-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, J2HwLy+2UFUrAX8eDe4NgH5IqPJATZh1w2+tIrSUK3ZmIdRBguEmk9vXJEkkKCk6 /kZWM2TxxnSD4HswpkhCnA== 0000889429-99-000009.txt : 19990413 0000889429-99-000009.hdr.sgml : 19990413 ACCESSION NUMBER: 0000889429-99-000009 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 19981227 FILED AS OF DATE: 19990412 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PARAGON TRADE BRANDS INC CENTRAL INDEX KEY: 0000889429 STANDARD INDUSTRIAL CLASSIFICATION: CONVERTED PAPER & PAPERBOARD PRODS (NO CONTAINERS/BOXES) [2670] IRS NUMBER: 911554663 STATE OF INCORPORATION: DE FISCAL YEAR END: 1230 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-11368 FILM NUMBER: 99591430 BUSINESS ADDRESS: STREET 1: 180 TECHNOLOGY PARLWAY CITY: NORCROSS STATE: GA ZIP: 30092 BUSINESS PHONE: 6789695000 MAIL ADDRESS: STREET 1: 180 TECHNOLOGY PKWY CITY: NORCROSS STATE: GA ZIP: 30092 10-K405 1 ANNUAL REPORT ON FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 27, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 1-11368 PARAGON TRADE BRANDS, INC. (Exact name of registrant as specified in its charter) DELAWARE 91-1554663 (State or other jurisdiction of (I.R.S. employer identification no.) incorporation or organization) 180 TECHNOLOGY PARKWAY NORCROSS, GEORGIA 30092 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (678) 969-5000 Securities registered pursuant to Section 12(b) of the Act: NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED Common Stock, par value $.01 per share New York Stock Exchange Series A participating Cumulative New York Stock Exchange Preferred Stock Purchase Rights Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. 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 ] As of March 31, 1999, there were 11,946,226 shares of the Registrant's Common Stock outstanding, and the aggregate market value of such stock held by nonaffiliates of the Registrant was $29,865,565 (based on the closing price on the New York Stock Exchange on March 31, 1999). Exhibit Index on Page 86 PARAGON TRADE BRANDS, INC. TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10-K PART I PAGE Item 1: BUSINESS 1 Item 2: PROPERTIES 9 Item 3: LEGAL PROCEEDINGS 10 Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 15 PART II Item 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS 16 Item 6: SELECTED FINANCIAL DATA 16 Item 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 18 Item 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 32 Item 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 33 Item 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 69 PART III Item 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 69 Item 11: EXECUTIVE COMPENSATION 70 Item 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 79 Item 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 80 PART IV Item 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 80 Page i PART I ITEM 1: BUSINESS GENERAL Paragon Trade Brands, Inc. (the "Company") is the leading manufacturer of store brand infant disposable diapers in the United States and Canada. Paragon manufactures a line of premium and economy diapers, training pants and feminine care and adult incontinence products which are distributed throughout the United States and Canada, primarily through grocery and food stores, mass merchandisers, warehouse clubs, toy stores and drug stores that market the Company's products under their own store brand names. Paragon has also established international joint ventures in Mexico, Argentina, Brazil and China for the manufacture and sale of infant disposable diapers and other absorbent personal care products. On February 9, 1996, the Company completed the purchase of substantially all of the assets of Pope & Talbot, Inc.'s ("Pope & Talbot") disposable diaper business. The purchase price of $63.5 million was paid in a combination of cash and stock. The Company closed all the acquired disposable diaper operations in 1996. The plants and a major portion of the manufacturing equipment have been sold. The remaining equipment is being held for sale. In 1996 the Company took a charge of $8.1 million for the costs of integration and write-downs of duplicate equipment owned by the Company prior to the purchase transaction. REORGANIZATION CASE The Company has previously disclosed that The Procter & Gamble Company ("P&G") had filed a lawsuit against it in the United States District Court for the District of Delaware alleging that the Company's "Ultra" disposable baby diaper products infringe two of P&G's dual cuff diaper patents. The lawsuit sought injunctive relief, lost profit and royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by P&G. The Company also disclosed that if P&G were to prevail on its claims, an award of all or a substantial amount of the relief requested by P&G could have a material adverse effect on the Company's financial condition and results of operations. On December 30, 1997, the District Court issued a Judgment and Opinion which found, in essence, two of P&G's dual cuff diaper patents to be valid and infringed by certain of the Company's disposable diaper products, while also rejecting the Company's patent infringement claims against P&G. The District Court had earlier dismissed the Company's antitrust counterclaim on summary judgment. The Judgment entitled P&G to damages based on sales of the Company's diapers containing the "inner-leg gather" feature. While the final damages number of approximately $178.4 million was not entered by the District Court until June 2, 1998, the Company originally estimated the liability and associated litigation costs to be approximately $200 million. The amount of the award resulted in violation of certain covenants under the Company's then-existing bank loan agreements. As a result, the issuance of the Judgment and the uncertainty it created caused an immediate and critical liquidity issue for the Company. On January 6, 1998, the Judgment was entered on the docket in Delaware in such a manner that P&G would have been able to begin placing liens on the Company's assets. As a result, the Company filed for relief under Chapter 11 of the Bankruptcy Code, 11 U.S.C. Section 101 et seq., in the United States Bankruptcy Court for the Northern District of Georgia (Case No. 98-60390) on January 6, 1998 (the "Chapter 11 filing"). None of the Company's subsidiaries were included in the Chapter 11 filing. The Chapter 11 filing was designed to prevent P&G from placing liens on Company property, permit the Company to appeal