10-K405/A 1 y41081e10-k405a.txt APPLIED GRAPHICS TECHNOLOGIES 1 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K/A AMENDMENT NO. 2 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO . COMMISSION FILE NUMBER 0-28208 ------------------------ APPLIED GRAPHICS TECHNOLOGIES, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 13-3864004 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 450 WEST 33RD STREET, NEW YORK, NY 10001 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 212-716-6600 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- COMMON STOCK, PAR VALUE $.01 PER SHARE NASDAQ NATIONAL MARKET
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of registrant's voting stock held by non-affiliates as of August 15, 2000, was $72,597,038. The number of shares of the registrant's Common Stock outstanding as of August 15, 2000, was 22,584,282 shares. The following documents are hereby incorporated by reference into this Form 10-K/A: None. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 This amendment is being filed to reflect the publishing business of Applied Graphics Technologies, Inc. (the "Company"), as a discontinued operation. In June 2000, the Company's Board of Directors approved a plan to sell the publishing business that was acquired as part of the merger with Devon Group, Inc. 3 TABLE OF CONTENTS
ITEM PAGE ---- ---- PART I 1. Business.................................................... 1 2. Properties.................................................. 6 3. Legal Proceedings........................................... 6 4. Submission of Matters to a Vote of Security Holders......... 6 Executive Officers of the Company........................... 7 PART II 5. Market for the Registrant's Common Equity and Related Stockholder Matters....................................... 9 6. Selected Financial Data..................................... 9 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 11 7A. Quantitative and Qualitative Disclosures About Market Risk...................................................... 18 8. Financial Statements and Supplementary Data................. 19 9. Changes in and disagreements with Accountants on Accounting and Financial Disclosure.................................. 60 PART III 10. Directors and Executive Officers of the Registrant.......... 61 11. Executive Compensation...................................... 64 12. Security Ownership of Certain Beneficial Owners and Management................................................ 67 13. Certain Relationships and Related Transactions.............. 69 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................................................... 71 SIGNATURES.................................................................. 74
4 PART I Certain statements made in this Annual Report on Form 10-K/A are "forward-looking" statements (within the meaning of the Private Securities Litigation Reform Act of 1995). Such statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements of the Company to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Company's actual results could differ materially from those set forth in the forward-looking statements. Certain factors that might cause such a difference include the following: the ability to attain compliance with the amended financial covenants under the 1999 Credit Agreement (as defined herein) or to obtain waivers from its lending institutions in the case such compliance is not attained; the trend toward electronic distribution of content; the efficiency of competitors or customers of the Company; the expansion of on-line distribution services; the growth of the market for digital services; market acceptance of the Company's digital photography product line; the amount of broadcast media distribution services business received under the agreement with Western (as defined herein); the timing of completion and the success of the Company's various restructuring plans; the ability to sell certain properties and non-core businesses, including its publishing business; the rate and level of capital expenditures; and the adequacy of the Company's credit facilities and cash flows to fund cash needs. ITEM 1. BUSINESS. GENERAL Applied Graphics Technologies, Inc. and its subsidiaries (the "Company") primarily provide digital media asset management services. Through its various divisions and significant operations, including the Black Dot Group and Seven Worldwide, the Company offers content management services, broadcast media distribution services, and an array of digital services to magazine publishers, advertising agencies, entertainment companies, automobile and other consumer product manufacturers, and retailers. In May 1999, the Company, through a wholly-owned subsidiary, acquired Wace Group Limited (formerly Wace Group Plc) ("Wace"), an international operator of digital imaging businesses and a provider of digital services in the areas of prepress, color management, and interactive multimedia. As a result of the acquisition, the Company enhanced its range of services already provided in the United States and expanded its operations into the United Kingdom and Australia. In June 2000, the Company's Board of Directors approved a plan to sell the publishing business that was acquired as part of the merger with Devon Group, Inc. ("Devon"). This business, which publishes greeting cards, calendars, art prints, and other wall decor items, sells its products primarily to mass markets merchants, card shops, bookstores, art galleries, designers, and framers. The Company was incorporated in Delaware on December 12, 1995. On April 16, 1996, simultaneous with the consummation of the initial public offering of its common stock, the Company acquired substantially all of the assets and certain related liabilities relating to the prepress, digital imaging services, and related businesses of Applied Printing Technologies, L.P. ("Applied Printing"). SEGMENT INFORMATION See Note 23 to the Company's Consolidated Financial Statements for financial information about industry segments. SERVICES The Company's digital media asset management business consists of content management services, digital services, and broadcast media distribution services. 1 5 Content Management Services. The Company's content management services cover a broad spectrum of services from creation through distribution. The scope of the Company's content management services and the range of customers that can make use of these services have expanded with the emergence of electronic distribution channels and the ability to create digital archives. These services include advertising production services, prepress services, electronic transmission services, and limited print services. The Company provides a full range of advertising production services for certain of its customers, primarily retailers. Such services include strategic marketing, creative design, and photography. The Company's strategic marketing services assist customers in reaching a broader audience with targeted messages through the use of research, surveys, and media planning. The creative design services offered by the Company provide customers with a creative concept along with the requisite art direction, copywriting, and design for their advertising and marketing materials. The Company's photographic services provide a wide range of digital and traditional photographic services that include model booking, prop acquisition, location procurement, set designing, and studio photography. The Company offers a full range of prepress services to customers regardless of whether the advertising production services are performed by the Company, an advertising agency, or the customer. Prepress services combine text with black and white and full-color picture and graphic content into page format for publication in print and distribution on the World Wide Web, e-mail, proprietary on-line services, and CD-ROM. Most of the Company's facilities are connected by a data network system that enables the Company to allocate prepress work among its facilities for timely completion. Through its dedicated satellite, the Company provides electronic transmission services to deliver its customers' creative content to locations around the world. The Company also provides electronic design, digital advertising composition, and transmission of display advertising to newspapers. In addition, the Company provides printing services as an ancillary service to certain customers, primarily those in the entertainment industry. For these customers, the Company prints movie posters, CD covers, video covers, and promotional materials. The Company also offers specialty printing for large format requirements such as movie posters, billboards, and other outdoor signage. Digital Services. The Company offers a broad range of digital services and products, including archiving systems, interactive services, digital photography systems, and publishing systems. Using integrated equipment and proprietary software, the Company's Digital Link(R) system offers a method to store, manipulate, repurpose, and distribute digital images. The Company uses Digital Link to provide advanced digital imaging services, such as archiving and online distribution, to new groups of customers and to its existing content management customers. The Company creates digital archives of photographic prints, slides, film, and other images to provide the customer with an organized, easily accessible digital format in which its images can be retrieved, distributed, substituted, and re-edited. The archive may be created at the customer's location or the Company's facilities depending on the size of the library. The Company's archiving services are generally provided under long-term contracts and are usually priced on a per-image basis according to the Company's evaluation of the customer's images and the scope of services to be provided. Through its interactive business, the Company offers website and multimedia creative development, implementation, and management for various marketing and e-commerce applications. The Company also provides customers with consulting services regarding how technology can be used to improve the communication of the customers' message. The Company has developed digital photography systems, including a digital portrait system that integrates a suite of proprietary Digital Link software applications with specialized hardware and is based on an open architecture that supports the leading digital cameras and printers. The Company's digital portrait system provides studio photography services to retailers and other major providers in the consumer portrait market. The Company's digital portrait system provides its customers with a web-based environment in which the end retail consumer can process, store, manage, and distribute their photographs. This system integrates 2 6 with the customer's website, thereby providing the Company's customers with the ability to retain their brand equity and reap any ancillary benefits of having consumers visit their websites. The Company's TeamBase(TM) software provides newspaper and magazine publishers with a professional publishing editorial system to assist in streamlining operations and organizing workflow. Broadcast Media Distribution Services. In its broadcast media distribution business, the Company receives a master copy of a commercial on video or audiotape, duplicates the tape, and ships the copies via air freight to radio and television stations for rebroadcast. As part of its acquisition of SpotLink, Inc. ("SpotLink") in December 1996 from Western International Media Corporation ("Western"), the Company entered into a multi-year contract under which Western is obligated to direct all of its broadcast media distribution business to the Company. DISCONTINUED OPERATIONS Publishing. Through its subsidiary, Portal Publications, Ltd. ("Portal"), the Company publishes greeting cards, posters, art prints, calendars, original artwork, and other wall decor items. The product lines range from moderately priced items intended for a broad customer base to higher quality items consisting of fine art reproductions, limited edition prints, and upscale posters intended for a narrower and more selective customer base. The Company obtains the images for its publishing products by purchasing the rights to publish photographs and artwork that are either in an artist's stock or are commissioned specifically for the Company's use. Images are also obtained from the public domain primarily through photo libraries. The Company's publishing products are printed by outside vendors that are selected based upon quality, ability to deliver, and price. The products are delivered directly to the Company's warehouses, from where shipments are made directly to customers. The Company's publishing customers are primarily mass-market merchants, card shops, bookstores, art galleries, institutional customers, and framers. In June 2000, the Company's Board of Directors approved a plan to sell the publishing business. CUSTOMERS The Company's digital media asset management customer base encompasses a wide variety of enterprises and organizations, including retailers, publishers, advertising agencies, entertainment companies, and automobile and other consumer product manufacturers. The Company's five largest nonaffiliated customers accounted for approximately 30% of total revenues in 1999. The loss of business from any of these five top customers could have a material adverse effect on the Company. The Company's fifty largest nonaffiliated customers accounted for approximately 56% of the Company's revenues in 1999. Revenues from many of the Company's large customers, however, are an aggregation of revenues for services provided by the Company to different groups or publications within a customer, which limits the Company's exposure to the loss of larger customers. In most cases there is no contractual arrangement that would prevent customers from selecting a competitor of the Company to perform some or all of their work. In 1999, approximately 2.4% of the Company's total revenues came from business with affiliates. Such affiliates include U.S. News & World Report, L.P., Daily News, L.P., and Applied Printing, companies beneficially owned by Mortimer B. Zuckerman, the Chairman of the Board of Directors of the Company, and Fred Drasner, Chairman and a director of the Company. SALES AND MARKETING The Company relies primarily on its general managers and regional sales organizations to market its content management services. Because they have conducted business together over several years, personnel at each facility have established strong working relationships with particular customer industries that are prevalent around its location. For instance, personnel at the Los Angeles facilities have strong relationships with the entertainment industry, at the Detroit facility with the automotive industry, at the New York facilities with the publishing industry, and at other locations with major retailers. These relationships also extend to advertising agencies that perform work for these customers. 3 7 The Company maintains a separate sales force to market digital services to existing content management customers and to new groups of customers. The Company also has a sales force to market its broadcast media distribution services. The Company sells its publishing products through an internal sales force and independent representatives as well as through contacts and efforts of senior executives. Sales of mass-market publishing products are managed through in-store service programs that enhance the ability of a product to be carried by customers for many years. VENDOR ARRANGEMENTS The Company is a major purchaser of certain types of products. Because of the dollar amount of the products it purchases, the Company has been in a position to enter into arrangements with vendors pursuant to which the vendors pay rebates to the Company based upon a specified dollar volume of products purchased by the Company over a given time period. COMPETITION Content Management Services: Content management services, especially prepress services, are performed primarily by three types of businesses: (i) independent providers that typically do not also offer commercial printing services as a principal part of their overall business, (ii) commercial printers, such as R. R. Donnelley & Sons, Co., Quebecor Printing, Inc., and Quad/Graphics, Inc., that provide prepress and other image management services as an adjunct to their printing businesses, and (iii) customers that perform certain services themselves using available desktop publishing technologies. The industry currently is extremely fragmented and serviced by a large number of regional and local businesses and few national enterprises. Commercial printers providing prepress services generally compete on the basis of the convenience of "one-stop shopping" for prepress and printing services, and on the basis of price by bundling the cost of prepress and other content management services with the printing cost or by substantially discounting the separate prepress services. A customer might prefer services by a printer where price is the primary consideration and quality of and control over the artistic process are not key concerns. Independent providers, such as the Company, generally are able to offer a higher level of specialization, customization, and individualized service and also provide customers with the flexibility to select the printer of their choice, thus giving the customer greater leverage in negotiating for printing services. A customer would look to perform its own prepress services internally if the customer believed that control over the process was advantageous and quality of the product was not paramount. Customers typically provide for themselves only a portion of the prepress services they need, augmenting their own capabilities, as needed, with third-party services usually from independent providers. The Company competes for prepress work on the basis of quality of service, price of service, and the ability to satisfy demanding customers. The Company believes that not every prepress provider can meet the demands of the types of customers served by the Company. Among this smaller group, the Company competes primarily based on historical reliability of service and on price. The Company believes it maintains competitive prices by efficiently implementing new technologies in its digital imaging and prepress businesses. Additionally, the Company believes that it is able to maintain competitive prices by coordinating its customers' in-house capabilities with its own equipment, thereby minimizing redundant processes and lowering customer costs. In addition, the Company competes for prepress work based on its ability to provide other digital imaging services. For example, the Company provides digital archiving services for prepress customers at a lower cost than if purchased on a stand-alone basis because of the Company's ability to efficiently integrate the prepress and archiving processes. Independent prepress providers typically provide services based upon a customer's request for which the provider is paid on a per-job basis. In most cases, there is no contractual arrangement that would prevent a customer from changing prepress providers on a per-project basis except for the Company's typical on-site arrangement for which a multi-year contract is obtained. 4 8 The Company competes for advertising production services primarily with major advertising agencies and professional photography studios primarily on the basis of quality of service. Digital Services: In the area of digital imaging and archiving, the Company competes with a small number of software-development companies marketing products to manage image databases. In the area of retail portrait photography, the Company's main competitor is a division of Kodak. The Company believes that its approach, which uses its customers' websites as the portals through which consumers access their photographs as opposed to using a generic site, better serves its customers by allowing the customers to retain their brand equity and reap any ancillary benefits of having consumers visit their websites. Broadcast Media Distribution Services: In the broadcast media distribution business, the Company competes with many local and/or regional suppliers as well as national suppliers, such as Vyvx, Inc., a subsidiary of The Williams Companies, Inc., Digital Generation Systems, Inc., and VDI Media. These services are typically provided on a per-job basis. The Company generally has no contractual arrangements that would prevent a customer from changing providers. The Company believes competition is based on quality of duplication, speed, and reliability of distribution as well as price. Publishing: In the publishing business, the Company primarily competes with major greeting card companies such as Hallmark Cards, Inc., and American Greetings Corporation. The Company also competes with local and regional producers of posters and art prints. The Company believes competition is based on reliability of service, timeliness of delivery, and the ability to select images with mass-market appeal. EMPLOYEES As of December 31, 1999, the Company had approximately 5,200 total employees, approximately 5,000 of whom were full-time employees. Of the total employees, approximately 2,400 were salaried employees and approximately 2,800 were hourly employees. Approximately 480 of the Company's employees were covered by collective bargaining agreements. The Company has never experienced a work stoppage and believes that its relationships with its employees, both unionized and nonunionized, are satisfactory. INTELLECTUAL PROPERTY The Company has a copyright in the software comprising Digital Link. Copyrights do not preclude competitors from developing comparable software. The Company does not currently have any patents. The Company owns the registered trademarks "Applied Graphics Technologies," "Digital Link," "AGT," and other marks used in its business. GEOGRAPHIC INFORMATION See Note 23 to the Company's Consolidated Financial Statements for financial information about geographic regions. Operating income from foreign operations was approximately $284,000 for the year ended December 31, 1999. RECENT DEVELOPMENTS In March 2000, the Company announced that it had retained an investment banking firm to explore strategic alternatives, including a possible sale of the Company. In August 2000, the Board of Directors of the Company decided that it would no longer actively pursue a sale of the Company, but would continue to pursue other strategic alternatives. There can be no assurance that any transaction will occur as a result of this effort. In April 2000, the Company sold the photographic laboratory business that was acquired as part of Wace for a sales price of approximately $11,500,000. The Company did not realize a gain or loss on the sale of this business. In June 2000, the Company's Board of Directors approved a plan to sell the publishing business that was acquired as part of the merger with Devon. The Company expects to consummate the sale of the publishing business by June 2001, although there can be no assurance that the sale will be consummated within that timeframe. 5 9 ITEM 2. PROPERTIES The Company rents its corporate headquarters in New York City under a lease that expires in 2011 and operates its principal facilities at the locations indicated below. New York City Wilmington, Ohio Washington, DC (5 content management facilities; (1 broadcast facility) (1 content management facility) 1 broadcast facility; 1 digital facility) Atlanta, Georgia Central Illinois Indianapolis, Indiana (1 content management facility) (2 content management facilities) (1 content management facility) Boulder, Colorado Rochester, New York Orlando, Florida (1 digital facility) (1 digital facility) (3 content management facilities) Chicago, Illinois Seattle, Washington Nashua, New Hampshire metropolitan area (1 content management facility; (1 digital facility) (9 content management facilities; 1 publishing facility) 1 digital facility) Detroit, Michigan San Diego, California International Locations: metropolitan area (1 content management facility) (3 content management facilities; United Kingdom 1 broadcast facility) (4 content management facilities; 1 digital facility; 1 publishing Los Angeles, California San Francisco, California facility) metropolitan area metropolitan area Australia (4 content management facilities; (2 content management facilities; (1 content management facility; 1 digital facility; 1 broadcast 2 publishing facilities) 1 publishing facility) facility) Northern New Jersey Dallas, Texas Canada (4 content management facilities) (2 content management facilities) (1 publishing facility) Central Michigan Omaha, Nebraska (1 content management facility) (1 content management facility)
The Company owns ten of the content management facilities and one publishing facility. The remaining facilities are operated under leases that expire in 2000 through 2009. The Company also provides on-site services at certain other customer locations where services are performed only for that specific customer. The Company believes that its facilities are adequate to meet its needs. ITEM 3. LEGAL PROCEEDINGS. The Company is not subject to any material litigation nor, to the Company's knowledge, is any material litigation currently threatened against the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1999. 6 10 EXECUTIVE OFFICERS OF THE COMPANY The following table lists the executive officers of the Company. Officers are appointed by the Board of Directors and serve at the discretion of the Board.
NAME AGE POSITION ---- --- -------- Fred Drasner.............................. 57 Chairman and Director Derek Ashley.............................. 40 Vice Chairman, Chief Executive Officer, Chief Operating Officer, and Director Marne Obernauer, Jr....................... 57 Vice Chairman and Director Scott A. Brownstein....................... 51 Executive Vice President and Chief Technology Officer Martin D. Krall........................... 59 Executive Vice President, Chief Legal Officer, Secretary, and Director Joseph D. Vecchiolla...................... 44 Senior Vice President and Chief Financial Officer
Fred Drasner, Chairman and a director of the Company, served as Chief Executive Officer of the Company from 1996 until April 2000. Mr. Drasner has been co-owner of Pro Football, Inc., d/b/a The Washington Redskins, since July 1999. He has been the Chief Executive Officer of Daily News and Co-Publisher of the New York Daily News since 1993, Co-Chairman of U.S. News & World Report, L.P. ("U.S. News"), since 1998, Chief Executive Officer of U.S. News from 1985 to 1998, President of U.S. News from 1985 to 1997, Chairman and Chief Executive Officer of Applied Printing since 1988, and Co-Chairman from 1998 to 1999 and Vice-Chairman and Chief Executive Officer from 1986 to 1998 of The Atlantic Monthly Company. Mr. Drasner has served as Co-Chairman of Fast Company Media Group, L.L.C. ("Fast Company"), since January 1999. Mr. Drasner was also senior counsel to Shaw Pittman, formerly known as Shaw Pittman Potts & Trowbridge, until his resignation in April 1996. Derek Ashley, Vice Chairman, Chief Executive Officer, Chief Operating Officer, and a director of the Company, joined the Company in May 1999 in connection with the acquisition of Wace. Mr. Ashley served as Group Chief Executive of Wace from June 1998 until its acquisition by the Company. Prior to that, Mr. Ashley served as President and Chief Executive Officer of Seven Worldwide, Inc., a wholly-owned subsidiary of Wace, from July 1997 and as European Managing Director of Wace from 1995. Marne Obernauer, Jr., Vice Chairman and a director of the Company, joined the Company in May 1998 in connection with the merger with Devon. Prior to joining the Company, and up until its merger with the Company, he served as Chief Executive Officer of Devon from 1980 and as Chairman of the Board of Directors of Devon from 1986. Scott A. Brownstein, Executive Vice President and Chief Technology Officer of the Company, was the Senior Vice President and General Manager of the Company's digital operations from 1993 to 1995, where he was responsible for developing, manufacturing, and marketing the Company's digital services. Martin D. Krall, Executive Vice President, Chief Legal Officer, Secretary, and a director of the Company, has been Executive Vice President, Chief Legal Officer, and Secretary of Daily News, Applied Printing, and U.S. News since January 1995. Mr. Krall served as Executive Vice President, Chief Legal Officer, and Secretary of The Atlantic Monthly Company from 1995 to 1999. Mr. Krall has served as Executive Vice President, Chief Legal Officer, and Secretary of Fast Company and its majority owner, FC Holdings, L.L.C., since January 1999. Prior to 1995, Mr. Krall was a partner in the law firm of Shaw Pittman, where he was a member of the Management Committee from 1978 to 1994, and the Vice Chairman of such Committee from 1991 to 1994. From 1995, Mr. Krall was also senior counsel to Shaw Pittman until his resignation in April 1996. Joseph D. Vecchiolla, Senior Vice President and Chief Financial Officer of the Company, joined the Company in May 2000. From February 1999 through April 2000 he served as Vice President of Marketing and Vice President of Finance at Favorite Brands International, which was acquired by Nabisco in November 1999. Favorite Brands International filed for protection under Chapter 11 of the U.S. Bankruptcy 7 11 Code in March 1999. From May 1997 until February 1999 he served as President of Old Greenwich Capital Corporation. From June 1993 through December 1997 he served in various capacities at Bird Corporation, beginning as Senior Vice President and Chief Financial Officer (June 1993 through September 1993), then President, Chief Operating Officer, and Chief Financial Officer (September 1993 through January 1994), then President and Chief Executive Officer (January 1994 through April 1995), and finally Chairman of the Board of Directors (May 1995 through December 1997). Concurrent to his tenure at Bird Corporation, from May 1995 through December 1997, Mr. Vecchiolla served as Senior Vice President of Corporate Finance at S.N. Phelps & Co., Vice President and Chief Financial Officer of Wyatt Energy Corp., President of American Modular Technologies, LLP, and Vice President and Chief Financial Officer of Commonwealth Oil of Puerto Rico, LLP. 8 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's common stock is traded on the Nasdaq National Market. The following table sets forth the high and low closing sales price for each full quarterly period during 2000, 1999, and 1998.
2000 1999 1998 --------------- --------------- --------------- HIGH LOW HIGH LOW HIGH LOW ---- --- ---- --- ---- --- First quarter................................... 9 5/16 3 5/16 17 1/16 6 7/8 60 1/4 45 1/2 Second quarter.................................. 6 1/4 3 1/16 14 5/8 6 5/8 53 1/2 42 19/32 Third quarter................................... 4 11/16 3 5/16 14 1/2 7 3/16 55 3/4 12 1/2 Fourth quarter.................................. 9 3/16 6 1/2 16 1/2 7 7/8
As of September 26, 2000, there were 4,940 holders of record of the Company's common stock. No dividends have been paid since April 17, 1996, the date the Company's common stock commenced trading. The Company currently intends to retain any future earnings for use in the operation of its business for the foreseeable future. The Company is prohibited from paying dividends under its existing credit facility. In February 2000, the Company issued 109,510 shares of its common stock as additional contingent consideration to the former stockholders of Amusematte Corp. and Agile Enterprise, Inc., which the Company acquired in December 1997 and September 1998, respectively. All contingencies on the additional consideration were satisfied as of December 31, 1999. The sale and issuance of such securities by the Company were effected in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act. ITEM 6. SELECTED FINANCIAL DATA.
