terms used in this Agreement are defined in Section 11.1; NOW, THEREFORE, in consideration of the premises and the mutual covenants and agreements hereinafter contained, the parties hereby agree as follows: Article I SALE AND PURCHASE OF SHARES Section 1.1 Sale and Purchase of Shares. Upon the terms and subject to the conditions contained herein, on the Closing Date each Seller identified on Schedule 1.1 shall sell, assign, transfer, convey and deliver to the Purchaser, and the Purchaser shall purchase from each such Seller, the Shares of such Seller set forth opposite such Seller's name on Schedule 1.1 hereto. Article II PURCHASE PRICE AND PAYMENT Section 2.1 Amount of Purchase Price. The aggregate purchase price (the "Purchase Price") for the Shares shall be an amount equal to $10,180,000 less (A) the amount by which Working Capital as of the earlier of September 15, 1999 and the Closing Date (the "Determination Date") (i) falls short of 108% of the amount of Working Capital for September 15, 1998 (the "1998 Working Capital") if the 1998 Working Capital was greater than or equal to zero or (ii) is less than 92% of the 1998 Working Capital if the 1998 Working Capital was less than zero, and (B) the excess of Indebtedness as of the Determination Date over $4.5 million. Each Seller identified on Schedule 1.1 shall receive the amount set forth opposite his or its name on Schedule 1.1, subject to adjustment as described in (A) and (B) above, such adjustments for each such Seller being calculated pro rata in accordance with the sharing ratios set forth on Schedule 1.1 (the "Sharing Ratios"). Section 2.2 Payment of Estimated Purchase Price. No later than the close of business on September 7, 1999, the Purchaser and Jay Gartlan shall agree on the estimate of the 1998 Working Capital and shall agree on a schedule to this Agreement to be initialed by William J. Fox and Jay Gartlan and inserted as Schedule 2.1. Schedule 2.1 shall show the estimate of the 1998 Working Capital, based on the average of the Working Capital as of August 31, 1998 and the Working Capital as of September 30, 1998, as shown on the unaudited balance sheets of the Company as of such respective dates (the "1998 Interim Balance Sheets"). The 1998 Working Capital shall be compiled from the relevant line items on the 1998 Interim Balance Sheets consistent with the definition of Working Capital herein, including consistency with GAAP, except as noted in Schedule 2.1. At least two Business Days prior to the Closing Date, the Purchaser and the Sellers' Representatives shall agree on an estimate of the Purchase Price (the "Estimated Purchase Price") based on the 1998 Working Capital as shown on Schedule 2.1 and using the internal accounting records of the Company and its Subsidiaries for purposes of estimating the Working Capital as of the Determination Date. On the Closing Date, the Purchaser shall pay the Estimated Purchase Price, adjusted as set forth in Section 2.3, to the Sellers identified on Schedule 1.1 in accordance with the Sharing Ratios. Each Seller's portion of the Estimated Purchase Price shall be paid to such Seller by wire transfer of immediately available funds into an account designated in writing by such Seller not later than two Business Days before the Closing Date (or, if no account is designated, then by certified check payable in immediately available funds to the order of such Seller). Section 2.3 Escrows. (a) The Purchaser shall withhold from each Seller identified on Schedule 1.1, pro rata in accordance with the Sharing Ratios, an aggregate of $200,000 (the "Purchase Price Escrow Amount") from the Estimated Purchase Price on the Closing Date pending agreement pursuant to Section 2.4 as to the amounts of 1998 Working Capital and Working Capital and Indebtedness on the Determination Date. The Purchase Price Escrow Amount shall be deposited in an interest bearing escrow account with Hudson United Bank or another Person acceptable to the Purchaser and the Sellers' Representatives, as escrow agent (the "Escrow Agent"), pursuant to an Escrow Agreement (the "Escrow Agreement") substantially in the form of Exhibit A attached hereto, pending final determination of the Purchase Price pursuant to Section 2.4. Upon the final determination of the Purchase Price pursuant to Section 2.4, the Purchase Price Escrow Amount, if any, shall be disbursed in accordance with such final determination. (b) The Purchaser shall withhold from each Seller identified on Schedule 1.1, pro rata in accordance with the Sharing Ratios, an aggregate of $500,000 (together with the Additional Indemnification Amount, if any, the 2 "Indemnification Escrow Amount") from the Estimated Purchase Price on the Closing Date, which will be held in an interest bearing escrow account (the "Indemnification Escrow Account") with the Escrow Agent pursuant to the Escrow Agreement, as security for the Purchaser with respect to the representations and warranties of the Sellers set forth in Article IV and the indemnification obligations of the Sellers set forth in Article X. Subject to certain exceptions set forth in the Escrow Agreement, on January 2, 2001 or as promptly as practicable thereafter, the remaining balance of the Indemnification Escrow Amount and interest earned on all amounts deposited pursuant to the Escrow Agreement, if any, shall be disbursed to the Sellers in accordance with their Sharing Ratios. (c) The Purchaser shall withhold from each Seller identified on Schedule 1.1, pro rata in accordance with the Sharing Ratios, an aggregate of $500,000 (the "Receivable Escrow Amount") from the Estimated Purchase Price on the Closing Date, which will be held in an interest bearing escrow account with the Escrow Agent pursuant to the Escrow Agreement, as security for the Purchaser with respect to the collectability of accounts receivable of the Company and its Subsidiaries existing as of the Closing Date which are older than 90 days, and which are set forth on Schedule 2.3, which Schedule shall be updated in accordance with Section 6.1(b) hereof as of the close of business on the day immediately preceding the Closing Date (collectively, the "Aged Accounts Receivable"). An amount equal to the aggregate Aged Accounts Receivable (other than Aged Accounts Receivable which have been previously written-off) which have not been collected by the Company or its Subsidiaries by the date which is 90 days after the Closing Date (the "Collection Date"), less an amount equal to the $38,743 general reserve against Aged Accounts Receivable reflected on the unaudited compiled consolidated balance sheet as of June 30, 1999 (the "Uncollected Receivables Amount") shall be disbursed to the Purchaser from the Receivable Escrow Amount as promptly as practicable following the Collection Date, and the remaining balance of the Receivable Escrow Amount, if any (the "Additional Indemnification Amount"), shall be transferred and deposited into the Indemnification Escrow Account. Thereafter, the Indemnification Escrow Amount shall be increased by an amount equal to the Additional Indemnification Amount, and shall be held as security for the Purchaser with respect to the representations and warranties of the Sellers set forth in Article IV and the indemnification obligations of the Sellers set forth in Article X. The Purchaser shall cause the Company and/or its Subsidiaries, as the case may be, to assign to the Sellers (or their respective designees) all of the Company's and/or its Subsidiaries' right, title and interest in and to Aged Accounts Receivable, as the Purchaser shall select in its sole discretion (as evidenced by one or more invoices), in an aggregate amount equal to the funds disbursed from escrow to the Purchaser in respect of the Uncollected Receivables Amount. During the period following the Closing Date and until the Collection Date (the "Collection Period"), all payments received by the Company and its Subsidiaries from any customer owing both Aged Accounts Receivable and other accounts receivable to the Company or any Subsidiary during the Collection Period shall be applied to such accounts receivables as directed by such customer. Section 2.4 Determination of Purchase Price. (a) As soon as practicable following the Closing Date, but in no event later than 30 days following the Closing Date, the Purchaser shall cause the Company to prepare and deliver to the Sellers a final calculation of 1998 Working Capital and Working Capital and Indebtedness as of the Determination Date and a balance sheet for the Company and its Subsidiaries as of the Determination Date (the "Closing Date Balance Sheet") and Jay Gartlan shall be entitled to consult with the Company in the preparation of such final calculations and the Closing Date Balance Sheet. The Closing Date Balance Sheet shall be prepared in accordance with GAAP and shall (i) include all Taxes accrued on the June 30, 1999 Balance Sheet, (ii) include all Taxes accruing after June 30, 1999 and until the Closing Date in the ordinary course of business of the Company and its Subsidiaries and which are not due for payment on or prior to the Closing Date, (iii) be subject to the exception set forth on Schedule 10.1 hereto with respect to sales and use Tax liabilities, and (iv) include all such other reserves required by GAAP. If no objections are raised to the calculations of 1998 Working Capital, Working Capital and Indebtedness as of the Determination Date or the Closing Date Balance Sheet by the Sellers' Representatives within 30 days after receipt thereof by the Sellers, such calculations and such Closing Date Balance Sheet shall be deemed accepted and approved by the Sellers and a supplemental closing (herein called the "Supplemental Closing") shall be held at either the same place and time as is provided in Section 3.1 hereof, by conference telephone originated from such place at such time or as the Sellers and the Purchaser may otherwise agree in a signed writing on the fifth (5th) Business Day following the expiration of such 30 day period. At such Supplemental Closing any difference between the Estimated Purchase Price and the actual Purchase Price shall be paid to the Sellers or reimbursed to the Purchaser, as the case may be. Any amount payable hereunder shall be satisfied first from the Purchase Price Escrow Amount and thereafter shall be satisfied by direct payments by the Sellers identified on Schedule 1.1 (pro rata in accordance with their Sharing Ratios) or the Purchaser, as the case may be. (b) During the 30-day period after the Sellers' receipt of the final calculations of 1998 Working Capital and Working Capital and Indebtedness as of the Determination Date, the Purchaser shall permit the Sellers' Representatives, at the expense of the Sellers, to have reasonable access during normal business hours to appropriate supporting work papers specifically requested by the Sellers' Representatives with respect to such calculations. If the Sellers' Representatives object to the final calculations of 1998 Working Capital, Working Capital or Indebtedness as of the Determination Date or the Closing Date Balance Sheet within 30 days after receipt thereof, then the specific matters disputed by the Sellers' Representatives shall be submitted to Deloitte & Touche LLP or another independent, nationally recognized accounting firm acceptable to the Purchaser and the Sellers' Representatives, which accounting firm shall make a final and binding determination as to such matters. The Supplemental Closing shall then take place five (5) Business Days following the receipt of such final determination by the Purchaser and the Sellers' Representatives. (c) The parties shall cooperate with each other and each other's authorized representatives and with the accounting firm selected by the Purchaser and the Sellers' Representatives in order that any and all matters in dispute under this Section 2.4 shall be resolved as soon as practicable and that a final determination shall be made. (d) The fees and expenses of the accounting firm retained pursuant to this Section 2.4 shall be paid by the objecting Seller(s) and/or the Purchaser, as determined by such accounting firm. 4 Article III CLOSING AND TERMINATION Section 3.1 Closing Date. Subject to the satisfaction of the conditions set forth in Sections 8.1 and 8.2 hereof (except for the condition set forth in Sections 8.1(q) and 8.2(l)) or the waiver thereof by the party entitled to waive that condition, the closing of the sale and purchase of the Shares provided for in Section 1.1 hereof (the "Closing") shall take place at 10:00 a.m., New York City time, at the offices of Akin, Gump, Strauss, Hauer & Feld, L.L.P. located at 590 Madison Avenue, New York, New York 10022 (or at such other place as the parties may designate in writing) on the date that the parties hereto reasonably expect the conditions in Sections 8.1 and 8.2 hereof to be satisfied or as soon as practicable thereafter as the parties may otherwise agree. The date on which the Closing shall be held is referred to in this Agreement as the "Closing Date." Section 3.2 Termination of Agreement. This Agreement may be terminated prior to the Closing as follows: (a) At the election of the Sellers' Representatives or the Purchaser on or after September 21, 1999, if conditions to the obligation of the relevant party to close shall not have been fulfilled or if the Closing shall not have otherwise occurred by the close of business on such date, provided that the party seeking to terminate is not in material default of any of its obligations hereunder; (b) by mutual written consent of the Sellers' Representatives and the Purchaser; (c) by the Sellers' Representatives or the Purchaser if there shall be in effect a final nonappealable Order of a Governmental Body of competent jurisdiction restraining, enjoining or otherwise prohibiting the consummation of the transactions contemplated hereby; it being agreed that the parties hereto shall promptly appeal any adverse determination which is not nonappealable (and pursue such appeal with reasonable diligence); or (d) by the Purchaser pursuant to Section 6.1. Section 3.3 Procedure Upon Termination. In the event of a termination of this Agreement pursuant to Section 3.2 hereof, written notice thereof shall forthwith be given to the other parties, this Agreement shall terminate, and the purchase of the Shares hereunder shall be abandoned, without further action by the Purchaser or the Sellers. If this Agreement is terminated as provided herein each party shall redeliver all documents, work papers and other material of any other party relating to the transactions contemplated hereby, whether so obtained before or after the execution hereof, to the party furnishing the same. Section 3.4 Effect of Termination. 5 In the event that this Agreement is validly terminated as provided herein, then each of the parties shall be relieved of their respective duties and obligations arising under this Agreement after the date of such termination and such termination shall be without liability to the Purchaser, the Company or any Seller; provided, however, that the obligations of the parties set forth in Sections 6.5, 11.3 and 11.6 and the provisions of Section 6.1 relating to confidentiality shall survive any such termination and shall be enforceable hereunder; provided, further, however, that nothing in this Article III shall relieve the Purchaser or any Seller of any liability for a breach of this Agreement. Article IV REPRESENTATIONS AND WARRANTIES OF THE SELLERS Each of the Sellers hereby jointly and severally represents and warrants to the Purchaser with respect to all representations and warranties in this Article IV, other than those set forth in Sections 4.2 and 4.6 and Section 4.24 (to the extent Section 4.24 relates to Sections 4.2 and 4.6). Each of the Sellers severally represents and warrants to the Purchaser as to itself only with respect to the representations and warranties in Sections 4.2 and 4.6 and Section 4.24 (to the extent Section 4.24 relates to Sections 4.2 and 4.6). Section 4.1 Organization and Good Standing. The Company is a corporation duly organized, validly existing and in good standing under the laws of Delaware and has all requisite corporate power and authority to own, lease and operate its properties and to carry on its business as now conducted. The Company is duly qualified or authorized to do business as a foreign corporation and is in good standing under the laws of the jurisdictions set forth on Schedule 4.1, which lists each jurisdiction in which it owns or leases real property and each other jurisdiction in which the conduct of its business or the ownership of its properties requires such qualification or authorization except where a failure to be so qualified would not have a material adverse effect on the condition, financial or otherwise, or on the earnings, prospects, business or operations of the Company and its Subsidiaries taken as a whole ("Material Adverse Effect"). Section 4.2 Authorization of Agreement. Such Seller has all requisite power, authority and legal capacity to execute and deliver this Agreement and each other agreement, document instrument or certificate contemplated by this Agreement to be executed by such Seller in connection with the consummation of the transactions contemplated by this Agreement (the "Seller Documents"), and to consummate the transactions contemplated hereby and thereby. This Agreement has been, and each of the Seller Documents shall be at or prior to the Closing, duly and validly authorized (if applicable), executed and delivered by such Seller and (assuming the due authorization, execution and delivery by the other parties hereto and thereto) this Agreement constitutes, and each of the Seller Documents when so executed and delivered shall constitute, legal, valid and binding obligations of such Seller, enforceable against such Seller in accordance with their respective terms, subject to applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting creditors' rights and remedies generally, and 6 subject, as to enforceability, to general principles of equity, including principles of commercial reasonableness, good faith and fair dealing (regardless of whether enforcement is sought in a proceeding at law or in equity). Section 4.3 Capitalization. (a) The authorized capital stock of the Company consists of 1,500 shares of Common Stock. After giving effect to the exercise of Options contemplated by Section 7.2 hereof and the exercise of the Option held by Jay Gartlan (collectively, the "Options Exercise"), as of the Closing Date there will be 110 shares of Common Stock issued and outstanding. After giving effect to the Options Exercise, as of the Closing Date all of the issued and outstanding shares of Common Stock will be duly authorized and validly issued, fully paid and non-assessable. Schedule 4.3(a) sets forth the names of the record and beneficial owners of all of the issued and outstanding shares of Common Stock as of the Closing Date and the number of shares of Common Stock owned by each such stockholder as of the Closing Date after giving effect to the Options Exercise. (b) Except as set forth on Schedule 4.3(b) and in the Memo Agreement dated January 15, 1998 (the "January Memo"), there is no existing option, warrant, call, right, commitment or other agreement of any character to which any Seller or the Company is a party requiring, and there are no securities of the Company outstanding which upon conversion or exchange would require, the issuance, sale or transfer of any additional shares of capital stock or other equity securities of or rights to participate in the Company or other securities convertible into, exchangeable for or evidencing the right to subscribe for or purchase shares of capital stock or other equity securities of or rights to participate in the Company. Except for the January Memo and as set forth on Schedule 4.3(b), none of the Sellers nor the Company is a party to any voting trust or other voting agreement with respect to any of the shares of Common Stock or other equity securities of or rights to participate in the Company or to any agreement relating to the issuance, sale, redemption, transfer or other disposition of the capital stock of the Company. (c) The Shares to be sold to the Purchaser represent all of the capital stock and other equity securities or rights of any kind to acquire any such securities of the Company. Upon the Closing and after the consummation of the transactions contemplated hereby, no party other than the Purchaser (or other Persons acquiring such rights directly or indirectly from the Purchaser) will have any right or claim to participate in the assets or earnings of the Company. Section 4.4 Subsidiaries. Schedule 4.4 sets forth each Subsidiary of the Company, and, with respect to each Subsidiary, the jurisdiction in which it is incorporated or organized, the jurisdictions, if any, in which it is qualified to do business as a foreign corporation, the number of shares of its authorized capital stock, the number and class of shares thereof duly issued and outstanding, the names of all stockholders or other equity owners and the number of shares of stock owned by each stockholder or the amount of equity owned by each equity owner. Each Subsidiary of the Company is in good standing under the laws of the jurisdictions set forth on Schedule 4.4, which lists each jurisdiction in which 7 such Subsidiary owns or leases real property and each other jurisdiction in which the conduct of its business or the ownership of its properties requires it to possess such qualification or authorization, except where a failure to be so qualified would not have a Material Adverse Effect. The outstanding shares of capital stock or equity interests of each Subsidiary are validly issued, fully paid and non-assessable, and all such shares or other equity interests represented as being owned by the Company are owned by it free and clear of any and