the Delaware District Court's decision on the P&G case in an orderly fashion and give the Company the opportunity to resolve liquidated and unliquidated claims against the Company, which arose prior to the Chapter 11 filing, thereby protecting all stakeholders' interests. The Company is currently operating as a debtor-in-possession under the Bankruptcy Code. In connection with the Chapter 11 filing, on January 30, 1998, the Bankruptcy Court entered a Final Order approving the Credit Agreement (the "DIP Credit Facility") as provided under the Revolving Credit and Guarantee Agreement dated as of January 7, 1998, among the Company, as Borrower, certain subsidiaries of Page 1 the Company, as guarantors, and a bank group led by The Chase Manhattan Bank ("Chase"). Pursuant to the terms of the DIP Credit Facility, Chase has made available to the Company a revolving credit and letter of credit facility in an aggregate principal amount of $75 million. The Company's maximum borrowing under the DIP Credit Facility may not exceed the lesser of $75 million or an available amount as determined by a borrowing base formula. The borrowing base formula is comprised of certain specified percentages of eligible accounts receivable, eligible inventory, equipment and personal and real property of the Company. The DIP Credit Facility has a sublimit of $10 million for the issuance of letters of credit. The DIP Credit Facility expires on the earlier of July 7, 1999, or the date of entry of an order by the Bankruptcy Court confirming a plan of reorganization. The Company is currently negotiating an extension of the maturity date on the DIP Credit Facility with Chase. As of December 27, 1998, there were no outstanding direct borrowings under the DIP Credit Facility. The Company had an aggregate of $1.3 million in letters of credit issued under the DIP Credit Facility at December 27, 1998. The DIP Credit Facility contains customary covenants. The Company for a period of time has been unable to fully comply with certain reporting requirements of such covenants. The Company has obtained waivers with respect to these events of default which are effective through May 10, 1999. The Company believes that it will be in compliance with the reporting requirements of the DIP Credit Facility by May 10, 1999. The United States Trustee for the Northern District of Georgia has appointed an Official Committee of Unsecured Creditors (the "Creditors' Committee") and an Official Committee of Equity Security Holders (the "Equity Committee" and together with the Creditors' Committee, the "Committees"). The roles of the Committees include, among other things: (i) consultation with the Company concerning the administration of the Chapter 11 case, and (ii) participation in the formulation of a plan of reorganization. In discharging these responsibilities, the Committees have standing to raise issues with the Bankruptcy Court relating to the business of the Company and the conduct and course of the Chapter 11 case. The Company is required to pay certain expenses of the Committees, including professional fees, to the extent allowed by the Bankruptcy Court. On February 2, 1999, the Company entered into a Settlement Agreement with P&G which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Delaware Judgment, the Company's appeal of the Delaware Judgment, P&G's motion to find the Company in contempt of the Delaware Judgment and P&G's proof of claim filed in the Company's Chapter 11 reorganization proceeding. As a part of the P&G settlement, Paragon grants P&G an allowed unsecured prepetition claim of $158.5 million and an allowed administrative claim of $5 million. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to certain of the patents asserted by P&G in its proof of claim, including those asserted in the Delaware Action. The U.S. and Canadian patent rights licensed by the Company will allow the Company to manufacture a dual cuff baby diaper design. In exchange for these rights, the Company has agreed to pay P&G running royalties on net sales of the licensed products equal to 2 percent through October 2005, .75 percent thereafter through October 2006 and .375 percent thereafter through March 2007 in the U.S.; and 2 percent through October 2008 and 1.25 percent thereafter through December 2009 in Canada. The Settlement Agreement also provides, among other things, that P&G will grant the Company and/or its affiliates "most favored licensee" status with respect to patents owned by P&G on the date of the Settlement Agreement or for which an application was pending on that date. In addition, the Company has agreed with P&G that prior to litigating any future patent dispute, the parties will engage in good faith negotiations and will consider arbitrating the dispute before resorting to litigation. While the Company believes that the royalty rates being charged by P&G are the same royalties that will be paid by the Company's major store brand competitors for similar patent rights, these royalties, together with royalties to be paid to Kimberly-Clark Corporation ("K-C") described below, will have a material adverse impact on the Company's future financial condition and results of operations. While these royalty costs are expected to be partially offset by projected raw material cost savings related to the conversion to a dual cuff design, the Company's overall raw material costs are expected to increase. These royalty costs are also expected to be partially offset by price increases announced by the Company in the fourth quarter of 1998 to the extent such price increases are realized. Under the terms of the P&G Settlement Agreement, the Company and P&G jointly requested modification of the injunction entered in Delaware District Court so as to allow the Company to begin converting to a dual cuff design pursuant to the License Agreements described above. The injunction was modified as requested on February 22, 1999 and the product conversion is substantially complete. As also provided under the terms of the P&G Page 2 Settlement Agreement, once a Final Order, as defined therein, has been entered by the Bankruptcy Court approving the settlement, the Company will withdraw with prejudice its appeal of the Delaware Judgment to the Federal Circuit, and P&G will withdraw with prejudice its motion in Delaware District Court to find the Company in contempt of the Delaware Judgment. A hearing on the Company's motion to seek approval from the Bankruptcy Court of this settlement was commenced on March 22 and 23, 1999 and