DECEMBER 31, -------------------------------------------------------- 1999(A) 1998(B) 1997(C) 1996 1995(D) -------- -------- -------- -------- -------- (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS) Revenues............................ $532,064 $338,942 $184,993 $132,725 $117,802 Income (loss) from continuing operations before provision for income taxes and minority interest.......................... $ (7,270) $ 16,290 $ 22,707 $ 10,820 $ (7,812) Income (loss) from continuing operations........................ $(11,534) $ 6,318 $ 13,567 $ 9,955 $ (7,812) Earnings (loss) per common share from continuing operations: Basic............................. $ (0.51) $ 0.31 $ 0.88 $ 0.79 Diluted........................... $ (0.51) $ 0.30 $ 0.83 $ 0.77 Total assets........................ $931,010 $703,074 $224,793 $ 72,147 $ 44,809 Long-term obligations: Long-term debt.................... $298,125 $203,087 $ 812 $ 6,005 $ 853 Subordinated notes................ 29,867 Obligations under capital leases......................... 3,814 3,475 2,011 1,265 2,415 -------- -------- -------- -------- -------- Total..................... $331,806 $206,562 $ 2,823 $ 7,270 $ 3,268 ======== ======== ======== ======== ========
9 13
JUNE 30, -------------------------- 2000(E) 1999 ----------- ----------- (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS) Revenues............................ $291,342 $224,655 Income (loss) from continuing operations before provision for income taxes and minority interest.......................... $ (5,757) $ 6,986 Income (loss) from continuing operations........................ $ (9,121) $ 1,493 Earnings (loss) per common share from continuing operations: Basic............................. $ (0.40) $ 0.07 Diluted........................... $ (0.40) $ 0.07 Total assets........................ $764,358 $920,856 Long-term obligations: Long-term debt.................... $260,589 $302,655 Subordinated notes................ 28,119 Obligations under capital leases......................... 2,773 5,207 -------- -------- Total..................... $291,481 $307,862 ======== ========
No dividends have been paid on the Company's common stock. --------------- (a) Amounts in 1999 include charges of $3,572, $744, $5,558, $2,419, $750, $488, and $418 for restructurings, impairment of a business, impairments of property and equipment, loss on disposal and abandonment of fixed assets, a litigation accrual, write off of acquisition costs, and a change in accounting estimate, respectively. (See Note 5 and Note 6 to the Consolidated Financial Statements.) (b) Amounts in 1998 include charges of $8,550, $3,150, and $2,509 for restructurings, abandonment of a business, and impairment of intangible assets, respectively. (See Note 5 and Note 6 to the Consolidated Financial Statements.) (c) Amounts in 1997 include a charge of $2,487 related to the Chapter 11 bankruptcy filing of one of the Company's customers. (d) Amounts in 1995 include restructuring charges of $3,060. (e) Amounts in 2000 include $611 and $1,241 for a restructuring charge and impairment charges, respectively. (See Note 3 and Note 4 to Interim Consolidated Financial Statements.) 10 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The accompanying financial statements have been restated to reflect the Company's publishing business as a discontinued operation. The following discussion and analysis (in thousands of dollars) should be read in conjunction with the Company's Consolidated Financial Statements and notes thereto. RESULTS OF OPERATIONS Year ended December 31, 1999, compared with 1998 Revenues in 1999 were $193,122 higher than in the comparable period in 1998. Revenues increased by $206,000 from facilities operated for none or only a portion of the 1998 period. Such increase was comprised of $130,205 in revenues from Wace Group Limited (formerly Wace Group Plc) ("Wace"), $65,679 in revenues from Devon Group, Inc. ("Devon"), and $10,116 in revenues from other acquired operations. The acquisition of Wace and the merger with Devon were consummated on May 21, 1999, and May 27, 1998, respectively. This increase in revenues from acquired operations was offset by a decrease in revenues of $12,878 at facilities operated during the comparable 1998 period. This decrease at existing facilities was caused primarily by the loss of customers and reduced business from other customers, principally those in the entertainment industry. Revenues in 1999 increased by $185,395 from content management services, $4,538 from broadcast media distribution services, and $3,189 from digital services. Increased revenues from content management services resulted from revenues of $203,478 associated with acquired operations, primarily the content management businesses acquired in the merger with Devon and the acquisition of Wace, partially offset by a decrease in revenues of $18,083 at the Company's prepress facilities operated in both periods. Increased broadcast media distribution services revenues resulted from internally generated growth. Increased revenues from digital services primarily resulted from the digital operations acquired as part of Wace. Gross profit increased $54,822 in 1999 as a result of the additional revenues for the period as discussed above. The gross profit percentage in 1999 was 31.7% as compared to 33.5% in the 1998 period. This decrease in the gross profit percentage resulted from reduced margins at traditional prepress facilities as a result of the decrease in revenues discussed above, which resulted in lower absorption of fixed manufacturing costs and the acceptance of lower margin work. In addition, the gross profit percentage of the creative business within content management services decreased to 29.5% in 1999 from 33.2% in 1998 due to additional work being accepted at lower margins. These decreases were partially offset by higher margins in the broadcast media distribution business, which benefited from better pricing and internal expansion that reduced reliance on outside services. Selling, general, and administrative expenses in 1999 were $60,855 higher than in the 1998 period, and as a percent of revenue increased to 25.3% in the 1999 period from 21.7% in the 1998 period. Such expenses grew at a greater rate than revenue due primarily to higher costs incurred at the Wace operations that have not been fully integrated. Selling, general, and administrative expenses in 1999 include a charge of $750 for a litigation accrual and a charge of $418 related to increased amortization of software costs resulting from a change in the estimated useful life. Amortization expense for intangible assets increased by $5,582 in 1999 due primarily to the goodwill associated with acquisitions consummated during and subsequent to the 1998 period. The loss on disposal of fixed assets was $2,402 in 1999. The Company abandoned or disposed of significant amounts of equipment in 1999 as a result of the reallocation of work among various facilities, a change in service requirements of certain major customers, and a general upgrade of equipment at certain of the Company's larger facilities to achieve anticipated efficiencies from the various integration efforts. The results of operations for 1999 included a charge of $3,572 related to various restructuring efforts initiated by the Company (see Note 5 to the Consolidated Financial Statements). During 1998, the Company commenced two separate plans to restructure certain of its operations (the "1998 Second Quarter Plan" and the "1998 Fourth Quarter Plan", respectively). The 1998 Second Quarter Plan was revised in the fourth quarter of 1998 in response to additional acquisitions and a change in operation management. As part of the 11 15 1998 Second Quarter Plan, the Company closed a facility in New Jersey and made modifications to its Carlstadt, NJ, facility to accommodate the transfer of work performed at the closed location to the Carlstadt facility. In addition, as part of the 1998 Second Quarter Plan, the Company vacated a portion of one of its Chicago, IL, facilities and transferred a portion of the work performed at that facility to its other Chicago metropolitan area facilities. Also as part of the 1998 Second Quarter Plan, the Company terminated certain employees and consolidated the work performed in its West Coast facilities, resulting in the closure of one such facility. The results of operations for 1999 included a charge of $228 related to the 1998 Second Quarter Plan resulting from the Company not being released as early as originally estimated from certain rental obligations on abandoned equipment. As part of the 1998 Fourth Quarter Plan, the Company closed several facilities in Illinois and terminated employees on a Company-wide basis. The work performed at each of the closed Illinois facilities is being performed at the Company's other midwest facilities. The results of operations for 1999 included income of $1,447 resulting from the reversal of liabilities no longer needed related to the 1998 Fourth Quarter Plan. The adjustment to the liability resulted from the Company not terminating as many employees as originally anticipated and negotiating favorable settlements on certain building lease obligations. Fewer employees were terminated under the 1998 Fourth Quarter Plan than was originally anticipated due to the Company's re-evaluation of its plans in light of the acquisition of Wace and the voluntary termination of certain employees. The Company commenced a plan in the third quarter of 1999 to consolidate certain of its West Coast operations (the "1999 Third Quarter Plan"). As part of the 1999 Third Quarter Plan, the Company closed the Los Angeles facility previously operated by Wace and intends to move Wace's San Francisco operation to a more suitable facility. A portion of the work previously performed in the Company's Foster City facility was transferred to Wace's San Francisco facility and the remaining operation will be moved to a smaller Foster City location. The results of operations for 1999 included a charge of $636 related to the 1999 Third Quarter Plan. The Company commenced action in the fourth quarter of 1999 to consolidate certain of its New York and Chicago metropolitan area and United Kingdom operations and consolidate certain administrative functions (the "1999 Fourth Quarter Plan"). As part of the 1999 Fourth Quarter Plan, the Company transferred all of the work performed at one of its New York City facilities to Wace's Varick Street operation. Also as part of the 1999 Fourth Quarter Plan, the Company is further consolidating its Carlstadt, NJ, operation to occupy only two of the three buildings that currently comprise that facility. The Company intends to sublet the vacated building. The Company also redistributed certain work among its various metropolitan New York area operations. In the midwest, the Company closed one of its Chicago facilities and transferred the work previously performed there to one of Wace's Chicago facilities. In the United Kingdom, the Company streamlined certain operations and workflows and initiated a plan to shut down a portion of its digital operations. Additionally, as part of the 1999 Fourth Quarter Plan, the Company initiated a plan to transfer certain centralized administrative functions to the various regional operations, which will result in the closure of a New York metropolitan area administrative office. The results of operations for 1999 included a charge of $4,155 related to the 1999 Fourth Quarter Plan. The Company does not anticipate any material adverse effect on its future results of operations from the facility closings since all work performed at such locations has been and will be transferred to its other facilities. The employees terminated and to be terminated under the restructuring plans are principally production workers, sales people, and administrative support staff. The Company completed both the 1998 Second Quarter Plan and the 1998 Fourth Quarter Plan during 1999. The Company expects to complete the 1999 Third Quarter Plan and the 1999 Fourth Quarter Plan by September 2000 and December 2000, respectively. Impairments and other charges totaled $6,302 in 1999 and were comprised of $5,558 related to the impairment of property and equipment and $744 related to the impairment of a business. The Company incurred a charge of $2,429 from the impairment of equipment related to its various restructuring and integration efforts. In addition, in connection with the acquisition of Wace, the Company incurred a charge of $3,129 related to the abandonment of certain software development projects that were replaced by systems 12 16 already in service at the various Wace locations or were no longer viable for the combined entity. In December 1999, the Company incurred a charge of $744 for the write down of long-lived assets related to its events-based digital photography operation. Interest expense in 1999 was $12,839 higher than in 1998 due primarily to the interest on borrowings to finance acquisitions. Four interest rate swap agreements entered into by the Company resulted in $354 of additional interest expense in the year. Interest income in 1999 was $1,342 lower than during the 1998 period due to the sale of marketable securities to fund certain mergers and acquisitions in 1998. Other income in 1999 was primarily comprised of a gain of $1,000 on the sale of an internet-related asset in connection with entering into a long-term agreement to perform content management services and approximately $500 of rental income associated with certain vacated properties. This income was partially offset by a write-off of $488 for acquisition costs related to transactions no longer being pursued. The Company incurred a provision for income taxes at a rate equal to 29.8% of the pretax loss for the year. A provision was incurred, as opposed to a benefit being received, due to the permanent items related to the nondeductible goodwill associated with the Devon merger and the Wace acquisition and the nondeductible portion of meals and entertainment expenses exceeding the amount of the pretax loss. In June 2000, the Company's Board of Directors approved a plan to sell the publishing business that was acquired as part of the merger with Devon. The results of operations in 1999 include an after tax loss from discontinued operations of $452, as compared to net income of $1,858 in 1998. In accordance with the Company's credit agreement, the net after tax proceeds from the sale of the publishing business will be used to repay outstanding borrowings. The Company continues to transact business with Applied Printing Technologies, L.P. ("Applied Printing"), an entity beneficially owned by the Chairman of the Board of Directors of the Company (the "Chairman of the Board") and the Chairman of the Company (the "Chairman"), which owned approximately 22.2% of the Company's outstanding common stock at December 31, 1999. The Company also transacts business with other affiliates, including the Daily News, L.P., and U.S. News & World Report, L.P., both of which are beneficially owned by the Chairman of the Board and the Chairman as well as with Snyder Communications, Inc., a provider of outsourced marketing services, of which both the Chairman of the Board and the Chairman were members of the Board of Directors and in the aggregate owned approximately 10.0% of the outstanding common stock as of December 31, 1999. Sales to related parties for the years ended December 31, 1999, 1998, and 1997, totaled $13,008, $23,658, and $16,845, respectively, representing 2.4%, 7.0%, and 9.1%, respectively, of the Company's revenues. Year ended December 31, 1998, compared with 1997 Revenues in 1998 were $153,949 higher than in the comparable period in 1997. This increase resulted from $22,101 of revenues from additional business generated internally and $131,848 of revenues from acquired operations. In 1998, revenues increased by $142,556 from content management services, $6,605 from broadcast media distribution services, and $4,788 from digital services. Increased revenues from content management services were due primarily to the operations of the content management business acquired in the merger with Devon as well as other operations acquired subsequent to the 1997 period, including the content management operations of Flying Color Graphics, Inc. ("Flying Color"), and Color Control, Inc. ("Color Control"), which were acquired in January 1998 and June 1998, respectively, and from an overall increase in business at various facilities. Increased broadcast media distribution services revenues primarily resulted from a full year of revenue in 1998 from operations acquired in 1997 and internally generated growth. Increased revenues from digital services primarily resulted from increased software and equipment sales, including amounts generated from acquired operations, and increased digital photography sales. The gross profit percentage in 1998 was 33.5% as compared to 34.6% in 1997. Gross profit increased $49,701 in 1998 as a result of the additional revenues for the period as discussed above. 13 17 Selling, general, and administrative expenses in 1998 were $32,693 higher than in 1997, and as a percent of revenue decreased to 21.7% in 1998 from 22.1% in 1997. Amortization expense for intangible assets increased by $4,933 in 1998 due primarily to the goodwill associated with acquisitions. The results of operations for 1998 include a charge of $8,550 related to restructurings, comprised of $5,713 related to the 1998 Second Quarter Plan and $2,837 related to the 1998 Fourth Quarter Plan. Impairments and other charges totaled $5,659 in 1998 and were comprised of $3,150 relating to the abandonment of a business and $2,509 from the impairment of intangible assets. In December 1998, the Company adopted a plan to cease certain of its digital photography operations, primarily those operations acquired as part of the acquisition of Digital Imagination, Inc. ("DI"), in June 1997. As of December 31, 1998, the Company had shut down all locations associated with this operation. The charge of $3,150 related to the abandonment of this operation is comprised primarily of the unamortized goodwill related to the DI acquisition, the write-off of certain equipment no longer being utilized as a result of the abandonment, and facility closure costs. In December 1998, the Company incurred a charge of $2,509 for the write down of long-lived assets related to its events-based digital photography operation. Interest expense in 1998 was $5,273 higher than in 1997 due primarily to the interest on borrowings to finance the Devon merger and the Color Control acquisition. Three interest rate swap agreements entered into by the Company during 1998 resulted in an immaterial amount of additional interest expense in the year. The effective rate of the provision for income taxes of 61.2% in 1998 was higher than the statutory rate due primarily to the permanent items related to the nondeductible goodwill associated with the Devon merger and other acquisitions and the nondeductible portion of meals and entertainment expenses. Six months ended June 30, 2000, compared with 1999 Revenues in the first six months of 2000 were $66,687 higher than in the comparable period in 1999. This increase was due to the revenues from Wace, which was acquired in the latter part of the 1999 period. Revenues in the 2000 period increased by $56,650 from content management services, $7,969 from digital services, and $2,068 from broadcast media distribution services. Increased revenues from content management services primarily resulted from increased revenues of $64,759 associated with the content management businesses acquired in the acquisition of Wace as well as from higher revenues at the Company's West Coast operations, principally from customers in the entertainment industry. These increases were partially offset by a decrease in revenues from the Black Dot operations acquired in the merger with Devon, and a decrease in revenues at the Company's East Coast operations, principally from customers in the publications industry. Increased revenues from digital services resulted from the digital operations acquired as part of Wace and from additional digital photography systems sales. Increased revenues from broadcast media distribution services resulted from internal growth. Gross profit increased $27,182 in the first six months of 2000 as a result of the additional revenues for the period as discussed above. The gross profit percentage in 2000 was 33.4% as compared to 31.3% in the 1999 period. This increase in the gross profit percentage resulted primarily from the acquisition of the Wace operations, which have higher gross profit margins than the Company's other content management operations, and improved margins at the Company's West Coast content management facilities, where the increase in revenue discussed above resulted in greater absorption of fixed manufacturing costs. These improvements were partially offset by lower margins at the Company's East Coast content management operations, where the reduction in revenue discussed above resulted in lower absorption of fixed manufacturing costs and other operating inefficiencies. Selling, general, and administrative expenses in the first six months of 2000 were $29,350 higher than in the 1999 period, and as a percent of revenue increased to 28.1% in the 2000 period from 23.3% in the 1999 period. Such expenses grew at a greater rate than revenue due primarily to a higher rate of costs incurred at the acquired Wace operations than at the Company's other content management operations. Additionally, 14 18 selling, general, and administrative expenses in the 2000 period include a charge of $1,732 for nonrestructuring-related employee termination costs. The results of operations for the six months ended June 30, 2000, include a restructuring charge of $611 related to a plan (the "2000 Second Quarter Plan") to close the Atlanta operation acquired as part of the Wace acquisition. The charge for the 2000 Second Quarter Plan consisted of $456 for facility closure costs and $155 for employee termination costs for 34 employees. As of June 30, 2000, no payments had been made related to the 2000 Second Quarter Plan. Impairment charges totaled $1,241 for the six months ended June 30, 2000, and consisted of $583 from the impairment of equipment related to the 2000 Second Quarter Plan and $658 from the write down of long-lived assets related to the Company's events-based digital photography business. Amortization expense for intangible assets increased by $1,737 in the first six months of 2000 due primarily to the goodwill associated with the Wace acquisition. Interest expense in the first six months of 2000 was $7,036 higher than in the 1999 period due primarily to the interest on borrowings to finance the Wace acquisition and higher interest rates under the amended and restated credit agreement entered into in connection with the acquisition of Wace. Four interest rate swap agreements entered into by the Company resulted in an immaterial reduction of interest expense in the 2000 period. Notwithstanding the fact that the Company reported a pretax loss from continuing operations for the period, the Company incurred a provision for income taxes of $2,068. A provision was incurred, as opposed to a benefit being received, due to the projected annual permanent items related to nondeductible goodwill and the nondeductible portion of meals and entertainment expenses exceeding the amount of the projected pretax loss for the year. The results of operations in the 2000 period include an after tax loss from discontinued operations of $98,383, which consisted of a loss from operations of $3,141 and an estimated loss on disposal of $95,242. Revenues from business transacted with affiliates for the six months ended June 30, 2000 and 1999, totaled $5,493 and $6,460, respectively, representing 1.9% and 2.9%, respectively, of the Company's revenues. LIQUIDITY AND CAPITAL RESOURCES In connection with the acquisition of Wace, the Company entered into an amended and restated credit agreement (the "1999 Credit Agreement") with its lending institutions. On June 4, 1999 (the "Initial Funding Date"), the Company borrowed $296,000, the proceeds of which were used to pay off existing borrowings under the Company's previous credit arrangements and to finance the Wace acquisition. The total borrowing capacity under the 1999 Credit Agreement is a maximum of $350,000, comprised of a $100,000 revolving credit line (the "Revolver") and three term loans aggregating $250,000 (the "Term Loans"). The Revolver extends through June 2005. The Term Loans are comprised of three tranches of $125,000, $75,000, and $50,000 that have terms extending through June 2005, June 2006, and June 2007, respectively. Interest rates on funds borrowed under the 1999 Credit Agreement vary from either LIBOR or the prime rate in effect at the time of the borrowing, plus a factor based on annual pro forma EBITDA (as defined in the 1999 Credit Agreement). Under the terms of the 1999 Credit Agreement, the Company was obligated to enter into hedge arrangements within 180 days of the Initial Funding Date for a minimum of two years covering at least 30% of the amount borrowed on the Initial Funding Date. The Company has entered into four interest rate swap agreements, two of which expire in August 2003 (the "August 2003 Swaps"), one of which expires in August 2001 (the "August 2001 Swap"), and one of which expires in December 2001 (the "December 2001 Swap"). Under the August 2003 Swaps, the August 2001 Swap, and the December 2001 Swap, the Company pays a fixed rate of 5.798%, 5.69%, and 6.45%, respectively, per annum on a quarterly basis and is paid a floating rate based on the three month LIBOR rate in effect at the beginning of each quarterly payment 15 19 period. The notional amounts of the August 2003 Swaps are $35,000 and $15,000 and the notional amounts of the August 2001 Swap and the December 2001 Swap are $25,000 and $15,000, respectively. Under the terms of the 1999 Credit Agreement, the Company must comply with certain covenants related to leverage ratios, interest coverage ratios, fixed charge coverage ratios, minimum net worth, and capital spending. At December 31, 1999, the Company was in compliance with all covenants. At December 31, 1999, total senior funded debt (as defined in the 1999 Credit Agreement) was $328,580. Although the Company may continue to borrow up to the maximum capacity during the course of subsequent periods, on the last day of each quarterly period in 1999 it was required to have a ratio of total senior funded debt to pro forma EBITDA for the most recently completed four fiscal quarters that did not exceed 4.25 in order to remain in compliance with the covenants of the 1999 Credit Agreement. In August 2000, the Company entered into an amendment to the 1999 Credit Agreement (the "Fourth Amendment") to relax the interest coverage ratio and net worth covenants as of June 30, 2000, and to modify all of the financial covenant requirements to be less restrictive than previously required in the 1999 Credit Agreement for the quarterly fiscal periods through June 30, 2001. In addition to modifying the various financial covenants, the Fourth Amendment increased the interest rates on all future borrowings under the 1999 Credit Agreement by 50 basis points and lowered the borrowing capacity of the Revolver to $85,000. In July 2000, the Company entered into an amendment to the 1999 Credit Agreement (the "Third Amendment") that lowered the net worth covenant threshold to enable the Company to proceed with its planned disposal of the publishing business. Also in July 2000, the lending institutions granted a waiver of covenant defaults to enable the Company to make the July 31, 2000, scheduled interest payment to the holders of its subordinated notes. In connection with entering into the Third Amendment and the Fourth Amendment, the Company incurred fees of $496 and $1,535, respectively. The fee incurred in connection with the Third Amendment is included in the loss on disposal of discontinued operations for the six months ended June 30, 2000. The fee incurred in connection with the Fourth Amendment will be included as a component of interest expense in future periods. Based upon the modified financial covenants as contained in the Fourth Amendment, the Company was able to remain in compliance with all covenants through June 30, 2000. Had the Company not entered into the aforementioned amendments to the 1999 Credit Agreement, the Company would not have been in compliance with the interest coverage ratio and net worth covenants at June 30, 2000. The Company's net worth at June 30, 2000, was adversely affected by the $95,242 estimated loss on disposal of the publishing business, including the write off of approximately $100,000 of goodwill. There can be no assurance that the Company will be able to attain compliance with the amended covenant requirements in future periods. If the Company does not attain compliance, it intends to engage in additional discussions with its lending institutions to obtain additional waivers and amendments, although there can be no assurance that such additional waivers or amendments will be granted. During 1999, in addition to the borrowings under the 1999 Credit Agreement and the acquisition of Wace, the Company repaid $2,478 of notes and capital lease obligations and invested $16,833 in facility construction and new equipment. Additionally, the Company spent $9,123 on software-related projects. Such amounts were primarily generated by cash flows from operations and sale and leaseback transactions that generated proceeds of $2,249. The sale and leaseback arrangements, which are accounted for as operating leases, resulted in immaterial gains that have been deferred and are being recognized as a credit against future rental expenses. Cash flows from operating activities during 1999 increased by $31,389 as compared to 1998 due primarily to the receipt of income tax refunds and the timing of customer collections. During the first six months of 2000, the Company repaid $37,522 of its borrowings under the 1999 Credit Agreement, repaid $1,450 of notes and capital lease obligations, and made contingent payments related to acquisitions of $4,217. In addition, the Company invested $9,978 in facility construction and new equipment, and spent $1,113 on software-related projects. Such amounts were primarily generated from cash from 16 20 operating activities of $15,169 and the sale of property, equipment, and a business that generated aggregate proceeds of $25,732. Cash flows from operating activities of continuing operations during the first six months of 2000 decreased by $2,861 as compared to the comparable period in 1999 due primarily to a decrease in cash from operating income and the timing of collections from customers, partially offset by the timing of vendor payments. Cash generated by discontinued operations during the first six months of 2000 increased by $8,591 as compared to the 1999 period. The Company expects to spend approximately $17,000 over the course of the next twelve months for capital improvements and management information systems, essentially all of which is for modernization and growth. The Company intends to finance a substantial portion of these expenditures under operating or capital leases, sale and leaseback arrangements, or with working capital. At December 31, 1999, the Company had a liability of approximately $3,405 for the future costs related to its restructuring charges, which the Company intends to finance from cash flows from operations. The Company is continuing to pursue operating efficiencies and synergies and, as a result, may incur additional restructuring charges. The Company anticipates terminating employees on a Company-wide basis and potentially integrating certain operations during 2000. In March 2000, the Company announced that it had retained an investment banking firm to explore strategic alternatives, including a possible sale of the Company. In August 2000, the Board of Directors of the Company decided that it would no longer actively pursue a sale of the Company, but would continue to pursue other strategic alternatives. There can be no assurance that any transaction will occur as a result of this effort. In April 2000, the Company sold the photographic laboratory business that was acquired as part of Wace for a sales price of approximately $11,500. The Company did not realize a gain or loss on the sale of this business. In June 2000, the Company's Board of Directors approved a plan to sell the publishing business that was acquired as part of the merger with Devon. The Company expects to consummate the sale of the publishing business by June 2001, although there can be no assurance that the sale will be consummated within that timeframe. The Company believes that cash flows from operations, including potential improvements in operations as a result of its various integration and restructuring efforts, sales of certain properties and certain non-core businesses, and available borrowing capacity, subject to the Company's ability to attain compliance or obtain a waiver in the event of noncompliance, if any, with the revised financial covenants under the 1999 Credit Agreement, will provide sufficient cash flows to fund its cash needs for the foreseeable future. Statement of Financial Accounting Standards (SFAS) No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities (an amendment of FASB Statement No. 133)," was issued in June 2000. SFAS No. 138 amended certain definitions and clarified certain requirements of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities and requires that entities recognize derivative instruments as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for the change in fair value of a derivative instrument will depend on the intended use of the instrument. The adoption of SFAS No. 133 will require the Company to reflect the fair value of its interest rate swap agreements on its Consolidated Balance Sheet. The offsetting gain or loss at the time of adoption of SFAS No. 133 will be accounted for as a cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes." The cumulative gain or loss at the time of adoption of SFAS No. 133 and future gains and losses resulting from the change in fair value of the swap agreements will be reflected in cumulative comprehensive income as a separate component of stockholders' equity to the extent the swaps qualify as cash flow hedges. To the extent the swaps do not qualify as cash flow hedges, such gains and losses will be reflected in net income. The Company intends to determine 17 21 the potential impact of the adoption of SFAS No. 133 on its financial position and results of operations by the end of 2000. The Company does not believe that inflation has had a material impact on its business. YEAR 2000 COMPLIANCE Many computer systems and applications use a two-digit field to designate a year rather than a four-digit field. This could have resulted in these systems and applications recognizing the use of "00" as either the year 1900 or some other year as opposed to the year 2000 ("Y2K"). Such failure to recognize the correct year could have resulted in system failures and miscalculations that could have adversely impacted the ability of a company to do business (the "Y2K Issue"). The Company identified, reviewed, implemented, and tested modifications to its various computer systems and software to ensure Y2K compliance. The Company did not experience any significant problems related to the Y2K Issue nor was its business adversely impacted by the Y2K Issue. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company's primary exposure to market risk is interest rate risk. The Company had $312,539 and $275,643 outstanding under its credit facilities at December 31, 1999, and June 30, 2000, respectively. Interest rates on funds borrowed under the Company's credit facilities vary based on changes to the prime rate or LIBOR. The Company partially manages its interest rate risk through four interest rate swap agreements under which the Company pays a fixed rate and is paid a floating rate based on the three month LIBOR rate. The notional amounts of the four interest rate swaps totaled $90,000 at both December 31, 1999, and June 30, 2000. A change in interest rates of 1.0% would result in an annual change in income before taxes of $1,856 based on the outstanding balance under the Company's credit facilities and the notional amounts of the interest rate swap agreements at June 30, 2000. 18 22 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. (a) Audited financial statements. 19 23 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Applied Graphics Technologies, Inc. We have audited the accompanying consolidated balance sheets of Applied Graphics Technologies, Inc. and subsidiaries ("the Company") as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1999 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 4 to the consolidated financial statements, the Company discontinued the publishing business segment of its operations in June 2000. The results prior to the discontinuation are included in income (loss) from discontinued operations in the accompanying consolidated financial statements. /s/ DELOITTE & TOUCHE LLP --------------------------------------------------------- New York, New York September 22, 2000 20 24 APPLIED GRAPHICS TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)
DECEMBER 31, -------------------- 1999 1998 -------- -------- ASSETS Current assets: Cash and cash equivalents................................. $ 23,218 $ 17,979 Marketable securities..................................... 2,127 Trade accounts receivable (net of allowances of $7,732 in 1999 and $9,325 in 1998)................................ 119,997 76,786 Due from affiliates....................................... 6,615 6,561 Inventory................................................. 26,283 23,807 Income tax receivable..................................... 3,477 14,936 Prepaid expenses.......................................... 12,095 2,947 Deferred income taxes..................................... 26,985 19,443 Other current assets...................................... 10,367 9,485 Net current assets of discontinued operations............. 36,233 26,258 -------- -------- Total current assets............................... 267,397 198,202 Property, plant, and equipment -- net....................... 95,281 68,155 Goodwill and other intangible assets (net of accumulated amortization of $17,991 in 1999 and $7,002 in 1998)....... 437,674 309,145 Deferred income taxes....................................... 1,309 Other assets................................................ 18,270 10,350 Net non-current assets of discontinued operations........... 112,388 115,913 -------- -------- Total assets....................................... $931,010 $703,074 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses..................... $ 92,056 $ 48,891 Current portion of long-term debt and obligations under capital leases.......................................... 19,024 2,855 Due to affiliates......................................... 1,909 1,513 Other current liabilities................................. 33,477 20,442 -------- -------- Total current liabilities.......................... 146,466 73,701 Long-term debt.............................................. 298,125 203,087 Subordinated notes.......................................... 29,867 Obligations under capital leases............................ 3,814 3,475 Deferred income taxes....................................... 2,975 Other liabilities........................................... 8,763 5,413 -------- -------- Total liabilities.................................. 490,010 285,676 -------- -------- Commitments and contingencies Minority interest -- Redeemable Preference Shares issued by subsidiary................................................ 33,050 -------- Stockholders' Equity: Preferred stock (no par value, 10,000,000 shares authorized; no shares outstanding) Common stock ($0.01 par value, shares authorized: 150,000,000 in 1999 and 1998; shares issued and outstanding: 22,474,772 in 1999 and 22,379,127 in 1998)................................................... 225 224 Additional paid-in capital................................ 386,548 385,279 Accumulated other comprehensive income (loss)............. 1,264 (4) Retained earnings......................................... 19,913 31,899 -------- -------- Total stockholders' equity............................ 407,950 417,398 -------- -------- Total liabilities and stockholders' equity......... $931,010 $703,074 ======== ========
See Notes to Consolidated Financial Statements 21 25 APPLIED GRAPHICS TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)
FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1999 1998 1997 -------- -------- -------- Revenues................................................... $532,064 $338,942 $184,993 Cost of revenues........................................... 363,540 225,240 120,992 -------- -------- -------- Gross profit............................................... 168,524 113,702 64,001 -------- -------- -------- Selling, general, and administrative expenses.............. 134,449 73,594 40,901 Amortization of intangibles................................ 11,306 5,724 791 Loss (gain) on disposal of property and equipment.......... 2,402 (318) 200 Restructuring charges...................................... 3,572 8,550 Impairments and other charges.............................. 6,302 5,659 -------- -------- -------- Total operating expenses......................... 158,031 93,209 41,892 -------- -------- -------- Operating income........................................... 10,493 20,493 22,109 Interest expense........................................... (19,146) (6,307) (1,034) Interest income............................................ 475 1,817 1,724 Other income (expense) -- net.............................. 908 287 (92) -------- -------- -------- Income (loss) from continuing operations before provision for income taxes and minority interest................... (7,270) 16,290 22,707 Provision for income taxes................................. 2,166 9,972 9,140 -------- -------- -------- Income (loss) from continuing operations before minority interest................................................. (9,436) 6,318 13,567 Minority interest.......................................... (2,098) -------- -------- -------- Income (loss) from continuing operations................... (11,534) 6,318 13,567 Income (loss) from discontinued operations................. (452) 1,858 -------- -------- -------- Net income (loss).......................................... (11,986) 8,176 13,567 Other comprehensive income (loss).......................... 1,268 27 (31) -------- -------- -------- Comprehensive income (loss)................................ $(10,718) $ 8,203 $ 13,536 ======== ======== ======== Basic earnings (loss) per common share: Income (loss) from continuing operations................. $ (0.51) $ 0.31 $ 0.88 Income (loss) from discontinued operations............... (0.02) 0.09 -------- -------- -------- Total............................................ $ (0.53) $ 0.40 $ 0.88 ======== ======== ======== Diluted earnings (loss) per common share: Income (loss) from continuing operations................. $ (0.51) $ 0.30 $ 0.83 Income (loss) from discontinued operations............... (0.02) 0.09 -------- -------- -------- Total.................................................... $ (0.53) $ 0.39 $ 0.83 ======== ======== ======== Weighted average number of common shares: Basic.................................................... 22,456 20,563 15,475 Diluted.................................................. 22,456 21,225 16,430
See Notes to Consolidated Financial Statements 22 26 APPLIED GRAPHICS TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS OF DOLLARS)
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 1999 1998 1997 --------- --------- --------- Cash flows from operating activities: Net income (loss)....................................... $ (11,534) $ 6,318 $ 13,567 Adjustments to reconcile net income (loss) to net cash from operating activities: Depreciation and amortization......................... 35,352 17,838 6,222 Deferred taxes........................................ (4,254) (3,835) (1,591) Noncash restructuring charges......................... 2,063 Noncash impairment charges............................ 6,302 4,935 Loss (gain) on disposal of property and equipment..... 2,402 (318) 200 Provision for bad debts and returns................... 2,732 1,869 3,990 Other................................................. 699 (156) (1,059) Changes in Operating Assets and Liabilities, net of effects of acquisitions: Trade accounts receivable............................. (4,817) (12,788) (13,779) Due from/to affiliates................................ 342 (410) (4,991) Inventory............................................. 2,666 1,941 (1,285) Income tax receivable................................. 17,584 (1,804) Other assets.......................................... 833 (4,556) (1,042) Accounts payable and accrued expenses................. (11,628) (8,892) 1,139 Other liabilities..................................... 2,767 505 2,268 Net cash provided by (used in) operating activities of discontinued operations............................ (3,965) 1,382 --------- --------- --------- Net cash provided by operating activities............... 35,481 4,092 3,639 --------- --------- --------- Cash flows from investing activities: Investment in available-for-sale securities........... (200) (178,433) (320,553) Proceeds from sale of available-for-sale securities... 283,779 231,072 Proceeds from maturities of held-to-maturity securities......................................... 1,600 Property, plant, and equipment expenditures........... (16,833) (21,449) (13,029) Software expenditures................................. (9,123) (7,812) (968) Proceeds from the sale of property and equipment...... 13,910 500 12 Other investing activities............................ (5,921) (4,721) Entities purchased, net of cash acquired.............. (120,929) (259,770) (10,533) Net cash used in investing activities of discontinued operations......................................... (2,692) (1,612) --------- --------- --------- Net cash used in investing activities................... (141,788) (189,518) (112,399) --------- --------- --------- Cash flows from financing activities: Proceeds from sale of common stock.................... 121,700 Proceeds from exercise of stock options............... 960 24 5,641 Borrowings (repayments) under credit facilities -- net.................................. 111,189 201,350 (5,628) Proceeds from sale/leaseback transactions............. 2,249 6,685 3,469 Repayment of notes and capital lease obligations...... (2,478) (16,840) (4,805) Repayment of Applied Printing Note.................... (1,600) Net cash used in financing activities of discontinued operations......................................... (303) (398) --------- --------- --------- Net cash provided by financing activities............... 111,617 190,821 118,777 --------- --------- --------- Net increase in cash and cash equivalents............... 5,310 5,395 10,017 Effect of exchange rate changes on cash and cash equivalents........................................... (71) Cash and cash equivalents at beginning of year.......... 17,979 12,584 2,567 --------- --------- --------- Cash and cash equivalents at end of year................ $ 23,218 $ 17,979 $ 12,584 ========= ========= =========
See Notes to Consolidated Financial Statements 23 27 APPLIED GRAPHICS TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN- COMPREHENSIVE RETAINED STOCK CAPITAL INCOME (LOSS) EARNINGS ------ ---------- ------------- -------- Balance at January 1, 1997.................... $143 $ 25,584 $ 10,156 Issuance of 3,000,000 common shares in a public offering at $43.00 per share......... 30 121,670 Granting of 19,000 warrants to purchase common shares...................................... 330 Issuance of 486,700 common shares upon exercise of stock options................... 5 5,636 Income tax benefit associated with exercise of stock options............................... 6,407 Unrealized holding loss on available-for-sale securities.................................. $ (31) Net income.................................... 13,567 ---- -------- ------ -------- Balance at December 31, 1997.................. 178 159,627 (31) 23,723 ---- -------- ------ -------- Issuance of 68,103 common shares in Flying Color Graphics, Inc., acquisition at $48.46 per share................................... 1 3,299 Issuance of 4,427,290 common shares in Devon merger at $50 per share..................... 44 221,321 Issuance of 45,351 common shares in Agile Enterprise, Inc., merger at $22.05 per share....................................... 1 999 Issuance of 2,000 common shares upon exercise of stock options............................ 24 Income tax benefit associated with exercise of stock options............................... 9 Unrealized holding gain on available-for-sale securities.................................. 31 Unrealized loss from foreign currency translation adjustments..................... (4) Net income.................................... 8,176 ---- -------- ------ -------- Balance at December 31, 1998.................. 224 385,279 (4) 31,899 ---- -------- ------ -------- Issuance of 15,645 common shares as additional consideration in connection with a 1997 acquisition................................. 240 Issuance of 80,000 common shares upon exercise of stock options............................ 1 959 Income tax benefit associated with exercise of stock options............................... 15 Fair value of stock options issued to non-employee................................ 55 Unrealized holding gain on available-for-sale securities.................................. 1,117 Unrealized gain from foreign currency translation adjustments..................... 151 Net loss...................................... (11,986) ---- -------- ------ -------- Balance at December 31, 1999.................. $225 $386,548 $1,264 $ 19,913 ==== ======== ====== ========
See Notes to Consolidated Financial Statements 24 28 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER-SHARE AMOUNTS) 1. ORGANIZATION AND BASIS OF PRESENTATION Applied Graphics Technologies, Inc., and its subsidiaries (the "Company") primarily provide digital media asset management services, offering content management services, broadcast media distribution services, and an array of digital services. The Company provides its digital media asset management services to retailers, magazine publishers, advertising agencies, entertainment companies, and automobile and other consumer product manufacturers. The Company was incorporated in Delaware on December 12, 1995. Applied Printing Technologies, L.P. ("Applied Printing"), an entity beneficially owned by the Chairman of the Board of Directors of the Company (the "Chairman of the Board") and the Chairman of the Company (the "Chairman"), was issued 100 shares of common stock and became the Company's sole stockholder. Applied Printing subsequently received 9,309,000 shares of the Company's common stock upon completion of an initial public offering. At December 31, 1999, Applied Printing owned approximately 22.2% of the Company's outstanding common stock. On September 3, 1997, the Company completed an offering of 6,900,000 shares of its common stock (the "Offering"), 3,000,000 of which were sold by the Company. The Offering generated proceeds to the Company, net of underwriters' discount and transaction expenses, of $121,700. As part of the Offering, 3,900,000 shares were sold by certain stockholders of the Company, of which 3,650,000 shares were sold by Applied Printing. Certain prior-period amounts in the accompanying financial statements have been reclassified to conform to the 1999 presentation. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION: The Consolidated Financial Statements include the accounts of the Company and all of its subsidiaries. All intercompany accounts and transactions have been eliminated in the Consolidated Financial Statements. CASH AND CASH EQUIVALENTS: Cash and cash equivalents include all cash balances and highly liquid investments having original maturities of three months or less. MARKETABLE SECURITIES: Marketable Securities at December 31, 1999, were classified as "available for sale" and were recorded at fair market value. The Company held no marketable securities at December 31, 1998. INVENTORY: Raw materials are valued at the lower of cost (cost being determined on a weighted average basis) or market. Work-in-process, consisting of labor, materials, and overhead on partially completed projects, is recorded at the lower of cost or net realizable value. PROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment is stated at cost. Depreciation is computed principally on the straight-line method over the estimated useful lives of the assets, which generally range from 30 years for buildings to three years for certain machinery and equipment. Leasehold improvements and amounts recorded under capital leases are amortized on the straight-line method over the shorter of the terms of the leases or their estimated useful lives. REVENUE RECOGNITION: Revenues from content management services and broadcast media distribution services are recognized at the time projects are shipped or transmitted to the customer. Revenues for digital archiving services are recognized on a per-image basis as items are prepared and scanned. Revenue from the licensing of software and the sale of digital equipment is recognized upon the later of delivery or satisfaction of significant obligations. 25 29 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) GOODWILL AND OTHER INTANGIBLES: Goodwill and other intangibles are being amortized on the straight-line method over periods ranging from 5 to 40 years. INCOME TAXES: The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Foreign subsidiaries are taxed according to regulations existing in the countries in which they do business. Provision has not been made for United States income taxes on distributions that may be received from foreign subsidiaries, which are considered to be permanently invested overseas. LONG-LIVED ASSETS: The Company evaluates the recoverability of its long-lived assets by comparing their carrying value to the expected future undiscounted cash flows to be generated from such assets when events or circumstances indicate that an impairment may have occurred. FOREIGN CURRENCY TRANSLATION: Assets and liabilities of foreign operations are translated from the functional currency into United States dollars using the exchange rate at the balance sheet date. Revenues and expenses of foreign operations are translated from the functional currency into United States dollars using the average exchange rate for the period. Adjustments resulting from the translation into United States dollars are included in other comprehensive income. COMPREHENSIVE INCOME: Other comprehensive income and accumulated other comprehensive income as of and for the years ended December 31, 1999, 1998, and 1997, are comprised of unrealized gains and losses from foreign currency translation adjustments and unrealized holding gains and losses on available-for-sale securities. DERIVATIVE FINANCIAL INSTRUMENTS: The Company has entered into four interest rate swap agreements to reduce the Company's exposure to interest rate risk on its variable rate borrowings under its credit facilities. Accordingly, the interest rate swaps are treated as hedges and amounts receivable or payable under the swaps are recorded as current assets or liabilities, respectively, with realized gains and losses recognized as adjustments to interest expense. ESTIMATES: The preparation of these financials statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECENTLY ISSUED ACCOUNTING STANDARDS: Statement of Financial Accounting Standards (SFAS) No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities (an amendment of FASB Statement No. 133)," was issued in June 2000. SFAS No. 138 amended certain definitions and clarified certain requirements of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities and requires that entities recognize derivative instruments as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for the change in fair value of a derivative instrument will depend on the intended use of the instrument. The adoption of SFAS No. 133 will require the Company to reflect the fair value of its interest rate swap agreements on its Consolidated Balance Sheet. The offsetting gain or loss at the time of adoption of SFAS No. 133 will be accounted for as a cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes." The cumulative gain or loss at the time of adoption of SFAS No. 133 and future gains and losses resulting from the change in fair value of the swap agreements will be reflected in cumulative comprehensive income as a separate component of stockholders' equity to the extent the swaps qualify as cash flow hedges. To the extent the swaps do not qualify as cash flow hedges, such gains and losses 26 30 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) will be reflected in net income. The Company intends to determine the potential impact of the adoption of SFAS No. 133 on its financial position and results of operations by the end of 2000. 3. ACQUISITIONS In May 1999, the Company, through a wholly-owned subsidiary, acquired Wace Group Limited (formerly Wace Group Plc) ("Wace"), an international operator of digital imaging businesses and a provider of digital services in the areas of prepress, color management, and interactive multimedia. The total cash consideration paid by the Company was $125,141 including transaction costs. The Company entered into an amended and restated credit agreement with its lending institutions to finance the acquisition (see Note 11 to the Consolidated Financial Statements). The Company also offered to acquire Wace's preferred securities through an exchange for subordinated notes issued by the Company (see Note 12 to the Consolidated Financial Statements). In January 1999, the Company acquired the outstanding stock of a publishing company located in Australia for $1,300 in cash. In September 1999, the Company acquired the operations of a broadcast media distribution company located in California for $269 in cash. In May 1998, the Company, through a wholly-owned subsidiary, merged with Devon Group, Inc. ("Devon"), a digital prepress and publishing company. The Company paid $30 per share in cash and distributed 0.6 shares of the Company's common stock in exchange for each outstanding share of Devon common stock. The total consideration paid was $442,730 including transaction costs. To fund the cash portion of the merger consideration, the Company used approximately $86,365 in cash from working capital, including cash acquired from Devon, and borrowed $135,000 under its then existing credit facilities. In January 1998, the Company acquired the operations of Flying Color Graphics, Inc. ("Flying Color"), a prepress company with five facilities throughout the midwest. In June 1998, the Company acquired the stock of Color Control, Inc. ("Color Control"), a prepress company with operations in Redmond, WA. In May 1998, the Company acquired the operation of Tint Masters, Inc., a prepress company with a facility in New Jersey. In September 1998, the Company, through a wholly-owned subsidiary, merged with Agile Enterprise, Inc. ("Agile"), a software development company located in Nashua, NH. In November 1998, the Company acquired the operations of Electronic Color Imaging, LLC ("ECI"), a prepress company located in Edgewater, NJ. For these five acquisitions, the Company paid $51,482 in cash, issued 113,454 shares of the Company's common stock valued at $4,300, and assumed certain liabilities. During 1999, the Company made contingent payments in the form of cash or shares of common stock in the aggregate amount of $5,087 as additional consideration for certain of the acquisitions based on 1998 performance of the acquired businesses. In addition, the Company will make contingent payments in 2000 in the form of cash or shares of common stock in the amount of approximately $7,784 related to certain acquisitions based on 1999 performance of the acquired businesses. Such amounts are included in "Other current liabilities" in the Consolidated Balance Sheets. Any additional consideration will be determined based upon the future financial performance of the acquired operations. Such contingent payments have been and will be recorded as additional purchase price at the time the necessary conditions are satisfied. Such additional consideration may be in the form of cash or shares of common stock. The acquisitions discussed above were accounted for using the purchase method of accounting. Accordingly, the assets and liabilities have been recorded at their estimated fair values at the date of the respective acquisitions, with the amounts related to acquisitions consummated in 1999 subject to adjustment based on the completion of appraisals and other analyses. The Company does not expect such adjustments to be material. The excess of the purchase price over the fair value of assets acquired recorded in 1999 and 1998, exclusive of the publishing business (see Note 4 to the Consolidated Financial Statements), was approximately $142,679 and $291,208, respectively, which is being amortized over periods ranging from 20 to 27 31 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 40 years. The results of operations of these acquisitions have been included in the Consolidated Statements of Operations subsequent to the respective dates of acquisition. The following unaudited pro forma information combines the results of operations of the Company, Wace, and the other acquisitions for the years ended December 31, 1999 and 1998, exclusive of the publishing business (see Note 4 to the Consolidated Financial Statements), calculated as if the acquisitions had occurred on January 1, 1998. The pro forma information has been prepared for comparative purposes only and does not purport to be indicative of the results of operations that would have occurred had the acquisitions been consummated at the beginning of 1998 or of results that may occur in the future.