all Liens, except as set forth in Schedule 4.4 hereto. There is no existing option, warrant, call, commitment or agreement to which any Subsidiary is a party requiring, and there are no convertible securities of any Subsidiary outstanding which upon conversion would require, the issuance of any additional shares of capital stock or other equity interests of any Subsidiary or other securities convertible into shares of capital stock or other equity interests of any Subsidiary or other equity security of any Subsidiary. Each Subsidiary is a duly organized and validly existing corporation or other entity in good standing under the laws of the jurisdiction of its organization and is duly qualified to do business and is in good standing under the laws of (i) each jurisdiction in which it owns or leases real property and (ii) each other jurisdiction in which the conduct of its business or the ownership of its assets requires such qualification except where a failure to be so qualified would not have a Material Adverse Effect. Section 4.5 Conflicts; Certain Consents of Third Parties. (a) Except as set forth on Schedule 4.5, none of the execution and delivery by any Seller of this Agreement and the Seller Documents, the consummation of the transactions contemplated hereby or thereby, or compliance by any Seller with any of the provisions hereof or thereof will (i) conflict with, or result in the breach of, any provision of the certificate of incorporation or by-laws or comparable organizational documents of the Company or any Subsidiary; (ii) conflict with, violate, result in the breach or termination of, accelerate the performance required by, give rise to any right of termination, acceleration, cancellation or amendment under, or constitute a default under any Contract, instrument, note, bond, mortgage, indenture, lease, license, franchise, commitment, covenant, understanding, arrangement, agreement or other instrument or obligation to which the Company or any Subsidiary is a party or by which any of them or any of their respective properties or assets is bound; (iii) violate any statute, rule, regulation, order or decree of any Governmental Body by which the Company or any Subsidiary is bound; or (iv) result in the creation of any Lien upon the properties or assets of the Company or any Subsidiary except, in case of clauses (ii), (iii) and (iv), for such violations, breaches or defaults as would not, individually or in the aggregate, have a Material Adverse Effect. (b) Except as set forth on Schedule 4.5, no consent, waiver, approval, Order, Permit or authorization of, or declaration or filing with, or notification to, any Person or Governmental Body is required on the part of the Company or any Subsidiary in connection with the execution and delivery of this Agreement or the Seller Documents, or the compliance by the Company, with any of the provisions hereof or thereof, except that no representation is made as to anything under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and the rules and regulations promulgated thereunder (the "HSR Act"). Section 4.6 Ownership and Transfer of Shares; Seller Consents. (a) After giving effect to the Options Exercise, as of the Closing Date the Purchaser shall be the record and beneficial owner of the 8 Shares indicated as being owned by each Seller on Schedule 4.6, and on the Closing Date, after giving effect to the Options Exercise, will have valid and marketable title to the Shares to be sold by such Seller, free and clear of any and all Liens after giving effect to the transactions contemplated by this Agreement. Each Seller has the capacity, power, corporate or otherwise, and authority to sell, transfer, assign and deliver such Shares as provided in this Agreement, and such delivery will convey to the Purchaser good and marketable title to such Shares, free and clear of any and all Liens upon the consummation of the transactions contemplated by this Agreement. (b) Except as set forth on Schedule 4.6, no consent, waiver, approval, Order, Permit or authorization of, or declaration or filing with, or notification to, any Person or Governmental Body is required on the part of any Seller in connection with the execution and delivery of this Agreement or the Seller documents, or the compliance by each Seller with any provisions hereof or thereof, except that no representation is made as to anything under the HSR Act. Section 4.7 Financial Statements. Attached hereto as Schedule 4.7 are copies of (i) the audited consolidated balance sheets of the Company and its Subsidiaries as at December 31, 1998 and the related audited consolidated statements of income and of cash flows of the Company and its Subsidiaries for the year then ended and, (ii) the unaudited compiled consolidated balance sheets of RCC and its subsidiaries as at December 31, 1997 and the unaudited compiled consolidated balance sheets of the Company and its Subsidiaries as at June 30, 1999 (the "June 30, 1999 Balance Sheet") and the related consolidated statements of income and cash flows (except that there are no cash flows for the June 30, 1999 Balance Sheet) for the year and six-month period then ended, respectively (such audited and unaudited statements, including the related notes (except that there are no notes for the June 30, 1999 Balance Sheet) and schedules thereto, are referred to herein as the "Financial Statements"). Except as set forth on Schedule 4.7, each of the Financial Statements is complete and correct in all material respects, has been prepared in accordance with GAAP and in conformity with the practices consistently applied by RCC or the Company, as the case may be, without modification of the accounting principles used in the preparation thereof and presents fairly the financial position, results of operations and cash flows of RCC and its subsidiaries or the Company and its Subsidiaries, as the case may be, as at the dates and for the periods indicated. For the purposes hereof, the audited consolidated balance sheet of the Company and its Subsidiaries as at December 31, 1998 is referred to as the "Balance Sheet" and December 31, 1998 is referred to as the "Balance Sheet Date." Except as set forth on Schedule 2.1, the 1998 Interim Balance Sheets, to the extent relevant to the determination of the 1998 Working Capital, are complete and correct in all material respects, have been prepared in accordance with GAAP and in conformity with the practices consistently applied by RCC or the Company, as the case may be, without modification of the accounting principles used in the preparation thereof and present fairly the financial position of the Company and its Subsidiaries as at the dates and for the periods indicated. The 1998 Working Capital set forth on Schedule 2.1 has 9 been accurately compiled from the relevant line items in the 1998 Interim Balance Sheets and properly calculated in accordance with the definition of Working Capital contained herein (except for inconsistencies with GAAP specifically set forth on Schedule 2.1). Section 4.8 No Undisclosed Liabilities. Except as set forth on Schedule 4.8, neither the Company nor any Subsidiary has any indebtedness, obligations or liabilities of any kind (whether accrued, absolute, contingent or otherwise, and whether due or to become due) that would have been required to be reflected in, reserved against or otherwise described on the Balance Sheet or the June 30, 1999 Balance Sheet or in the notes thereto in accordance with GAAP which was not fully reflected in, reserved against or otherwise described in the Balance Sheet or the notes thereto or the June 30, 1999 Balance Sheet in accordance with GAAP or was not incurred in the ordinary course of business consistent with past practice since June 30, 1999. Section 4.9 Absence of Certain Developments. Except as expressly contemplated by this Agreement or as set forth on Schedule 4.9, since the Balance Sheet Date: (i) there has not been any Material Adverse Change nor has there occurred any event which is reasonably likely to result in a Material Adverse Change; (ii) there has not been any damage, destruction or loss, whether or not covered by insurance, with respect to the property and assets of the Company or any Subsidiary having a replacement cost of more than $25,000 for any single loss or $100,000 for all such losses; (iii) there has not been any declaration, setting aside or payment of any dividend or other distribution in respect of any shares of capital stock of the Company or any repurchase, redemption or other acquisition by any Seller or the Company or any Subsidiary of any outstanding shares of capital stock or other securities of, or other ownership interest in, the Company or any Subsidiary; (iv) neither the Company nor any Subsidiary has awarded or paid any bonuses to employees of the Company or any Subsidiary with respect to the fiscal year ending December 31, 1999, or entered into any employment, deferred compensation, severance or similar agreement (nor amended any such agreement) or agreed to increase the compensation payable or to become payable by it to any of the Company's or any Subsidiary's directors, officers, employees, agents or representatives or agreed to increase the coverage or benefits available under any severance pay, termination pay, vacation pay, company awards, salary continuation for disability, sick leave, deferred compensation, bonus or other incentive compensation, insurance, pension or other employee benefit plan, payment or arrangement made to, for or with such directors, officers, employees, agents or representatives (other than normal increases in the ordinary course of business consistent with past practice or consistent with the terms of the existing employment agreements set forth in Schedule 4.15(a) and that in the aggregate have not resulted in a material increase in the benefits or compensation expense of the Company and its Subsidiaries taken as a whole); 10 (v) there has not been any change by the Company or any Subsidiary in accounting or Tax reporting principles, methods or policies; (vi) neither the Company nor any Subsidiary has entered into any transaction or Contract in excess of $25,000 (other than contracts relating to sales to customers and purchases of materials and services included in the Company's accounts for costs of goods sold, in each case (A) which have been fully performed by all parties thereto or (B) which have not been fully performed and do not involve payments exceeding $50,000) or conducted its business other than in the ordinary course consistent with past practice, except to the extent that during the entire period since the Balance Sheet Date, the Company and its Subsidiaries have been engaged in discussions relating to the sale or refinancing of their respective businesses; (vii) neither the Company nor any Subsidiary has made any loans, advances or capital contributions to, or investments in, any Person or paid any fees or expenses to any Seller or any Affiliate of any Seller (other than (x) payments to Sleepeck Printing or Dixon Webb Printing Company for printing services in the ordinary course of business which are included in the Company's accounts for costs of goods sold, and (y) employee expense reimbursements in the ordinary course of business consistent with current contracts in an amount not to exceed $50,000 in the aggregate per employee); (viii) neither the Company nor any Subsidiary has subjected to any Lien (other than Permitted Exceptions) any of its assets, or acquired any assets or sold, assigned, transferred, conveyed, leased or otherwise disposed of any assets of the Company or any Subsidiary, except for assets acquired or sold, assigned, transferred, conveyed, leased or otherwise disposed of in the ordinary course of business consistent with past practice and Liens granted and transfers to Sleepeck Printing in connection with the Sleepeck Indebtedness; (ix) neither the Company nor any Subsidiary has made or committed to make any capital expenditures or capital additions or betterments in excess of $25,000 individually or $100,000 in the aggregate; and (x) none of the Sellers nor the Company has agreed to do anything set forth in and not excepted by this Section 4.9. Section 4.10 Taxes. (a) Except as set forth on Schedule 4.10, (A) all Tax Returns required to be filed by or on behalf of the Company and each of its Subsidiaries have been properly prepared and duly and timely filed with the appropriate taxing authorities in all jurisdictions in which such Tax Returns are required to be filed (after giving effect to any valid extensions of time in which to make such filings), and all such Tax Returns were true, complete and correct in all material respects; (B) all Taxes owed and required to be paid by any of the Company and its Subsidiaries prior to the date hereof or prior to the Closing Date (whether or not shown on any Tax Return) have been paid or properly reflected as an accrual on the June 30, 1999 Balance Sheet; and (C) neither the Company nor any Subsidiary has executed or filed with the IRS or any other taxing authority any agreement, waiver or other document or arrangement extending or having the effect of extending the period for assessment or collection of Taxes (including, but not limited to, any applicable statute of 11 limitation), and no power of attorney with respect to any Tax matter is currently in force. (b) The Company and each of its Subsidiaries has complied in all material respects with all applicable laws, rules and regulations relating to the payment and withholding of Taxes and has duly and timely withheld from employee salaries, wages and other compensation and has paid over to the appropriate taxing authorities all amounts required to be so withheld and paid over for all periods under all applicable laws. (c) Purchaser has received complete copies of (A) all federal, state, local and foreign income or franchise Tax Returns of the Company and each Subsidiary relating to taxable periods since 1995 and (B) any audit report issued within the last three years relating to Taxes due from or with respect to the Company and each Subsidiary, its income, assets or operations. All income and franchise Tax Returns filed by or on behalf of the Company and each Subsidiary for the taxable years ended on the respective dates set forth on Schedule 4.10 have been examined by the relevant taxing authority or the statute of limitations with respect to such Tax Returns has expired. (d) Except as set forth on Schedule 4.10, no claim has been made by a taxing authority in a jurisdiction where the Company or any of its Subsidiaries does not file Tax Returns that it is or may be subject to taxation by that jurisdiction. (e) Except as set forth on Schedule 4.10, all deficiencies asserted or assessments made as a result of any examinations by the IRS or any other taxing authority of the Tax Returns of or covering or including the Company or any of its Subsidiaries have been fully paid, and none of the Sellers, the Company or any of its Subsidiaries have received any notice that there are any other audits or investigations by any taxing authority that are in progress, nor have the Sellers, Company or any of its Subsidiaries received any notice from any taxing authority that it intends to conduct such an audit or investigation. No issue has been raised by a federal, state, local or foreign taxing authority in any current or prior examination which, by application of the same or similar principles, could reasonably be expected to result in a proposed deficiency for any subsequent taxable period. (f) Except as set forth on Schedule 4.10, neither the Company nor any of its Subsidiaries nor any other Person (including any of the Sellers) on behalf of the Company or any of its Subsidiaries has (A) filed a consent pursuant to Section 341(f) of the Code or agreed to have Section 341(f)(2) of the Code apply to any disposition of a subsection (f) asset (as such term is defined in Section 341(f)(4) of the Code) owned by the Company or any of its Subsidiaries, (B) agreed to or is required to make any adjustments pursuant to Section 481(a) of the Code or any similar provision of state, local or foreign law by reason of a change in accounting method initiated by the Company or any of its Subsidiaries or has any knowledge that the IRS has proposed any such adjustment or change in accounting method, or has any application pending with any taxing authority requesting permission for any changes in accounting methods that relate to the business or operations of the Company or any of its Subsidiaries or (C) requested any extension of time within which to file any Tax Return of the Company or any of its Subsidiaries, which Tax Return has since not been filed. Each of the Company and its Subsidiaries has disclosed in its federal income Tax Returns all positions taken that could give rise to a 12 substantial understatement of federal income Tax within the meaning of Section 6662 of the Code. (g) No Seller is a foreign person within the meaning of Section 1445 of the Code. (h) Neither the Company nor any of its Subsidiaries is a party to any tax sharing or similar agreement or arrangement (whether or not written) pursuant to which it will have any obligation to make any payments after the Closing. (i) There is no contract, agreement, plan or arrangement covering any person that, individually or collectively, could give rise to the payment of any amount by the Company or any of its Subsidiaries that would not be deductible by the Company or any of its Subsidiaries, the Purchaser, or any of their respective Affiliates by reason of Section 280G of the Code. (j) There are no Liens except Permitted Exceptions as a result of any unpaid Taxes upon any of the assets of the Company or any of its Subsidiaries. (k) Neither the Company nor any of its Subsidiaries has ever been a member of any consolidated, combined or affiliated group of corporations for any Tax purposes except the consolidated group of which they are currently members. (l) For each taxable period beginning in 1986 and ending on December 31, 1997, RCC had a valid election to be treated as an S corporation as the term is defined in Code Sections 1361(a) for federal income tax purposes and a similar valid election under the laws of the State of New York or any other applicable governmental authority. RCC has not been, and will not be, subject to Tax under Code Section 1374 or 1375 (or any comparable provision of New York law) for any period ending on or prior to the Closing Date. Section 4.11 Real Property. Neither the Company nor its Subsidiaries own any real property or interests in real property in fee. Schedule 4.11 sets forth a complete list of all real property and interests in real property leased by the Company and its Subsidiaries ("Real Property Leases") as lessee, all security deposits made thereunder and any and all guarantees or other agreements relating to the Real Property Leases. The Real Property Leases constitute all interests in real property currently used or currently held for use in connection with the business of the Company and its Subsidiaries and which are necessary for the continued operation of the business of the Company and its Subsidiaries as the business is currently conducted. The Company and its Subsidiaries have a valid and enforceable leasehold interest under each of the Real Property Leases, subject to applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting creditors' rights and remedies generally and subject, as to enforceability, to general principles of equity (regardless of whether enforcement is sought in a proceeding at law or in equity), and except as set forth on Schedule 4.11, there is no default under any Real Property Lease by the Company or any of its Subsidiaries or, to the best knowledge of the Sellers, by any other party thereto, and no event has occurred that with notice or lapse of time, or both, would constitute a default by the Company or any Subsidiary thereunder. The Sellers have delivered to the Purchaser true, correct and complete copies of the Real Property Leases, together with all amendments, modifications or supplements, if any, thereto. 