is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have objected to the P&G settlement. The Company intends to continue to pursue approval of the P&G Settlement by the Bankruptcy Court. Should the P&G Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by July 31, 1999, however, the License Agreements described above will become terminable at P&G's option. The Company cannot predict when, or if, such approval will be granted. See "ITEM 3: LEGAL PROCEEDINGS: --IN RE PARAGON TRADE BRANDS, INC.," and "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES.". On October 26, 1995, K-C filed a lawsuit against the Company in U.S. District Court in Dallas, Texas, alleging infringement by the Company's products of two K-C patents relating to dual cuffs. The lawsuit sought injunctive relief, royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by K-C. In addition, K-C sued the Company on another patent issued to K-C which is based upon a further continuation of one of the K-C dual cuff patents asserted in the case. On March 19, 1999, the Company entered into a Settlement Agreement with K-C which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Texas action, including the Company's counterclaims, and K-C's proof of claim filed in the Company's Chapter 11 reorganization proceeding. Under the terms of the K-C Settlement Agreement, the Company grants K-C an allowed unsecured prepetition claim of $110 million and an allowed administrative claim of $5 million. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to the patents asserted by K-C in the Texas action. The patent rights licensed by the Company from K-C will allow the Company to manufacture a dual cuff diaper design. In exchange for these patent rights, the Company has agreed to pay K-C annual running royalties on net sales of the licensed products in the U.S. and Canada equal to: 2.5 percent of the first $200 million of net sales of the covered diaper products and 1.5 percent of such net sales in excess of $200 million in each calendar year commencing January 1999 through November 2004. In addition, the Company has agreed to pay a minimum annual royalty for diaper sales of $5 million, but amounts due on the running royalties will be offset against this minimum. The Company will also pay K-C running royalties of 5 percent of net sales of covered training pant products for the same period, but there is no minimum royalty for training pants. As part of the settlement, the Company has granted a royalty-free license to K-C for three patents which the Company in the Texas action claimed K-C infringed. While the Company believes that, based on its projected level of sales, the overall effective royalty rate that the Company will pay to K-C is less than the royalty rate that will be paid by the Company's major store brand competitors for similar patent rights, these royalties will, together with royalties to be paid to P&G described above, have a material adverse impact on the Company's future financial condition and results of operations. While these royalty costs are expected to be partially offset by projected raw material cost savings related to the conversion to a dual cuff product, the Company's overall raw material costs are expected to increase. These royalty costs are also expected to be partially offset by price increases announced by the Company in the fourth quarter of 1998 to the extent such price increases are realized. As a part of the K-C License Agreement, K-C has agreed not to sue the Company on two of K-C's patents related to the use of super-absorbent polymers ("SAP") in diapers and training pants, so long as the Company uses SAP which exhibits certain performance characteristics (the "SAP Safe Harbor"). The Company has experienced certain product performance issues the Company believes may be related to such SAP. As a result, the Company expects that it will incur increased marketing and selling, general and administrative expenses ("SG&A") expenditures in 1999 to address product performance issues. These increased expenditures are expected to have a material adverse impact on the Company's financial position and results of operations in 1999. The Company is encountering increased product costs due to the increased price and usage of the new SAP. While the Company is working diligently with its SAP suppliers to develop a better performing alternative which is still within the SAP Safe Harbor, the Company cannot predict at this time whether or when such an alternative SAP would be available. The Company expects that these increased product costs will have a Page 3 material adverse impact on its financial condition and results of operations for at least 1999 and potentially beyond. Upon the Effective Date, as defined in the K-C Settlement Agreement, K-C will dismiss with prejudice its complaint in the Texas action, as well as its related filings in the District Court in Georgia, and the Company will simultaneously dismiss with prejudice its counterclaims in the Texas action. The Company intends to file shortly a motion with the Bankruptcy Court to seek approval of the settlement. If the K-C Settlement Agreement is not approved by an order of the Bankruptcy Court entered before August 1, 1999, the K-C License Agreement described above will terminate automatically. The Company intends to vigorously pursue approval of the settlement but cannot predict when, or if, such approval will be granted. See "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES." As a result of the Chapter 11 filing, the Company is prohibited from paying any prepetition liabilities without Bankruptcy Court approval. The Chapter 11 filing resulted in a default under its prepetition revolving credit facility. Pursuant to the Bankruptcy Code, the Company can seek Bankruptcy Court approval for the rejection of executory contracts or unexpired leases, including real property leases. Any such rejection may give rise to a prepetition unsecured claim for damages arising therefrom. Substantially all liabilities outstanding as of the date of the Chapter 11 filing are subject to resolution under a plan of reorganization to be voted upon by those of the Company's creditors and shareholders entitled to vote and confirmed by the Bankruptcy Court. Schedules were filed by the Company on March 3, 1998 with the Bankruptcy Court setting forth the assets and liabilities of the Company as of the date of the Chapter 11 filing, as shown by the Company's accounting records. Amended schedules were filed by the Company on March 30, 1998 with the Bankruptcy