UNAUDITED -------------------- 1999 1998 -------- -------- Total revenues.............................................. $601,174 $593,658 Loss before provision for income taxes and minority interest.................................................. $(17,733) $ (7,935) Net loss.................................................... $(18,582) $(11,402) Loss per common share: Basic..................................................... $ (0.83) $ (0.51) Diluted................................................... $ (0.83) $ (0.51)
4. DISCONTINUED OPERATIONS In June 2000, the Company's Board of Directors approved a plan to sell the publishing business that was acquired as part of the merger with Devon. The Company expects to consummate the sale of the publishing business by June 2001, although there can be no assurance that the sale will be consummated within that timeframe. The accompanying financial statements have been restated to reflect the operations of the publishing business as a discontinued operation. The results of operations of the discontinued business, presented as Discontinued Operations in the accompanying Consolidated Statements of Operations, for the years ended December 31, 1999 and 1998, were as follows:
1999 1998 ------- ------- Revenues.................................................... $90,168 $55,183 ======= ======= Income from operations before income taxes.................. $ 678 $ 4,149 Provision equivalent to income taxes........................ 1,130 2,291 ------- ------- Income (loss) from discontinued operations.................. $ (452) $ 1,858 ======= =======
The results of operations of the publishing business include an allocation of interest expense of $4,513 and $1,757 for the years ended December 31, 1999 and 1998, respectively. The allocated interest expense consisted solely of the interest expense on the Company's borrowings under its primary credit facilities, which represents the interest expense not directly attributable to the Company's other operations. Interest expense was allocated based on the ratio of the net assets of the discontinued operation to the sum of the consolidated net assets of the Company and the outstanding borrowings under the Company's primary credit facilities. 28 32 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The results of operations and cash flows of the discontinued operations for the years ended December 31, 1999 and 1998, include amounts for selected items as follows:
1999 1998 ------ ------ Interest expense............................................ $4,687 $1,867 Interest income............................................. $ 132 $ 75 Depreciation and amortization expense....................... $4,072 $2,213 Loss on disposal of property and equipment.................. $ 17 $ 7 Property, plant, and equipment expenditures................. $2,064 $1,634 Repayments of notes and capital lease obligations........... $ 303 $ 398
The net assets of discontinued operations include $832 and $1,135 at December 31, 1999 and 1998, respectively, of long-term debt and obligations under capital leases, inclusive of the current portion. 5. RESTRUCTURING During 1998, the Company commenced two separate plans to restructure certain of its operations (the "1998 Second Quarter Plan" and the "1998 Fourth Quarter Plan", respectively). The 1998 Second Quarter Plan was revised in the fourth quarter of 1998 in response to additional acquisitions and a change in operation management. As part of the 1998 Second Quarter Plan, the Company closed a facility in New Jersey and made modifications to its Carlstadt, NJ, facility to accommodate the transfer of work performed at the closed location to the Carlstadt facility. In addition, as part of the 1998 Second Quarter Plan, the Company vacated a portion of one of its Chicago, IL, facilities and transferred a portion of the work performed at that facility to its other Chicago metropolitan area facilities. Also as part of the 1998 Second Quarter Plan, the Company terminated certain employees and consolidated the work performed in its West Coast facilities, resulting in the closure of one such facility. As part of the 1998 Fourth Quarter Plan, the Company closed several facilities in Illinois and terminated employees on a Company-wide basis. The work performed at each of the closed Illinois facilities is being performed at the Company's other Midwest facilities. The Company commenced a plan in the third quarter of 1999 to consolidate certain of its West Coast operations (the "1999 Third Quarter Plan"). As part of the 1999 Third Quarter Plan, the Company closed the Los Angeles facility previously operated by Wace and intends to move Wace's San Francisco operation to a more suitable facility. A portion of the work previously performed in the Company's Foster City facility was transferred to Wace's San Francisco facility and the remaining operation will be moved to a smaller Foster City location. The Company commenced action in the fourth quarter to consolidate certain of its New York and Chicago metropolitan area and United Kingdom operations and consolidate certain administrative functions (the "1999 Fourth Quarter Plan"). As part of the 1999 Fourth Quarter Plan, the Company transferred all of the work performed at one of its New York City facilities to Wace's Varick Street operation. Also as part of the 1999 Fourth Quarter Plan, the Company is further consolidating its Carlstadt, NJ, operation to occupy only two of the three buildings that currently comprise that facility. The Company intends to sublet the vacated building. The Company also redistributed certain work among its various metropolitan New York area operations. In the midwest, the Company closed one of its Chicago facilities and transferred the work previously performed there to one of Wace's Chicago facilities. In the United Kingdom, the Company streamlined certain operations and workflows and initiated a plan to shut down a portion of its digital operations. Additionally, as part of the 1999 Fourth Quarter Plan, the Company initiated a plan to transfer certain centralized administrative functions to the various regional operations, which will result in the closure of a New York metropolitan area administrative office. 29 33 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The results of operations for the years ended December 31, 1999 and 1998, include charges of $3,572 and $8,550, respectively, and resulted from the various restructuring plans as follows:
1999 1998 ------- ------ 1998 Second Quarter Plan.................................... $ 228 $5,713 1998 Fourth Quarter Plan.................................... (1,447) 2,837 1999 Third Quarter Plan..................................... 636 1999 Fourth Quarter Plan.................................... 4,155 ------- ------ Total....................................................... $ 3,572 $8,550 ======= ======
The components of the restructuring charges incurred in 1998 were as follows:
1998 SECOND 1998 FOURTH QUARTER PLAN QUARTER PLAN ------------ ------------ Facility closure costs...................................... $1,182 $ 994 Employee termination costs.................................. 1,108 1,067 Abandoned assets............................................ 3,423 776 ------ ------ Total....................................................... $5,713 $2,837 ====== ======
The charge for employee termination costs related to approximately 100 employees for the 1998 Second Quarter Plan and approximately 350 employees for the 1998 Fourth Quarter Plan. The components of the restructuring charges incurred in 1999 were as follows:
1998 SECOND 1998 FOURTH 1999 THIRD 1999 FOURTH QUARTER PLAN QUARTER PLAN QUARTER PLAN QUARTER PLAN ------------ ------------ ------------ ------------ Facility closure costs............ $(93) $ (514) $468 $1,516 Employee termination costs........ (3) (639) 152 2,081 Abandoned assets.................. 324 (294) 16 558 ---- ------- ---- ------ Total............................. $228 $(1,447) $636 $4,155 ==== ======= ==== ======
The charge for employee termination costs related to approximately 34 employees for the 1999 Third Quarter Plan and approximately 137 employees for the 1999 Fourth Quarter Plan. 30 34 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The amount included in "Other current liabilities" in the accompanying Consolidated Balance Sheets as of December 31, 1999 and 1998, for the future costs of the various restructuring plans and the amounts charged against the respective restructuring liabilities in 1999 and 1998 were as follows:
1998 SECOND 1998 FOURTH 1999 THIRD 1999 FOURTH QUARTER PLAN QUARTER PLAN QUARTER PLAN QUARTER PLAN ------------ ------------ ------------ ------------ Restructuring charge.............. $ 5,713 $ 2,837 Facility closure costs............ (510) Employee termination costs........ (818) Abandoned assets.................. (2,880) ------- ------- Balance at December 31, 1998...... 1,505 2,837 Restructuring charge.............. $ 636 $ 4,155 Facility closure costs............ (579) (140) (242) (191) Employee termination costs........ (288) (385) (64) (1,685) Abandoned assets.................. (572) (363) Adjustment to liability........... 228 (1,447) ------- ------- ----- ------- Balance at December 31, 1999...... $ 294 $ 502 $ 330 $ 2,279 ======= ======= ===== =======
The number of employees comprising the charge against the various restructuring plans' liabilities in 1999 and 1998 for employee termination costs was as follows:
1999 1998 ---- ---- 1998 Second Quarter Plan.................................... 25 44 1998 Fourth Quarter Plan.................................... 108 1999 Third Quarter Plan..................................... 24 1999 Fourth Quarter Plan.................................... 102
In 1999, the Company adjusted the liability associated with both the 1998 Second Quarter Plan and the 1998 Fourth Quarter Plan to reflect changes to estimates made when the plans were originally initiated. The adjustment to the liability for the 1998 Second Quarter Plan primarily resulted from the Company not being released as early as originally estimated from certain rental obligations on abandoned equipment. The adjustment to the 1998 Fourth Quarter Plan resulted from the Company not terminating as many employees as originally anticipated and negotiating favorable settlements on certain building lease obligations. Fewer employees were terminated under the 1998 Fourth Quarter Plan than was originally anticipated due to the Company's re-evaluation of its plans in light of the acquisition of Wace and the voluntary termination of certain employees. The Company does not anticipate any material adverse effect on its future results of operations from the facility closings since all work performed at such locations has been and will be transferred to its other facilities. The employees terminated and to be terminated under the restructuring plans are principally production workers, sales people, and administrative support staff. The Company completed both the 1998 Second Quarter Plan and the 1998 Fourth Quarter Plan during 1999. The remaining liabilities for these plans primarily represent future rental obligations for abandoned property and equipment. The Company expects to complete the 1999 Third Quarter Plan and the 1999 Fourth Quarter Plan by September 2000 and December 2000, respectively. The Company is continuing to pursue operating efficiencies and synergies and, as a result, may incur additional restructuring charges. The Company anticipates terminating employees on a Company-wide basis and potentially integrating certain operations during 2000. 31 35 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 6. IMPAIRMENTS AND OTHER CHARGES Impairments and other charges for the years ended December 31, 1999 and 1998, consisted of the following:
1999 1998 ------ ------ Impairment of a business.................................... $ 744 $2,509 Impairment of property and equipment........................ 5,558 Abandonment of a business................................... 3,150 ------ ------ Total....................................................... $6,302 $5,659 ====== ======
In December 1999, the Company incurred a charge of $744 for the write down of long-lived assets related to its events-based digital photography operation. The Company reviewed the assets of this operation for impairment due to having incurred a similar charge in the prior year. The Company incurred a charge of $2,509 in 1998 for the write down of long-lived assets related to this operation. The revised carrying value of the assets of this operation as of December 31, 1999 and 1998, was calculated based on discounted estimated future cash flows. In 1999, the Company integrated certain operations, discontinued certain services, and abandoned certain projects. Due to a change in the use of certain assets resulting from such actions, the Company reviewed those assets of the affected operations for impairment, resulting in a charge of $5,558 for the year ended December 31, 1999. Of this charge, $2,429 related to a write down to net realizable value of equipment to be disposed of that is no longer in service. The charge also included $3,129 related to certain software development projects that were replaced by systems already in service at the various Wace locations or abandoned due to the project no longer being viable for the combined entity. In addition to the charges discussed above, in 1999 the Company incurred a charge of $2,419 for the loss on disposal of property and equipment. Such disposals primarily resulted from the reallocation of work among various facilities, a change in service requirements of certain major customers, and a general upgrade of equipment at certain of the Company's larger facilities to achieve anticipated efficiencies from the various integration efforts. Also in 1999, selling, general, and administrative expenses included $418 of additional amortization resulting from a change in the amortization of capitalized software costs to better reflect the current trends in desktop software. The Company now amortizes desktop and other non-production software over a one-year period. Additionally, other expenses included a charge of $488 in 1999 for the write-off of acquisition costs related to transactions no longer being pursued. In December 1998, the Company adopted a plan to cease certain of its events-based digital photography operations, primarily the remaining operations obtained in 1997 as part of the acquisition of Digital Imagination, Inc. ("DI"). As of December 31, 1998, the Company closed down all locations associated with these operations. The charge of $3,150 related to the abandonment of this operation is comprised primarily of the unamortized goodwill related to the DI acquisition, the write-off of certain equipment no longer being utilized as a result of the abandonment, and facility closure costs. At December 31, 1999 and 1998, a liability of approximately $382 and $713, respectively, related to this abandonment is included in "Other current liabilities" in the accompanying Consolidated Balance Sheets. 7. MARKETABLE SECURITIES The Company classified its investments in marketable securities at December 31, 1999, as "available for sale" and recorded them at fair market value. The Company held no marketable securities at December 31, 1998. Marketable securities at December 31, 1999, consisted of equity securities with a fair market value of $2,127 and a cost of $200. 32 36 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) At December 31, 1999, all marketable securities held by the Company were available for current operations and were therefore classified in the Consolidated Balance Sheet as current assets. Unrealized holding gains and losses on available-for-sale securities are reflected in "Other comprehensive income (loss)." Proceeds from sales of available-for-sale securities during the years ended December 31, 1998 and 1997, totaled $283,779 and $231,072, respectively, and resulted in no realized gain or loss. There were no sales of marketable securities for the year ended December 31, 1999. Realized gains and losses are determined based on a specific identification basis. 8. INVENTORY The components of inventory at December 31 were as follows:
1999 1998 ------- ------- Work-in-process............................................. $21,718 $19,227 Raw materials............................................... 4,565 4,580 ------- ------- Total....................................................... $26,283 $23,807 ======= =======
9. PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment at December 31 consisted of the following:
1999 1998 -------- ------- Land........................................................ $ 7,293 $ 3,596 Machinery and equipment..................................... 62,124 37,791 Buildings and improvements.................................. 51,663 48,011 Furniture and fixtures...................................... 7,211 2,745 Construction in progress.................................... 3,778 4,962 -------- ------- Total....................................................... 132,069 97,105 Less accumulated depreciation and amortization.............. 36,788 28,950 -------- ------- Net......................................................... $ 95,281 $68,155 ======== =======
Interest capitalized on construction of buildings and improvements and other qualifying assets during the year ended December 31, 1998, was $227. No interest was capitalized during the years ended December 31, 1999 and 1997. 10. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses at December 31 consisted of the following:
1999 1998 ------- ------- Accounts payable............................................ $24,756 $21,024 Salaries and benefits....................................... 17,915 9,110 Accrued commissions......................................... 4,643 2,868 Accrued customer rebates.................................... 3,900 2,393 Accrued interest............................................ 2,660 2,465 Other operating accruals.................................... 38,182 11,031 ------- ------- Total....................................................... $92,056 $48,891 ======= =======
33 37 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 11. LONG-TERM DEBT Long-term debt at December 31 consisted of the following:
1999 1998 -------- -------- Variable rate lines of credit............................... $ 62,537 $201,350 Variable rate term loans.................................... 234,688 6% - 10% notes payable due 2001 through 2019................ 837 6.5% IDA bond due 2004...................................... 900 900 -------- -------- Total....................................................... $298,125 $203,087 ======== ========
In March 1999, the Company entered into an amended and restated credit agreement (the "1999 Credit Agreement") to finance the Wace acquisition. The 1999 Credit Agreement replaced the credit agreement entered into in May 1998 (the "1998 Credit Agreement") and is secured by certain inventory, receivables, and equipment. On June 4, 1999 (the "Initial Funding Date"), the Company borrowed $296,000, the proceeds of which were used to pay off existing borrowings under the 1998 Credit Agreement and to finance the Wace acquisition. The total borrowing capacity under the 1999 Credit Agreement is a maximum of $350,000, comprised of a $100,000 revolving line of credit (the "Revolver") and three term loans totaling $250,000 (the "Term Loans"). The Revolver extends through June 2005. The Term Loans are comprised of tranches of $125,000, $75,000, and $50,000 that have terms extending through June 2005, June 2006, and June 2007, respectively. Interest rates on funds borrowed under the 1999 Credit Agreement vary from either LIBOR or the prime rate in effect at the time of the borrowing, plus a factor based on annual pro forma EBITDA (as defined in the 1999 Credit Agreement). At December 31, 1999, $312,539 was outstanding under the 1999 Credit Agreement, of which $62,539 was outstanding under the Revolver and $250,000 was outstanding under the Term Loans. The average variable rate on borrowings under both the 1999 Credit Agreement and the 1998 Credit Agreement for the year ended December 31, 1999, was 8.0%. The average variable rate on borrowings under both the 1998 Credit Agreement and its predecessor agreement for the year ended December 31, 1998, was 6.5%. Principal payments on the long-term debt are due as follows: 2000...................................................... $ 17,106 2001...................................................... 21,562 2002...................................................... 23,438 2003...................................................... 26,250 2004...................................................... 27,150 Thereafter................................................ 199,725 -------- Total..................................................... 315,231 Less current portion...................................... 17,106 -------- Total long-term debt...................................... $298,125 ========
Under the terms of the 1999 Credit Agreement, the Company was obligated to enter into hedge arrangements for a minimum of two years covering at least 30% of the amount borrowed on the Initial Funding Date. The Company entered into four interest rate swap agreements (collectively, the "Swaps") under which the Company pays a fixed rate per annum on a quarterly basis and is paid a floating rate based on 34 38 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) the three month LIBOR rate in effect at the beginning of each quarterly payment period. The inception dates, notional amounts, fixed rates, and maturity dates of the Swaps are as follows:
INCEPTION NOTIONAL FIXED MATURITY DATE AMOUNT RATE DATE ------------- -------- ----- ------------- August 1998 $35,000 5.798% August 2003 August 1998 $15,000 5.798% August 2003 August 1998 $25,000 5.69% August 2001 December 1999 $15,000 6.45% December 2001
The Swaps are being accounted for as hedges against the variable interest rate component of the 1999 Credit Agreement. All or a portion of the swaps will no longer be hedges and therefore will expose the Company to market risk to the extent the borrowings under the 1999 Credit Agreement fall below the combined notional amounts of the Swaps or the Credit Agreement is not extended beyond its current term to at least cover the term of the 2003 Swaps. The counterparties to the Swaps are major financial institutions. The Company believes the credit risk associated with nonperformance will not be significant. Under the terms of the 1999 Credit Agreement, the Company must comply with certain covenants related to leverage ratios, interest coverage ratios, fixed charge coverage ratios, minimum net worth, and capital spending. Such covenants become more restrictive in future periods. At December 31, 1999, the Company was in compliance with all covenants. The Company is prohibited from paying dividends on its common stock under the terms of the 1999 Credit Agreement. In August 2000, the Company entered into an amendment to the 1999 Credit Agreement (the "Fourth Amendment") to relax the interest coverage ratio and net worth covenants as of June 30, 2000, and to modify all of the financial covenant requirements to be less restrictive than previously required in the 1999 Credit Agreement for the quarterly fiscal periods through June 30, 2001. In addition to modifying the various financial covenants, the Fourth Amendment increased the interest rates on all future borrowings under the 1999 Credit Agreement by 50 basis points and lowered the borrowing capacity of the revolving line of credit to $85,000. In July 2000, the Company entered into an amendment to the 1999 Credit Agreement (the "Third Amendment") that lowered the net worth covenant threshold to enable the Company to proceed with its planned disposal of the publishing business. Also in July 2000, the lending institutions granted a waiver of covenant defaults to enable the Company to make the July 31, 2000, scheduled interest payment to the holders of its subordinated notes. In connection with entering into the Third Amendment and the Fourth Amendment, the Company incurred fees of $496 and $1,535, respectively. The fee incurred in connection with the Third Amendment will be included in the loss on disposal of discontinued operations. The fee incurred in connection with the Fourth Amendment will be included as a component of interest expense in future periods. Based upon the modified financial covenants as contained in the Fourth Amendment, the Company was able to remain in compliance with all covenants through June 30, 2000. Had the Company not entered into the aforementioned amendments to the 1999 Credit Agreement, the Company would not have been in compliance with the interest coverage ratio and net worth covenants at June 30, 2000. There can be no assurance that the Company will be able to attain compliance with the amended covenant requirements in future periods. If the Company does not attain compliance, it intends to engage in additional discussions with its lending institutions to obtain additional waivers and amendments, although there can be no assurance that such additional waivers or amendments will be granted. 35 39 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 12. SUBORDINATED NOTES At May 21, 1999, Wace had L39,164, or approximately $62,733, of 8% Cumulative Convertible Redeemable Preference Shares (the "Preference Shares") outstanding. The Preference Shares carry the right to a fixed cumulative preferential dividend of 8% and are redeemable on July 31, 2005. On July 5, 1999, the Company offered each holder of the Preference Shares the right to exchange such Preference Shares, at an equivalent nominal rate, for subordinated notes issued by the Company (the "Subordinated Notes"). As of December 31, 1999, L18,531, or approximately $29,867, of the Preference Shares, which accrued dividends through July 31, 1999, had been exchanged for Subordinated Notes. The Subordinated Notes, which bear interest at a fixed rate of 10% annually commencing on August 1, 1999, and mature on October 31, 2005, are subject to redemption by the Company at any time after July 31, 2000. The initial redemption premium is 4% and decreases in 0.5% increments every six months until July 31, 2005, at which time the Subordinated Notes are redeemable at par. The Subordinated Notes are listed on the London Stock Exchange. The Company recorded dividends of $2,098 on the Preference Shares for the year ended December 31, 1999, which are reflected as "Minority interest" in the Consolidated Statement of Operations. The Company incurred interest expense of $1,257 on the Subordinated Notes for the period ended December 31, 1999. 13. LEASES The Company leases certain property and equipment used in its operations under agreements that are classified as both capital and operating leases. Such agreements generally include provisions for inflation-based rate adjustments and, in the case of leases for buildings and office space, payments of certain operating expenses and property taxes. Future minimum rental payments required under capital leases and operating leases that have initial or remaining noncancelable lease terms in excess of one year are as follows:
CAPITAL OPERATING LEASES LEASES ------- --------- 2000..................................................... $2,368 $17,233 2001..................................................... 1,951 13,987 2002..................................................... 1,420 11,126 2003..................................................... 587 8,162 2004..................................................... 156 6,343 Later years.............................................. 22,196 ------ ------- Total minimum lease payments............................. 6,482 $79,047 ======= Less imputed interest.................................... 750 ------ Present value of minimum lease payments.................. 5,732 Less current portion..................................... 1,918 ------ Long-term obligation under capital leases................ $3,814 ======
36 40 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Assets recorded under capital leases are included in property, plant, and equipment as follows:
1999 1998 ------- ------- Buildings................................................... $ 4,768 Machinery and equipment..................................... $17,480 16,552 ------- ------- Total....................................................... 17,480 21,320 Less accumulated depreciation............................... 9,476 11,696 ------- ------- Net......................................................... $ 8,004 $ 9,624 ======= =======
Total rental expense under operating leases amounted to $20,723, $13,760, and $10,002, for the years ended December 31, 1999, 1998, and 1997, respectively. The Company enters into sale and leaseback arrangements that are recorded as either capital or operating leases. The gain from these sale and leaseback arrangements is deferred and recognized as credits against either future amortization of the leased asset or future rental expense over the terms of the related leases. At December 31, 1999 and 1998, the remaining balance of the deferred gain totaling $235 and $354, respectively, is included in "Other liabilities," both current and noncurrent, in the accompanying Consolidated Balance Sheets. 14. INCOME TAXES The components of the provision for income taxes were as follows:
1999 1998 1997 ------- ------- ------- CURRENT: Federal............................................. $ 3,861 $ 9,828 $ 3,018 State............................................... 1,975 2,023 1,187 Foreign............................................. 903 ------- ------- ------- Total current......................................... 6,739 11,851 4,205 ------- ------- ------- DEFERRED: Federal............................................. (3,124) (2,144) (430) State............................................... (955) 113 (1,161) Foreign............................................. (652) ------- ------- ------- Total deferred........................................ (4,731) (2,031) (1,591) ------- ------- ------- TAX BENEFITS NOT IMPACTING PROVISION: Federal............................................. 128 123 4,650 State............................................... 30 29 1,876 ------- ------- ------- Total tax benefits not impacting provision............ 158 152 6,526 ------- ------- ------- Total provision for income taxes...................... $ 2,166 $ 9,972 $ 9,140 ======= ======= =======
37 41 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The provision for income taxes varied from the Federal statutory income tax rate due to the following:
1999 1998 1997 ------- ------ ------- Taxes at statutory rate................................ $(2,545) $5,701 $ 7,720 State income taxes, net of Federal tax benefit......... 682 1,407 1,256 Amortization of nondeductible goodwill................. 3,272 2,489 10 Meals and entertainment expenses....................... 475 302 148 Other -- net........................................... 282 73 6 ------- ------ ------- Provision for income taxes............................. $ 2,166 $9,972 $ 9,140 ======= ====== ======= Federal statutory rate................................. 35.00% 35.00% 34.00% Effective rate......................................... (29.79)% 61.22% 40.25%
The components of the net deferred tax asset at December 31 were as follows:
1999 1998 ------- ------- Deferred tax assets: Accounts receivable......................................... $ 3,172 $ 947 Inventory................................................... 1,598 1,095 Property, plant, and equipment.............................. 1,299 Accrued expenses............................................ 1,583 Obligations under capital leases............................ 235 430 Other liabilities........................................... 22,001 17,968 Other assets................................................ 349 ------- ------- Total deferred tax assets................................... 28,305 22,372 ------- ------- Deferred tax liabilities: Prepaid expenses............................................ 812 672 Accrued expenses............................................ 2,040 Other assets................................................ 1,443 Property, plant, and equipment.............................. 948 ------- ------- Total deferred tax liabilities.............................. 4,295 1,620 ------- ------- Net deferred tax asset...................................... $24,010 $20,752 ======= =======
The Company believes that it is more likely than not that the benefit associated with Federal and state deferred tax assets will be realized in the future and therefore has not established a valuation allowance for deferred tax assets at December 31, 1999 and 1998. 15. STOCK OPTIONS In 1996, the Board of Directors and stockholders approved a Stock Option Plan (the "Employee Plan") and a Non-employee Directors' Nonqualified Stock Option Plan (the "Directors' Plan") (collectively, the "1996 Plans"). Under the Employee Plan, options were granted to key employees of the Company and its affiliates to purchase common stock of the Company. Options granted under the Employee Plan, which have a term of ten years, become exercisable over a five year period in varying amounts, but in no event less than 5% or more than 25% in any year for any individual optionee. Under the Directors' Plan, options were granted to members of the Board of Directors who were not eligible for grants under the Employee Plan. Options granted to new appointees under the Directors' Plan become exercisable over a two year period and have a term of ten years. The Directors' Plan also provided for an additional 5,000 options to be granted to non-employee 38 42 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) directors on each subsequent anniversary date of having first become a member of the Board of Directors. Such anniversary option grants had an exercise price equal to the fair market value of the common stock on the date of grant and were fully vested at grant. The 1996 Plans provided for a combined maximum of 4,200,000 shares of the Company's common stock to be available for issuance upon exercise of options. In May 1998, the Company's stockholders approved the 1998 Incentive Compensation Plan, as amended and restated (the "1998 Plan"). As of the adoption of the 1998 Plan, no further grants will be made under the 1996 Plans. The 1998 Plan allows for the granting of options to employees of the Company and its affiliates, nonemployee directors, and independent contractors to purchase common stock of the Company. Options are granted to members of the Board of Directors who are not employees of the Company or any of its affiliates under the 1998 Plan in the same manner as under the provisions of the 1996 Directors' Plan. Options granted under the 1998 Plan have a term of ten years unless a shorter term is established at date of grant. Options originally granted under the 1998 Plan vest over a five year period and, unless an alternative vesting schedule is established in individual award agreements, vest 20% on the first anniversary of the grant date, 5% on each of the second through fourth anniversaries of the grant date, and 65% on the fifth anniversary of the grant date. In May 2000, the 1998 Plan was amended to change the standard vesting schedule on future grants to be ratable over a five-year period unless an alternative vesting schedule is established in individual award agreements. A maximum of 7,000,000 shares of the Company's common stock is available for issuance upon exercise of options under the 1998 Plan, inclusive of the remaining shares available for grant under the 1996 Plans. At December 31, 1999, there were 4,307,500 shares reserved for the issuance of stock options under the 1998 Plan. Information relating to activity in the Company's stock option plans is summarized in the following table. Unless otherwise indicated, options have been issued with exercise prices equal to market price.