13 Section 4.12 Tangible Personal Property. (a) Schedule 4.12 sets forth each lease of personal property ("Personal Property Leases") involving annual payments in excess of $6,000 relating to personal property used in the business of the Company or any of its Subsidiaries or to which the Company or any of its Subsidiaries is a party or by which the properties or assets of the Company or any of its Subsidiaries is bound. The Sellers have delivered to the Purchaser true, correct and complete copies of the Personal Property Leases, together with all amendments, modifications or supplements thereto. (b) The Company and each of its Subsidiaries have a valid leasehold interest under each of the Personal Property Leases under which it is a lessee, subject to applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting creditors' rights and remedies generally and subject, as to enforceability, to general principles of equity (regardless of whether enforcement is sought in a proceeding at law or in equity), and there is no material default under any Personal Property Lease by the Company or any of its Subsidiaries or, to the knowledge of the Sellers, by any other party thereto, and no event has occurred that with notice or lapse of time or both would constitute a material default thereunder by the Company or any Subsidiary. (c) The Company and its Subsidiaries have good and marketable title to all of the items of tangible personal property reflected in the Balance Sheet (except as sold or disposed of subsequent to the date thereof in the ordinary course of business consistent with past practice), free and clear of any and all Liens other than the Permitted Exceptions and Liens in favor of Sleepeck Printing. All such items of tangible personal property which, individually or in the aggregate, are material to the operation of the business of the Company and its Subsidiaries are in good condition and in a state of good maintenance and repair (ordinary wear and tear excepted) and are suitable for the purposes used. (d) All of the items of tangible personal property used by the Company and its Subsidiaries under the Personal Property Leases are in good condition and repair (ordinary wear and tear excepted) and are suitable for the purposes used. Section 4.13 Intellectual Property; Proprietary Information. (a) Schedule 4.13 contains a complete and correct list of each patent, patent application, trademark (registered or not), trademark application, common law mark, trade name, service mark, service mark application, and copyright (registered or not), software, manufacturing and development process, know-how, inventions, trade-secret, regardless of the form of manifestation of any of the above, and Internet domain name (including the domain name registration, the content contained within said domain and any proprietary software used in conjunction with said domain) owned, necessary or used by the Company and/or its Subsidiaries in the business as now conducted (collectively the "Intellectual Property") as well as all registrations thereof and pending applications therefor, and each license or other agreement relating thereto. Except for Liens in favor of Sleepeck Printing, each of the foregoing is owned by the party shown on such Schedule as owning the same, free and clear 14 of all Liens and is in good standing and not the subject of any challenge. There have been no claims made and neither the Sellers, the Company nor any Subsidiary has received any notice or otherwise knows, or has reason to believe, that any of the foregoing or the operations, business or products of the Company or any Subsidiary, is invalid, unenforceable, infringes upon or conflicts with the proprietary rights of others, nor does the Company or any Subsidiary know of any basis for any such claim (whether pending or threatened). The Company and each of its Subsidiaries possess or have rights to use all the Intellectual Property necessary for the conduct of its business as now conducted, not subject to any restrictions, licenses or third-party rights except as set forth on Schedule 4.13, and without any known conflict with the rights of others, and neither the Company nor any of its Subsidiaries has forfeited or otherwise relinquished any right in or to such Intellectual Property necessary for the conduct of their respective businesses as conducted or contemplated to be conducted on the date hereof. Neither the Company nor any of its Subsidiaries is under any obligation to pay any royalties or similar payments in connection with any license to any Seller or any Affiliate thereof. (b) Except as set forth on Schedule 4.13, the products, processes, proprietary technology and other proprietary know-how owned, used or contemplated to be used by the Company and/or its Subsidiaries were completely developed by the full time employees of the Company and/or its Subsidiaries only, using only resources of the Company and/or its Subsidiaries. The inventions and original works of authorship owned or used by the Company and/or its Subsidiaries were developed or conceived by employees within the scope of their employment by the Company and/or its Subsidiaries in connection with the underlying products, processes and proprietary technology of the Company and/or its Subsidiaries. Except as set forth on Schedule 4.13, no independent contractors or consultants were used or contracted by the Company and/or its Subsidiaries in the development of the products, processes, proprietary technology and other proprietary know-how owned or used or contemplated to be used by the Company and/or its Subsidiaries. To the extent that independent contractors or consultants were used or contracted by the Company as specified in Schedule 4.13 (the "Consultants"), the Sellers represent and warrant that any and all such Consultants have executed and delivered to the Company a document evidencing either the exclusive ownership of such Intellectual Property by the Company or its Subsidiaries, or the due conveyance, assignment and transfer of any and all rights, title and interest such Consultants may have in any work product, invention, idea, concept, original work of authorship or Intellectual Property they may have conceived, worked upon or otherwise participated in their development within the context of, or in connection with, their employment with the Company and/or its Subsidiaries, and the Company has all necessary releases, documents and agreements to make all necessary future filings for the registration and otherwise perfection of rights and to defend against any claim raised thereupon, duly executed by such Consultants, complete copies of which have been delivered to the Purchaser. (c) Except as set forth on Schedule 4.13, each employee, consultant or contractor of the Company and/or its Subsidiaries who works with Intellectual Property (other than clerical workers) has executed and delivered a non-disclosure, non-solicitation or invention assignment agreement, and a true and complete copy of each such agreement has been delivered to the Purchaser. The Company is not aware that any of its employees is in violation thereof, and the Sellers shall cause the Company to use its best efforts to prevent any such violation prior to Closing. 15 Section 4.14 Material Contracts. Schedule 4.14 sets forth all of the following Contracts to which the Company or any of its Subsidiaries is a party or by which any of them are bound, other than Contracts for which the Company or its Subsidiaries has no liabilities or continuing obligations whatsoever (collectively, the "Material Contracts"): (i) Contracts with any Seller or any current officer or director of the Company or any of its Subsidiaries; (ii) Contracts pursuant to which any party is required to purchase or sell a stated portion of its requirements or output from or to another party or relating to the sale or distribution of the Company's products; (iii) Contracts for the sale of any of the assets of the Company or any of its Subsidiaries other than in the ordinary course of business or for the grant to any person of any preferential rights to purchase any of its assets; (iv) joint venture agreements; (v) Contracts containing nondisclosure covenants or covenants not to compete in any line of business or with any person in any geographical area; (vi) Contracts relating to the acquisition by the Company or any of its Subsidiaries of any operating business or the capital stock of any other person; (vii) Contracts relating to the borrowing of money; or (viii) any other Contracts, other than Real Property Leases, Personal Property Leases or Contracts which pertain to the purchase or sale of goods and/or services in the ordinary course of business, which individually involve the expenditure of more than $50,000 in the aggregate or $6,000 annually, or require performance by any party more than one year from the date hereof. True and complete copies of all of the Material Contracts have been delivered to the Purchaser, or its representatives. Except as set forth on Schedule 4.14, all of the Material Contracts and other agreements are in full force and effect and are the legal, valid and binding obligations of the Company and/or its Subsidiaries, enforceable against them in accordance with their respective terms, subject to applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting creditors' rights and remedies generally and subject, as to enforceability, to general principles of equity (regardless of whether enforcement is sought in a proceeding at law or in equity). Neither the Company nor any Subsidiary is in default in any material respect under any Material Contract, nor, to the knowledge of any Seller, is any other party to any Material Contract in default thereunder in any material respect and no event has occurred that with notice or lapse of time or both would constitute a material default thereunder by the Company or any Subsidiary. Section 4.15 Employee Benefits. (a) All benefit and compensation plans, contracts, policies, agreements or other arrangements providing for compensation, severance, termination pay, performance awards, stock or stock related awards, fringe benefits, change in control compensation or benefits, employment, deferred compensation or other employee benefits of any kind, whether formal or informal, funded or unfunded, written or oral, and whether or not legally binding, or arrangements covering current employees or former employees of the Company and its Subsidiaries ("Employees") and current or former directors of the Company, including, but not limited to, "employee benefit plans" within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA") (the "Benefit Plans"), are listed on Schedule 4.15. Each "change in control" or similar provision contained therein is specifically identified on Schedule 4.15. 16 (b) All employee benefit plans, other than "multiemployer plans" within the meaning of Section 3(37) of ERISA, covering Employees (the "Plans"), to the extent subject to ERISA, are in substantial compliance with ERISA, the Code, and all other applicable law. Each Plan which is an "employee pension benefit plan" within the meaning of Section 3(2) of ERISA ("Pension Plan") and which is intended to be qualified under Section 401(a) of the Code, has received a favorable determination letter from the Internal Revenue Service with respect to "TRA" (as defined in Section 1 of Rev. Proc. 93-39), and the Company is not aware of any circumstances likely to result in revocation of any such favorable determination letter. There is no material pending or threatened litigation relating to the Plans. Neither the Company nor any of its Subsidiaries has engaged in a transaction with respect to any Plan that, assuming the taxable period of such transaction expired as of the date hereof, could subject the Company or any Subsidiary to a tax or penalty imposed by either Section 4975 of the Code or Section 502(i) of ERISA in an amount which would be material. (c) No current or former Pension Plan of the Company or any of its Subsidiaries, or any entity which is considered one employer with the Company under Section 4001 of ERISA or Section 414 of the Code (an "ERISA Affiliate"), is or has ever been subject to Title IV of ERISA or Section 412 of the Code. (d) All contributions required to be made under the terms of any Benefit Plan have been timely made or have been reflected on the financial statements of the Company. (e) Neither the Company nor any of its Subsidiaries has any obligations for retiree health and life benefits under any Benefit Plan or has ever represented, promised or contracted (whether in oral or written form) to any Employee(s) that such Employee(s) would be provided with retiree health or life benefits, other than rights and obligations under COBRA. (f) Except as contemplated by Section 8.1(u), the consummation of the transactions contemplated by this Agreement will not (x) entitle any Employees of the Company or any of the Subsidiaries to severance pay, (y) accelerate the time of payment or vesting or trigger any payment or funding (through a grantor trust or otherwise) of compensation or benefits under, increase the amount payable or trigger any other material obligation pursuant to, any of the Benefit Plans or (z) result in any breach or violation of, or a default under, any of the Benefit Plans. It is understood that in connection with the agreements referred to in Section 7.3 hereof, the Company will incur the obligations set forth therein. (g) Any amount that could be received (whether in cash, property, or vesting of property) as a result of the transaction contemplated by this Agreement by any officer, director, employee or independent contractor of the Company or any of its subsidiaries, who is a "disqualified individual" (as defined in proposed Treasury Regulation Section 1.280G-1), under any employment arrangement or Benefit Plan would not be characterized as an "excess parachute payment" (as defined in Section 280G of the Code). (i) True, correct and complete copies of the following documents, with respect to each of the Benefit Plans have been delivered to the Purchaser (A) any plans and related trust documents, and all amendments thereto, (B) the Forms 5500 for the past three years and schedules thereto, (C) the most 17 recent financial statements and actuarial valuations for the past three years, (D) the most recent Internal Revenue Service determination letter, (E) the most recent summary plan descriptions (including letters or other documents updating such descriptions) and (F) written descriptions of all non-written agreements relating to the Benefit Plans. (j) Except as set forth on Schedule 4.15, the Company and each of its Subsidiaries and any ERISA Affiliate which maintains a "group health plan" within the meaning of Section 5000(b)(1) of the Code have complied with the notice and continuation requirements of Section 4980B of the Code or Part 6 of Title I of ERISA and the applicable regulations thereunder. (k) No stock or other security issued by the Company or any of its Subsidiaries forms or has formed a material part of the assets of any Benefit Plan. Section 4.16 Labor. (a) Neither the Company nor any of its Subsidiaries is party to any labor or collective bargaining agreement and as of the date hereof there are no labor or collective bargaining agreements which pertain to employees of the Company or any of its Subsidiaries. (b) No employees of the Company or any of its Subsidiaries are represented by any labor organization. No labor organization or group of employees of the Company or any of its Subsidiaries has made a pending demand for recognition, and there are no representation proceedings or petitions seeking a representation proceeding presently pending or, to the best knowledge of the Sellers, threatened to be brought or filed, with the National Labor Relations Board or any other labor relations tribunal. There is no organizing activity involving the Company or any of its Subsidiaries pending or, to the best knowledge of any Seller, threatened by any labor organization or group of employees of the Company or any of its Subsidiaries. (c) There are no (i) strikes, work stoppages, slowdowns, lockouts or arbitrations or (ii) material grievances or other labor disputes pending or, to the best knowledge of any Seller, threatened against or involving the Company or any of its Subsidiaries. There are no unfair labor practice charges, grievances or complaints pending or, to the best knowledge of any Seller, threatened by or on behalf of any employee or group of employees of the Company. (d) Schedule 4.16 sets forth all consultants and independent contractors used by the Company as of the date hereof. None of such consultants and independent contractors is an employee of the Company. (e) All employees treated as "exempt" employees by the Company are "exempt" employees under the Fair Labor Standards Act, 29 U.S.C. Section 201, et seq., or under another analogous federal, state, or municipal wage and hour law. 18 Section 4.17 Litigation. Except as set forth in Schedule 4.17, there is no Legal Proceeding pending or, to the knowledge of the Sellers, overtly threatened against the Company or any of its Subsidiaries (or, to the knowledge of the Sellers, pending or threatened, against any of the officers, directors or key employees of the Company or any of its Subsidiaries with respect to their business activities on behalf of the Company or any of its Subsidiaries), or to which the Sellers or the Company or any of its Subsidiaries is otherwise a party, before any court, or before any Governmental Body; nor to the knowledge of the Sellers is there any reasonable basis for any such Legal Proceeding. Except as set forth in Schedule 4.17, neither the Company nor any Subsidiary is subject to any judgment, order or decree of any court or governmental agency and neither the Company nor any Subsidiary is engaged in any legal action to recover monies due it or for damages sustained by it. None of the Purchaser, the Company or any of its Subsidiaries shall have any liabilities or damages whatsoever incurred after the Closing Date (other than legal fees and expenses relating to the dismissal of such action) arising out of or otherwise related to the Cellesence proceeding set forth on Schedule 4.17 (the "Cellesence Matter"). Section 4.18 Compliance with Laws; Permits. The Company and each of its Subsidiaries is in compliance with all Laws applicable to it or to the conduct of its business or operations or the use of its properties (including any leased properties) and assets, except for such non-compliances, individually or in the aggregate, as would not be reasonably expected to result in a Material Adverse Effect. The Company and each of its Subsidiaries has all governmental Permits from state, federal or local authorities which are required for the Company and each of its Subsidiaries to operate its business, except for the absence of Permits, individually or in the aggregate, that would not be reasonably expected to result in a Material Adverse Effect. Section 4.19 Environmental Matters. Except as set forth on Schedule 4.19 hereto: (a) the operations of the Company and each of its Subsidiaries have been and are in compliance with all applicable Environmental Laws and all permits issued pursuant to Environmental Laws or otherwise; (b) the Company and each of its Subsidiaries has obtained all permits required under all applicable Environmental Laws necessary to operate its business; (c) neither the Company nor any of its Subsidiaries is the subject of any outstanding written order or Contract with any governmental authority or person respecting (i) Environmental Laws, (ii) Remedial Action or (iii) any Release or threatened Release of a Hazardous Material; 19 (d) neither the Company nor any of its Subsidiaries has received any written communication alleging that the Company and/or any of its Subsidiaries may be in violation of any Environmental Law, or any Permit issued pursuant to any Environmental Law, or may have any liability under any Environmental Law; (e) neither the Company nor any of its Subsidiaries has any current contingent liability in connection with any Release of any Hazardous Materials into the indoor or outdoor environment (whether on-site or off-site), or the unlawful use, generation, emission, discharge, transportation, storage, handling, treatment or disposal of any Hazardous Material; (f) to the Sellers' knowledge, there are no investigations of the business, operations, or currently or previously owned, operated or leased property of the Company or any of its Subsidiaries pending or threatened which could lead to the imposition of any liability pursuant to any Environmental Law; (g) there has been no release of Hazardous Material at any property leased or operated by the Company or any of its Subsidiaries. (h) Neither the Company nor any of its Subsidiaries is aware of any existing, pending, threatened or past demand, suit or cause of action for damages, including, without limitation, claims for personal injury or property damage, by any Person, including, without limitation, those alleged to result from use, handling or exposure to or injury from any Hazardous Material; and (i) None of the off-site locations to where Company or any of its Subsidiaries has transported, disposed or arranged for disposal of Hazardous Materials has been identified as a facility that is subject to an existing claim under any Environmental Law, or, to the Sellers' knowledge, is the subject of any threatened claim by any Governmental Body, and all of the off-site locations to where Company or any of its Subsidiaries has transported, disposed or arranged for disposal of Hazardous Materials are properly permitted pursuant to Environmental Laws. Section 4.20 Insurance. Schedule 4.20 sets forth a complete and accurate list of all policies of insurance of any kind or nature covering the Company or any of its Subsidiaries or any of their respective employees, properties or assets, including, without limitation, policies of life, disability, fire, theft, workers compensation, employee fidelity and other casualty and liability insurance. All such policies are in full force and effect, and, to the Sellers' knowledge, neither the Company nor any of its Subsidiaries is in default of any provision thereof, except for such defaults as would not, individually or in the aggregate, have a Material Adverse Effect. Since December 31, 1997, no policy of insurance of any kind has lapsed or been cancelled which was not replaced by a policy or insurance with substantially the same or better coverage at a comparable price. Section 4.21 Inventories; Receivables; Payables. (a) The inventories of the Company and its Subsidiaries are in good and marketable condition, and are saleable in the ordinary course of 20 business. None of the Company or any of its Subsidiaries has obsolete or otherwise unusable inventory which is not reflected on the Balance Sheet or the June 30, 1999 Balance Sheet. (b) Set forth on Schedule 4.21 is a true, complete and correct list of all outstanding accounts receivable of the Company and its Subsidiaries as of August 27, 1999 (the "Outstanding Receivables"). All outstanding accounts receivable of the Company and its Subsidiaries have arisen from bona fide transactions in the ordinary course of business consistent with past practice. All accounts receivable of the Company and its Subsidiaries reflected on the June 30, 1999 Balance Sheet are good and collectible at the aggregate recorded amounts thereof, net of any applicable reserve for returns or doubtful accounts reflected thereon, which reserves are adequate and were calculated in a manner consistent with past practice and in accordance with GAAP consistently