Court. The Bankruptcy Court set a date of June 5, 1998 by which time creditors had to have filed proofs of claims setting forth any claims which arose prior to the Chapter 11 filing. The ability of the Company to effect a successful reorganization will depend, in significant part, upon the Company's ability to formulate a plan of reorganization that is approved by the Bankruptcy Court. The Company cannot predict at this time the effect of the material adverse impact related to the increased costs described above on the Company's enterprise valuation and on the Company's ability to timely formulate a plan of reorganization. The Company believes, however, that it may be impossible to satisfy in full all of the claims against the Company. Investment in securities of, and claims against, the Company, therefore, should be regarded as highly speculative. See "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES." The Company is unable to predict at this time when it will emerge from Chapter 11 protection. See "Notes 1, 12 and 15 of Notes to Financial Statements" and "ITEM 3: LEGAL PROCEEDINGS" herein. PRODUCTS The Company manufactures several diaper product lines: a premium-quality Ultra line, an economy line ("Economy") and a Supreme line. The Company also manufactures a line of training pants. Ultra diaper sales accounted for approximately 86 percent, 81 percent, and 78 percent of the Company's total unit sales in 1998, 1997 and 1996, respectively. Economy diaper units represented approximately 7 percent, 9 percent and 12 percent of the Company's total unit sales in fiscal years 1998, 1997 and 1996, respectively. The Supreme product represented approximately 4 percent, 5 percent and 4 percent of the Company's total unit sales in fiscal years 1998, 1997 and 1996, respectively. Training pant sales represented approximately 4 percent of the Company's total unit sales over the same periods. The Company's Ultra diaper combines fluff pulp with SAP in the absorbent inner core. SAP is significantly more absorbent and better able to retain liquids than fluff pulp. To enhance performance and appearance, the Ultra diaper incorporates a number of product features comparable to those introduced by national branded manufacturers. The Company now produces its Ultra diaper in six different sizes which are designed to fit babies better as they grow and develop. Additionally, the Company continued its agreement with Jim Henson Productions, Inc., pursuant to which the Company reproduces the Muppet Babies(R) cartoon characters on the "tape landing zone" of its Ultra diapers. In 1998, the Company introduced an improved Ultra diaper which Page 4 incorporated stretch tabs and a hook and loop closure system. In late 1996 and 1997, the Company introduced an improved Ultra diaper which incorporates a cloth-like backsheet and breathable side panels. The Economy diaper is designed to satisfy the needs of the more cost-conscious value segment shopper. Its absorbent pad contains fluff pulp and SAP. Its features include a "tape landing zone" allowing for easy fitting and re-adjustment after fastening. The Company produces the Economy diaper in three unisex sizes. The Company's Supreme diaper product is similar to its Ultra diaper but contains a premium absorbent core and parts of the outer cover and closure systems use premium materials. The Company's training pant is designed for use by children primarily during their transition from diapers. The Company's training pant utilizes an absorbent core of fluff pulp and SAP and a cloth-like nonwoven outer cover. The Company produces its training pant in two gender-specific sizes and two unisex sizes. In 1996, the Company began manufacturing a line of feminine care products that included ultra thin, maxi and super maxi pads, pantiliners, panty shields and regular and super absorbent tampons. In 1997, the Company began manufacturing a line of adult incontinence products that includes guards, undergarments and bladder control pads. In 1998, the Company curtailed its tampon manufacturing operations. PRODUCT DEVELOPMENT To enhance the Company's objective of providing its trade customers with premium-quality store brand disposable diapers, training pants and feminine care and adult incontinence products, the Company devotes significant resources to market research and product design and development to enable it to improve product performance and consumer acceptance. The Company believes that it has the largest product development program of any manufacturer in the U.S. disposable diaper market, other than the national branded manufacturers. The Company spent approximately $4.2 million, $5.1 million and $4.2 million on research and development in fiscal years 1998, 1997 and 1996, respectively. PATENT RIGHTS Because of the emphasis on product innovations in the disposable diaper, feminine care and adult incontinence markets, patents and other intellectual property rights are an important competitive factor. The national branded manufacturers have sought to vigorously enforce their patent rights. Patents held by the national branded manufacturers could severely limit the Company's ability to keep up with branded product innovations by prohibiting the Company from introducing products with comparable features. To protect its competitive position, the Company has created an intellectual property portfolio through development, acquisition and licensing that includes approximately 300 U.S. and foreign patents relating to disposable diaper, feminine care and adult incontinence product features and manufacturing processes. The Company also subjects new product innovations to a rigorous patent clearance process which includes a review by the Company's outside patent counsel. This process is designed to minimize patent risk related to the Company's products. See "ITEM 3: LEGAL PROCEEDINGS." MAJOR CUSTOMERS The Company's net sales to its largest trade customer, Wal-Mart Stores, Inc., and Sam's Club, a division of Wal-Mart Stores, Inc., represented an aggregate of approximately 19 percent, 15 percent and 13 percent of total net sales in fiscal years 1998, 1997 and 1996, respectively. As is customary in the infant disposable diaper market, the Company in most cases does not have long-term contracts with its trade customers. The Company estimates that approximately 7 percent, 7 percent and 9 percent of net sales were to trade customers in Canada in fiscal years 1998, 1997 and 1996, respectively. FOREIGN OPERATIONS On January 26, 1996, the Company through its wholly