WEIGHTED WEIGHTED NUMBER OF AVERAGE AVERAGE SHARES EXERCISE PRICE FAIR VALUE ---------- -------------- ---------- Options outstanding at January 1, 1997................. 2,491,000 $12.07 Options granted........................................ 255,500 $45.15 $26.84 Options exercised...................................... (486,700) $12.03 Options forfeited...................................... (50,600) $12.79 ---------- Options outstanding at December 31, 1997............... 2,209,200 $15.89 Options granted........................................ 450,000 $47.86 $27.61 Options granted with exercise price greater than market............................................... 4,013,000 $30.70 $14.58 Options exercised...................................... (2,000) $12.00 Options forfeited...................................... (197,500) $26.64 Options cancelled...................................... (2,250,500) $43.21 ---------- Options outstanding at December 31, 1998............... 4,222,200 $18.31 Options granted........................................ 160,000 $12.19 $ 9.22 Options granted with exercise price greater than market............................................... 340,000 $14.58 $ 7.15 Options exercised...................................... (80,000) $12.00 Options forfeited...................................... (247,600) $18.30 ---------- Options outstanding at December 31, 1999............... 4,394,600 $17.91 ========== Options exercisable at December 31, 1997............... 72,500 $18.29 ========== Options exercisable at December 31, 1998............... 615,700 $13.55 ========== Options exercisable at December 31, 1999............... 1,442,600 $16.60 ==========
39 43 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Information relating to options outstanding at December 31, 1999, is summarized as follows:
OUTSTANDING EXERCISABLE ------------------------------------------- ------------------------ RANGE OF WEIGHTED AVG. WEIGHTED AVG. WEIGHTED AVG. EXERCISE PRICES OPTIONS EXERCISE PRICE REMAINING LIFE OPTIONS EXERCISE PRICE --------------- --------- -------------- -------------- ------- -------------- $7.06 - $16.63 2,145,100 $12.06 6.82 915,300 $11.96 $22.50 2,162,500 $22.50 8.75 477,500 $22.50 $39.25 - $52.75 87,000 $48.15 6.87 49,800 $45.47
The Company accounts for the issuance of stock options to employees and nonemployee directors in accordance with the provisions of Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," which requires compensation cost to be measured at the date of grant based on the intrinsic value of the options granted. The intrinsic value of an option is equal to the difference between the market price of the common stock on the date of grant and the exercise price of the option. There was no compensation cost recognized by the Company on the options granted in 1999, 1998, and 1997. The Company accounts for the issuance of stock options to nonemployees, other than directors, in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," which requires the cost of a transaction to be measured at the date of grant based on the fair value of the options granted. SFAS No. 123 also provides for an alternative measurement of compensation cost based on the fair value of the options granted to employees and directors. The fair value of an option is based on the intrinsic value as well as the time value of the option. The fair value of stock options granted was estimated on the grant dates using the Black-Scholes option-pricing model. During 1999, the Company granted 25,000 options to a former employee in connection with the abandonment of the DI business. The fair value of this option grant of approximately $55 was charged against the liability related to the abandonment of the DI business. The following weighted average assumptions were used in calculating the fair value of options granted:
1999 1998 1997 --------- --------- --------- Risk-free interest rate............................ 5.27% 5.34% 6.20% Expected life...................................... 7.0 years 6.9 years 6.0 years Expected volatility................................ 0.7912 0.6159 0.5606 Expected dividend yield............................ 0% 0% 0%
Had the Company elected to account for the issuance of stock options to employees and directors under SFAS No. 123, the compensation cost would have been $7,142, $3,515, and $3,957 for the years ended December 31, 1999, 1998, and 1997, respectively. The pro forma net income (loss) and earnings (loss) per share for the years ended December 31, 1999, 1998 and 1997, calculated as if the Company had elected to account for the issuance of stock options under SFAS No. 123, were as follows:
1999 1998 1997 -------- ------ ------- Net income (loss)..................................... $(16,128) $6,137 $11,203 Basic earnings (loss) per share....................... $ (0.72) $ 0.30 $ 0.72 Diluted earnings (loss) per share..................... $ (0.72) $ 0.30 $ 0.70
16. EARNINGS PER SHARE Basic earnings per share of common stock are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding. Diluted earnings per share of common stock are computed by giving effect to all dilutive potential shares. There were no reconciling items to net income to arrive at income available to common stockholders for the years ended December 31, 1999, 1998, and 1997. The number of common shares used in the computation of basic and diluted earnings per 40 44 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) share for the years ended December 31, 1999, 1998, and 1997, including pro forma computations, are summarized as follows:
1999 1998 1997 ---------- ---------- ---------- Basic: Weighted average issued shares outstanding... 22,434,000 20,554,000 15,475,000 Contingently issuable common shares not issued.................................... 22,000 9,000 ---------- ---------- ---------- Weighted average shares outstanding -- Basic... 22,456,000 20,563,000 15,475,000 Effect of Dilutive Securities: Stock options and warrants................... 658,000 946,000 Contingently issuable common shares.......... 4,000 9,000 ---------- ---------- ---------- Weighted average shares outstanding -- Diluted....................... 22,456,000 21,225,000 16,430,000 ========== ========== ==========
17. RELATED PARTY TRANSACTIONS In addition to the business it transacts with Applied Printing, the Company also does business and shares services with entities beneficially owned by the Chairman of the Board and the Chairman, including the Daily News, L.P. (the "Daily News") and U.S. News & World Report, L.P. ("U.S. News"). The Company also does business with Snyder Communications, Inc. and its subsidiaries, a provider of outsourced marketing services, of which both the Chairman of the Board and the Chairman were members of the Board of Directors and in the aggregate owned approximately 10.0% of the outstanding common stock at December 31, 1999. Also, during the year ended December 31, 1998, the Company utilized the services of Boston Properties, Inc. ("Boston Properties"), a real estate development company of which the Chairman of the Board is the Chairman of the Board of Directors and owns approximately 12.3% of the outstanding common stock, primarily for construction related to office space occupied by the Company in New York City. Due to/from affiliates -- Affiliates owed the Company $6,615 and $6,561 at December 31, 1999 and 1998, respectively, representing trade receivables. The Company owed affiliates $1,909 and $1,513 at December 31, 1999 and 1998, respectively. Affiliate sales and purchases -- The Company has entered into agreements with U.S. News, the Daily News, and Applied Printing pursuant to which it provides content management and digital services. The agreement with U.S. News expires on December 31, 2000, and is renewable annually thereafter by mutual agreement of the parties. The agreements with the Daily News are renewable annually by mutual agreement of the parties. The agreement with Applied Printing commenced in January 1999 and extends for a period of five years. The Company paid $500 to secure the Applied Printing agreement, which is being amortized over the life of the agreement. In addition, the Company occasionally provides services to and purchases services from related parties. Sales to and purchases from related parties for the years ended December 31, 1999, 1998, and 1997, were as follows:
1999 1998 1997 ------- ------- ------- Affiliate sales....................................... $13,008 $23,658 $16,845 Affiliate purchases................................... $ 2,962 $ 7,921 $ 4,683
Sales to affiliates represented 2.4%, 7.0%, and 9.1%, of the Company's revenues for the years ended December 31, 1999, 1998, and 1997, respectively. Shared costs -- The Company receives certain legal and computer services from the Daily News and U.S. News. For such services, the Company incurred charges of $1,244, $508, and $308 for the years ended December 31, 1999, 1998, and 1997, respectively. The Company also received certain merger and acquisition 41 45 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) services from the Daily News in 1999 and 1998, for which the Company was charged $280 and $251, respectively. In addition, during 1998, the Company jointly implemented new financial and administrative systems with the Daily News and U.S. News. Certain of the software vendor costs incurred for this project were divided among the Company and its affiliates on the basis of either specific identification or an allocation of common charges based on an estimate of the number of end users. The Company incurred charges of $3,810 during 1998 related to the software vendor for this project, which was included as part of property, plant, and equipment at December 31, 1999 and 1998. Leases -- The Company leases office space in Washington, D.C., from U.S. News. The charges incurred for the lease were $205, $306, and $301, for the years ended December 31, 1999, 1998, and 1997, respectively. The Company leased office space in New York City from Applied Printing for a portion of 1998 and the year ended December 31, 1997, for which it incurred charges of $106 and $385, respectively. The Company leased a facility in New Jersey from the Daily News and incurred charges of $72 for the year ended December 31, 1997. The Company leased a facility in New York City from the Daily News for the year ended December 31, 1999, and a portion of 1998, for which the Company incurred charges of $156 and $174, respectively. The Company also incurred charges with U.S. News of $184 for the year ended December 31, 1999, for leasing additional space used by the Company at its corporate headquarters in New York City. 18. RETIREMENT PLANS The Company has a defined contribution plan in which employees are eligible to participate upon the completion of six months of service and the attainment of 21 years of age. Participants can contribute into the plan on both a pre-tax and after-tax basis. In addition, the Company can make discretionary contributions into the plan. Participants vest 100% in the Company's discretionary contribution upon the completion of five years of service. The Company did not make any discretionary contributions for the years ended December 31, 1999, 1998, and 1997. The Company has various defined contribution plans covering employees at certain acquired operations who meet eligibility requirements. Amounts contributed to these defined contribution plans are at the Company's discretion. Contributions charged to operations for such plans for the years ended December 31, 1999 and 1998, were $1,983 and $806, respectively. The Company also contributes to various multi-employer benefit plans that cover employees pursuant to collective bargaining agreements. The total contributions to multi-employer plans charged to operations for the years ended December 31, 1999, 1998, and 1997, were $558, $461, and $203, respectively. 19. COMMITMENTS AND CONTINGENT LIABILITIES The Company is contingently liable as a result of transactions arising in the ordinary course of business and is involved in certain legal proceedings in which damages and other remedies are sought. In the opinion of Company management, after review with counsel, the ultimate resolution of these matters will not have a material effect on the Company's Consolidated Financial Statements. 20. CONCENTRATION OF CREDIT RISK Other than interest rate swap agreements (see Note 11 to the Consolidated Financial Statements), financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash equivalents and trade receivables. The Company maintains cash balances and cash equivalents with high credit quality financial institutions and limits the amount of credit exposure to any one financial institution. 42 46 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company provides credit to customers on an uncollateralized basis after evaluating customer credit worthiness. The Company's customers are not concentrated in any specific geographic region, but are concentrated in the publishing, advertising agency, entertainment, and retailing businesses. The Company's five largest nonaffiliated customers, excluding related parties, comprise 30%, 32%, and 33% of revenues for the years ended December 31, 1999, 1998, and 1997, respectively. In addition, amounts due from these customers represent 23% and 17% of trade accounts receivable as of December 31, 1999 and 1998, respectively. Any termination or significant disruption of the Company's relationships with any of its principal customers could have a material adverse effect on the Company's business, financial condition, results of operations, and cash flows. 21. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Payments of interest and income taxes were as follows:
1999 1998 1997 --------- --------- -------- Interest paid (net of amounts capitalized)....... $ 22,092 $ 5,097 $ 1,138 Income taxes paid................................ $ 2,673 $ 15,214 $ 4,847
Noncash investing and financing activities were as follows:
1999 1998 1997 --------- --------- -------- Increase in additional paid-in capital from income tax benefit associated with exercise of stock options.................................. $ 15 $ 9 $ 6,407 Reduction of goodwill from amortization of excess tax deductible goodwill........................ $ 143 $ 143 $ 119 Acquisition of property, plant, and equipment in exchange for obligations under capital leases......................................... $ 3,373 $ 1,235 Additions to intangible assets for contingent payments....................................... $ 7,784 $ 5,001 $ 3,174 Non-contingent future payments related to acquisitions................................... $ 1,234 $ 488 Common stock issued as additional consideration for 1997 acquisition........................... $ 240 Fair value of stock options issued to non-employee................................... $ 55 Common stock and warrants issued for acquisitions................................... $ 225,665 $ 330 Exchange of Preference Shares for Subordinated Notes.......................................... $ 29,867 Acquisitions: Fair value of assets acquired.................... $ 254,561 $ 572,986 $ 22,204 Cash paid........................................ (125,419) (272,752) (11,024) Fair value of common stock and warrants issued... (225,665) (330) --------- --------- -------- Liabilities assumed.............................. $ 129,142 $ 74,569 $ 10,850 ========= ========= ========
22. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required in 43 47 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The carrying amount and estimated fair values of financial instruments at December 31 are summarized as follows:
1999 1998 ---------------------- ---------------------- CARRYING ESTIMATED CARRYING ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE -------- ---------- -------- ---------- ASSETS: Cash and cash equivalents............... $ 23,218 $ 23,218 $ 17,979 $ 17,979 Marketable securities................... $ 2,127 $ 2,127 Other assets............................ $ 5,165 $ 5,165 $ 7,444 $ 7,444 LIABILITIES: Long-term debt.......................... $315,231 $314,246 $204,394 $204,355 Subordinated notes...................... $ 29,867 $ 31,184 Minority interest....................... $ 33,050 $ 31,193 Obligations under capital leases........ $ 5,732 $ 5,449 $ 5,023 $ 5,007 OFF BALANCE SHEET FINANCIAL INSTRUMENTS: Unrealized gain (loss) on interest rate swap agreements....................... $ 2,058 $ (1,711) Unrealized gain on warrants to purchase marketable securities................. $ 68
The following methods and assumptions were used to estimate the fair value of financial instruments presented above: Cash and cash equivalents -- the carrying amount is a reasonable approximation of fair value. Marketable securities -- the fair value of marketable securities is based on quoted market prices. Other assets -- the carrying amount of non-trade accounts receivable is a reasonable approximation of fair value. Long-term debt -- the fair value of notes payable, including the current portion, is estimated by discounting the future streams of payments using the rate at which the Company can currently obtain funds under its credit facilities. The carrying amount of the amounts outstanding under the 1999 Credit Agreement is a reasonable approximation of fair value since it is a variable-rate obligation. Subordinated notes -- the fair value of subordinated notes is estimated by discounting the future stream of payments using the rate at which the Company can currently obtain funds under its credit facilities. Minority interest -- the fair value of redeemable preference shares is estimated by discounting the future stream of payments using the rate at which the Company can currently obtain funds under its credit facilities. Obligations under capital leases -- the fair value of obligations under capital leases, including the current portion, is estimated by discounting the future streams of payments using the rate at which the Company can currently obtain funds under its credit facilities. Interest rate swap agreements -- the fair value of the interest rate swap agreements is the estimated amount the Company would receive or have to pay to terminate the agreements. Warrants to purchase marketable securities -- the fair value of warrants to purchase marketable securities is estimated using the Black-Scholes option-pricing model. 44 48 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 23. SEGMENT INFORMATION The Company has determined that its only reportable segment is content management services. The content management services segment provides creative and editorial design services and prepress services, which combine text with pictures and graphics into page layout format for reproduction. The Company provides content management services to magazine publishers, advertising agencies, entertainment companies, automobile and other consumer products manufacturers, and retailers. The Company identifies its reportable segments based on the services provided by its various operations. The content management services segment is an aggregation of such services the Company offers at its own facilities and the similar services provided at customer locations under facilities management contracts. The Company's other operating segments are broadcast media distribution services and digital services, neither of which are reportable segments because they do not meet the quantitative thresholds, and are reported as "Other operating segments" in the following disclosure. The Company previously reported its publishing business as a reportable segment. This segment, which sells greeting cards, calendars, art prints, and other wall decor products to mass-market merchants, card shops, bookstores, art galleries, designers, and framers, is reported as a discontinued operation (see Note 4 to the Consolidated Financial Statements). The Company measures profit or loss of its segments based on operating income. Operating income for segments includes interest associated with equipment financing, which is included in interest expense in the Consolidated Statements of Income, and excludes amortization of intangible assets, loss on sale of fixed assets, restructuring charges, and impairments and other charges. The accounting policies used to measure operating income of the segments are the same as those outlined in Note 2 to the Consolidated Financial Statements. Segment information relating to results of continuing operations was as follows:
1999 1998 1997 -------- -------- -------- Revenue: Content Management Services........................ $489,462 $303,243 $158,694 Other operating segments........................... 42,602 35,699 26,299 -------- -------- -------- Total.............................................. $532,064 $338,942 $184,993 ======== ======== ======== Operating Income: Content Management Services........................ $ 53,968 $ 51,475 $ 22,348 Other operating segments........................... 3,655 2,147 6,132 -------- -------- -------- Total.............................................. 57,623 53,622 28,480 Other business activities.......................... (24,055) (13,971) (5,950) Amortization of intangibles........................ (11,306) (5,724) (791) Gain (loss) on disposal of fixed assets............ (2,402) 318 (200) Interest expense................................... (18,639) (5,850) (464) Interest income.................................... 475 1,817 1,724 Other income (expense)............................. 908 287 (92) Restructuring charges.............................. (3,572) (8,550) Impairments and other charges...................... (6,302) (5,659) -------- -------- -------- Consolidated income (loss) from continuing operations before provision for income taxes and minority interest................................ $ (7,270) $ 16,290 $ 22,707 ======== ======== ========
45 49 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1999 1998 1997 -------- -------- -------- Interest expense on equipment financing: Content Management Services........................ $ 486 $ 378 $ 488 Other operating segments........................... 17 21 7 Other business activities.......................... 3 58 75 -------- -------- -------- Total.............................................. $ 506 $ 457 $ 570 ======== ======== ======== Depreciation expense: Content Management Services........................ $ 20,782 $ 10,735 $ 4,481 Other operating segments........................... 1,977 1,013 546 Other business activities.......................... 1,287 1,523 1,028 -------- -------- -------- Total.............................................. $ 24,046 $ 13,271 $ 6,055 ======== ======== ========
Segment information related to the Company's assets was as follows:
1999 1998 -------- -------- Total Assets: Content Management Services................................. $711,830 $470,484 Other operating segments.................................... 35,423 33,601 Other business activities................................... 35,136 56,818 Discontinued operations..................................... 148,621 142,171 -------- -------- Total....................................................... $931,010 $703,074 ======== ======== Expenditures on long-lived assets: Content Management Services................................. $ 15,414 $ 17,718 Other operating segments.................................... 1,622 2,477 Other business activities................................... 8,920 9,066 -------- -------- Total....................................................... $ 25,956 $ 29,261 ======== ========
Prior to 1999, all of the Company's revenues from continuing operations were generated, and all of its property, plant, and equipment for continuing operations was located, in the United States. The Company's publishing business generated revenues in foreign countries of $17,088 and $6,475, and had long-lived assets of $675 and $456, as of and for the years ended December 31, 1999 and 1998, respectively. Segment information for continuing operations relating to geographic regions for 1999 was as follows:
1999 -------- Revenues: United States............................................... $495,793 United Kingdom.............................................. 32,746 Other foreign countries..................................... 3,525 -------- Total....................................................... $532,064 ========
46 50 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1999 -------- Long-lived assets: United States............................................... $ 88,033 United Kingdom.............................................. 19,182 Other foreign countries..................................... 967 -------- Total....................................................... $108,182 ========
24. COMPREHENSIVE INCOME Comprehensive income includes all changes to equity that are not the result of transactions with shareholders and is comprised of net income and other comprehensive income. Other comprehensive income and accumulated other comprehensive income as of and for the years ended December 31, 1999, 1998, and 1997, are comprised of unrealized holding gains and losses on available-for-sale securities and gains and losses from foreign currency translation adjustments. No income tax effect is reported for unrealized gains and losses from foreign currency translation adjustments since they relate to indefinite investments in foreign subsidiaries. Comprehensive income and accumulated comprehensive income, including related tax effects, were as follows:
FOREIGN ACCUMULATED CURRENCY OTHER HOLDING GAINS (LOSSES) ON TRANSLATION COMPREHENSIVE AVAILABLE-FOR-SALE SECURITIES ADJUSTMENTS INCOME ----------------------------- ----------- ------------- PRETAX TAX AFTER TAX AFTER TAX AFTER TAX AMOUNT EFFECT AMOUNT AMOUNT AMOUNT ------ ------ --------- ----------- ------------- Balance at January 1, 1997............. $ -- $ -- $ -- $ -- $ -- Unrealized gain........................ 53 (22) 31 31 ------ ----- ------ ---- ------ Balance at December 31, 1997........... 53 (22) 31 -- 31 Unrealized loss........................ (4) (4) Reclassification adjustment for gains realized in net income............... (53) 22 (31) (31) ------ ----- ------ ---- ------ Balance at December 31, 1998........... -- -- -- (4) (4) Unrealized gain........................ 1,926 (809) 1,117 151 1,268 ------ ----- ------ ---- ------ Balance at December 31, 1999........... $1,926 $(809) $1,117 $147 $1,264 ====== ===== ====== ==== ======
25. SUBSEQUENT EVENTS In March 2000, the Company announced that it had retained an investment banking firm to explore strategic alternatives, including a possible sale of the Company. In August 2000, the Board of Directors of the Company decided that it would no longer actively pursue a sale of the Company, but would continue to pursue other strategic alternatives. There can be no assurance that any transaction will occur as a result of this effort. In April 2000, the Company sold the photographic laboratory business that was acquired as part of Wace for a sales price of approximately $11,500. The Company did not realize a gain or loss on the sale of this business. In June 2000, the Company's Board of Directors approved a plan to sell the publishing business that was acquired as part of the merger with Devon (see Note 4 to the Consolidated Financial Statements). The Company expects to consummate the sale of the publishing business by June 2001, although there can be no assurance that the sale will be consummated within that timeframe. 47 51 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 26. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
1999 QUARTER ENDED, ----------------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30(1) DECEMBER 31(2) -------- ------- --------------- -------------- (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS) Revenues................................ $93,945 $130,710 $151,144 $156,265 Gross profit............................ $29,094 $ 41,172 $ 51,548 $ 46,710 Income (loss) from continuing operations before provision for income taxes and minority interest..................... $ 2,160 $ 4,826 $ 1,533 $(15,789) Income (loss) from continuing operations............................ $ (565) $ 2,058 $ 819 $(13,846) Income (loss) from discontinued operations............................ 940 (121) (1,640) 369 ------- -------- -------- -------- Net income (loss)....................... $ 375 $ 1,937 $ (821) $(13,477) ======= ======== ======== ======== Earnings (loss) per common share from continuing operations: Basic................................. $ (0.02) $ 0.09 $ 0.03 $ (0.61) Diluted............................... $ (0.02) $ 0.09 $ 0.03 $ (0.61) 1998 QUARTER ENDED, ----------------------------------------------------------- MARCH 31 JUNE 30(3) SEPTEMBER 30 DECEMBER 31(4) -------- ---------- ------------ -------------- (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS) Revenues................................ $59,655 $ 71,795 $ 96,925 $110,567 Gross profit............................ $20,615 $ 25,268 $ 30,290 $ 37,529 Income (loss) from continuing operations before provision for income taxes..... $ 9,446 $ 4,364 $ 4,045 $ (1,565) Income (loss) from continuing operations............................ $ 5,573 $ 2,581 $ 2,100 $ (3,936) Income (loss) from discontinued operations............................ 618 1,531 (291) ------- -------- -------- -------- Net income (loss)....................... $ 5,573 $ 3,199 $ 3,631 $ (4,227) ======= ======== ======== ======== Earnings (loss) per common share from continuing operations: Basic................................. $ 0.31 $ 0.13 $ 0.09 $ (0.18) Diluted............................... $ 0.30 $ 0.13 $ 0.09 $ (0.18)