applied. Except as set forth on Schedule 4.21, all accounts receivable arising after the Balance Sheet Date are good and collectible at the aggregate recorded amounts thereof, net of any applicable reserve for returns or doubtful accounts, which reserves are adequate and were calculated in a manner consistent with past practice and in accordance with GAAP consistently applied. The representations and warranties contained in this Section 4.21(b) shall not be deemed to be a guaranty of collection of Outstanding Receivables. Except as set forth on Schedule 4.21, none of such accounts receivable are older than 90 days from the date the Company recognized such revenue except for accounts receivable from Gary Farn Ltd. which are not older than 120 days from the date the Company recognized such revenue and are in an aggregate amount not exceeding $85,000 Except as set forth on Schedule 4.21, there are no loans, draws against commissions or other accounts receivable from any officer, director or employee of the Company or any of its Subsidiaries (collectively, the "Employee Receivables"). (c) Except as set forth on Schedule 4.21, all accounts payable of the Company and its Subsidiaries reflected in the Balance Sheet or arising after the date thereof are the result of bona fide transactions in the ordinary course of business and have either since been paid or are not yet due and payable. Schedule 4.21 sets forth a description of all outstanding accounts payable of the Company to Sleepeck Printing Company ("Sleepeck Printing"), and shows the date of each invoice. Except as set forth on Schedule 4.21, none of such accounts payable to Sleepeck Printing are overdue by 30 days or more. Section 4.22 Related Party Transactions. Except as set forth on Schedule 4.22, none of the Sellers or any of their respective Affiliates has borrowed any moneys from or has outstanding any indebtedness or other similar obligations to the Company or any of its Subsidiaries. Except as set forth in Schedule 4.22, and other than ownership of three percent (3%) or less of the outstanding voting securities of a company whose stock is traded on a national securities exchange or The Nasdaq Stock Market, none of the Sellers, the Company, any Subsidiary of the Company, any of their respective Affiliates nor any officer or employee of any of them (i) owns any direct or indirect interest of any kind in, or controls or is a director, officer, employee or partner of, or consultant to, or lender to or borrower from or has the right to participate in the profits of, any Person which is (A) a competitor, supplier, customer, landlord, tenant, creditor or debtor of the Company or any of its Subsidiaries, (B) engaged in a business related to the business of the Company or any of its Subsidiaries, or (C) a participant in any transaction to which the Company or any of its Subsidiaries 21 is a party or (ii) is a party to any Contract with the Company or any of its Subsidiaries. Section 4.23 Banks. Schedule 4.23 contains a complete and correct list of the names and locations of all banks and other financial institutions in which the Company or any Subsidiary has accounts or safe deposit boxes or lockbox or similar arrangements into which accounts receivable of the Company or any Subsidiary are deposited or remitted and the names of all persons authorized on behalf of the Company or any Subsidiary to draw thereon or to have access thereto. Except as set forth on Schedule 4.23, no person holds a power of attorney or other authority to act on behalf of the Company or any Subsidiary. Section 4.24 Full Disclosure. The Sellers know of no information or facts that individually or in the aggregate, have had or could reasonably be expected to have a Material Adverse Effect which has not been disclosed to the Purchaser Group in this Agreement or other written materials furnished to the Purchaser Group. No representation or warranty of any Seller contained in this Agreement or in any schedule hereto or in any Seller Document, contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained herein or therein not misleading. Section 4.25 Financial Advisors. No Person has acted, directly or indirectly, as a broker, finder or financial advisor for the Sellers or the Company in connection with the transactions contemplated by this Agreement and no Person is entitled to any fee or commission or like payment in respect thereof. Section 4.26 Year 2000 Compliance. Each item of hardware, software, information technology, embedded, or processor based system and/or any combination thereof, used by the Company in providing service to its customers, developed, manufactured, distributed or licensed by the Company and its Subsidiaries (collectively, the "System"), shall be able to correctly function, operate, process data or perform date-related calculations, including, but not limited to, calculating, comparing and sequencing, from, into and between the years 1999 and 2000, and shall accurately process, provide and/or receive date-data, including leap year calculations, into and between the years 1999 and 2000, except for such inabilities which, individually or in the aggregate, would not be reasonably expected to result in a Material Adverse Effect. Neither performance nor functionality of the System shall be affected by dates prior to, during and after January 1, 2000, except for such non-performances or non-functionalities which, individually or in the aggregate, would not be reasonably expected to result in a Material Adverse Effect. A System containing or calling on a calendar function including, without limitation, any function indexed to the CPU clock, and any function providing specific dates or days, or calculating spans of dates or days shall record, store, process, provide and, where appropriate, insert, true and accurate dates and calculations for dates and spans, before, during and following January 1, 2000, except for such inabilities which, individually or in the aggregate, would not be reasonably expected to result in a Material Adverse Effect. The System shall have no lesser functionality or 22 operability with respect to records containing dates, before, during or after January 1, 2000 than heretofore with respect to dates prior to January 1, 2000, except for such lesser functionalities or operabilities which, individually or in the aggregate, would not be reasonably expected to result in a Material Adverse Effect. Section 4.27 Representations and Warranties Exclusive The representations and warranties made by the Sellers in this Agreement and in the other Seller Documents are the only representations and warranties made by any Seller in connection with the transactions contemplated hereby and by the other Seller Documents, and are intended by the parties to exclude any other basis of recovery against the Sellers by reason of any representation or warranty of the Sellers which is not set forth in this Agreement and in the other Seller Documents, including liability under Rule 10b-5 promulgated under the Securities Exchange Act of 1934, as amended. Article V REPRESENTATIONS AND WARRANTIES OF THE PURCHASER The Purchaser hereby represents and warrants to the Sellers that: Section 5.1 Organization and Good Standing. The Purchaser is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. Section 5.2 Authorization of Agreement. The Purchaser has full corporate power and authority to execute and deliver this Agreement and each other agreement, document, instrument or certificate contemplated by this Agreement or to be executed by the Purchaser in connection with the consummation of the transactions contemplated hereby and thereby (the "Purchaser Documents"), and to consummate the transactions contemplated hereby and thereby. The execution, delivery and performance by the Purchaser of this Agreement and each Purchaser Document have been duly authorized by all necessary corporate action on behalf of the Purchaser. This Agreement has been, and each Purchaser Document will be at or prior to the Closing, duly executed and delivered by the Purchaser and (assuming the due authorization, execution and delivery by the other parties hereto and thereto) this Agreement constitutes, and each Purchaser Document when so executed and delivered will constitute, legal, valid and binding obligations of the Purchaser, enforceable against the Purchaser in accordance with their respective terms, subject to applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting creditors' rights and remedies generally, and subject, as to enforceability, to general principles of equity, including principles of commercial reasonableness, good faith and fair dealing (regardless of whether enforcement is sought in a proceeding at law or in equity). Section 5.3 Conflicts; Consents of Third Parties. 23 (a) None of the execution and delivery by the Purchaser of this Agreement and of the Purchaser Documents, nor the compliance by the Purchaser with any of the provisions hereof or thereof will (i) conflict with, or result in the breach of, any provision of the certificate of incorporation or by-laws of the Purchaser, (ii) conflict with, violate, result in the breach of, or constitute a default under any Contract, instrument, note, bond, mortgage, indenture, lease, license, franchise, commitment, covenant, understanding, arrangement, agreement or other obligation to which the Purchaser is a party or by which the Purchaser or its properties or assets are bound or (iii) violate any statute, rule, regulation, order or decree of any governmental body or authority by which the Purchaser is bound, except, in the case of clauses (ii) and (iii), for such violations, breaches or defaults as would not, individually or in the aggregate, have a material adverse effect on the condition, financial or otherwise, or the earnings, prospects, business or operations of the Purchaser and its subsidiaries, taken as a whole. (b) Except as set forth on Schedule 5.3, no consent, waiver, approval, Order, Permit or authorization of, or declaration or filing with, or notification to, any Person or Governmental Body is required on the part of the Purchaser in connection with the execution and delivery of this Agreement or the Purchaser Documents or the compliance by the Purchaser with any of the provisions hereof or thereof. Section 5.4 Litigation. There are no Legal Proceedings pending or, to the best knowledge of the Purchaser, threatened against the Purchaser before any court or any Governmental Body that are reasonably likely to prohibit or restrain the ability of the Purchaser to enter into this Agreement or any of the other Purchaser Documents or to consummate the transactions contemplated hereby and thereby. Section 5.5 Investment Intention. The Purchaser is acquiring the Shares for its own account, for investment purposes only and not with a view to the distribution thereof in violation of the Securities Act of 1933, as amended (the "Securities Act"). The Purchaser understands that the Shares have not been registered under the Securities Act and cannot be sold unless subsequently registered under the Securities Act or an exemption from such registration is available. Section 5.6 Financial Advisors. Except for Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") and William J. Fox, no Person has acted, directly or indirectly, as a broker, finder or financial advisor for the Purchaser in connection with the transactions contemplated by this Agreement and no person is entitled to any fee or commission or like payment in respect thereof. All fees payable to DLJ or William J. Fox as a result of the transactions contemplated by this Agreement shall be paid by the Purchaser. 24 Article VI COVENANTS Section 6.1 Access to Information. (a) The Sellers shall use their reasonable best efforts to afford the Purchaser and its representatives full access to all financial, legal, management and other information concerning the Company and its Subsidiaries and their respective businesses, and permit the Purchaser to complete its reasonable due diligence investigation. Such investigation shall be conducted in all respects in accordance with the terms of the Confidentiality Agreement entered into between the Company and Arcade, Inc., dated as of March 31, 1998 (the "Retcom Confidentiality Agreement"), and, as applicable, the Confidentiality Agreement entered into between Arcade Marketing, Inc. and Sleepeck Printing dated as of October 6, 1998 (the "Sleepeck Confidentiality Agreement", and collectively with the Retcom Confidentiality Agreement, the "Confidentiality Agreements") which the Purchaser agrees are both still in full force and effect and are binding on the Purchaser, its parent corporation and all of its subsidiaries, consultants and agents (collectively, the "Purchaser Group"). The Purchaser shall not involve anyone in the due diligence investigation on its behalf who has not agreed to be bound by the Confidentiality Agreements. Subject to the foregoing, until the Closing or earlier termination of this Agreement, each of the parties shall take, or cause to be taken, such further actions as are reasonably necessary to consummate the transactions contemplated hereby. No investigation by the Purchaser or any Seller prior to or after the date of this Agreement shall diminish or obviate any of the representations, warranties, covenants or agreements of the Sellers or the Purchaser, respectively, contained in this Agreement, the Seller Documents or the Purchaser Documents, as the case may be; provided however, that if the Purchaser discovers any fact prior to the Closing which would make any representation or warranty of the Sellers untrue (regardless of materiality) then the Purchaser shall notify the Sellers' Representatives of such fact and the Purchaser may (i) terminate this Agreement pursuant to Section 3.2, (ii) request a reduction in the Purchase Price, or (iii) proceed with closing the transactions contemplated hereby without a reduction to the Purchase Price. If the Purchaser fails to notify the Sellers' Representatives, then the Closing shall constitute the Purchaser's waiver of any such untruth in any representation or warranty and the Sellers shall have no liability as a result thereof. If the Purchaser notifies the Sellers' Representatives but elects not to proceed as provided in clause (i) above, or proceeds as provided in clause (ii) above and reaches a satisfactory agreement with the Sellers in regard thereto or proceeds as provided in clause (iii) above, then at the Sellers' request the Purchaser shall waive such untruth in the relevant representation or warranty in writing and then the Sellers shall have no liability as a result thereof, except as otherwise provided in Section 11.3 hereof. (b) The Sellers may deliver to the Purchaser information concerning events subsequent to the date of this Agreement which relates to the business of the Company and its Subsidiaries in the ordinary course, which with the written consent of the Purchaser (which consent shall not be unreasonably withheld), shall supplement the information contained in the Schedules hereto. In addition, the Sellers shall promptly deliver to the Purchaser information concerning events subsequent to the date of this Agreement which relates to the business of the Company and its Subsidiaries which are not in the ordinary 25 course; provided that receipt of such information shall not be deemed a waiver by the Purchaser of any of the conditions precedent to the Closing and the Purchaser may at its option either terminate this Agreement pursuant to Section 3.2, seek a reduction in the Purchase Price or proceed with closing the transactions contemplated hereby without a reduction to the Purchase Price. If the Purchaser terminates this Agreement or seeks a reduction in the Purchase Price by reason of such information and reaches a satisfactory agreement with the Sellers in regard thereto or proceeds without a reduction to the Purchase Price, then at the Sellers' request, the Purchaser shall waive such untruth in the relevant representation or warranty, and then the Sellers shall have no liability as a result thereof, except as provided in Section 11.3 hereof. Section 6.2 Conduct of the Business Pending the Closing. (a) Except as otherwise expressly contemplated by this Agreement or with the prior written consent of the Purchaser, the Sellers shall, and shall cause the Company and its Subsidiaries to, (i) conduct the respective businesses of the Company and its Subsidiaries only in the ordinary course consistent with past practice and (ii) use its reasonable best efforts to preserve the business assets and earning potential of the Company and its Subsidiaries. (b) Except as otherwise expressly contemplated by this Agreement or with the prior written consent of the Purchaser, the Sellers shall not, and shall cause the Company and its Subsidiaries not to: (i) declare, set aside, make or pay any dividend or other distribution in respect of the capital stock of the Company or repurchase, redeem or otherwise acquire any outstanding shares of the capital stock or other securities of, or other ownership interests in, the Company or any of its Subsidiaries; (ii) transfer, issue, sell or dispose of any shares of capital stock or other securities of the Company or any of its Subsidiaries or grant options, warrants, calls or other rights to purchase or otherwise acquire shares of the capital stock or other securities of the Company or any of its Subsidiaries; (iii) effect any recapitalization, reclassification, stock split or like change in the capitalization of the Company or any of its Subsidiaries; (iv) amend the certificate of incorporation or by-laws of the Company or any of its Subsidiaries; (v) make any payments to (other than payments under employment agreements existing as of the Balance Sheet Date) or enter into any other transactions with its shareholders; (vi) write-off any of the Outstanding Receivables; or (vii) agree to do anything prohibited by this Section 6.2 or anything which would make any of the representations and warranties of the Sellers in this Agreement or the Seller Documents untrue or incorrect as of any time through and including the Closing Date. 26 Notwithstanding anything in this Agreement to the contrary, the parties hereto agree that Sleepeck Printing shall be entitled to protect its interests as a vendor and a lender to the Company and certain of its Subsidiaries. Section 6.3 Consents. (a) The Sellers shall use their reasonable best efforts, and the Purchaser shall cooperate with the Sellers, to obtain at the earliest practicable date all consents and approvals required to be obtained by the Sellers or the Company so that the Sellers may consummate the transactions contemplated by this Agreement, including, without limitation, the consents and approvals referred to in Sections 4.5(b) and 4.6(b) hereof; provided, however, that neither the Sellers nor the Purchaser shall be obligated to pay any consideration therefor to any third party from whom consent or approval is requested. (b) The Purchaser shall use its reasonable best efforts, and the Sellers shall cooperate with the Purchaser, to obtain at the earliest practicable date all consents and approvals required to be obtained by the Purchaser so that the Purchaser may consummate the transactions contemplated by this Agreement, including, without limitation, the consents and approval referred to in Section 5.3(b) hereof; provided, however, that neither the Purchaser or the Sellers shall be obligated to pay any consideration therefor to any third party from whom consent or approval is requested. Section 6.4 Other Actions. Each of the Sellers and the Purchaser shall use its best efforts to (i) take all actions necessary or appropriate to consummate the transactions contemplated by this Agreement by September 21, 1999 and (ii) cause the fulfillment at the earliest practicable date of all of the conditions to their respective obligations to consummate the transactions contemplated by this Agreement. The Purchaser shall prepare the necessary filings and shall pay all filing fees in connection with any filing under the HSR Act relating to the transactions contemplated hereby in the event that the Purchaser determines such a filing is necessary or required. Section 6.5 No Solicitation. Each of the Sellers agrees, severally, that it will not and it will cause the Company not to, directly or indirectly, without the prior written consent of Purchaser, until the Closing Date or earlier termination hereof: (i) solicit or encourage any other offers for any shares of capital stock or material assets of the Company or any of its Subsidiaries, or provide any information to, or participate in any discussions or negotiations or otherwise cooperate with any person other than Purchaser and its designees with respect to the possible sale or other transfer of any shares of capital stock or material assets of the Company or any of its Subsidiaries, regardless of when such offers were received or negotiations were initiated or (ii) take any action or permit any action or inaction to be taken that would, directly or indirectly, frustrate the purpose of this Agreement or the ability of Purchaser to consummate any of the transactions contemplated hereby. Each of the Sellers further agrees that it will inform Purchaser immediately of the terms and details of any offer received 27 by it or the Company after the date of this Agreement to acquire any capital stock or material assets of the Company or any of its Subsidiaries. Without limitation of any other rights or remedies of the Purchaser hereunder, if any of the Sellers or the Company engage in discussions regarding the sale or transfer of the Common Stock or Options or any material assets of the Company or any of its Subsidiaries with a third party (whether or not in response to a proposal) or take any of the other actions prohibited by the first paragraph of this Section 6.5 during the period referred