owned subsidiary PTB International, Inc. ("PTBI") completed the purchase of a 15 percent interest in Grupo P.I. Mabe, S.A. de C.V. ("Mabesa"), the second largest manufacturer of infant disposable diapers in Mexico, for $15.3 million in cash plus additional consideration based Page 5 on Mabesa's future financial results through 2001. The Company also acquired an option to purchase an additional 34 percent interest in Mabesa at a contractually determined price. In 1998 and 1997, based on Mabesa's prior year's financial results, the Company paid additional consideration of $2.8 million and $3.4 million, respectively. In addition, PTBI acquired a 49 percent interest for $1.6 million in cash in Paragon-Mabesa International ("PMI"), a joint venture that developed a diaper manufacturing facility in Tijuana, Mexico. The Company sold certain assets to PMI as part of the development of PMI's manufacturing facility in Tijuana, Mexico. The Company has assisted in financing the equipment, building construction and start-up of the Tijuana, Mexico facility which is completely operational. The Company has signed a Product Supply Agreement with PMI and purchases substantially all of PMI's production for sale to U.S. and European retail customers. On August 26, 1997, PTBI purchased a 49 percent interest in Stronger Corporation S.A. ("Stronger"), a financial investment corporation incorporated under Uruguayan law. An affiliate of Mabesa owns the remaining 51 percent. Stronger has been used to establish joint ventures in Argentina and Brazil and can be used to establish additional Latin American joint ventures. On August 26, 1997, Stronger acquired 70 percent of Serenity S.A., the third largest diaper manufacturer in Argentina, for approximately $11.6 million in cash plus additional consideration based on Serenity's future financial results through 2000. Stronger also acquired an option to purchase the remaining 30 percent interest in Serenity by 2002 at a contractually determined exercise price. Serenity manufactures infant disposable diapers, sanitary napkins and adult incontinence products in two facilities. PTBI advanced $5.7 million to Stronger, its pro-rata share of the purchase price, and paid additional consideration of $.6 million in 1998. PTBI has guaranteed Stronger's additional consideration obligations which are estimated not to exceed an aggregate of $2.3 million through 2000. On November 10, 1997, Stronger acquired 99 percent of the disposable diaper business of MPC Productos para Higiene Ltda. ("MPC") for approximately $10.5 million in cash from Cremer S.A., a Brazilian textile manufacturer. MPC is engaged in the manufacture, distribution, and sale of disposable diapers, skin lotions for children and other personal care products. PTBI advanced $5.1 million to Stronger, its pro-rata share of the purchase price in 1997. In 1998, PTBI converted $2.0 million of outstanding notes receivable and accumulated interest for equipment sales into an additional capital contribution. In 1998 Paragon established Goodbaby Paragon Hygienic Products Co. Ltd., a manufacturing and marketing joint venture in China with Goodbaby Group of Kunshan City and First Shanghai Investment of Hong Kong. Paragon purchased a 40 percent interest in the joint venture with Goodbaby Group and First Shanghai Investment at 30 percent each. Initial registered capital of the venture was approved by the Chinese government at $15 million, to be funded over a two-year period. A joint venture business license was approved by the Chinese government on December 31, 1997. Groundbreaking for a new factory took place in February 1998. The joint venture began production and distribution of infant disposable diapers in October 1998. Paragon advanced $4.0 million, its pro-rata share, in 1998. RAW MATERIALS The principal raw material components of the Company's products are SAP, fluff pulp, polyethylene backsheet, polypropylene nonwoven liner, adhesive closure tape, hotmelt adhesive, elastic and tissue. One of the primary raw materials used in the production of disposable diapers is SAP. In early 1998, the Company entered into an agreement with Clariant International Ltd. (subsequently purchased by BASF Corporation) whereby it agreed, subject to certain limitations, to purchase 100 percent of its requirements of SAP through December 31, 2001. Fluff pulp, a product made from wood fibers, is another primary raw material. The Company's agreement with Weyerhaeuser Company ("Weyerhaeuser") pursuant to which it purchased 100 percent of its requirements of bleached chemical fluff pulp expired August 31, 1998. The Company has continued purchasing substantially all of its fluff pulp requirements from Weyerhaeuser. The Company believes that at least two other sources of supply exist for fluff pulp. Page 6 The Company's gross margins are significantly impacted by raw material prices, especially the price of fluff pulp which can fluctuate dramatically. The Company's operating results benefited from favorable fluff pulp market prices in 1998 and may be adversely affected by increases in raw material prices, primarily fluff pulp, in 1999. See "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: Risks and Uncertainties." COMPETITION-Disposable Diapers National Branded Manufacturers The principal aspects of competition from the national branded manufacturers are price, product quality, product innovation and customer service. The U.S. disposable diaper market is led by the national brands manufactured by P&G and K-C. The Company estimates that, in 1998, the national branded manufacturers accounted for approximately 74 percent of all U.S. disposable diaper sales. The market position of these manufacturers, relative to the Company, varies from one geographic region to another, but due to their substantial financial, technical and marketing resources, each of these companies has the ability to exert significant influence on the infant disposable diaper market. The market for disposable diapers is divided into the premium and value segments. The premium segment accounts for approximately 60 percent of the unit volume. Both K-C and P&G dominate the premium segment. The value segment of the industry, which the Company estimates accounted for approximately 40 percent of unit volume in 1998, is highly competitive. The Company includes store brands, control labels, P&G's Luvs(R), Drypers(R), Fitti(R), and all other regional brands in the value segment. In total, P&G is the dominant manufacturer in the U.S. diaper market, with approximately 