--------------- (1) Includes a $827 restructuring charge and a $1,038 impairment charge related to property and equipment in connection with the Company's plan to restructure its operations to achieve operating efficiencies associated with the growth of its content management operations, primarily resulting from the acquisition of Wace. (2) Includes a $2,745 restructuring charge for continued integration efforts related to the acquisition of Wace, a $4,520 impairment charge related to property and equipment, a $744 charge for impairment of certain digital events photography operations, a loss of $2,368 on disposal of equipment, and a charge of $418 relating to a change in accounting estimate. (3) Includes a $5,300 restructuring charge in connection with the Company's plan to restructure its operations to achieve operating efficiencies associated with the growth of its content management operations, primarily resulting from the merger with Devon and the acquisition of Color Control. (4) Includes a $3,250 restructuring charge, a $3,150 charge related to the abandonment of certain of the Company's digital events photography operations obtained as part of the acquisition of DI, and a $2,509 charge for the impairment of intangibles related to the digital events photography operations obtained in the acquisition of Amusematte Corp. in 1997. 48 52 (b) Unaudited financial statements. 49 53 APPLIED GRAPHICS TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)
JUNE 30, DECEMBER 31, 2000 1999 -------- ------------ ASSETS Current assets: Cash and cash equivalents................................. $ 8,611 $ 23,218 Marketable securities..................................... 289 2,127 Trade accounts receivable (net of allowances of $7,879 in 2000 and $7,732 in 1999)................................ 107,551 119,997 Due from affiliates....................................... 6,654 6,615 Inventory................................................. 28,244 26,283 Prepaid expenses.......................................... 8,882 12,095 Deferred income taxes..................................... 27,757 26,985 Other current assets...................................... 10,277 13,844 Net current assets of discontinued operations............. 44,673 36,233 -------- -------- Total current assets.................................... 242,938 267,397 Property, plant, and equipment -- net....................... 71,252 95,281 Goodwill and other intangible assets (net of accumulated amortization of $21,861 in 2000 and $15,145 in 1999)...... 427,058 437,674 Other assets................................................ 23,110 18,270 Net non-current assets of discontinued operations........... 112,388 -------- -------- Total assets....................................... $764,358 $931,010 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses..................... $ 79,929 $ 92,056 Current portion of long-term debt and obligations under capital leases.......................................... 17,943 19,024 Due to affiliates......................................... 1,466 1,909 Other current liabilities................................. 23,750 33,477 -------- -------- Total current liabilities.......................... 123,088 146,466 Long-term debt.............................................. 260,589 298,125 Subordinated notes.......................................... 28,119 29,867 Obligations under capital leases............................ 2,773 3,814 Deferred income taxes....................................... 3,413 2,975 Other liabilities........................................... 12,900 8,763 -------- -------- Total liabilities.................................. 430,882 490,010 -------- -------- Commitments and contingencies Minority interest -- Redeemable Preference Shares issued by subsidiary................................................ 32,982 33,050 -------- -------- Stockholders' Equity: Preferred stock (no par value, 10,000,000 shares authorized; no shares outstanding) Common stock ($0.01 par value, 150,000,000 shares authorized; shares issued and outstanding: 22,584,282 in 2000 and 22,474,772 in 1999)............................ 226 225 Additional paid-in capital................................ 388,547 386,548 Accumulated other comprehensive income (loss)............. (688) 1,264 Retained earnings (deficit)............................... (87,591) 19,913 -------- -------- Total stockholders' equity............................ 300,494 407,950 -------- -------- Total liabilities and stockholders' equity......... $764,358 $931,010 ======== ========
See Notes to Interim Consolidated Financial Statements 50 54 APPLIED GRAPHICS TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)
FOR THE SIX MONTHS ENDED JUNE 30, --------------------- 2000 1999 --------- -------- Revenues.................................................... $ 291,342 $224,655 Cost of revenues............................................ 193,894 154,389 --------- -------- Gross profit................................................ 97,448 70,266 --------- -------- Selling, general, and administrative expenses............... 81,741 52,391 Amortization of intangibles................................. 6,744 5,007 Gain on disposal of property and equipment.................. (47) (34) Restructuring charges....................................... 611 Impairment charges.......................................... 1,241 --------- -------- Total operating expenses.......................... 90,290 57,364 --------- -------- Operating income............................................ 7,158 12,902 Interest expense............................................ (13,194) (6,158) Interest income............................................. 433 128 Other income (expense) -- net............................... (154) 114 --------- -------- Income (loss) from continuing operations before provision for income taxes and minority interest.................... (5,757) 6,986 Provision (benefit) for income taxes........................ 2,068 4,927 --------- -------- Income (loss) from continuing operations before minority interest.................................................. (7,825) 2,059 Minority interest........................................... (1,296) (566) --------- -------- Income (loss) from continuing operations.................... (9,121) 1,493 Income (loss) from discontinued operations.................. (98,383) 819 --------- -------- Net income (loss)........................................... (107,504) 2,312 Other comprehensive income (loss)........................... (1,952) 134 --------- -------- Comprehensive income (loss)................................. $(109,456) $ 2,446 ========= ======== Basic earnings (loss) per common share: Income (loss) from continuing operations.................. $ (0.40) $ 0.07 Income (loss) from discontinued operations................ (4.35) 0.03 --------- -------- Total..................................................... $ (4.75) $ 0.10 ========= ======== Diluted earnings (loss) per common share: Income (loss) from continuing operations.................. $ (0.40) $ 0.07 Income (loss) from discontinued operations................ (4.35) 0.03 --------- -------- Total..................................................... $ (4.75) $ 0.10 ========= ======== Weighted average number of common shares: Basic....................................................... 22,615 22,396 Diluted..................................................... 22,615 22,397
See Notes to Interim Consolidated Financial Statements 51 55 APPLIED GRAPHICS TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS OF DOLLARS)
FOR THE SIX MONTHS ENDED JUNE 30, ---------------------- 2000 1999 --------- --------- Cash flows from operating activities: Net income (loss)........................................... $(107,504) $ 2,312 Adjustments to reconcile net income (loss) to net cash from operating activities: Depreciation and amortization............................. 19,578 14,704 Deferred taxes............................................ (1,760) Impairment charges........................................ 1,241 Loss (income) from discontinued operations................ 98,383 (819) Other..................................................... 755 989 Changes in Operating Assets and Liabilities, net of effects of acquisitions and dispositions: Trade accounts receivable................................. 2,569 5,571 Due from/to affiliates.................................... (482) (712) Inventory................................................. (3,536) (2,640) Other assets.............................................. 4,844 8,300 Accounts payable and accrued expenses..................... (8,294) (12,628) Other liabilities......................................... (962) (3,864) Net cash provided by (used in) operating activities of discontinued operations................................ 8,577 (14) --------- --------- Net cash provided by operating activities................... 15,169 9,439 --------- --------- Cash flows from investing activities: Property, plant, and equipment expenditures............... (9,978) (6,491) Software expenditures..................................... (1,113) (4,860) Proceeds from sale of property and equipment.............. 14,039 Proceeds from sale of a business.......................... 11,693 Entities purchased, net of cash acquired.................. (99,931) Other..................................................... (4,217) (5,066) Net cash used in investing activities of discontinued operations............................................. (706) (1,784) --------- --------- Net cash provided by (used in) investing activities......... 9,718 (118,132) --------- --------- Cash flows from financing activities: Proceeds from exercise of stock options................... 210 Proceeds from sale/leaseback transactions................. 1,496 Repayments of notes and capital lease obligations......... (1,450) (630) Repayments of term loans.................................. (33,397) Borrowings (repayments) under revolving credit line -- net............................................ (4,125) 98,524 Net cash used in financing activities of discontinued operations............................................. (87) (41) --------- --------- Net cash provided by (used in) financing activities......... (39,059) 99,559 --------- --------- Net decrease in cash and cash equivalents................... (14,172) (9,134) Effect of exchange rate changes on cash and cash equivalents............................................... (435) Cash and cash equivalents at beginning of period............ 23,218 17,979 --------- --------- Cash and cash equivalents at end of period.................. $ 8,611 $ 8,845 ========= =========
See Notes to Interim Consolidated Financial Statements 52 56 APPLIED GRAPHICS TECHNOLOGIES, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED) (IN THOUSANDS OF DOLLARS EXCEPT SHARE AMOUNTS)
FOR THE SIX MONTHS ENDED JUNE 30, 2000 -------------------------------------------------- ACCUMULATED ADDITIONAL OTHER RETAINED COMMON PAID-IN COMPREHENSIVE EARNINGS STOCK CAPITAL INCOME (LOSS) (DEFICIT) ------ ---------- ------------- --------- Balance at January 1, 2000.................... $225 $386,548 $ 1,264 $ 19,913 Issuance of 109,510 common shares as additional consideration in connection with prior period acquisitions................... 1 1,999 Unrealized holding loss on available-for-sale securities.................................. (1,066) Unrealized loss from foreign currency translation adjustments..................... (1,202) Reclassification adjustment for losses realized in net income...................... 316 Net loss...................................... (107,504) ---- -------- ------- --------- Balance at June 30, 2000...................... $226 $388,547 $ (688) $ (87,591) ==== ======== ======= =========
See Notes to Interim Consolidated Financial Statements 53 57 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS OF DOLLARS) 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of Applied Graphics Technologies, Inc. and its subsidiaries (the "Company"), which have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles, should be read in conjunction with the notes to consolidated financial statements contained elsewhere herein. In the opinion of the management of the Company, all adjustments (consisting primarily of normal recurring accruals) necessary for a fair presentation have been included in the financial statements. The operating results of any quarter are not necessarily indicative of results for any future period. Certain prior-period amounts in the accompanying financial statements have been reclassified to conform with the 2000 presentation. 2. DISCONTINUED OPERATIONS In June 2000, the Company's Board of Directors approved a plan to sell the publishing business that was acquired as part of the merger with Devon Group, Inc. The Company expects to consummate the sale of the publishing business within the next year, although there can be no assurance that the sale will be consummated within that timeframe. For purposes of estimating the loss on disposal, the Company assumed a disposal date of December 31, 2000. The accompanying financial statements have been restated to reflect the operations of the publishing business as a discontinued operation. Provision has been made for estimated operating income through the expected disposal date and for the estimated loss on disposal, including the write off of approximately $100,000 of goodwill. The results of operations of the discontinued business and the estimated loss on disposal, presented as Discontinued Operations in the accompanying Consolidated Statements of Operations, were as follows:
FOR THE SIX MONTHS ENDED JUNE 30, ------------------- 2000 1999 -------- ------- Revenues.................................................... $ 36,361 $39,731 ======== ======= Income (loss) from operations before income taxes........... $ (3,134) $(1,229) Provision (benefit) equivalent to income taxes.............. 7 (2,048) -------- ------- Income (loss) from operations............................... (3,141) 819 Loss on disposal (including provision for income taxes of $2,157)................................................... (95,242) -------- ------- Income (loss) from discontinued operations.................. $(98,383) $ 819 ======== =======
The results of operations of the publishing business include an allocation of interest expense of $2,950 and $1,492 for the six month periods ended June 30, 2000 and 1999, respectively. The estimated loss on disposal includes estimated future net income from operations for the period through December 31, 2000, the assumed disposal date, of $1,273, which includes an allocation of interest expense of $1,000. The allocated interest expense consisted solely of the interest expense on the Company's borrowings under its primary credit facilities (the "1999 Credit Agreement"), which represents the interest expense not directly attributable to the Company's other operations. Interest expense was allocated based on the ratio of the net assets of the discontinued operation to the sum of the consolidated net assets of the Company and the outstanding borrowings under the 1999 Credit Agreement. 54 58 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The results of operations and cash flows of the discontinued operations include amounts for selected items as follows:
FOR THE SIX MONTHS ENDED JUNE 30, ------------------- 2000 1999 ------- -------- Interest expense............................................ $3,026 $ 1,586 Interest income............................................. $ 68 $ 64 Depreciation and amortization expense....................... $2,150 $ 1,812 Loss (gain) on disposal of property and equipment........... $ 8 $ (5) Provision (benefit) equivalent to income taxes.............. $2,164 $(2,048) Property, plant, and equipment expenditures................. $ 706 $ 1,156 Repayments of notes and capital lease obligations........... $ 87 $ 41
The net assets of discontinued operations include $745 and $832 at June 30, 2000, and December 31, 1999, respectively, of long-term debt and obligations under capital leases, inclusive of the current portion. 3. RESTRUCTURING In June 2000, the Company initiated and completed a plan (the "2000 Second Quarter Plan") to close the Atlanta operation acquired as part of the acquisition of Wace Group Limited ("Wace"). As part of the 2000 Second Quarter Plan, the Company terminated certain employees and transferred the work previously performed in the Atlanta facility to Wace's facility in Dallas, Texas. The results of operations for the six month period ended June 30, 2000, include a charge of $611 for the 2000 Second Quarter Plan, which consisted of $456 for facility closure costs and $155 for employee termination costs for 34 employees. In 1998 and 1999, the Company commenced four separate plans to restructure certain of its operations (the "1998 Second Quarter Plan," the "1998 Fourth Quarter Plan," the "1999 Third Quarter Plan," and the "1999 Fourth Quarter Plan," respectively). The amounts included in "Other current liabilities" in the accompanying Consolidated Balance Sheets as of June 30, 2000, and December 31, 1999, for the future costs of the various restructuring plans, and the amounts charged against the respective restructuring liabilities during the six months ended June 30, 2000, were as follows:
1998 SECOND 1998 FOURTH 1999 THIRD 1999 FOURTH 2000 SECOND QUARTER PLAN QUARTER PLAN QUARTER PLAN QUARTER PLAN QUARTER PLAN ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1999....................... $ 294 $ 502 $ 330 $2,279 Restructuring charge......... $611 Facility closure costs....... (54) (167) (257) Employee termination costs... (37) (53) (312) Abandoned assets............. (102) (106) (4) (366) ----- ----- ----- ------ ---- Balance at June 30, 2000..... $ 192 $ 305 $ 106 $1,344 $611 ===== ===== ===== ====== ====
The number of employees included in the charge against the various restructuring plans' liabilities for employee termination costs for the six months ended June 30, 2000, was 14, 5, and 12 for the 1998 Fourth Quarter Plan, the 1999 Third Quarter Plan, and the 1999 Fourth Quarter Plan, respectively. The Company does not anticipate any material adverse effect on its future results of operations from the various restructuring plans. The employees terminated and to be terminated under the restructuring plans are principally production workers, salespeople, and administrative support staff. The Company completed both the 1998 Second Quarter Plan and the 1998 Fourth Quarter Plan during 1999. The remaining liabilities for these plans primarily represent future rental obligations for abandoned property and equipment. The Company 55 59 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) expects to complete the 1999 Third Quarter Plan and the 1999 Fourth Quarter Plan by September 2000 and December 2000, respectively. The Company is continuing to pursue operating efficiencies and synergies and, as a result, may incur additional restructuring charges. During the six month period ended June 30, 2000, the Company terminated 134 employees and incurred employee termination costs of $1,732 that were not related to its various restructuring plans. Such costs are included in "Selling, general, and administrative expenses" in the accompanying Consolidated Statements of Operations for the six month period ended June 30, 2000. 4. IMPAIRMENT CHARGES In June 2000, the Company incurred a charge of $583 from the impairment of equipment abandoned in connection with the 2000 Second Quarter Plan. In May 2000, the Company commenced a plan to sell its events-based digital photography business. In connection with such action, the Company incurred a charge of $658 for the write down of long-lived assets related to this business. The net assets of this business, which are a component of the Company's digital services segment, are included in "Other current assets" in the Company's Consolidated Balance Sheet at June 30, 2000. The Company consummated the sale of this business in August 2000 for approximately $220. The revenues, gross profit, and operating loss from this business included in the Company's results of operations for the six month period ended June 30, 2000 and 1999, were as follows:
SIX MONTHS ENDED JUNE 30, --------------- 2000 1999 ----- ------ Revenues.................................................... $ 462 $1,056 Gross profit................................................ $(131) $ 207 Operating loss.............................................. $(632) $ (198)
5. LONG-TERM DEBT Under the terms of the 1999 Credit Agreement, the Company must comply with certain financial covenants related to leverage ratios, interest coverage ratios, fixed charge coverage ratios, minimum net worth, and capital spending. In August 2000, the Company entered into an amendment to the 1999 Credit Agreement (the "Fourth Amendment") to relax the interest coverage ratio and net worth covenants as of June 30, 2000, and to modify all of the financial covenant requirements to be less restrictive than previously required in the 1999 Credit Agreement for the quarterly fiscal periods through June 30, 2001. In addition to modifying the various financial covenants, the Fourth Amendment increased the interest rates on all future borrowings under the 1999 Credit Agreement by 50 basis points and lowered the borrowing capacity of the revolving line of credit to $85,000. In July 2000, the Company entered into an amendment to the 1999 Credit Agreement (the "Third Amendment") that lowered the net worth covenant threshold to enable the Company to proceed with its planned disposal of the publishing business. Also in July 2000, the lending institutions granted a waiver of covenant defaults to enable the Company to make the July 31, 2000, scheduled interest payment to the holders of its subordinated notes. In connection with entering into the Third Amendment and the Fourth Amendment, the Company incurred fees of $496 and $1,535, respectively. The fee incurred in connection with the Third Amendment is included in the loss on disposal of discontinued operations. The fee incurred in connection with the Fourth Amendment will be included as a component of interest expense in future periods. Based upon the modified financial covenants as contained in the Fourth Amendment, the Company was in compliance with all covenants at June 30, 2000. Had the Company not entered into the aforementioned amendments to the 1999 Credit Agreement, the Company would not have been in compliance with the 56 60 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) interest coverage ratio and net worth covenants at June 30, 2000. The Company's net worth at June 30, 2000, was adversely affected by the $95,242 estimated loss on disposal of the publishing business, including the write off of approximately $100,000 of goodwill (see Note 2). There can be no assurance that the Company will be able to attain compliance with the amended covenant requirements in future periods. If the Company does not attain compliance, it intends to engage in additional discussions with its lending institutions to obtain additional waivers and amendments, although there can be no assurance that such additional waivers or amendments will be granted. 6. INVENTORY The components of inventory were as follows:
JUNE 30, DECEMBER 31, 2000 1999 -------- ------------ Work-in-process............................................. $24,992 $21,092 Raw materials............................................... 3,252 5,191 ------- ------- Total....................................................... $28,244 $26,283 ======= =======
7. RELATED PARTY TRANSACTIONS Sales to, purchases from, and administrative charges incurred with related parties during the six months ended June 30, 2000 and 1999, were as follows:
SIX MONTHS ENDED JUNE 30, ---------------- 2000 1999 ------ ------ Affiliate sales............................................. $5,493 $6,460 Affiliate purchases......................................... $ 278 $2,252 Administrative charges...................................... $ 734 $ 832
Administrative charges include charges for certain legal, administrative, and computer services provided by affiliates and for rent incurred for leases with affiliates. 8. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Payments of interest and income taxes for the six months ended June 30, 2000 and 1999, were as follows:
2000 1999 ------- -------- Interest paid............................................... $15,145 $ 7,651 Income taxes paid........................................... $ 1,341 $ 1,831
Noncash investing and financing activities for the six months ended June 30, 2000 and 1999, were as follows:
2000 1999 ------- -------- Exchange of Preference Shares for subordinated notes........ $ 68 Issuance of common stock as additional consideration in connection with prior period acquisitions................. $ 2,000 $ 240 Reduction of goodwill from amortization of excess tax deductible goodwill....................................... $ 98 $ 17 Fair value of stock options issued to non-employee.......... $ 55
57 61 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2000 1999 ------- -------- Acquisitions: Fair value of assets acquired............................... $244,900 Cash paid................................................... (105,777) Non contingent future payments.............................. (17,778) -------- Liabilities assumed......................................... $121,345 ========
9. SEGMENT INFORMATION Segment information relating to results of continuing operations for the six months ended June 30, 2000 and 1999, was as follows:
SIX MONTHS ENDED JUNE 30, -------------------- 2000 1999 -------- -------- Revenue: Content Management Services................................. $262,448 $205,798 Other operating segments.................................... 28,894 18,857 -------- -------- Total....................................................... $291,342 $224,655 ======== ======== Operating Income: Content Management Services................................. $ 27,406 $ 25,995 Other operating segments.................................... 3,582 3,053 -------- -------- Total....................................................... 30,988 29,048 Other business activities................................... (15,531) (11,385) Amortization of intangibles................................. (6,744) (5,007) Restructuring charges....................................... (611) Gain on disposal of fixed assets............................ 47 34 Impairment charges.......................................... (1,241) Interest expense............................................ (12,944) (5,946) Interest income............................................. 433 128 Other income (expense)...................................... (154) 114 -------- -------- Consolidated income (loss) from continuing operations before provision for income taxes and minority interest.......... $ (5,757) $ 6,986 ======== ========
Segment information relating to the Company's assets as of June 30, 2000, was as follows: Total Assets: Content Management Services................................. $645,942 Other operating segments.................................... 36,267 Other business activities................................... 37,476 Discontinued operations..................................... 44,673 -------- Total....................................................... $764,358 ========
58 62 APPLIED GRAPHICS TECHNOLOGIES, INC. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 10. RECENTLY ISSUED ACCOUNTING STANDARDS Statement of Financial Accounting Standards (SFAS) No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities (an amendment of FASB Statement No. 133)," was issued in June 2000. SFAS No. 138 amended certain definitions and clarified certain requirements of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities and requires that entities recognize derivative instruments as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for the change in fair value of a derivative instrument will depend on the intended use of the instrument. The adoption of SFAS No. 133 will require the Company to reflect the fair value of its interest rate swap agreements on its Consolidated Balance Sheet. The offsetting gain or loss at the time of adoption of SFAS No. 133 will be accounted for as a cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes." The cumulative gain or loss at the time of adoption of SFAS No. 133 and future gains and losses resulting from the change in fair value of the swap agreements will be reflected in cumulative comprehensive income as a separate component of stockholders' equity to the extent the swaps qualify as cash flow hedges. To the extent the swaps do not qualify as cash flow hedges, such gains and losses will be reflected in net income. The Company intends to determine the potential impact of the adoption of SFAS No. 133 on its financial position and results of operations by the end of 2000. 11. SUBSEQUENT EVENT As previously disclosed, the Company announced in March 2000 that it had retained an investment banking firm to explore strategic alternatives, including a possible sale of the Company. In August 2000, the Board of Directors of the Company decided that it would no longer actively pursue a sale of the Company, but would continue to pursue other strategic alternatives. There can be no assurance that any transaction will occur as a result of this effort. 12. SELECTED QUARTERLY FINANCIAL DATA
2000 QUARTER ENDED, -------------------- MARCH 31 JUNE 30 -------- -------- Revenue..................................................... $144,319 $147,023 Gross profit................................................ $ 47,032 $ 50,416 Loss from continuing operations before provision for income taxes and minority interest............................... $ (4,645) $ (1,112) Loss from continuing operations............................. $ (7,445) $ (1,676) Loss from discontinued operations........................... (1,474) (96,909) -------- -------- Net loss.................................................... $ (8,919) $(98,585) ======== ======== Loss per common share from continuing operations: Basic..................................................... $ (0.33) $ (0.07) Diluted................................................... $ (0.33) $ (0.07)
59 63 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. 60 64 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. (a) Directors. -- The following table lists the directors and persons nominated to be directors of the Company. The term of each director will expire at the Company's 2000 annual meeting of stockholders unless such director is nominated and elected to serve as a director for an additional one-year term at such annual meeting or until their successors are elected and qualified or their earlier resignation or removal.