to therein, and prior to September 21, 2000, the Sellers sell their Shares or the Sellers or the Company otherwise engage in a transaction which in either case results in the realization by the Sellers of cash or non-cash proceeds in an amount that would exceed the amount that they could reasonably be expected to realize from the consummation of the transactions set forth herein, then the Sellers who realize such proceeds severally (pro rata in accordance with the percentage of such proceeds realized by each of them from the consummation of the sale or other transaction or their percentage of ownership of the Company, as the case may be) and not jointly, shall pay the Purchaser the lesser of (x) $1,000,000 or (y) the amount realized by the Sellers in the consummation of such a transaction, minus (i) the Purchase Price (as adjusted) and (ii) the Company's reasonable attorney's and accountant's fees incurred in connection with the transactions contemplated hereby; provided, however, that if the transactions contemplated hereby are not consummated as a result of a breach by the Purchaser of its obligations under this Agreement, or an injunction prohibiting the consummation of the transaction (which is not the result of actions by the Sellers), then the payment obligations of this paragraph of Section 6.5 shall not apply. Notwithstanding the foregoing, nothing contained in this Section 6.5 shall prohibit the Board of Directors of the Company from furnishing information to or negotiating with any Person that makes a Superior Proposal, if, and only to the extent that, the Board of Directors in good faith determines that such action is required to comply with its fiduciary duties. Nothing in this paragraph shall permit the Sellers to terminate or breach this Agreement or to enter into any agreement which would frustrate the purposes of this Agreement. Section 6.6 Preservation of Records. Subject to Section 10.4(e) hereof (relating to the preservation of Tax records), the Sellers and the Purchaser shall each preserve and keep the records held by it relating to the business of the Company and its Subsidiaries and the Purchaser shall cause the Company and its Subsidiaries to preserve and keep their respective records for a period of three years from the Closing Date and shall make such records and personnel available to the other party as may be reasonably required by such party in connection with, among other things, any insurance claims by, legal proceedings against or governmental investigations of the Sellers or the Purchaser or any of their Affiliates or in order to enable the Sellers or the Purchaser to comply with their respective obligations under this Agreement and each other agreement, document or instrument contemplated hereby or thereby. In the event the Sellers, the Purchaser, the Company or any Subsidiary wishes to destroy such records after that time, such party (or the Purchaser on behalf of the Company or any Subsidiary) shall first give ninety (90) days' prior written notice to the other parties and each of such other parties shall have the right at its option and expense, upon prior written notice given to such party within that ninety (90) day period, to take possession of the records within one hundred and eighty (180) days after the date of such notice. 28 Section 6.7 Publicity. None of the Sellers nor the Purchaser shall issue any press release or public announcement concerning this Agreement or the transactions contemplated hereby or otherwise publicly disclose the existence of this Agreement without obtaining the prior written approval of the other party hereto, which approval will not be unreasonably withheld or delayed, unless, in the sole judgment of the Purchaser, disclosure is otherwise required by applicable Law, provided that, to the extent required by applicable Law or the rules or regulations of any securities exchange or The Nasdaq Stock Market, the party intending to make such release shall use its reasonable best efforts consistent with such applicable Law or the rules or regulations of any securities exchange or The Nasdaq Stock Market, to consult with the other party with respect to the text thereof. Section 6.8 Termination of Agreements. Prior to or simultaneously with the Closing, (a) the Employment Agreement by and between Michael Berman and RCC dated December 31, 1997, (b) the Employment Agreement by and between Michael Berman and Encapsulation Services, Inc. dated January 1, 1998, (c) the Employment Agreement by and between Jay Gartlan and Encapsulation Services, Inc. dated January 1, 1998, and the Employment Agreement by and between Jay Gartlan and RCC dated January 1, 1998, and (d) all other Contracts or transactions between Affiliates of the Company, on the one hand, and the Company or its Subsidiaries, on the other hand, as set forth on Schedule 4.22 (other than (i) any agreements relating to photography services between Paul Pearl and the Company, (ii) the consulting agreement between Albert Pearl and RCC dated January 15, 1998 (the "Pearl Consulting Agreement"), and (iii) any completed work not yet invoiced or accounts payable to Sleepeck Printing by the Company or any of its Subsidiaries which are not included in the Sleepeck Indebtedness and any work-in-progress being performed by Sleepeck Printing for the Company or its Subsidiaries in the ordinary course of business) shall have been terminated without payment or further liability of any party thereto, except as otherwise contemplated hereby or as set forth on Schedule 6.8. The bonuses payable in respect of calendar year 1998, which are identified on Schedule 6.8, shall be paid at Closing to the extent such bonuses are reflected on the Balance Sheet and the June 30, 1999 Balance Sheet. Section 6.9 Intellectual Property. Prior to or simultaneously with the Closing, any and all right, title and interest in any Intellectual Property held by any Affiliate of any of the Sellers and/or Fragrance Technology Trust that is currently used, or contemplated to be used, in the business of the Company or its Subsidiaries shall be conveyed to RCC, without further consideration, or otherwise made available to the Company or its Subsidiaries on an irrevocable, worldwide, exclusive and royalty free basis, provided however, that this obligation to convey Intellectual Property does not extend to Intellectual Property of Sleepeck Printing relating to the printing of products or the rendering of printing services. Section 6.10 Collection of Accounts Receivable. 29 The Purchaser shall cause the Company and its Subsidiaries to use their diligent efforts to collect all accounts receivable outstanding as of the Closing Date prior to the Collection Date. Prior to the Collection Date, and only to the extent requested by the Company in its sole discretion, Paul Pearl shall (i) assist in accordance with the Company's directions in the collection of such accounts receivable and (ii) act as an advisor to the Company in connection with any settlements with customers of the Company or its Subsidiaries with respect to such accounts receivable. Article VII OTHER AGREEMENTS Section 7.1 Payment of Sleepeck Indebtedness. Simultaneously with the Closing, the Purchaser shall pay, or cause the Company or one of its Subsidiaries to pay, the Sleepeck Indebtedness in full. Contemporaneously with the payment in full of the Sleepeck Indebtedness, Sleepeck Printing shall release all guarantees and Liens made in connection with the Sleepeck Indebtedness and shall acknowledge to the Purchaser that no money is owed to Sleepeck Printing by the Company or any of its Affiliates in relation to the Sleepeck Indebtedness. Notwithstanding the foregoing, any release or acknowledgement given or made pursuant to this Section 7.1 shall not be deemed to include any obligations of the Company or any Affiliate with respect to (a) amounts not yet paid for printing services performed by Sleepeck Printing, which has been billed and such bills have been outstanding for less than 90 days, (b) payments set aside, withdrawn or otherwise revoked in respect of printing services performed by Sleepeck Printing prior to the Closing Date, or (c) obligations associated with printing work-in-progress being performed by Sleepeck Printing. Section 7.2 Exercise of Options and Releases. (a) Simultaneously with the Closing, the Purchaser shall exercise the Options which as of the date hereof are owned by (i) Sleepeck Printing to acquire Common Stock from Retail TCA Corporation ("TCA") and Retail TCB Corporation ("TCB") and (ii) Stuart Fleischer to acquire Common Stock from TCB at the exercise price of $1,000,000, $884,000 and $136,000, respectively. Immediately upon the exercise of such Options, (i) TCA shall repay all outstanding indebtedness owed by TCA to the Company or its Subsidiaries and (ii) TCB shall repay all outstanding indebtedness owed by TCB to Albert Pearl pursuant to the Note dated January 15, 1998 and to the Company or its Subsidiaries. (b) Simultaneously with the Closing, each of the Sellers shall, and the Sellers shall cause Albert Pearl to, issue full releases to each other and to the Company, its Subsidiaries and their respective Affiliates (in the form attached hereto as Exhibit F and otherwise satisfactory to the Purchaser). (c) Simultaneously with the Closing, Sellers shall cause each of the parties referenced in the January Memo to execute and deliver such releases as are set forth therein, in substantially the form attached hereto as Exhibit F and otherwise satisfactory to the Purchaser. 30 (d) Simultaneously with the Closing, the Company, its Affiliates and the Sellers (other than Sleepeck Printing) shall issue a full release to Sleepeck Printing (except with respect to liabilities associated with completed work not yet invoiced, accounts receivable and printing work-in-progress as described in Section 6.8(iii)), in substantially the form attached hereto as Exhibit F and otherwise satisfactory to the Purchaser. Section 7.3 Employees. Subsequent to the Closing and for a period of one year thereafter, Purchaser agrees that it will not and it will cause the Company not to terminate without cause the employment with the Company or any of its Subsidiaries of any of (i) Bob Dona, Arthur Inglesby or Paul Bousselli prior to the date that is nine (9) months from written notice from Purchaser to the Company regarding the employment status of each such person, (ii) William Deierlein or Bob Westover prior to the date that is six (6) months from written notice from Purchaser to the Company regarding the employment status of each such person, and (iii) Robert Larr or Fayez Hamma prior to the date that is three (3) months from written notice from Purchaser to the Company regarding the employment status of each such person. Purchaser shall provide Jay Gartlan with a copy of each such notice. The Sellers (other than Sleepeck Printing) shall recommend and encourage in good faith each such employee to enter into a confidentiality and non-compete agreement satisfactory to the Purchaser. Notwithstanding anything to the contrary, none of the Purchaser, the Company or any of its Subsidiaries shall have any obligation or liability to the Sellers or any such employee if such employee fails to enter into such confidentiality and non-compete agreement. Section 7.4 Certain Insurance Coverage. After the Closing Date and until January 2, 2001, the Purchaser shall cause the Company to maintain the Company's insurance policy covering professional errors and omissions liability having an annual premium cost of $3,486 in effect on the date hereof or another substantially similar insurance policy providing for coverage on a "claims made" basis; provided, however, that the Purchaser and the Company shall have no obligations pursuant to this Section 7.4 in the event of any material increase in the cost of premiums charged for any such policy over the costs of premiums charged under the Company's current policy. In the event that the Purchaser or the Company determines to cancel such insurance policy prior to the sixth anniversary of the Closing Date, the Purchaser shall or shall cause the Company to (a) notify the Sellers' Representatives of such cancellation at least 30 days prior thereto, and (b) reasonably cooperate (without any cost to the Purchaser, the Company or any of its Subsidiaries) with the Sellers' Representatives' undertaking to purchase continuation of such insurance coverage for the benefit of any of Jay Gartlan, Michael Berman or Paul Pearl who choose to be so insured. Article VIII CONDITIONS TO CLOSING Section 8.1 Conditions Precedent to Obligations of the Purchaser. 31 The obligation of the Purchaser to consummate the transactions contemplated by this Agreement is subject to the fulfillment, on or prior to the Closing Date, of each of the following conditions (any or all of which may be waived by the Purchaser in whole or in part to the extent permitted by applicable law or which shall be deemed waived if the Closing occurs): (a) all representations and warranties of the Sellers contained herein qualified as to materiality shall be true and correct, and the representations and warranties of the Sellers contained herein not qualified as to materiality shall be true and correct in all material respects, as of the date hereof and at and as of the Closing Date with the same effect as though those representations and warranties had been made again at and as of that time without amendment for subsequent disclosure, except as specifically provided in Section 6.1; (b) the Sellers shall have performed and complied in all material respects with all obligations and covenants required by this Agreement to be performed or complied with by them on or prior to the Closing Date; (c) the Purchaser shall have been furnished with certificates (dated the Closing Date and in form and substance reasonably satisfactory to the Purchaser) executed by each Seller certifying as to the fulfillment of the conditions specified in Sections 8.1(a) and 8.1(b) hereof; (d) Stock certificates (or other appropriate documentation) representing 100% of the Shares shall have been, or shall at the Closing be, validly delivered and transferred to the Purchaser, free and clear of any and all Liens; (e) there shall not have been or occurred any Material Adverse Change; (f) the Sellers shall have obtained all consents and waivers referred to in Schedules 4.5 and 4.6 hereto, in a form reasonably satisfactory to the Purchaser, with respect to the transactions contemplated by this Agreement and the Seller Documents and the Sellers shall have obtained releases, in form and substance satisfactory to the Purchaser, of all Liens (other than Permitted Exceptions) filed against the Company or its Subsidiaries or their respective assets; (g) no Legal Proceedings shall have been instituted or threatened or claim or demand made against the Sellers, the Company or any of its Subsidiaries, or the Purchaser which challenges the validity or propriety of the transactions contemplated hereby or otherwise affects the ability of any of the parties to gain the material intended benefits contemplated hereby; (h) there shall not be in effect any Order by a Governmental Body of competent jurisdiction restraining, enjoining or otherwise prohibiting the consummation of the transactions contemplated hereby; (i) each of the Sellers shall have provided the Purchaser with an affidavit of non-foreign status that complies with Section 1445 of the Code (a "FIRPTA Affidavit"); (j) the Purchaser shall have received the written resignation of each director of the Company; 32 (k) each of the Sellers and the Escrow Agent shall have entered into the Escrow Agreement; (l) Jay Gartlan shall have entered into an employment agreement with the Purchaser or the Company containing terms that are acceptable to the Purchaser; (m) Paul Pearl shall have entered into an employment agreement with the Company (the "Employment Agreement") substantially in the form of Exhibit B hereto; (n) Michael Berman shall have entered into a consulting agreement (the "Consulting Agreement") substantially in the form of Exhibit C hereto; (o) Sleepeck Printing shall have entered into a printing services agreement (the "Printing Services Agreement") substantially in the form of Exhibit D hereto; (p) each of Jay Gartlan, Michael Berman and Paul Pearl shall have entered into a non-competition and non-solicitation agreement (each a "Non-Competition and Non-Solicitation Agreement") substantially in the form of Exhibit E hereto; (q) the actions contemplated by Sections 6.9, 7.1 (other than the first sentence of such Section) and 7.2 hereof (other than the first sentence of Section 7.2(a)), including, without limitation, the execution and delivery of the releases described in such sections, substantially in the form of Exhibit F hereto, shall have been taken simultaneously with the Closing; (r) each Employee Receivable, other than Employee Receivables set forth on Schedule 8.1(r), shall have been paid to the Company and satisfied in full; (s) the Sleepeck Lockbox shall have been terminated as of 11:59 p.m., New York City time, on the day immediately preceding the Closing Date and provision shall have been made to have (i) all amounts held in the Sleepeck Lockbox for the account of the Company or its Subsidiaries to be disbursed and paid to the Company, and (ii) all future amounts remitted to the Sleepeck Lockbox for the account of the Company or any of its Subsidiaries to be remitted to the Company; (t) no Person other than a Seller shall have made, or threatened to make, any claim to any Common Stock, Option or other rights in the Company; (u) the employment of the employees listed on Schedule 8.1(u) shall have been terminated; and (v) Sleepeck Printing shall have executed a confidentiality agreement in form and substance reasonably acceptable to the Purchaser and Sleepeck Printing. It is understood that it is not a condition to the Purchaser's obligations to consummate the transactions contemplated hereby that the Purchaser shall have obtained financing to consummate the transactions contemplated hereby. 33 Section 8.2 Conditions Precedent to Obligations of the Sellers. The obligations of the Sellers to consummate the transactions contemplated by this Agreement are subject to the fulfillment, prior to or on the Closing Date, of each of the following conditions (any or all of which may be waived by the Sellers in whole or in part to the extent permitted by applicable law or which shall be deemed waived if the Closing occurs): (a) all representations and warranties of the Purchaser contained herein qualified as to materiality shall be true and correct, and all representations and warranties of the Purchaser contained herein not qualified as to materiality shall be true and correct in all material respects, as of the date hereof and at and as of the Closing Date with the same effect as though those representations and warranties had been made again at and as of that date; (b) the Purchaser shall have performed and complied in all material respects with all obligations and covenants required by this Agreement to be performed or complied with by Purchaser on or prior to the Closing Date; (c) the Sellers shall have been furnished with certificates (dated the Closing Date and in form and substance reasonably satisfactory to the Sellers) executed by the Chief Executive Officer and Chief Financial Officer of the Purchaser certifying as to the fulfillment of the conditions specified in Sections 8.2(a) and 8.2(b); (d) the Purchaser shall have obtained all consents and waivers referred to in Schedule 5.3 hereto with respect to the transactions contemplated hereby; (e) no Legal Proceedings shall have been instituted or threatened or claim or demand made against the Sellers, the Company or any of its Subsidiaries, or the Purchaser which challenges the validity or propriety of the transactions contemplated hereby or otherwise affects the ability of any of the parties to gain the material intended benefits contemplated hereby; (f) there shall not be in effect any Order by a Governmental Body of competent jurisdiction restraining, enjoining or otherwise prohibiting the consummation of the transactions contemplated hereby; (g) the Purchaser shall have entered into, or caused the Company to enter into, an employment agreement with Jay Gartlan acceptable to Jay Gartlan; (h) the Purchaser shall have entered into, or caused the Company to enter into, the Employment Agreement with Paul Pearl substantially in the form of Exhibit B hereto; (i) the Purchaser shall have entered in to the Consulting Agreement with Michael Berman substantially in the form of Exhibit C hereto; (j) the Purchaser shall have entered into the Printing Services Agreement with Sleepeck Printing substantially in the form of Exhibit D hereto; 34 (k) the Purchaser shall have entered into a Non-Competition and Non-Solicitation Agreement with each of Jay Gartlan, Michael Berman and Paul Pearl substantially in the form of Exhibit E hereto; (l) the actions contemplated by Sections 7.1 and 7.2 (other than the second sentence of Section 7.2(a)) hereof, including without limitation, the execution and delivery of the releases described in such sections substantially in the form of Exhibit F hereto, shall have been taken simultaneously with the Closing; (m) the Purchaser and the Escrow Agent shall have entered into the Escrow Agreement; (n) the Sellers shall have received any waivers to which they are properly entitled pursuant to Section 6.1; and (o) the Purchaser shall have proffered the payments referred to in Section 2.2 hereof and shall have proffered the deposits into escrow contemplated by Section 2.3 hereof. Article IX CLOSING DELIVERIES Section 9.1 Documents to be Delivered by the Sellers. At the Closing, the Sellers shall deliver, or cause to be delivered, to the Purchaser and to each other party as appropriate the following: (a) stock certificates (or other appropriate