40 percent market share. P&G manufactures two brands: Pampers(R), its premium brand with approximately 26 percent market share, and Luvs, its value brand with 14 percent market share. K-C manufactures the number one diaper brand, Huggies, with approximately 34 percent market share. K-C does not offer a value brand, but supplies some store brand training pants within the value segment. Price has been a significant variable in the competitive strategy of the national branded companies in the past three years. In recent years, pricing pressure by the brands has been most evident in the shift of volume to mass merchants who aggressively sell multi-packs. Multi-packs represent a package configuration that provides the consumer 2, 3 or 4 times the amount of diapers found in a standard convenience count package. These multi-packs sell at prices 10 to 15 percent below the branded convenience count package. For most of 1998, pricing pressures from store brand competitors and a shift of volume to mass merchants continued. In October of 1998, the national brands instituted a 5 percent price increase on certain of their product offerings. The Company began implementing a similar price increase on certain of its products in the fourth quarter of 1998. Competitive factors may prevent the Company from realizing the full benefit of the price increase. The Company believes that the national branded manufacturers have lower per unit costs and higher margins than the Company, principally due to their higher volume and prices, coupled with fewer variations in product and packaging. In addition, the national branded manufacturers have access to substantially greater financial resources than the Company. As a result, the Company believes that the national branded manufacturers are capable of maintaining or reducing prices, even in an environment of rising raw material prices. Product quality and innovation are critical aspects of competition for the national branded manufacturers. They have substantially larger research and development budgets than the Company and are able to develop product innovations more rapidly than the Company and may thereby gain market share at the Company's expense. The Company estimates that since 1985, the national branded manufacturers have generally introduced a product innovation approximately every 12 months. Page 7 While in recent years the Company has been able to introduce product enhancements comparable to those introduced by the national branded manufacturers, there can be no assurance that the Company will be able to continue to introduce such product innovations at the pace required to remain competitive with the national branded manufacturers. Producing comparable products could adversely affect the Company's gross margins, particularly in light of the significant royalty costs the Company must pay under the P&G and K-C licenses described herein. To the extent that the Company is unable to introduce comparable products due to the patent landscape, it could experience a decline in net sales and net earnings. See "ITEM 3: LEGAL PROCEEDINGS" and "ITEM 7: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES." Customer service is another area where the national brands are able to compete. The Company believes that each of the national branded manufacturers has an order-delivery cycle that is significantly shorter than the Company's order-delivery cycle. In addition, the national branded manufacturers devote substantially greater financial resources than the Company to providing trade customers with category expertise, customized promotional campaigns and market support. The national branded manufacturers have sophisticated electronic data interchange systems that interface directly with their customers' product information systems. In 1998, the Company successfully implemented a process improvement and information technology upgrading project to further enhance its customer service capabilities. See "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." Value Segment The Company competes in the value segment of the market with national value brands and store brand products. The value segment is characterized by excess capacity and vigorous price competition. The Company's largest competitor in the value segment is P&G with its Luvs brand. The next largest competitor is Drypers Corp. K-C also produces store brand training pants. The Company seeks to compete against other value segment manufacturers by emphasizing research and development and by striving to maintain a leading position among value segment competitors in product quality. Smaller competitors of the Company are sometimes able to introduce new product features more quickly than the Company, in part as a result of having fewer diaper machines to convert to new production processes. COMPETITION-Feminine Care & Adult Incontinence The principal bases of competition in the feminine care and adult incontinence market are price, product quality, product innovation and customer service. The U.S. feminine care and adult incontinence retail market is led by national branded manufacturers including K-C, P&G, Johnson and Johnson, Inc., and Playtex Products, Inc. The Company estimates that in 1998, the national branded manufacturers accounted for approximately 92 percent of all U.S. feminine care and approximately 76 percent of all U.S. adult incontinence sales. The market position of these manufacturers, relative to the Company, varies from one geographic region to another, but due to their substantial financial, technical and marketing resources, each of these companies has the ability to exert significant influence on the feminine care market and adult incontinence market. Another manufacturer is the dominant supplier of store brand feminine care products. The Company experienced greater than anticipated operating losses in its feminine care and adult incontinence businesses in 1998 and 1997 and expects these losses to continue near-term. The Company has developed a business plan that supports the realization of its investment in its feminine care and adult incontinence business. Accordingly, the Company has not recorded any adjustments in its financial statements relating to the recoverability of the operating assets of the feminine care and adult incontinence business The Company's ability to recover its investment is dependent upon a prompt emergence from Chapter 11 and the successful execution of the Company's feminine care and adult incontinence business plan. The Company cannot predict at