DIRECTOR NAME AGE SINCE ---- --- -------- Mortimer B. Zuckerman....................................... 63 1996 Fred Drasner................................................ 57 1995 Derek Ashley................................................ 40 1999 John W. Dreyer.............................................. 62 -- John R. Harris.............................................. 51 1996 Martin D. Krall............................................. 59 1996 Marne Obernauer, Jr......................................... 57 1998 David R. Parker............................................. 57 1998 Louis Salamone, Jr.......................................... 53 1999 Howard Stringer............................................. 58 1996 Joseph D. Vecchiolla........................................ 44 -- Linda J. Wachner............................................ 54 1996 John R. Walter.............................................. 53 -- John Zuccotti............................................... 63 1998
Mortimer B. Zuckerman, Chairman of the Board of the Company, has been Chairman of the Board of Directors and a principal stockholder of Boston Properties, Inc., a national real estate development and management company, since 1970. He has been Chairman of U.S. News & World Report, L.P. ("U.S. News") and Editor-in-Chief of U.S. News & World Report since 1985, Chairman of Daily News, L.P. ("Daily News") and Co-Publisher of the New York Daily News since 1993, and served as Chairman of The Atlantic Monthly Company from 1980 to 1999. Mr. Zuckerman has served as Chairman of Fast Company Media Group, L.L.C. ("Fast Company") and President of FC Holdings, L.L.C., its majority owner, since January 1999. Mr. Zuckerman also serves as a director of Snyder Communications, Inc. ("Snyder"), Loews Cineplex Entertainment Corporation, and Chase Manhattan Bank National Advisory Board. Fred Drasner, Chairman and a director of the Company, served as Chief Executive Officer of the Company from 1996 until April 2000. Mr. Drasner has been co-owner of Pro Football, Inc., d/b/a The Washington Redskins, since July 1999. He has been the Chief Executive Officer of Daily News and Co-Publisher of the New York Daily News since 1993, Co-Chairman of U.S. News since 1998, Chief Executive Officer of U.S. News from 1985 to 1998, President of U.S. News from 1985 to 1997, Chairman and Chief Executive Officer of Applied Printing since 1988, and Co-Chairman from 1998 to 1999 and Vice Chairman and Chief Executive Officer from 1986 to 1998 of The Atlantic Monthly Company. Mr. Drasner has served as Co-Chairman of Fast Company since January 1999. Mr. Drasner was also senior counsel to Shaw Pittman, formerly known as Shaw Pittman Potts & Trowbridge, until his resignation in April 1996. Mr. Drasner also serves as a director of Snyder and Ventiv Health, Inc. Derek Ashley, Vice Chairman, Chief Executive Officer, Chief Operating Officer, and a director of the Company, joined the Company in May 1999 following the acquisition by the Company of Wace Group Limited (formerly Wace Group Plc ("Wace")), of which Mr. Ashley was Group Chief Executive. Wace operated an international network of digital imaging businesses and provided digital services in the areas of prepress, color management, interactive multimedia services, and print procurement. Mr. Ashley served as Group Chief Executive of Wace from June 1998 until its acquisition by the Company. Prior to that, 61 65 Mr. Ashley served as President and Chief Executive Officer of Seven Worldwide, Inc., a wholly-owned subsidiary of Wace, from July 1997 and as European Managing Director of Wace from 1995. John W. Dreyer, has been Chairman of the Board since 1978 and Chief Executive Officer since 1977 of Pitman Company, a graphic arts and image supplier. He also served as President of Pitman Company until 1998 and Chief Operating Officer until 1994. Mr. Dreyer is also a director of Presstek, Inc. John R. Harris has been President, Chief Executive Officer, and a director of Ztango.com, a wireless Internet software and services company, since September 1999 and Chairman of the Board of Directors since April 2000. Previously, Mr. Harris was a Corporate Vice President at Electronic Data Systems Corp. ("EDS") from 1997 through March 1999 where he was responsible for marketing and corporate strategy. From 1989 to 1997, he served as President of the Communications Industry Group at EDS where he was responsible for four business units directed toward wirelines, wireless, media, and interactive services markets. Mr. Harris also serves as a director of CapRock Communications Corp. and Ventiv Health, Inc. Martin D. Krall, Executive Vice President, Chief Legal Officer, Secretary, and a director of the Company, has been Executive Vice President, Chief Legal Officer, and Secretary of Daily News, Applied Printing, and U.S. News since January 1995. Mr. Krall served as Executive Vice President, Chief Legal Officer, and Secretary of The Atlantic Monthly Company from 1995 to 1999. Mr. Krall has served as Executive Vice President, Chief Legal Officer, and Secretary of Fast Company and FC Holdings, L.L.C., its majority owner, since January 1999. Prior to 1995, Mr. Krall was a partner in the law firm of Shaw Pittman, where he was a member of the Management Committee from 1978 to 1994, and Vice Chairman of such Committee from 1991 to 1994. From 1995, Mr. Krall was also senior counsel to Shaw Pittman until his resignation in April 1996. Marne Obernauer, Jr., Vice Chairman and a director of the Company, served as Chairman of the Board of Directors of Devon Group, Inc. ("Devon"), from 1986 and Chief Executive Officer of Devon from 1980 until Devon's merger with and into a wholly-owned subsidiary of the Company in May 1998. Mr. Obernauer also serves as a director of The Advest Group, Inc. David R. Parker is a founder and Managing General Partner of Interprise Technology Partners, L.P., a venture capital fund focused on Internet and information technology investments established in January 1999. From 1992 through May 1998, Mr. Parker was Chairman of ProSource Distribution Services, Inc., a food service distributor, which was acquired by AmeriServe, Inc., in May 1998. In May 1998, Mr. Parker became Vice Chairman of AmeriServe, Inc., overseeing the integration of ProSource into AmeriServe. He served in this capacity until he resigned his officer position in August 1998 and his position on AmeriServe's Board of Directors in November 1999. Mr. Parker also serves on the Board of Directors of Tupperware Corporation and World Commerce Online, Inc. Louis Salamone, Jr., has been Senior Vice President and Chief Financial Officer of Enrev Corporation since June 2000. From 1996 through 2000, Mr. Salamone was Senior Vice President and Chief Financial Officer of the Company. He previously served as Vice President and Chief Financial Officer of Nextel Communications, Inc., a provider of wireless communications services, from September 1994 through May 1996. He was a partner in Deloitte & Touche LLP, an international accounting and consulting firm, from June 1980 through September 1994. Howard Stringer has been the Chairman and Chief Executive Officer of Sony Corporation of America since December 1998 and served as its President from 1997 to December 1998. From 1995 to 1997, Mr. Stringer was Chairman and Chief Executive Officer of Tele-TV, a joint venture among NYNEX, Pacific Telesis, and Bell Atlantic to provide home video delivery through telephone lines. Before joining Tele-TV, Mr. Stringer was President of CBS/Broadcast Group from 1988 to 1995 where he oversaw all broadcast operations, including news, sports, entertainment, and network-owned stations. Mr. Stringer serves on the Board of Directors of Loews Cineplex Entertainment Corporation and TiVo Inc. Joseph D. Vecchiolla, Senior Vice President and Chief Financial Officer, joined the Company in May 2000. From February 1999 through April 2000 he served as Vice President of Marketing and Vice President of Finance at Favorite Brands International, which was acquired by Nabisco in November 1999. Favorite Brands 62 66 International filed for protection under Chapter 11 of the U.S. Bankruptcy Code in March 1999. From May 1997 until February 1999 he served as President of Old Greenwich Capital Corporation. From June 1993 through December 1997 he served in various capacities at Bird Corporation, beginning as Senior Vice President and Chief Financial Officer (June 1993 through September 1993), then President, Chief Operating Officer, and Chief Financial Officer (September 1993 through January 1994), then President and Chief Executive Officer (January 1994 through April 1995), and finally Chairman of the Board of Directors (May 1995 through December 1997). Concurrent to his tenure at Bird Corporation, from May 1995 through December 1997, Mr. Vecchiolla served as Senior Vice President of Corporate Finance at S.N. Phelps & Co., Vice President and Chief Financial Officer of Wyatt Energy Corp., President of American Modular Technologies, LLP, and Vice President and Chief Financial Officer of Commonwealth Oil of Puerto Rico, LLP. Linda J. Wachner has been a director, President, and Chief Executive Officer of the Warnaco Group, Inc., since August 1987 and Chairman of the Board since August 1991. Ms. Wachner also served as Chairman and Chief Executive Officer of Authentic Fitness Corporation from May 1990 until its merger with Warnaco in December 1999. Ms. Wachner also serves as a director of the New York Stock Exchange, Inc. John R. Walter has been Chairman of Ashlin Management Corporation, a management consulting firm, since December 1997 and Chairman of the Board of Manpower, Inc., an employment services company, since April 1999. From November 1996 through July 1997, he served as President and Chief Operating Officer of AT&T Corp. Mr. Walter was Chairman and Chief Executive Officer from 1989 to October 1996 and President from 1987 to 1991 of R.R. Donnelley & Sons Company, a print and digital information management, reproduction, and distribution company. Mr. Walter also serves on the Board of Directors of Abbott Laboratories, Celestica, Inc., Deere & Company, Jones Lang LaSalle, Inc., and Manpower, Inc. John Zuccotti has been Chairman of Brookfield Financial Properties, Inc. (formerly World Financial Properties) since 1996 and in 1998 was appointed Vice Chairman of Brookfield Properties Corporation. Mr. Zuccotti has served as President and Chief Executive Officer of Olympia & York Companies (USA) from January 1990 until its reorganization in November 1996, at which time Brookfield Financial Properties, Inc., was formed to carry on a portion of the principal business of Olympia & York Companies (USA). Various entities affiliated with Olympia & York Companies (USA) filed for protection under Chapter 11 of the U. S. Bankruptcy Code, starting in 1992. Olympia & York Companies (USA) was reorganized in 1996 and all bankruptcy proceedings were completed as of 1997. Mr. Zuccotti has been a senior counsel at Weil, Gotshal & Manges LLP since 1997. Mr. Zuccotti also serves as a director of eight funds of The Dreyfus Corporation, a director of Empire Blue Cross and Blue Shield, and a trustee of Columbia University. (b) Executive Officers. -- The information with respect to executive officers required by this item is included at the end of Part I of the Company's Report on Form 10-K/A for the fiscal year ended December 31, 1999, under the heading Executive Officers of the Company. Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act") requires the Company's directors and executive officers and persons who own more than 10% of a registered class of the Company's equity securities to file with the Commission and the Nasdaq Stock Market initial reports of ownership and reports of changes in ownership of the Company's common stock and other equity securities of the Company. In addition, under Section 16(a), trusts for which a reporting person is a trustee or a beneficiary (or for which a member of his immediate family is a beneficiary) may have a separate reporting obligation with regard to ownership of the Company's common stock and other equity securities of the Company. Such reporting persons are required by rules of the Commission to furnish the Company with copies of all Section 16(a) reports (specifically, Forms 3, 4, and 5) they file. Based solely on the Company's review of the copies of such forms it has received and written representations from certain reporting persons that they were not required to file Forms 5 for the last fiscal year, the Company believes that all of its officers, directors, and greater than ten percent beneficial owners complied with all filing requirements applicable to them with respect to transactions during fiscal 1999. 63 67 ITEM 11. EXECUTIVE COMPENSATION. The following table sets forth the compensation paid to the Chief Executive Officer of the Company and to each of the six other most highly compensated executive officers (the "Named Executive Officers") for fiscal years 1999, 1998, and 1997. SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION AWARDS ANNUAL COMPENSATION ------------ ----------------------------------- NUMBER OF OTHER ANNUAL SECURITIES ALL OTHER SALARY BONUS COMPENSATION UNDERLYING COMPENSATION NAME AND PRINCIPAL POSITION YEAR ($) ($) ($) OPTIONS (#) ($) --------------------------- ---- ------- ------- ------------ ------------ ------------ Fred Drasner................ 1999 778,846 -- (1) -- -- Chairman and Former Chief 1998 300,000 -- (1) -- -- Executive Officer 1997 300,000 -- (1) -- -- Martin D. Krall............. 1999 348,000(2) 100,000(2) (1) -- -- Executive Vice President, 1998 (2) (2) -- 100,000 -- Chief Legal Officer, and 1997 (2) (2) -- -- -- Secretary Louis Salamone, Jr.(3)...... 1999 327,772 -- (1) -- -- Former Senior Vice President 1998 259,401 -- (1) 65,000 -- and Chief Financial Officer 1997 240,000 -- (1) -- -- Marne Obernauer, Jr. ....... 1999 311,538 -- (1) -- -- Vice Chairman 1998 162,355(4) -- 30,817(5) -- -- 1997 -- -- -- -- -- Diane Romano(6)............. 1999 309,462 -- 33,092(7) -- -- President e-business and 1998 275,339 -- 32,581(7) -- -- publications divisions 1997 250,000 -- 33,381(7) -- -- Derek Ashley................ 1999 231,461(8) 400,000 52,010(9) 300,000 -- Vice Chairman, Chief 1998 -- -- -- -- -- Executive Officer, and 1997 -- -- -- -- -- Chief Operating Officer Jonathan Swindle............ 1999 230,481 -- 43,847(10) -- 225,000(11) Former Senior Vice 1998 90,000(12) -- 24,865(10) 100,000 -- President, Administration 1997 -- -- -- -- --
--------------- (1) The Named Executive Officer received perquisites or other personal benefits in the years shown, although the value of these benefits did not exceed in the aggregate the lesser of $50,000 or 10% of his salary and bonus in such year. (2) Mr. Krall does not receive compensation directly from the Company. The 1999 amounts shown reflect reimbursement of the affiliate that employs Mr. Krall in accordance with the shared services agreement with such affiliate, plus reimbursement of the affiliate for work performed by Mr. Krall in 1999 for the Company in connection with the Wace acquisition and payment of a bonus. In 1998 and 1997 the Company reimbursed its affiliates $115,000 and $90,000, respectively, for legal services provided to the Company by such affiliates, of which Mr. Krall's services were a part. The Company is not able to determine how much of the reimbursement in those years was attributable to Mr. Krall's services. (3) Mr. Salamone's employment ceased on August 3, 2000. In connection with such termination, Mr. Salamone received a severance payment equal to one year's salary. (4) Mr. Obernauer, Jr., commenced employment with the Company in May 1998, following the merger of Devon, of which Mr. Obernauer, Jr., was Chief Executive Officer, with and into a wholly-owned subsidiary of the Company. 64 68 (5) The amount shown includes $25,325 as payment of professional fees for tax and accounting services provided to Mr. Obernauer, Jr., as well as an imputed amount for use of a Company-owned automobile. (6) Ms. Romano served as President from 1996 through March 2000. (7) The amount shown represents payment by the Company of apartment rent for a residence in New York City maintained partially for the Company's benefit and the reimbursement for a leased automobile and automobile insurance. (8) Mr. Ashley commenced employment with the Company in May 1999, following the Company's acquisition of Wace, of which Mr. Ashley was Group Chief Executive. (9) The amount shown includes payment by the Company of $40,810 of apartment rent for a residence in Chicago maintained partially for the Company's benefit, as well as reimbursement for a leased automobile and automobile insurance and payment of health club dues. (10) The amount shown represents payment by the Company of apartment rent and related expenses for a residence in New York City maintained partially for the Company's benefit. (11) The amount shown represents amounts received by Mr. Swindle as severance payments. Mr. Swindle's employment ceased on November 26, 1999. (12) Mr. Swindle commenced employment with the Company in June 1998. STOCK OPTION GRANTS IN FISCAL YEAR 1999 No stock options were granted during fiscal year 1999 to Named Executive Officers, other than Derek Ashley. The following table sets forth information concerning the stock options granted during 1999. OPTION GRANTS IN FISCAL YEAR 1999
INDIVIDUAL GRANTS POTENTIAL REALIZABLE VALUE ----------------------------------------------------- AT ASSUMED ANNUAL RATE OF NUMBER OF % OF TOTAL STOCK PRICE APPRECIATION SECURITIES OPTIONS FOR OPTION TERM UNDERLYING GRANTED TO EXERCISE --------------------------- OPTIONS EMPLOYEES PRICE EXPIRATION 5% 10% NAME GRANTED IN 1999 ($/SH) DATE ($) ($) ---- ---------- ---------- -------- ---------- ----------- ----------- Derek Ashley......... 300,000 64.5(1) 12.00 5/24/09 1,256,386 4,132,984
--------------- (1) Based on total grants of options to purchase 465,000 shares of the Company's common stock. No Named Executive Officer exercised stock options in fiscal year 1999. The following table sets forth information concerning the number and value of unexercised stock options granted to Named Executive Officers at December 31, 1999. AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1999 AND 1999 FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT FISCAL OPTIONS AT FISCAL YEAR-END (#) YEAR-END ($) (EXERCISABLE/ (EXERCISABLE/ NAME UNEXERCISABLE) UNEXERCISABLE) ---- ---------------------- -------------------- Fred Drasner........................................... --/-- --/-- Martin D. Krall........................................ 65,000/115,000 --/-- Louis Salamone, Jr. ................................... 63,000/102,000 --/-- Marne Obernauer, Jr. .................................. --/-- --/-- Diane Romano........................................... 90,000/90,000 --/-- Derek Ashley........................................... --/300,000 --/-- Jonathan Swindle....................................... 20,000/80,000 --/--
65 69 COMPENSATION OF DIRECTORS Directors who are not also employees of the Company or its affiliates ("nonemployee directors") receive from the Company $1,000 for each Board or committee meeting attended and reimbursement of expenses incurred in attending such meetings. Directors are also eligible to receive options to purchase the Company's common stock under the Company's 1998 Incentive Compensation Plan, as amended and restated (the "Incentive Compensation Plan"). Under the Incentive Compensation Plan, employees, nonemployee directors, certain affiliated persons, and independent contractors of the Company may be granted cash awards, options to purchase the Company's common stock, stock appreciation rights, stock awards, stock units, performance shares, and performance units. Options to purchase the Company's common stock granted under the Incentive Compensation Plan have a term of ten years and, except for those granted to nonemployee directors, vest over a five-year period pursuant to a vesting schedule determined by the committee administering the plan or, in lieu thereof, a vesting schedule specified in the plan. Under this plan, each nonemployee director is granted options to purchase 25,000 shares of the Company's common stock upon commencement of his or her service as a director that vest ratably over a two-year period. In addition, each nonemployee director then in office is automatically granted, on the anniversary date of his or her commencement of service as a director, a fully-vested, non-qualified option to purchase 5,000 shares of the Company's common stock at a per-share exercise price equal to its fair market value on such date. In April 1999, Messrs. Harris and Stringer and Ms. Wachner each received grants of options to purchase 5,000 shares of the Company's common stock at an exercise price of $7.063 per share. In May 1999, Messrs. Parker and Zuccotti each received grants of options to purchase 5,000 shares of the Company's common stock at an exercise price of $10.563 per share. In April 2000, Messrs. Harris and Stringer and Ms. Wachner each received grants of options to purchase 5,000 shares of the Company's common stock at an exercise price equal to $6.000 per share. In May 2000, Messrs. Parker and Zuccotti each received grants of options to purchase 5,000 shares of common stock at an exercise price equal to $3.063 per share. EXECUTIVE EMPLOYMENT CONTRACTS In May 1999, the Company entered into an employment agreement with Mr. Ashley, pursuant to which Mr. Ashley was to receive an annual base salary of $400,000, a discretionary bonus that was to be no less than $100,000 for the first twelve months of his employment, and a grant of options to purchase shares of the Company's common stock. In May 2000, in connection with Mr. Ashley's appointment as Chief Executive Officer of the Company, the Compensation Committee resolved to increase Mr. Ashley's salary to $600,000 and to pay Mr. Ashley a bonus of $400,000 in the event certain performance criteria were satisfied. In addition, the Committee resolved to change the expiration of the term of Mr. Ashley's agreement from May 2001 to the earlier of May 2002 or a change of control of the Company. Mr. Ashley's employment agreement contains a noncompete provision applicable during the term (and any extensions thereof) and extends for a period of the longer of two years from commencement of employment or six months after termination of employment with the Company, except in the event Mr. Ashley's employment is terminated by the Company without cause, in which case the noncompete provision terminates. The agreement also contains a nonsolicitation provision applicable during the term (and any extensions thereof) and for one year after termination of employment with the Company. The Company has also entered into an agreement with Ms. Romano extending the term of her employment agreement with the Company for the three-year period from April 2000 through March 2003. During such extended term, Ms. Romano will serve as President of the Company's e-business divisions and the publications divisions of its content management business. Ms. Romano's agreement contains a noncompete provision applicable during the term (and any extensions thereof) and a nonsolicitation provision applicable during the term (and any extensions thereof), and for one year after termination of her employment with the Company. The agreement provides for an annual base salary of $325,000, a bonus upon attainment of certain objectives, and options to purchase shares of the Company's common stock. 66 70 CHANGE OF CONTROL AND TERMINATION OF EMPLOYMENT ARRANGEMENTS In March 2000, the Company announced that it had retained an investment banking firm to explore the Company's strategic alternatives to enhance value for the Company's stockholders, including the possible sale of the Company. In order to incentivize the Company's key personnel to remain with the Company or otherwise make themselves available to the Company to assist in the process, in March 2000 the Compensation Committee approved payments to four key personnel in the event of the sale of the Company and the satisfaction of certain conditions. In August 2000, the Board decided that it would no longer actively pursue a sale of the Company, but would continue to pursue other strategic alternatives. Consequently, the Compensation Committee resolved that such personnel would no longer be eligible for such payments in the event of a sale of the Company, although in certain limited circumstances, if a sale occurred prior to May 8, 2001, Mr. Salamone would be entitled to $500,000 pursuant to the terms of the Agreement and General Release, effective June 4, 2000, between the Company and Mr. Salamone. Mr. Ashley's agreement contains a provision that requires the Company to continue to pay Mr. Ashley's base salary and provide certain employee benefits for the shorter of the remaining term of the agreement or six months, in the event that Mr. Ashley's employment is terminated by the Company without cause. Ms. Romano's employment agreement contains provisions that require the Company to make a cash payment to Ms. Romano equivalent to the amount of base salary provided for in the agreement for the longer of the remaining term of the agreement or two years in the event that Ms. Romano's employment is terminated by the Company without cause or if Ms. Romano resigns for good reason, which includes termination of employment following a change in control of the Company. In addition, under either of these circumstances, Ms. Romano would also be entitled to receive a cash payment equal to the aggregate amount that the market value of the Company's common stock as of the date of the termination exceeds the exercise price of any nonvested stock options held by Ms. Romano and to the continuation of certain employee benefits. In the event that Ms. Romano is employed by the Company on March 31, 2003, and a new agreement is not entered into extending the term of the existing agreement, Ms. Romano would be entitled to receive a cash payment equal to one year's base salary and the continuation of employee benefits for one year. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. SECURITY OWNERSHIP OF DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS The following table sets forth, as of September 26, 2000, information regarding the beneficial ownership of the Company's common stock by (i) each person known to the Company to be the beneficial owner of more than 5% of the Company's common stock, (ii) each director and each nominee to the Board of Directors, (iii) each of the executive officers of the Company named in the Summary Compensation Table under "Executive Compensation," and (iv) all directors and executive officers of the Company as a group. Except as indicated, each person identified in the following table has sole voting and investment power with respect to the shares shown. Percentage ownership of the Company's common stock is based on 22,584,282 shares outstanding as of September 26, 2000.