documentation) representing the Shares, duly endorsed in blank or accompanied by stock transfer powers and with all requisite stock transfer tax stamps attached; (b) the certificates referred to in Section 8.1(c) hereof; (c) copies of all consents, waivers and Lien releases referred to in Section 8.1(f) hereof; (d) Escrow Agreement, substantially in the form of Exhibit A hereto, duly executed by each Seller and the Escrow Agent; (e) employment agreement acceptable to Purchaser, duly executed by Jay Gartlan; (f) Employment Agreement substantially in the form of Exhibit B hereto, duly executed by Paul Pearl; (g) Consulting Agreement substantially in the form of Exhibit C hereto, duly executed by Michael Berman; 35 (h) Printing Services Agreement substantially in the form of Exhibit D hereto, duly executed by Sleepeck Printing; (i) Non-Competition and Non-Solicitation Agreements substantially in the form of Exhibit E hereto, duly executed by each of Michael Berman, Jay Gartlan and Paul Pearl; (j) the conveyances of Intellectual Property contemplated by Section 6.9 and the acknowledgment of payment and Seller releases contemplated by Sections 7.1 and 7.2, with the releases being substantially in the form of Exhibit F hereto, duly executed by each appropriate Seller; (k) written resignation of each of the directors of the Company; (l) duly executed FIRPTA Affidavits for each Seller; (m) certificates of good standing with respect to the Company and its Subsidiaries issued by the Secretary of State for each state in which the Company and its Subsidiaries is incorporated and in which each is qualified to do business as a foreign corporation; (n) evidence satisfactory to the Purchaser of the payment and satisfaction of each Employee Receivable, other than Employee Receivables set forth on Schedule 8.1(r); (o) evidence satisfactory to the Purchaser of the termination of the Sleepeck Lockbox; (p) the corporate books and records of the Company and its Subsidiaries; and (q) such other documents as the Purchaser shall reasonably request three (3) days prior to Closing. Section 9.2 Documents to be Delivered by the Purchaser. At the Closing, the Purchaser shall deliver to the Sellers (except as provided below) the following: (a) evidence of payment in full of the payments referred to in Section 2.2 hereof and the deposits into escrow contemplated by Section 2.3 hereof ; (b) the certificates referred to in Section 8.2(c) hereof; (c) copies of all consents and waivers referred to in Section 8.2(d) hereof; (d) Escrow Agreement, substantially in the form of Exhibit A hereto, duly executed by the Purchaser and the Escrow Agent; (e) employment agreement with Jay Gartlan acceptable to the Purchaser, duly executed by the Purchaser to be delivered to Jay Gartlan; 36 (f) Employment Agreement substantially in the form of Exhibit B hereto, duly Executed by the Purchaser; (g) Consulting Agreement substantially in the form of Exhibit C hereto, duly executed by the Purchaser; (h) Printing Services Agreement substantially in the form of Exhibit D hereto, duly executed by the Purchaser; (i) Non-Competition and Non-Solicitation Agreements with each of Michael Berman, Jay Gartlan and Paul Pearl substantially in the form of Exhibit E hereto, duly executed by the Purchaser; (j) the payments required by Sections 7.1 and 7.2; (k) the releases of Sleepeck Printing contemplated by Section 7.2; (l) any waivers executed by the Purchaser pursuant to Section 6.1; and (m) such other documents as the Sellers shall reasonably request three (3) days prior to Closing. Section 9.3 Simultaneous Transactions. All things which this Agreement contemplates are to happen at or in connection with the Closing shall be deemed to have happened in the order contemplated, if any, and unless all of such things shall happen none shall be deemed to have occurred. Article X INDEMNIFICATION Section 10.1 Non-Tax Indemnification. (a) Subject to Section 6.1, if applicable, and Section 10.2, the Sellers shall jointly and severally indemnify and hold the Purchaser, the Company, and their respective directors, officers, employees, Affiliates, agents, successors and assigns (collectively, the "Purchaser Indemnified Parties") harmless from and against: (i) subject to Sections 10.2(f) and 10.3(d), any and all Losses of the Company or any of its Subsidiaries of every kind, nature and description, absolute or contingent, existing as against the Company or any of its Subsidiaries prior to and including the Closing Date, including, without limitation, the Cellesence Matter (except as otherwise provided in Schedule 10.1 hereto), or thereafter coming into being or arising by reason of Claims related to any matters occurring on or prior to the Closing Date, except to the extent that the same (x) are reflected on the Balance Sheet or the June 30, 1999 Balance Sheet, (y) have been incurred in the ordinary course of business between the Balance Sheet Date and the Closing Date, or (z) are disclosed on the Schedules hereto (except as otherwise provided in Schedule 10.1 hereto); 37 (ii) subject to Section 11.2, any and all Losses attributable to or resulting from the failure of any representation or warranty of the Sellers set forth in Article IV hereof or any representation or warranty contained in any Seller Document to be true and correct in all respects as of the date made, as amended at or prior to Closing in accordance with Section 6.1, other than the representations and warranties set forth in Sections 4.2, 4.6 or Section 4.24, to the extent Section 4.24 relates to Sections 4.2 and 4.6 or similar representations and warranties contained in any Seller Document; (iii) any and all Losses attributable to or resulting from the breach of any covenant or other agreement on the part of any of the Sellers under this Agreement or the other Seller Documents; and (iv) any and all notices, actions, suits, proceedings, claims, demands, assessments, judgments, costs, penalties and expenses, including attorneys' and other professionals' fees and disbursements (collectively, "Expenses") incident to any and all Losses with respect to which indemnification is provided hereunder or the enforcement of the provisions of this Article X. (b) Notwithstanding anything in Section 10.1(a) to the contrary and subject to Sections 10.2 and 11.2, each of the Sellers shall severally (and not jointly and severally) indemnify and hold the Purchaser Indemnified Parties harmless from and against any Losses and Expenses based upon, attributable to or resulting from the failure of any of the respective individual representations and warranties of each such Seller set forth in Sections 4.2, 4.6 or Section 4.24, to the extent Section 4.24 relates to Sections 4.2 and 4.6 or any similar representation or warranty contained in any Seller Document, to be true and correct in all respects as of the date made. (c) The Purchaser shall indemnify and hold the Sellers and their respective Affiliates, agents, successors and assigns, and in the case of Sellers which are not natural persons, their respective directors, officers and employees (collectively, the "Seller Indemnified Parties"), harmless from and against: (i) subject to Section 11.2, any and all Losses attributable to or resulting from the failure of any representation or warranty of the Purchaser set forth in Article V hereof, or any representation or warranty contained in any Purchaser's Document, to be true and correct as of the date made; (ii) any and all Losses based upon, attributable to or resulting from the breach of any covenant or other agreement on the part of the Purchaser under this Agreement or the other Purchaser Documents; and (iii) any and all Losses of the Company or any of its Subsidiaries of every kind, nature and description absolute or contingent (A) existing as against the Company or any of its Subsidiaries prior to and including the Closing Date or thereafter coming into being or arising by reason of any matters occurring on or prior to the Closing Date, but only to the extent that the same (x) are reflected on the Balance Sheet or the June 30, 1999 38 Balance Sheet, (y) have been incurred in the ordinary course of business between the Balance Sheet Date and the Closing Date, or (z) are disclosed on the Schedules hereto (except as otherwise provided in Schedule 10.1 hereto), and (B) arising from Claims related to any matters occurring after the Closing Date; and (iv) any and all Expenses incident to Losses with respect to which indemnification is provided hereunder or the enforcement of the provisions of this Article X. (d) Sleepeck Printing shall indemnify and hold the Purchaser Indemnified Parties harmless from and against any and all Losses attributable to or resulting from the employment or termination of employment of the persons listed on Schedule 8.1(u). Section 10.2 Limitations on Indemnification for Breaches of Representations and Warranties. (a) The Sellers shall not have any liability under Sections 10.1(a)(i), 10.1(a)(ii), 10.1(a)(iv), 10.1(b) or 10.4(a)(i)(c) hereof unless the aggregate amount of Losses and Expenses of the Purchaser Indemnified Parties finally determined to arise thereunder that are attributable to or result from the failure of any representation or warranty of the Sellers to be true and correct exceeds $50,000 (the "Basket") and in such event, the Sellers shall be required to pay the entire amount of such Losses and Expenses from the first dollar thereof. In addition, the Sellers shall not have any liability under Sections 10.1(a), 10.1(b) and 10.4 (a)(i)(c) hereof which in the aggregate exceeds the Purchase Price (the "Ceiling"). (b) The liabilities of the Sellers under Section 10.1(a) hereof shall be joint and several and the liabilities of the Sellers under Section 10.1(b) hereof shall be several only. Subject to Section 10.2(a), the maximum liability of each Seller under this Agreement pursuant to Sections 10.1(a), 10.1(b) and 10.4(a)(i)(c) shall not exceed such Seller's Maximum Obligation. Each Seller's "Maximum Obligation" shall be as follows and shall be subject to proportionate adjustment upon an adjustment to the Purchase Price pursuant to Sections 2.1 and 2.4 hereof: Michael Berman: $3,829,500 Paul Pearl: $1,665,000 Jay Gartlan: $1,100,000 Sleepeck Printing: $3,344,100 Stuart Fleischer: $ 241,400 (c) Notwithstanding anything to the contrary and subject to Section 10.2(b) hereof, the Sellers who are equity holders in any Seller that is a corporation shall be jointly and severally liable with such corporate Seller for any and all indemnification obligations of such corporate Seller pursuant to Section 10.1(a) or 10.1(b). (d) Notwithstanding anything to the contrary, the Sellers shall not have any liability for any Loss arising from the breach or untruthfulness of any of the representations or warranties contained in Section 4.21(b) solely to the extent that the Purchaser shall have recovered in full an amount equal to such Loss pursuant to Section 2.3(c). 39 (e) The obligations of the Sellers under this Article X shall be satisfied first from the amount deposited in escrow pursuant to Sections 2.3(a) and 2.3(b) provided that funds are then held in escrow pursuant to Sections 2.3(a) or 2.3(b). (f) Notwithstanding anything to the contrary, in the event any Purchaser Indemnified Party has a claim for indemnification which, but for Section 11.2 or otherwise, may be brought pursuant to (x) both Sections 10.1(a)(ii) and 10.1(a)(i) hereof, such claim may only be brought pursuant to Section 10.1(a)(ii) hereof and recovery for such claim pursuant to Section 10.1(a)(i) shall be barred, or (y) both Sections 10.1(a)(ii) and 10.4 hereof, such claim may only be brought pursuant to Section 10.1(a)(ii) hereof and recovery for such claim pursuant to Section 10.4 hereof shall be barred. Section 10.3 Non-Tax Indemnification Procedures. (a) In the event that any Claim shall be instituted or asserted by any Person in respect of which indemnification may be sought under Section 10.1 hereof (regardless of the Basket or the Ceiling), the indemnified party shall reasonably and promptly cause written notice of the assertion of any Claim of which it has knowledge which is covered by this indemnity to be forwarded to the indemnifying party. The indemnifying party shall have the right, at its sole option and expense, to have the indemnified party be represented by counsel of the indemnifying party's choice, which must be reasonably satisfactory to the indemnified party, and to defend against, negotiate, settle or otherwise deal with any Claim which relates to any Losses indemnified against hereunder. If the indemnifying party elects to defend against, negotiate, settle or otherwise deal with any Claim which relates to any Losses indemnified against hereunder, it shall within ten (10) days (or sooner, if the nature of the Claim so requires) notify the indemnified party of its intent to do so. If the indemnifying party elects not to defend against, negotiate, settle or otherwise deal with any Claim which relates to any Losses indemnified against hereunder, fails to notify the indemnified party of its election as herein provided or contests its obligation to indemnify the indemnified party for such Losses under this Agreement, the indemnified party may defend against, negotiate, settle or otherwise deal with such Claim. If the indemnified party defends any Claim, then the indemnifying party shall reimburse the indemnified party for the Expenses of defending such Claim upon submission of periodic bills. If the indemnifying party shall assume the defense of any Claim, the indemnified party may participate, at his or its own expense, in the defense of such Claim; provided, however, that such indemnified party shall be entitled to participate in any such defense with separate counsel at the expense of the indemnifying party if, (i) so requested by the indemnifying party to participate or (ii) in the reasonable opinion of counsel to the indemnified party, an actual or potential conflict exists between the indemnified party and the indemnifying party that would require such separate representation under applicable rules of procedure or code of ethics; and provided, further, that the indemnifying party shall not be required to pay for more than one such counsel for all indemnified parties in connection with any Claim. The parties hereto agree to cooperate fully with each other in connection with the defense, negotiation or settlement of any such Claim. (b) After any final judgment or award shall have been rendered by a court, arbitration board or administrative agency of competent jurisdiction and the expiration of the time in which to appeal therefrom, or a settlement 40 shall have been consummated, or the indemnified party and the indemnifying party shall have arrived at a mutually binding agreement with respect to a Claim hereunder, the indemnified party shall forward to the indemnifying party notice of any sums due and owing by the indemnifying party pursuant to this Agreement with respect to such matter and the indemnifying party shall be required to pay all of the sums so due and owing to the indemnified party by wire transfer of immediately available funds within 10 Business Days after the date of such notice. (c) The failure of the indemnified party to give reasonably prompt notice of any Claim shall not release, waive or otherwise affect the indemnifying party's obligations with respect thereto except to the extent that the indemnifying party can demonstrate actual loss and prejudice as a result of such failure. (d) A claim for indemnity under Section 10.1(a)(i) may be made at any time prior to the close of business on December 31, 2001 and not thereafter. Section 10.4 Tax Matters. (a) Tax Indemnification. (i) Except to the extent Taxes are reserved for on the Closing Date Balance Sheet, each Seller, jointly and severally, agrees to be responsible for and to indemnify and hold the Purchaser Indemnified Parties harmless from and against any and all Taxes due and payable by the Company or any of its Subsidiaries: (a) with respect to all taxable periods ending on or prior to the Closing Date; (b) with respect to any and all Taxes of the Company or any of its Subsidiaries for the period allocated to the Sellers pursuant to Section 10.4(b)(iv); (c) arising by reason of any breach of the Sellers or inaccuracy of any of the representations contained in Section 4.10 hereof; and (d) with respect to any and all Taxes of any member of a consolidated, combined or unitary group of which the Company (or any predecessor) or any of its Subsidiaries is or was a member on or prior to the Closing Date pursuant to Treasury Regulation Section 1.1502-6(a) or any analogous or similar state, local or foreign law or regulation, as transferee or successor, by contract or otherwise. The Sellers shall also pay and shall indemnify and hold harmless the Purchaser Indemnified Parties from and against any losses, damages, liabilities, obligations, deficiencies, costs and expenses (including, without limitation, reasonable expenses and fees for attorneys and accountants) ("Related Costs") incurred in connection with the Taxes for which the Sellers are responsible to indemnify the Purchaser Indemnified Parties pursuant to this Section 10.4(a) (or any asserted deficiency, claim, demand, action, suit, proceeding, judgment or assessment, including the defense or settlement thereof, relating to such Taxes) or the enforcement of this Section 10.4(a). 41 (ii) The Purchaser shall indemnify and hold harmless the Seller Indemnified Parties from and against any and all Taxes (A) of the Company or any of its Subsidiaries with respect to any taxable period of the Company or any of its Subsidiaries beginning after the Closing Date, (B) of the Company of any of its Subsidiaries with respect to any taxable period prior to the Closing Date to the extent reserved on the Closing Date Balance Sheet, or (C) attributable to the period allocated to Purchaser pursuant to Section 10.4(b)(iv) as well as any Related Costs incurred in connection with the Taxes for which the Purchaser is responsible to indemnify the Seller Indemnified Parties pursuant to this Section 10.4(a) (or any asserted deficiency, claim, demand, action, suit, proceeding, judgment or assessment, including the defense or settlement thereof, relating to such Taxes) or the enforcement of this Section 10.4(a). (iii) If any indemnification payment under this Section 10.4 (including, without limitation, this Section 10.4(a)(iii)) is determined to be taxable to the party receiving such payment by any taxing authority, the paying party shall also indemnify the party receiving such payment for any Taxes incurred by reason of the receipt of such payment (taking into account any actual reduction in tax liability to the receiving party) and any Related Costs incurred by the party receiving such payment in connection with such Taxes (or any asserted deficiency, claim, demand, action, suit, proceeding, judgment or assessment, including the defense or settlement thereof, relating to such Taxes). (b) Preparation of Tax Returns; Payment of Taxes. (i) The Sellers shall cause the Company and each of its Subsidiaries to file all the federal, state, local and foreign Tax Returns required to be filed by the Company and each of its Subsidiaries for all periods ending on or prior to the Closing Date and shall pay any and all Taxes due with respect to such Returns to the extent not reserved on the Closing Date Balance Sheet. All Tax Returns described in this Section 10.4(b)(i) shall be prepared in a manner consistent with prior practice unless a past practice has been finally determined to be incorrect by the applicable taxing authority or a contrary treatment is required by applicable tax laws (or judicial or administrative interpretations thereof). The Sellers shall cause the Company and each of its Subsidiaries to provide the Purchaser with copies of such completed Tax Returns at least 10 days prior to the filing date, and the Purchaser shall be provided an opportunity to review and propose changes to such Tax Returns and supporting workpapers and schedules prior to the filing of such Tax Returns. The Sellers and the Purchaser shall attempt in good faith mutually to resolve any disagreements regarding such Tax Returns prior to the due date for filing thereof. (ii) Following the Closing, the Purchaser shall be responsible for preparing or causing to be prepared all federal, foreign, state and local Tax Returns required to be filed by the Company and each of its Subsidiaries for all periods which begin before and end after the Closing Date. To the extent any Taxes shown due on any such Tax Return are indemnifiable by the Sellers, (A) the Purchaser shall provide the Sellers with copies of such Tax Return at least 30 days prior to the due date for filing such return, and (B) the Sellers shall have the right to review and approve (which approval shall not be unreasonably withheld) such Tax Returns for 15 days following receipt thereof. The Sellers and Purchaser shall attempt in good faith mutually to resolve any disagreements regarding such Tax Returns prior to the due date for filing thereof. The Purchaser shall file or cause to be filed all such Tax 42 Returns on or prior to the due date, as it may be extended, and shall, subject to receiving the payments from the Sellers referred to in Section 10.4(b)(iii), pay the Taxes shown due thereon; provided, however, that nothing contained in the foregoing shall in any manner terminate, limit or adversely affect any right of Purchaser Indemnified Parties, the Sellers or the Company to receive indemnification pursuant to any provision in this Agreement. (iii) Not later than 5 days before the due date for payment of Taxes with respect to any Tax Returns which Purchaser has the responsibility to file, each of the Sellers shall pay to the Purchaser such Seller's proportionate share of an amount equal to that portion of the Taxes shown on such return for which the Sellers have an obligation to indemnify the Purchaser Indemnified Parties pursuant to the provisions of Section 10.4(a). (iv) For federal income tax purposes, the taxable year of the Company and each of its Subsidiaries shall end as of the close of the Closing Date and, with respect to all other Taxes of the Company and each of its Subsidiaries, the Sellers and the Purchaser will, unless prohibited by applicable law, close the taxable period of the Company and each of its Subsidiaries as of the close of the Closing Date. Neither the Sellers nor the Purchaser shall take any position inconsistent with the preceding sentence on any Tax Return. In any case where applicable law does not permit the Company and each of its Subsidiaries to close its taxable year on the Closing Date or in any case in which a Tax is assessed with respect to a taxable period which includes the Closing Date (but does not begin or end on that day), then Taxes, if any, attributable to the taxable period of the Company and each of its Subsidiaries beginning before and ending after the Closing Date shall be allocated (i) to the Sellers for the period up to and including the Closing Date, and (ii) to Purchaser for the period subsequent to the Closing Date. Any allocation of income or deductions required to determine any Taxes attributable to any period beginning before and ending after the Closing Date shall be prepared by Purchaser and shall be made by means of a closing of the books and records of the Company and each of its Subsidiaries as of the close of the Closing Date, provided that exemptions, allowances or deductions that are calculated on an annual basis (including, but not limited to, depreciation and amortization deductions) shall be allocated between the period ending on the Closing Date and the period after the Closing Date in proportion to the number of days in each such period. The Purchaser shall provide the Sellers with a schedule showing the computation of each item which is subject to allocation under this Section at least 30 days prior to the due date for filing a Tax Return for a taxable period which includes the Closing Date. The Sellers shall have the right to review such schedule, and the Purchaser and Sellers shall attempt in good faith mutually to resolve any disagreements regarding the determination of any such allocation. Any amount owing from Sellers under this Section 10.4(b)(iv) shall be paid no later than five (5) days prior to the filing of the underlying Tax Return. With respect to the Tax Returns of the Company and its Subsidiaries for the first taxable period following the Closing Date and amendments made following the Closing Date to Tax Returns of the Company and its Subsidiaries for taxable periods prior to the Closing Date, the Purchaser shall (i) notify or cause the Company and its Subsidiaries to notify the Sellers' Representatives at least 30 days prior to the due date for filing such Tax Returns if such Tax Returns report any item in a manner that is inconsistent with prior years, and (ii) provide the Sellers' Representatives with an opportunity to consult with the Purchaser and the Company in connection therewith. 