this time when it will emerge from Chapter 11 protection. The Company believes that once it emerges from Chapter 11 the feminine care and adult incontinence business will see an increase in sales and improved results. The Company cannot predict, however, whether or when such improved results will be realized. See "ITEM 7: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES." Page 8 EMPLOYEES At December 27, 1998, the Company had approximately 1,211 full-time employees, including 1,021 employees located at its five manufacturing facilities. ENVIRONMENT The Company is subject to federal, state, local and foreign laws, regulations and ordinances that (i) govern activities or operations that may have adverse environmental effects, such as discharges to air and water as well as handling and disposal practices for solid and hazardous wastes or (ii) impose liability for the costs of cleaning up, and certain damages resulting from, sites of past spills and disposals or other releases of hazardous substances (together, "Environmental Laws"). The Company uses certain substances and generates certain wastes that are regulated by or may be deemed hazardous under applicable Environmental Laws. The Company believes that it currently conducts its operations, and in the past has conducted its operations, in substantial compliance with applicable Environmental Laws. From time to time, however, the Company's operations have resulted or may result in certain noncompliance with applicable requirements. The Company believes, however, that it will not incur compliance or cleanup costs pursuant to applicable Environmental Laws that would have a material adverse effect on the Company's results of operations or financial condition. The Company monitors Environmental Laws and regulations, as well as pending legislation, in each of the markets in which its products are sold. A number of states have passed or are considering legislation intended to discourage the use of disposable products, including disposable diapers, or to encourage the use of nondisposable or recyclable products. The Company does not believe that any such laws currently in effect will have a material adverse effect on its results of operations or financial condition. See "ITEM 7: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: FORWARD-LOOKING STATEMENTS." ITEM 2: PROPERTIES As of December 27, 1998, the Company operated five manufacturing facilities, with plants located in the United States at Macon, Georgia; Harmony, Pennsylvania; Gaffney, South Carolina; and Waco, Texas; and in Canada at Brampton, Ontario. The Company owns four of its manufacturing facilities. The following table summarizes the physical properties that were held by the Company at December 27, 1998:
APPROXIMATE SIZE NUMBER OF LOCATION USE (SQ. FEET) OWNED/LEASED MACHINES - -------------------------------- ------------------ ---------------- ---------------- ------------ INFANT CARE: Brampton, Ontario Manufacturing 76,000 Owned 3 Harmony, Pennsylvania Manufacturing 173,000 Owned 9 Macon, Georgia Manufacturing 308,000 Owned 8 Oneonta, New York Held for Sale 93,000 Owned -- Porterville, California Held for Sale 69,000 Owned -- Waco, Texas Manufacturing 151,000 Owned 7 FEMININE CARE AND ADULT INCONTINENCE: Gaffney, South Carolina Manufacturing 213,000 Leased 6 CORPORATE AND OTHER: Norcross, Georgia Headquarters 69,000 Owned --
The facilities in Oneonta, New York and Porterville, California were sold in February 1999. Page 9 ITEM 3: LEGAL PROCEEDINGS THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC. - P&G filed a lawsuit in January 1994 in the District Court for the District of Delaware alleging that the Company's "Ultra" infant disposable diaper products infringed two of P&G's dual cuff diaper patents. The lawsuit sought injunctive relief, lost profit and royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by P&G. In March 1996, the District Court granted P&G's motion for summary judgment to dismiss the Company's antitrust counterclaim. The trial was completed in February 1997, the parties submitted post-trial briefs and closing arguments were conducted on October 22, 1997. Legal fees and costs for this litigation have been significant. On December 30, 1997, the Delaware District Court issued a Judgment and Opinion finding that P&G's dual cuff patents were valid and infringed, while at the same time finding the Company's patent to be invalid, unenforceable and not infringed by P&G's products. Judgment was entered on January 6, 1998. Damages of approximately $178.4 million were entered against Paragon by the District Court on June 2, 1998. At the same time, the District Court entered injunctive relief agreed upon by P&G and the Company. The Company had previously filed with the District Court a motion under Rule 59 for a new trial or to alter or amend the Judgment. The District Court denied Paragon's motion by order entered August 4, 1998. The District Court also denied a motion by P&G seeking to recover attorneys' fees it expended in defending itself against Paragon's patent infringement counterclaim. On August 4, 1998, the Company filed with the Federal Circuit Court of Appeals its amended notice of appeal. The appeal was fully briefed, and oral argument was scheduled for February 5, 1999. On September 22, 1998, P&G filed a motion in the Delaware District Court seeking to have the Court find Paragon in contempt of the injunction entered in the case on account of Paragon's manufacture and sale of its single cuff diaper product. P&G asserted in its claim that Paragon's single cuff diaper design (i) is no more than just colorably different from the design found to infringe the P&G patents at issue in the case and (ii) also infringes such patents. The Company opposed P&G's motion. Based on the advice of counsel, the Company believes that P&G's motion is without merit. If the motion were granted, however, the Company would be forced to discontinue the manufacture and sale of its single cuff design. In addition, P&G in its motion asked that the Court order the Company to send letters to all of its customers advising them that the continued resale by them of its single cuff design would also constitute patent infringement. Consequently, the Company believes that if the motion were granted it would have a material adverse effect on the Company's financial condition and results of operations and would seriously jeopardize the Company's future viability. The Judgment has had a material adverse effect on the Company's financial position and its