SHARES OF PERCENTAGE OF COMMON OUTSTANDING STOCK SHARES BENEFICIALLY BENEFICIALLY NAME OF BENEFICIAL OWNER OWNED OWNED ------------------------ ------------ ------------- Applied Printing Technologies, L.P.(1)(2)................... 4,985,000 22.1% State of Wisconsin Investment Board(3)...................... 3,517,000 15.6 Capital Group International, Inc.(4)........................ 2,742,700 12.1 Dimensional Fund Advisors, Inc.(5).......................... 1,198,500 5.3 Mortimer B. Zuckerman(1).................................... -- -- Fred Drasner(1)............................................. -- -- Marne Obernauer, Jr.(6)..................................... 524,799 2.3 Diane Romano(7)............................................. 135,000 * Louis Salamone, Jr.(7)...................................... 101,000 * Jonathan Swindle(8)......................................... -- --
67 71
SHARES OF PERCENTAGE OF COMMON OUTSTANDING STOCK SHARES BENEFICIALLY BENEFICIALLY NAME OF BENEFICIAL OWNER OWNED OWNED ------------------------ ------------ ------------- Derek Ashley(7)............................................. 60,000 * Martin D. Krall(7).......................................... 105,000 * John R. Harris(7)........................................... 16,250 * David R. Parker(9).......................................... 39,000 * Howard Stringer(10)......................................... 55,000 * Linda J. Wachner(10)........................................ 65,000 * John Zuccotti(7)............................................ 35,000 * John W. Dreyer.............................................. -- -- Joseph D. Vecchiolla........................................ -- -- John R. Walter.............................................. -- -- All directors and executive officers as a group (16 persons)(11).............................................. 6,256,049 26.9%
--------------- * Represents holdings of less than 1%. (1) Applied Printing Technologies, L.P. ("Applied Printing") is a limited partnership in which Mr. Drasner, the Company's Chairman and a director, is a minority limited partner and Mr. Zuckerman, Chairman of the Company's Board, beneficially owns the remaining limited partnership interests, and Mr. Zuckerman is the sole stockholder of the corporate general partner and a corporate limited partner. Messrs. Zuckerman and Drasner comprise the board of directors of the corporate general partner of Applied Printing. Mr. Zuckerman is the sole stockholder of the corporate general partner and therefore can change at any time the members of the board of directors of that entity. Consequently, Mr. Zuckerman indirectly will be able to exercise substantial influence over the outcome of all matters submitted to a vote of the Company's stockholders, including election of the members of the Company's Board, amendment of the Company's Restated Certificate of Incorporation and the consummation of a merger, sale of substantially all of the Company's assets or other significant corporate transactions. The address of Applied Printing is 77 Moonachie Avenue, Moonachie, New Jersey 07074. (2) Shares shown are reported on a Schedule 13D dated April 26, 1996, as amended on September 4, 1997, November 26, 1997, September 1, 1998, October 5, 1998, and November 25, 1998, filed with the Commission. Voting power with respect to such shares is held by Mr. Zuckerman. (3) Shares shown are reported on a Schedule 13G dated February 10, 2000, and amended March 10, 2000, and on a Form 13F dated August 14, 2000, filed with the Commission by State of Wisconsin Investment Board. The address of this person is P.O. Box 7842, Madison, Wisconsin 53708. (4) Shares shown are reported on a Schedule 13G dated February 8, 1999, and amended August 9, 1999, and February 10, 2000, filed with the Commission by Capital Group International, Inc. ("Capital") on behalf of itself and Capital Guardian Trust Company ("Capital Trust"). Capital is the parent holding company of Capital Trust, a bank, which may be deemed the beneficial owner of the shares reported on the Schedule 13G through its service as investment manager of certain institutional accounts. Capital Trust has voting power over only 2,046,500 of the shares reported. Capital and Capital Trust disclaim beneficial ownership of the shares of the Company's common stock covered by the Schedule 13G. The address of the above persons is 11100 Santa Monica Boulevard, Los Angeles, California 90025. (5) Shares shown are reported on a Form 13F dated August 29, 2000, filed with the Commission by Dimensional Fund Advisors, Inc. The address of this person is 1299 Ocean Avenue, Santa Monica, California 90401. (6) Includes an aggregate of 7,200 shares held by Mr. Obernauer, Jr., as trustee, for trusts created for the benefit of his two sons, a niece, and a nephew over which Mr. Obernauer, Jr., has sole voting and investment power. 68 72 (7) Represents shares of the Company's common stock issuable upon exercise of currently exercisable options. (8) Left the employment of the Company in November 1999. (9) Includes 35,000 shares of the Company's common stock issuable upon exercise of currently exercisable options. (10) Includes 45,000 shares of the Company's common stock issuable upon exercise of currently exercisable options. (11) Does not include Mr. Swindle. Includes 712,250 shares of the Company's common stock issuable upon exercise of currently exercisable options. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Mr. Zuckerman beneficially owns the shares of the Company's common stock owned by Applied Printing and beneficially owns a majority of U.S. News and Daily News. Additionally, Mr. Drasner is a minority limited partner of Applied Printing, U.S. News, and Daily News. The following is a description of certain transactions between the Company and Applied Printing, U.S. News, and Daily News, respectively. CONTENT MANAGEMENT AND DIGITAL IMAGING SERVICES FOR AFFILIATES The Company provides content management services to U.S. News under an agreement that expires December 31, 2000, and is renewable annually thereafter by mutual agreement of the parties. In addition, the Company provides content management services to a New York Daily News periodical, digital archiving services to the New York Daily News, and certain advertising make-up and related graphic services for Daily News' publications, all under agreements which are renewable annually by mutual agreement of the parties. The Company also provides content management services to Applied Printing under an agreement that expires December 31, 2004. In order to secure this agreement, the Company paid $500,000 to Applied Printing in 1999. The Company also performs additional services for U.S. News, Daily News, and Applied Printing on a per-project basis. The Company's 1999 revenues included approximately $5,513,000, $3,525,000, and $3,970,000 for services performed for each of U.S. News, Daily News, and Applied Printing, respectively. Included in the revenue figure for 1999 is $299,000 recognized under an agreement by Agile Enterprise, Inc., a wholly-owned subsidiary of the Company, to license certain software to U.S. News. SHARED SERVICES AGREEMENT The Company entered into a shared services agreement in 1999 with U.S. News and Daily News, under which both U.S. News and Daily News provide legal, computer, and administrative services to the Company. Under this agreement, the Company pays a percentage of the costs associated with U.S. News and Daily News employees who provide such services to the Company based on the percentage of each such employee's total time that is devoted to Company-related matters, including costs for services provided by Mr. Krall. See "Report of the Compensation Committee of the Board of Directors of the Company on Executive Compensation -- Base Salary." The term of the agreement is for one year and is renewable annually. During 1999, the Company incurred charges of approximately $1,514,000 for such services. The Company also received certain merger and acquisition services from Daily News personnel in 1999 for which the Company was charged $280,000. OTHER TRANSACTIONS The Company subleases space at the headquarters of U.S. News in Washington, D.C., from U.S. News. Such space is used primarily to perform content management services for U.S. News. The amount incurred by the Company for the sublease in fiscal year 1999 totaled approximately $205,000 and corresponds to the amounts U.S. News is required to pay for space under the prime lease. 69 73 The Company leases additional space at its corporate headquarters from U.S. News, for which the Company incurred charges of $184,000 in 1999. The Company has used certain Daily News space at its New York location, for which the Company incurred charges of $156,000 in 1999. Applied Printing provides printing services to the Company on a per-project basis. In 1999, the Company incurred charges of approximately $2,962,000 for such services. The Company engaged the law firm of Weil, Gotshal & Manges LLP, at which John Zuccotti, a director of the Company, is senior counsel, to perform legal services for the Company in 1999 and 2000. Pitman Company, of which John W. Dreyer, a nominee for director, is Chairman of the Board and Chief Executive Officer, is a distributor of film and other graphic arts materials. In 1999, the Company purchased approximately $25,000,000 of such materials from Pitman Company. The Company believes that the terms for its purchases of such materials are no less favorable to the Company than those that could be obtained from another vendor. VENDOR AGREEMENT The Company is a major purchaser of film and other graphic arts materials used in its manufacturing process, much of which it purchases through Pitman Company. See "Compensation Committee Interlocks and Insider Participation and Certain Transactions -- Other Transactions." Because of the dollar amount of the products it purchases, the Company has been in a position to enter into arrangements with manufacturers of such products pursuant to which the manufacturers pay rebates and, in some instances, prepay to the Company a rebate based upon a specified dollar volume of products purchased by the Company over a given time period. The Company is entitled to retain the prepaid amount in full if it purchases the stated volume, and would be obligated to repay all or a portion of the amount depending on the difference between the stated volume and the volume actually purchased. In 1995, pursuant to an agreement with one of its manufacturers, the Company received prepaid rebates aggregating approximately $2.7 million, which has been and will be earned based on purchases made and to be made from 1996 through 2000. The Company expects approximately $596,000 of rebates earned in 1999 to be applied to its obligation related to prepaid rebates. The agreement was extended by the parties, effective July 1, 1998, through December 31, 2001. Minimum purchase obligations have been satisfied to date, and the Company expects, through its normal purchasing requirements, to purchase the amounts necessary to earn rebates with respect to the period through 2001 in excess of the amount to be deducted by the manufacturer. In connection with this agreement, the manufacturer's affiliate loaned $15 million to Mr. Zuckerman. The loan, which matured on December 31, 1998, bore interest at the lender's commercial paper rate and was repaid in full by Mr. Zuckerman in January 1999. The Company believes that the terms for its purchases of the products covered by this agreement are no less favorable to the Company than those that could be obtained from another vendor or manufacturer. 70 74 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Listed below are the documents filed as a part of this report: 1. Financial Statements and the Independent Auditors' Report: Independent Auditors' Report. Consolidated Balance Sheets as of December 31, 1999 and 1998, and June 30, 2000. Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998, and 1997, and for the six months ended June 30, 2000 and 1999. Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998, and 1997, and for the six months ended June 30, 2000 and 1999. Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1999, 1998, and 1997, and for the six months ended June 30, 2000. Notes to Consolidated Financial Statements. 2. Financial Statement Schedules: Schedule II -- Valuation and Qualifying Accounts for the years ended December 31, 1999, 1998, and 1997. 3. Exhibits: 2.1 Asset Purchase Agreement by and among Applied Graphics Technologies, Inc., and Flying Color Graphics, Inc. and its Shareholders dated January 16, 1998 (Incorporated by reference to Exhibit No. 2.1 forming part of the Registrant's Report on Form 8-K (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, on January 30, 1998). 2.2 Agreement and Plan of Merger, dated as of February 13, 1998, by and among Devon Group, Inc., Applied Graphics Technologies, Inc., and AGT Acquisition Corp. (Incorporated by reference to Exhibit No. 2.2 forming part of the Registrant's Report on Form 10-K (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Act of 1934, as amended, for the fiscal year ended December 31, 1997). 3.1(a) First Restated Certificate of Incorporation (Incorporated by reference to Exhibit No. 3.1 forming part of the Registrant's Registration Statement on Form S-1 (File No. 333-00478) filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended). 3.1(b) Certificate of Amendment of First Restated Certificate of Incorporation (Incorporated by reference to Exhibit No. 3.1(b) forming part of the Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, for the quarterly period ended June 30, 1998). 3.2(a) Amended and Restated By-Laws of Applied Graphics Technologies, Inc. (Incorporated by reference to Exhibit No. 3.2 forming part of Amendment No. 3 to the Registrant's Registration Statement on Form S-1 (File No. 333-00478) filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended). 3.2(b) Amendment to Amended and Restated By-Laws of Applied Graphics Technologies, Inc. (Incorporated by reference to Exhibit No. 3.3 forming part of the Registrant's 71 75 Registration Statement on Form S-4 (File No. 333-51135) filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended). 4 Specimen Stock Certificate (Incorporated by reference to Exhibit No. 4 forming part of Amendment No. 3 to the Registrant's Registration Statement on Form S-1 (File No. 333-00478) filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended). 10.2 Applied Graphics Technologies, Inc. 1996 Stock Option Plan (Incorporated by reference to Exhibit No. 10.2 forming part of Amendment No. 3 to the Registrant's Registration Statement on Form S-1 (File No. 333-00478) filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended). 10.3 Applied Graphics Technologies, Inc. Non-Employee Directors Nonqualified Stock Option Plan (Incorporated by reference to Exhibit No. 10.3 forming part of Amendment No. 3 to the Registrant's Registration Statement on Form S-1 (File No. 333-00478) filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended). 10.6(a) Employment Agreement, effective as of May 1, 2000, between the Company and Joseph D. Vecchiolla (Incorporated by reference to Exhibit No. 10.6(a) forming part of the Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Act of 1934, as amended, for the quarterly period ended June 30, 2000). 10.6(b) Agreement and General Release, effective June 4, 2000, between the Company and Louis Salamone, Jr. (Incorporated by reference to Exhibit No. 10.6(b) forming part of the Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Act of 1934, as amended, for the quarterly period ended June 30, 2000). 10.6(c) Employment Agreement, effective as of May 24, 1999, between the Company and Derek Ashley (Incorporated by reference to Exhibit No. 10.6(c) forming part of Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, for the quarterly period ended June 30, 1999). 10.6(d)(i) Employment Agreement, effective as of April 1, 1996, between the Company and Scott A. Brownstein (Incorporated by reference to Exhibit No. 10.6 forming part of Amendment No. 3 to the Registrant's Registration Statement on Form S-1 (File No. 333-00478) filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended). 10.6(d)(ii) Employment Agreement Extension dated March 23, 1998, between the Company and Scott Brownstein (Incorporated by reference to Exhibit No. 10.6(d)(ii) forming part of the Registrant's Registration Statement on Form S-4 (File No. 333-51135) filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended). 10.7 Form of Registration Rights Agreement (Incorporated by reference to Exhibit No. 10.7 forming part of Amendment No. 3 to the Registrant's Registration Statement on Form S-1 (File No. 333-00478) filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended). 10.8 Applied Graphics Technologies, Inc., 1998 Incentive Compensation Plan, as Amended and Restated (Incorporated by reference to Exhibit No. 10.8 forming part of Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange 72 76 Commission under the Securities Exchange Act of 1934, as amended, for the quarterly period ended June 30, 1999). 10.8(a) Amendment No. 1, dated as of May 8, 2000, to the Applied Graphics Technologies, Inc., Amended and Restated 1998 Incentive Compensation Plan (Incorporated by reference to Exhibit No. 10.8(a) forming part of the Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, for the quarterly period ended June 30, 2000). 10.9(a) Amended and Restated Credit Agreement, dated as of March 10, 1999, among Applied Graphics Technologies, Inc., Other Institutional Lenders as Initial Lenders, and Fleet Bank, N.A. (Incorporated by reference to Exhibit 99.2 of the Registrant's Report on Form 8-K (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, on March 22, 1999). 10.9(b) Amendment No. 1, dated as of June 2, 1999, to the Amended and Restated Credit Agreement among Applied Graphics Technologies, Inc., Other Institutional Lenders as Initial Lenders, and Fleet Bank, N.A. (Incorporated by reference to Exhibit No. 10.9(b) forming part of Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, for the quarterly period ended June 30, 1999). 10.9(c) Amendment No. 2, dated July 28, 1999, to the Amended and Restated Credit Agreement among Applied Graphics Technologies, Inc., Other Institutional Lenders as Initial Lenders, and Fleet Bank, N.A. (Incorporated by reference to Exhibit No. 10.9(c) forming part of Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, for the quarterly period ended September 30, 1999). 10.9(d) Amendment No. 3, dated as of July 21, 2000, to the Amended and Restated Credit Agreement among Applied Graphics Technologies, Inc., Other Institutional Lenders as Initial Lenders, and Fleet Bank, N.A. (Incorporated by reference to Exhibit No. 10.9(d) forming part of the Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, for the quarterly period ended June 30, 2000). 10.9(e) Amendment No. 4, dated as of August 11, 2000, to the Amended and Restated Credit Agreement among Applied Graphics Technologies, Inc., Other Institutional Lenders as Initial Lenders, and Fleet Bank, N.A. (Incorporated by reference to Exhibit No. 10.9(e) forming part of the Registrant's Report on Form 10-Q (File No. 0-28208) filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, for the quarterly period ended June 30, 2000). 21 Subsidiaries of the Registrant. 23 Consent of Deloitte & Touche LLP 27 Financial Data Schedule (EDGAR filing only). (b) The Registrant did not file any reports on Form 8-K during the quarter ended December 31, 1999, or the six months ended June 30, 2000. 73 77 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. APPLIED GRAPHICS TECHNOLOGIES, INC. (Registrant) By: /s/ DEREK ASHLEY ------------------------------------ Derek Ashley Vice Chairman, Chief Executive Officer, Chief Operating Officer, and Director (Duly authorized officer) Date: October 10, 2000 74 78 APPLIED GRAPHICS TECHNOLOGIES, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997 (IN THOUSANDS OF DOLLARS)
ADDITIONS ------------------------ BALANCE AT CHARGED TO CHARGED TO BALANCE AT BEGINNING OF COSTS AND OTHER END OF DESCRIPTION PERIOD EXPENSES ACCOUNTS(1) DEDUCTIONS(2) PERIOD ----------- ------------ ---------- ----------- -------------- ---------- Allowances deducted in the balance sheet from assets to which they apply: For the year ended December 31, 1999 Allowance for doubtful accounts and returns.............................. $9,325 $2,732 $2,324 $(6,649) $7,732 ====== ====== ====== ======= ====== For the year ended December 31, 1998 Allowance for doubtful accounts and returns.............................. $3,989 $ 775 $7,859 $(3,298) $9,325 ====== ====== ====== ======= ====== For the year ended December 31, 1997 Allowance for doubtful accounts and returns.............................. $ 472 $3,990 $ 308 $ (781) $3,989 ====== ====== ====== ======= ======
--------------- (1) Represents allowances for doubtful accounts and returns recorded in connection with acquisitions. (2) In 1999 represents $2,506 for amounts written off and $4,143 for adjustments to goodwill relating to acquisitions. In 1998 and 1997 represents amounts written off. 75