43 (c) Cooperation with Respect to Tax Returns. Purchaser and the Sellers agree to furnish or cause to be furnished to each other, and each at their own expense, as promptly as practicable, such information relating to the Company or any of its Subsidiaries (including access to books and records) and assistance, including making employees available on a mutually convenient basis to provide additional information and explanations of any material provided as is reasonably necessary for the preparation and filing of any Tax Return, for the preparation for any audit, and for the prosecution or defense of any claim, suit or proceeding relating to any adjustment or proposed adjustment with respect to Taxes of the Company or any Subsidiary. Purchaser, the Company or any of its Subsidiaries shall retain in its possession, and shall provide the Sellers reasonable access to (including the right to make copies of), such supporting books and records and any other materials that the Sellers may specify with respect to Tax matters relating to any taxable period ending on or prior to the Closing Date or relating to the portion of any taxable period occurring on or before the Closing Date until the relevant statute of limitations has expired. After such time, Purchaser may dispose of such material, provided that prior to such disposition Purchaser shall give the Sellers a reasonable opportunity to take possession of such materials. (d) Tax Audits. (i) The Purchaser shall have the sole right to represent the interests of the Company and each of its Subsidiaries in any Tax audit or administrative or court proceeding relating to taxable periods of the Company or any of its Subsidiaries beginning after the Closing Date and to employ counsel of its choice at its expense; provided that Jay Gartlan and Sleepeck Printing shall each have the right to consult with such counsel. The Sellers agrees that they will cooperate fully with Purchaser and its counsel in the defense against or compromise of any claim in any said proceeding. (ii) If any taxing authority in writing asserts a claim, makes an assessment or otherwise disputes or affects the Tax reporting position of the Company or any of its Subsidiaries for taxable periods ending on or prior to the Closing Date, Purchaser shall, promptly upon receipt by Purchaser, the Company or any of its Subsidiaries of written notice thereof, inform the Sellers thereof. (iii) Sellers' Representatives shall have the right to represent the interests of the Company and each of its Subsidiaries in any Tax audit or administrative or court proceeding relating to taxable periods of the Company or any of its Subsidiaries ending on or prior to the Closing Date to the extent that it involves an asserted Tax liability with respect to which indemnity is sought under Section 10.04. The Purchaser shall cooperate, and shall cause the Company and its Subsidiaries to cooperate, at the Sellers' expense, with the Sellers and their counsel in the defense against any such claim in any such proceeding. At the request of the Sellers' Representatives, the Purchaser shall grant a power of attorney to the Sellers' Representatives to the extent reasonably necessary or required for the Sellers' Representatives to exercise their rights under this Section 10.4(d) (iii). The Sellers shall not enter into on behalf of the Purchaser any settlement agreement with respect to any asserted Tax liability without the prior written consent of the Purchaser, which consent may not be unreasonably withheld. 44 (iv) The Sellers and the Purchaser jointly shall represent the interests of the Company or any of its Subsidiaries in any Tax audit or administrative or court proceeding relating to any taxable period of the Company or any of its Subsidiaries which includes (but does not begin or end on) the Closing Date. All costs, fees and expenses paid to third parties in the course of such proceeding shall be borne by the Sellers and the Purchaser in the same ratio as the ratio in which, pursuant to the terms of this Agreement, the Sellers and the Purchaser would share the responsibility for payment of the Taxes asserted by the taxing authority in such claim or assessment if such claim or assessment were sustained in its entirety. (e) Refund Claims. Except as otherwise provided in Section 10.4(f), to the extent any determination of Tax liability of the Company or any of its Subsidiaries, whether as the result of an audit or examination, a claim for refund, the filing of an amended return or otherwise, results in any refund of Taxes paid attributable to (i) any period which ends on or before the Closing Date or (ii) any period which includes the Closing Date but does not begin or end on that day, any such refund shall belong to the Sellers, provided that in the case of any Tax refund described in clause (ii) of this Section 10.4(e), the portion of such Tax refund which shall belong to the Sellers shall be that portion that is attributable to the portion of that period which ends on the Closing Date (determined on the basis of an interim closing of the books as of the Closing Date), and Purchaser shall promptly pay any such refund, and the interest actually received thereon, to the Sellers upon receipt thereof by the Purchaser or by the Company or any of its Subsidiaries. Any and all other refunds shall belong to the Purchaser. Any payments made under this Section 10.4(e) shall be net of any Taxes payable by the Company or any of its Subsidiaries with respect to such refund, credit or interest thereon (taking into account any actual reduction in Tax liability of the Company or any Subsidiary realized upon the payment pursuant to this Section 10.4(e)). (f) Carrybacks. The Sellers shall pay to the Purchaser the amount of any Tax benefit (including interest thereon) realized by the Sellers or any Affiliate thereof as a result of the carryback of any Tax loss, deduction or credit of the Company or any of its Subsidiaries from any taxable period beginning after the Closing Date to a taxable period ending on or before the Closing Date. The Sellers shall pay such amount to Purchaser within 10 Business Days after such Tax benefit is realized by the Sellers or any Affiliate as a refund or otherwise, provided that Purchaser shall return to the Sellers the amount, if any, by which the amount of such Tax benefit is thereafter reduced pursuant to a final determination. (g) Transfer Taxes. The Sellers shall be liable for and shall pay (and shall indemnify and hold harmless Purchaser against) all sales, use, stamp, documentary, filing, recording, transfer or similar fees or taxes or governmental charges (including, without limitation, real property transfer gains taxes, UCC-3 filing fees, FAA, ICC, DOT, real estate and motor vehicle registration, title recording or filing fees and other amounts payable in respect of transfer filings) as levied by any taxing authority or governmental agency in connection with the transactions contemplated by this Agreement (other than taxes measured by or with respect to income imposed on the Sellers or on Purchaser or its Affiliates). The Sellers hereby agree to file all necessary documents (including, but not limited to, all Tax Returns) with respect to all such amounts in a timely manner. 45 (h) The indemnification provided for in this Section 10.4 shall be the sole remedy for any claim in respect of Taxes and the provisions of Sections 10.1 through 10.3 hereof shall not apply to such claims. (i) Any claim for indemnity under this Section 10.4 may be made at any time prior to 60 days after the expiration of the applicable Tax statute of limitations with respect to the relevant taxable period (including all periods of extension, whether automatic of permissive). Section 10.5 Tax Treatment of Indemnity Payments. The Sellers and the Purchaser agree to treat any indemnity payment made pursuant to this Article X as an adjustment to the Purchase Price for federal, state, local and foreign income tax purposes. Article XI MISCELLANEOUS Section 11.1 Certain Definitions. "Affiliate" means, with respect to any Person, any other Person controlling, controlled by or under common control with such Person. "Business Day" means a day other than a Saturday, a Sunday or a day on which commercial banks in New York City are authorized or required to be closed. "Code" shall mean the Internal Revenue Code of 1986, as amended. "Contract" means any contract, indenture, note, bond, loan, instrument, lease, commitment or other agreement. "Claim" means any legal proceeding, claim or demand. "Environmental Law" means any foreign, federal, state or local statute, regulation, ordinance or rule of common law as currently in effect in any way relating to the protection of human health and safety or the environment including, without limitation, the Comprehensive Environmental Response, Compensation and Liability Act (42 U.S.C. ss. 9601 et seq.), the Hazardous Materials Transportation Act (49 U.S.C. App. ss. 1801 et seq.), the Resource Conservation and Recovery Act (42 U.S.C. ss. 6901 et seq.), the Clean Water Act (33 U.S.C. ss. 1251 et seq.), the Clean Air Act (42 U.S.C. ss. 7401 et seq.), the Toxic Substances Control Act (15 U.S.C. ss. 2601 et seq.), the Federal Insecticide, Fungicide, and Rodenticide Act (7 U.S.C. ss. 136 et seq.), and the Occupational Safety and Health Act (29 U.S.C. ss. 651 et seq.), and the regulations promulgated pursuant thereto. "GAAP" means generally accepted United States accounting principles as of the date hereof. 46 "Governmental Body" means any government or governmental or regulatory body thereof, or political subdivision thereof, whether federal, state, local or foreign, or any agency, instrumentality or authority thereof, or any court or arbitrator (public or private). "Hazardous Material" means any substance, material or waste which is regulated by the United States, or any state or local governmental authority including, without limitation, petroleum and its by-products, asbestos, and any material or substance which is defined as a "hazardous waste," "hazardous substance," "hazardous material," "restricted hazardous waste," "industrial waste," "solid waste," "contaminant," "pollutant," "toxic waste" or "toxic substance" under any provision of Environmental Law. "Indebtedness" means debt of the Company and its Subsidiaries for borrowed money (including letters of credit), notes payable (including the Sleepeck Indebtedness), obligations to pay the deferred purchase price of property or services, capitalized leases and guarantees, but shall exclude trade accounts payable incurred and charges for liabilities accrued in the ordinary course of business, in accordance with GAAP and consistent with past practice. For the avoidance of doubt, the indebtedness of TCA to the Company or its Subsidiaries and the indebtedness of TCB to Al Pearl and to the Company or its Subsidiaries shall not be included in Indebtedness. "Law" means any federal, state, local or foreign law (including common law), statute, code, ordinance, rule, regulation or other requirement. "Legal Proceeding" means any legal action, suit, proceeding, investigation, claim or order. "Lien" means any lien, pledge, mortgage, deed of trust, security interest, claim, lease, charge, option, right of first refusal, easement, servitude, transfer restriction under any shareholder or similar agreement, encumbrance or any other restriction or limitation whatsoever. "Loss" means all losses, liabilities, obligations, damages, costs, expenses and other amounts for which an indemnified party becomes liable under Article X hereof. For purposes of this Agreement, the amount of a Loss and the amount of any Expense shall be calculated after giving effect to any reserve available for the matter or transaction in question reflected on the Closing Date Balance Sheet, and after taking into account any insurance or other third-party payments tendered as compensation for such Loss or Expense accruing to the benefit of the indemnified party by reason of such Loss or Expense and any tax effect by reason thereof or by reason of the receipt of such insurance or other third party payments tendered as compensation for such Loss or Expense. "Material Adverse Change" means any material adverse change in the condition, financial or otherwise, or in the earnings, prospects, business or operations of the Company and its Subsidiaries, taken as a whole. "Order" means any order, injunction, judgment, decree or ruling. "Permit" means any approvals, authorizations, consents, licenses or permits. 47 "Permitted Exceptions" means (i) all defects, exceptions, restrictions, easements, rights of way and encumbrances disclosed in policies of title insurance which have been provided to Purchaser; (ii) statutory liens for current taxes, assessments or other governmental charges not yet delinquent or the amount or validity of which is being contested in good faith by appropriate proceedings, provided an appropriate reserve is established therefor; (iii) mechanics', carriers', workers', repairers' and similar Liens arising or incurred in the ordinary course of business that are not material to the business, operations and financial condition of the property so encumbered or the Company; (iv) zoning, entitlement and other land use and environmental regulations by any Governmental Body, provided that such regulations have not been violated; and (v) such other imperfections in title, charges, easements, restrictions and encumbrances which do not materially detract from the value of or materially interfere with the present use of any property leased pursuant to a Real Property Lease subject thereto or affected thereby. "Person" means any individual, corporation, partnership, firm, joint venture, association, joint-stock company, trust, unincorporated organization, Governmental Body or other entity. "RCC" means Retail Communications Corp. "Release" means any release, spill, emission, leaking, pumping, injection, deposit, disposal, discharge, dispersal, or leaching into the indoor or outdoor environment, or into or out of any property. "Remedial Action" means all actions to (x) clean up, remove, treat or in any other way address any Hazardous Material; (y) prevent the Release of any Hazardous Material so it does not endanger or threaten to endanger public health or welfare or the indoor or outdoor environment; or (z) perform pre-remedial studies and investigations or post-remedial monitoring and care. "Sleepeck Indebtedness" means all indebtedness of the Company or any of its Subsidiaries to Sleepeck Printing, including principal, accrued and unpaid interest and expenses payable by the Company or a Subsidiary, other than indebtedness on account for goods or services provided by Sleepeck Printing in the ordinary course, unless such indebtedness has been outstanding for 90 days or more on the Closing Date, with the exception of indebtedness outstanding for 90 days or more on the Closing Date that relates to payables for printing services performed for the benefit of Gary Farn Ltd. or Zaharoff provided that the related accounts receivable of the Company or its Subsidiaries from such customers exceeds the related payable by the appropriate amount of gross profit and other related ordinary course ancillary charges. "Sleepeck Lockbox" means the Sleepeck Printing lockbox account (account number 99475) at the Bank of America, 231 South LaSalle Street, Chicago, Illinois. "Subsidiary" means any Person of which a majority of the outstanding voting securities or other voting equity interests are owned, directly or indirectly, by the Company. "Superior Proposal" means an unsolicited bona fide offer by an unaffiliated third party to purchase a majority of the Company's Common Stock or 48 substantially all of the assets of the Company and its Subsidiaries at a value significantly higher than that implied by this Agreement. "Taxes" shall mean any income, gross income, gross receipts, profits, capital stock, franchise, business, withholding payroll, social security, workers compensation, unemployment, disability, property, ad valorem, stamp, excise, occupation, service, sales, use, license, lease, commercial rent, transfer, import, export, customs duties, value added, goods and services, alternative minimum, estimated or other similar tax (including any fee, assessment, or other charge in the nature of or in lieu of any tax) imposed by any Governmental Body, and any interest, penalties, additions to tax, or additional amounts in respect of the foregoing. "Tax Return" means all returns, declarations, reports, estimates, information returns and statements required to be filed in respect of any Taxes. "Working Capital" means, without duplication, the sum of (i) accounts receivable, net of an allowance for doubtful accounts, plus (ii) inventory, plus (iii) taxes receivable, minus (iv) accounts payable (which includes accrued expenses and other current liabilities), minus (v) the Sleepeck Indebtedness, all as would be reflected on a balance sheet of RCC, prepared in accordance with GAAP on a basis consistent with the financial statements which have previously been delivered to the Purchaser. For the avoidance of doubt, accounts receivable which have been written-off or accounts receivable which relate to bill-and-hold arrangements shall not be included in Working Capital for purposes of this definition. In addition, the following terms shall have the respective meanings set forth in the Section noted below: Additional Indemnification Amount..................2.3(c) Aged Accounts Receivable...........................2.3(c) Agreement..........................................Recitals Agreement Duties...................................11.14 Arcade Group.......................................6.1 Balance Sheet......................................4.7 Balance Sheet Date.................................4.7 Basket.............................................10.2(a) Benefit Plans......................................4.15(a) Ceiling............................................10.2(a) Cellesence Matter..................................4.17 Claim..............................................10.3(a) Closing............................................3.1 Collection Date....................................2.3(c) Closing Date.......................................3.1 Closing Date Balance Sheet.........................2..4 Collection Date....................................2.3(c) Collection Period..................................2.3(c) Common Stock.......................................Recitals Company............................................Recitals Confidentiality Agreements.........................6.1 49 Consultants........................................4.13(b) Consulting Agreement...............................8.1(n) Determination Date.................................2.1 DLJ................................................5.6 Employee Receivables...............................4.21(b) Employees..........................................4.15(a) Employment Agreement...............................8.1(m) ERISA..............................................4.15(a) ERISA Affiliate....................................4.15(c) Escrow Agent.......................................2.3(a) Escrow Agreement...................................2.3(a) Estimated Purchase Price...........................2.2 Expenses...........................................10.1(a)(iv) Financial Statements...............................4.7 FIRPTA Affidavit...................................8.1(i) HSR Act............................................4.5(b) Indemnification Escrow Account.....................2.3(b) Indemnification Escrow Amount......................2.3(b) Intellectual Property..............................4.13(a) January Memo.......................................4.3(b) June 30, 1999 Balance Sheet........................4.7 Loss...............................................11.15 Material Adverse Effect............................4.1 Material Contracts.................................4.14 Maximum Obligation.................................10.2(b) Nonbreaching Parties...............................11.4 Non-Competition and Non-Solicitation Agreement.....8.1(p) Options............................................Recitals Options Exercise ..................................4.3(a) Outstanding Receivables............................4.21(b) Pearl Consulting Agreement.........................6.8 Pension Plan.......................................4.15(b) Personal Property Leases...........................4.12(a) Plans..............................................4.15(b) Printing Services Agreement........................8.1(o) Purchase Price.....................................2.1 Purchase Price Escrow Amount.......................2.3(a) Purchaser..........................................Recitals Purchaser Documents................................5.2 Purchaser Group....................................6.1 Purchaser Indemnified Parties......................10.1(a) Real Property Leases...............................4.11 Receivable Escrow Amount...........................2.3(c) Related Costs......................................10.4 Retcom Confidentiality Agreement...................6.1 Securities Act.....................................5.5 50 Seller Documents...................................4.2 Seller Indemnified Parties.........................10.1(c) Sellers' Representatives...........................11.14 Shares.............................................Recitals Sharing Ratios.....................................2.1 Sleepeck Confidentiality Agreement.................6.1 Sleepeck Printing..................................4.21(c) Supplemental Closing...............................2.4(a) System.............................................4.26 TCA................................................7.2 TCB................................................7.2 Uncollected Receivables Amount.....................2.3(c) 1998 Interim Balance Sheet.........................2.1 1998 Working Capital...............................2.1 Section 11.2 Survival. The parties hereto hereby agree that the representations and warranties and agreements contained in this Agreement or in any certificate, document or instrument delivered in connection herewith, shall survive the execution and delivery of this Agreement and the Closing hereunder, regardless of any investigation made by the parties hereto (except as otherwise provided in Section 6.1), and that claims based upon any of them may be asserted in writing until January 2, 2001; provided, however, that claims with respect to the representations and warranties contained in Sections 4.2, 4.3 and 4.6 shall survive for three (3) years from the Closing Date and all claims based on fraud shall survive for the applicable statute of limitations. The agreements contained in Articles VII and X shall survive the Closing in accordance with their respective terms. Section 11.3 Expenses. Whether or not the transactions contemplated hereby are consummated, each party shall bear its own fees and expenses in connection with the proposed transaction, including but not limited to attorney's, accountant's and consultant's fees, provided that the Purchaser, solely, shall bear the expense of all filings fees required under the HSR Act or any other law regarding competition; and provided further, that in the event this Agreement is terminated at any time prior to Closing by either the Sellers or the Purchaser for material breach or default by the other party of the terms of this Agreement, and such breach or default, in the aggregate, could reasonably be expected to result in a Loss of at least $50,000, then the breaching party will pay or reimburse the Sellers or the Purchaser, as the case may be (the "Nonbreaching Parties"), for the out-of-pocket costs and expenses incurred by the Nonbreaching Parties (but if the Purchaser is the breaching party, then the Purchaser shall not be liable for the fees and expenses of more than Dilworth Paxon LLP as counsel for the Sellers and if one of the Sellers is the breaching party, then the Sellers shall not be liable for the fees and expenses of more than one set of counsel for the Purchaser) in connection with the preparation and negotiation of the Agreement and the parties' due diligence investigations. 51 Section 11.4 Specific Performance. (a) The Sellers acknowledge and agree that in the event of a breach of this Agreement by the Sellers, including the Sellers' failure to close the transactions contemplated hereby in accordance with the terms of this Agreement, the Purchaser would be irreparably damaged and would not have an adequate remedy at law. Therefore, the obligations of the Sellers under this Agreement, including, without limitation, the Sellers' obligation to sell the Shares to the Purchaser, shall be enforceable by a decree of specific performance issued by any court of competent jurisdiction, and appropriate injunctive relief may be applied for and granted in connection therewith. Such remedies shall, however, be cumulative and not exclusive and shall be in addition to any other remedies which any party may have under this Agreement or otherwise. Section 11.5 Further Assurances. The Sellers and the Purchaser shall execute and deliver such other documents or agreements and to take such other action as may be reasonably necessary or desirable for the implementation of this Agreement and the consummation of the transactions contemplated hereby. Section 11.6 Arbitration. Except as herein may be provided to the contrary, all disputes between the Sellers and Purchaser, including, without limitation, those relating to this Agreement, shall be resolved by arbitration as provided in this Section 11.6. This agreement to arbitrate shall survive the rescission or termination of this Agreement. All arbitration shall be conducted pursuant to the Commercial Arbitration Rules of the American Arbitration Association and shall be conducted in the Borough of Manhattan, The City of New York, unless otherwise agreed in a signed writing by all of the parties to any such arbitration. The decision of the arbitrators shall be final and binding on all parties. All arbitration shall be undertaken pursuant to the Federal Arbitration Act, where applicable, and the decision of the arbitrators shall be enforceable in any court of competent jurisdiction. Section 11.7 Entire Agreement; Amendments and Waivers. This Agreement (including the schedules and exhibits hereto) and the Confidentiality Agreements represent the entire understanding and agreement between the parties hereto with respect to the subject matter hereof (and supersedes the letter of intent dated July 27, 1999) and can be amended, supplemented or changed, and any provision hereof can be waived, only by written instrument making specific reference to this Agreement signed by the party against whom enforcement of any such amendment, supplement, modification or waiver is sought. Except as otherwise provided in Sections 8.1 or 8.2, no action taken pursuant to this Agreement, including without limitation, any investigation by or on behalf of any party, shall be deemed to constitute a waiver by the party taking such action of compliance with any representation, warranty, covenant or agreement contained herein. Subject to Section 6.1, if applicable, the waiver by any party hereto of a breach of any provision of this Agreement shall not operate or be construed as a further or continuing waiver of such breach or as a waiver of any other or subsequent breach. No failure on the 53 part of any party to exercise, and no delay in exercising, any right, power or remedy hereunder shall operate as a waiver thereof, except as provided in Section 11.2, nor shall any single or partial exercise of such right, power or remedy by such party preclude any other or further exercise thereof or the exercise of any other right, power or remedy. All remedies hereunder are cumulative and are not exclusive of any other remedies provided by law. Section 11.8 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without regard to the conflicts of laws principles thereof. Section 11.9 Table of Contents and Headings. The table of contents and section headings of this Agreement are for reference purposes only and are to be given no effect in the construction or interpretation of this Agreement. Section 11.10 Notices. All notices and other communications under this Agreement shall be in writing and shall be deemed given when delivered personally or mailed by certified mail, return receipt requested, to the parties (and shall also be transmitted by facsimile to the Persons receiving copies thereof) at the following addresses (or to such other address as a party may have specified by notice given to the other party pursuant to this provision): If to the Purchaser: Arcade Marketing, Inc. 120 East 56th Street Twelfth Floor New York, New York 10022 Attention: Chief Executive Officer Fax: (212) 223-5776 and to: Arcade Marketing, Inc. 1815 East Main Street Chattanooga, Tennessee 37404 Attention: Chief Financial Officer Fax: (423) 622-4635 53 with a copy to: Akin, Gump, Strauss, Hauer & Feld, L.L.P. 590 Madison Avenue New York, New York 10022 Attention: Edward D. Sopher Fax: (212) 872-1002 If to the Sellers: Jay Gartlan c/o Retail Communications Corp. 350 Fifth Avenue Suite 7920 New York, New York 10018 Fax: (212) 465-8135 with a copy to: Dilworth Paxson LLP 457 Haddonfield Road Suite 700 Cherry Hill, New Jersey 08002 Attention: Harold G. Cohen Fax: (609) 663-8855 and to: Sleepeck Printing Company 815 Twenty-Fifth Avenue Bellwood, Illinois 60104 Attention: Vice President - Finance Fax: (708) 544-8928 54 with a copy to: Jenner & Block One IBM Plaza Chicago, Illinois 60611 Attention: Arthur Martin Fax: (312) 527-0484 If to Michael Berman: 1346 Curtis Road Southampton, Pennsylvania 18966 Attention: Michael Berman Fax: (215) 953-5069 with a copy to: Tenzer Greenblatt LLP The Chrysler Building 405 Lexington Avenue New York, New York 10174 Attention: Michael S. Mullman Fax: (212) 885-5001 Section 11.11 Severability. If any provision of this Agreement is invalid or unenforceable, the balance of this Agreement shall remain in effect. Section 11.12 Binding Effect; Assignment. This Agreement shall be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns. Nothing in this Agreement shall create or be deemed to create any third party beneficiary rights in any person or entity not a party to this Agreement except as provided below. No assignment of this Agreement or of any rights or obligations hereunder may be made by either the Sellers or the Purchaser (by operation of law or otherwise) without the prior written consent of the other parties hereto and any attempted assignment without the required consents shall be void; provided, however, that the Purchaser may assign this Agreement and any or all rights or obligations hereunder (including, without limitation, the Purchaser's rights to purchase the Shares and the Purchaser's rights to seek indemnification hereunder) to any Affiliate of the Purchaser; provided, however, that any such assignment to an Affiliate of the Purchaser shall not relieve the Purchaser of its obligations hereunder or under any Purchaser Document. Upon any such permitted assignment, the references in this Agreement to the Purchaser shall also apply to any such assignee unless the context otherwise requires. 55 Section 11.13 Sellers' Representatives. Jay Gartlan, Michael Berman and a designee of Sleepeck Printing, acting by majority, or such other persons as shall succeed them pursuant to this Section 11.13, are hereby designated as the representatives (the "Sellers' Representatives") to act for and represent the Sellers with respect to all matters arising out of Article X hereof and in those other matters with respect to which this Agreement specifies that the Sellers' Representatives shall so act, as well as matters which require notice to be given to the Sellers under this Agreement. Each Seller hereby fully authorizes and empowers each Sellers' Representative to act for such Seller and for all other Sellers in the matters to which authority is delegated to the Sellers' Representative in this Agreement (the "Agreement Duties"), and agrees that each Sellers' Representative shall have such authority in addition to what is expressly set forth herein as is necessary to facilitate disposition of all such Agreement Duties and that actions taken pursuant to that additional authority shall be comprehended within the term Agreement Duties. Each Seller further agrees and acknowledges that in acting as a Sellers' Representative, no Sellers' Representative assumes the status of a fiduciary for the Sellers or any of them, but serves solely as a volunteer for the convenience of all, and each Seller hereby agrees and assents to, and waives any right to make any claim based upon, each and every real or apparent conflict of interest each Sellers' Representative may have with respect to such Agreement Duties. Each Seller agrees that each Sellers' Representative shall be entitled to payment of all expenses they incur in discharging the Agreement Duties, and reasonable compensation for their time spent in so acting, from the Sellers in accordance with their Sharing Ratios or, if available, from funds held pursuant to the Escrow Agreement, and that the Sellers' Representatives shall have no liability to any Seller for any action or omission to act in the discharge of the Agreement Duties, except in the event of the Sellers' Representatives' gross negligence or willful misconduct. The Sellers agree jointly and severally to indemnify and hold each Sellers' Representative harmless from and against any claims made against them arising out of their actions or failures to act in the discharge of the Agreement Duties and from and against all costs and expenses, including attorneys' fees, incurred in investigating, defending and resolving any such claim, except to the extent that any such claims are determined to arise out of gross negligence or willful misconduct. Section 11.14Disclaimer of Certain Kinds of Damages. Notwithstanding any other provision of this Agreement (including those provisions which use and define the term "Loss"), no party shall be liable to another, whether for breach of contract, warranty or representation, for consequential damages, including loss of revenues, loss of profits, down time, extra production or labor costs or increased overhead, and no party shall be liable to another for punitive damages. [SIGNATURE PAGES FOLLOW] 56 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the day first written above. PURCHASER: AKI, INC. By: /S/ WILLIAM FOX --------------- Name:William Fox Title: President SELLERS: /S/ MICHAEL BERGMAN -------------------- Michael Berman /S/ PAUL PEARL -------------- Paul Pearl /S/ JAY GARTLAN --------------- Jay Gartlan /S/ STUART FLEISCHER -------------------- Stuart Fleischer SLEEPECK PRINTING COMPANY By: /S/ MICHAEL W. SLEEPECK ----------------------- Name: Michael W. Sleepeck Title: President RETAIL TCA CORPORATION By: /S/ STUART FLEISCHER -------------------- Name: Stuart Fleischer Title: President RETAIL TCB CORPORATION By: /S/ PAUL PEARL -------------- Name: Paul Pearl Title: President 57 EX-99 5 EXHIBIT 12.1 - RATIOS
EXHIBIT 12.1 AKI HOLDING CORP. AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (dollars in thousands) Predecessor The Company ------------------------------------------------------ ----------------------------------------- Fiscal Year Ended June 30, July 1, 1997 through December 16, 1997 Fiscal Year Ended -------------------------- -------------------- ----------------- ----------------- December 15, 1997 through June 30, 1998 June 30, 1999 ----------------- --------------------- ------------- 1995 1996 1997 ---- ---- ---- Income (loss) before income taxes...... $7,247 $4,279 $7,117 $3,234 $(7,545) $(5,456) Add: Interest on all indebtedness which includes amortization of deferred financing costs............. 6,170 6,762 6,203 2,646 11,327 16,740 ----- ----- ----- ----- ------ ------ Earnings available for fixed charges..... 13,417 11,041 13,320 5,880 3,782 11,284 Fixed charges....... 6,170 6,762 6,203 2,646 11,327 16,740 ----- ----- ----- ----- ------ ------ Ratio of earnings to fixed charges..... 2.2x 1.6x 2.1x 2.2x -- -- Earnings were not sufficient to cover fixed charges by $7,545 and $5,456 for the period from December 16, 1997 through June 30, 1998 and the fiscal year ended June 30, 1999, respectively. AKI, INC. AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (dollars in thousands) Predecessor AKI, Inc. ------------------------------------------------------ --------------------------------------------- Fiscal Year Ended June 30, July 1, 1997 through December 16, 1997 Fiscal Year Ended June -------------------------- --------------------- ------------------ ---------------------- December 15, 1997 through June 30, 1998 30, 1999 ----------------- --------------------- -------- 1995 1996 1997 ---- ---- ---- Income (loss) before income taxes...... $7,247 $4,279 $7,117 $3,234 $(7,487) $(1,744) Add: Interest on all indebtedness which includes amortization of deferred financing costs............. 6,170 6,762 6,203 2,646 11,269 13,028 ----- ----- ----- ----- ------ ------ Earnings available for fixed charges..... 13,417 11,041 13,320 5,880 3,782 11,284 Fixed charges....... 6,170 6,762 6,203 2,646 11,269 13,028 ----- ----- ----- ----- ------ ------ Ratio of earnings to fixed charges..... 2.2x 1.6x 2.1x 2.2x -- -- Earnings were not sufficient to cover fixed charges by $7,487 and $1,744 for the period from December 16, 1997 through June 30, 1998 and the fiscal year ended June 30, 1999, respectively.
EX-99 6 EXHIBIT 21.1 - SUBSIDIARIES OF AKI HOLDING CORP. EXHIBIT 21.1 SUBSIDIARIES OF AKI HOLDING CORP. AKI Holding Corp.'s only direct subsidiary is AKI, Inc. AKI, Inc.'s only direct subsidiaries are Scent Seal Inc., Arcade Europe SARL and RetCom Holdings Ltd. RetCom Holdings Ltd.'s direct subsidiaries are: RCC Retail Concepts Corp. RetCom Holdings Europe Ltd. RCC Product Development Corp. Encapsulation Services Inc EX-99 7 EXHIBIT 23.1 - CONSENT EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS ---------------------------------- We hereby consent to the incorporation by reference in this Registration Statement on Form S-4 of AKI, Inc. (a wholly-owned subsidiary of AKI Holding Corp.) and Subsidiaries of our report dated July 31, 1999, except for Note 18 which is as of September 15, 1999, relating to the consolidated financial statements which appears in AKI, Inc. (a wholly-owned subsidiary of AKI Holding Corp.) and Subsidiaries' Annual Report on Form 10-K for the year ended June 30, 1999. We also consent to the reference to us under the heading "Experts" in such Registration Statement. /s/PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Nashville, Tennessee September 28, 1999 EX-99 8 EXHIBIT 23.2 - CONSENT EXHIBIT 23.2 CONSENT OF INDEPENDENT ACCOUNTANTS ---------------------------------- We hereby consent to the incorporation by reference in this Registration Statement on Form S-4 of AKI Holding Corp. (a wholly-owned subsidiary of AHC I Acquisition Corp.) and Subsidiaries of our report dated July 31, 1999, except for Note 19 which is as of September 15, 1999, relating to the consolidated financial statements which appears in AKI Holding Corp. (a wholly-owned subsidiary of AHC I Acquisition Corp.) and Subsidiaries' Annual Report on Form 10-K for the year ended June 30, 1999. We also consent to the reference to us under the heading "Experts" in such Registration Statement. /s/PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Nashville, Tennessee September 28, 1999 EX-27 9 EXHIBIT 27.1 - RE. AKI HOLDING CORP. WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 1,000 3-MOS 12-MOS JUN-30-1999 JUN-30-1999 APR-01-1999 JUL-01-1998 JUN-30-1999 JUN-30-1999 7,015 7,015 0 0 16,538 16,538 251 251 5,109 5,109 29,295 29,295 24,245 24,245 5,734 5,734 213,579 213,579 14,442 14,442 146,000 146,000 0 0 0 0 0 0 49,797 49,797 213,579 213,579 16,988 85,967 16,988 85,967 11,291 55,199 11,291 55,199 0 0 114 240 4,237 16,740 (3,870) (5,456) (1,021) (340) (2,849) (5,116) 0 0 0 0 0 0 (2,849) (5,116) 0 0 0 0
EX-27.2 10 EXHIBIT 27.2 - RE AKI, INC.
5 1,000 3-MOS 12-MOS JUN-30-1999 JUN-30-1999 APR-01-1999 JUL-01-1998 JUN-30-1999 JUN-30-1999 7,015 7,015 0 0 16,538 16,538 251 251 5,109 5,109 29,295 29,295 24,245 24,245 5,734 5,734 210,853 210,853 14,442 14,442 116,349 116,349 0 0 0 0 0 0 76,722 76,722 210,853 210,853 16,988 85,967 16,988 85,967 11,291 55,199 11,291 55,199 0 0 114 240 3,276 13,028 (2,909) (1,744) (734) 847 (2,175) (2,591) 0 0 0 0 0 0 (2,175) (2,591) 0 0 0 0
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