results of operations. As a result of the District Court's Judgment, the Company filed for relief under Chapter 11 of the Bankruptcy Code, 11 U.S.C. Section 101 et seq., in the United States Bankruptcy Court for the Northern District of Georgia (Case No. 98-60390) on January 6, 1998. See "--IN Re PARAGON TRADE BRANDS, INC.," below. P&G filed alleged claims in the Company's Chapter 11 reorganization proceeding ranging from approximately $2.3 billion (without trebling) to $6.5 billion (with trebling), which included a claim of $178.4 million for the Delaware Judgment. See "--IN RE PARAGON TRADE BRANDS, INC.," below. The remaining claims include claims for, among other things, alleged patent infringement by the Company in foreign countries where it has operations. On February 2, 1999, the Company entered into a Settlement Agreement with P&G which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Delaware Judgment, the Company's appeal of the Delaware Judgment, P&G's motion to find the Company in contempt of the Delaware Judgment and P&G's proof of claim filed in the Company's Chapter 11 reorganization proceeding. As a part of the P&G settlement, Paragon grants P&G an allowed unsecured prepetition claim of $158.5 million and an allowed administrative claim of $5 million. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to certain of the patents asserted by P&G in its proof of claim, including those asserted in the Delaware Action. The U.S. and Canadian patent rights licensed by the Company will allow the Company to manufacture a dual cuff baby diaper design. In exchange for Page 10 these rights, the Company has agreed to pay P&G running royalties on net sales of the licensed products equal to 2 percent through October 2005, .75 percent thereafter through October 2006 and .375 percent thereafter through March 2007 in the U.S.; and 2 percent through October 2008 and 1.25 percent thereafter through December 2009 in Canada. The Settlement Agreement also provides, among other things, that P&G will grant the Company and/or its affiliates "most favored licensee" status with respect to patents owned by P&G on the date of the Settlement Agreement or for which an application was pending on that date. In addition, the Company has agreed with P&G that prior to litigating any future patent dispute, the parties will engage in good faith negotiations and will consider arbitrating the dispute before resorting to litigation. While the Company believes that the royalty rates being charged by P&G are the same royalties that will be paid by the Company's major store brand competitors for similar patent rights, these royalties, together with royalties to be paid to K-C described herein, will have a material adverse impact on the Company's future financial condition and results of operations. While these royalty costs are expected to be partially offset by projected raw material cost savings related to the conversion to a dual cuff design, the Company's overall raw material costs are expected to increase. These royalty costs are also expected to be partially offset by price increases announced by the Company in the fourth quarter of 1998 to the extent such price increases are realized. Under the terms of the P&G Settlement Agreement, the Company and P&G jointly requested modification of the injunction entered in Delaware District Court so as to allow the Company to begin converting to a dual cuff design pursuant to the License Agreements described above. The injunction was modified as requested on February 22, 1999 and the product conversion is substantially complete. As also provided under the terms of the P&G Settlement Agreement, once a Final Order, as defined therein, has been entered by the Bankruptcy Court approving the settlement, the Company will withdraw with prejudice its appeal of the Delaware Judgment to the Federal Circuit, and P&G will withdraw with prejudice its motion in Delaware District Court to find the Company in contempt of the Delaware Judgment. A hearing on the Company's motion to seek approval from the Bankruptcy Court of this settlement was commenced on March 22 and 23, 1999 and is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have objected to the P&G settlement. The Company intends to continue to pursue approval of the P&G Settlement by the Bankruptcy Court. Should the P&G Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by July 31, 1999, however, the License Agreements described above will become terminable at P&G's option. The Company cannot predict when, or if, such approval will be granted. See "ITEM 3: LEGAL PROCEEDINGS: --IN RE PARAGON TRADE BRANDS, INC.," and "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES" below. KIMBERLY-CLARK CORPORATION V. PARAGON TRADE BRANDS, INC. -- On October 26, 1995, K-C filed a lawsuit against the Company in U.S. District Court in Dallas, Texas, alleging infringement by the Company's products of two K-C patents relating to dual cuffs. The lawsuit sought injunctive relief, royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by K-C. Several pre-trial motions were filed by each party, including a motion for summary judgment filed by K-C with respect to the Company's antitrust counterclaim and a motion for summary judgment filed by the Company on one of the patents asserted by K-C. In addition, K-C sued the Company on another patent issued to K-C which is based upon a further continuation of one of the K-C dual cuff patents asserted in the case. That action was consolidated with the pending action. The Court appointed a special master to rule on the various pending motions. Legal fees and costs in connection with this litigation have been significant. As a result of the Company's Chapter 11 filing, the proceedings in the K-C litigation were stayed. The Bankruptcy Court issued an order on April 10, 1998 permitting, among other things, a partial lifting of the stay to allow the issuance of the special master's report on the items under his consideration. K-C filed with the Bankruptcy Court a motion for reconsideration of the Bankruptcy Court's April 10, 1998 order, which was denied on June 15, 1998. K-C has appealed this denial of reconsideration to the District Court for the Northern District of Georgia. The Company objected to K-C's appeal and sought to have it dismissed. K-C also filed a motion with the District Court in Atlanta to withdraw the reference with respect to all matters pertaining to its proof of claim from the jurisdiction of the Bankruptcy Court. By order executed February 18, 1999, the appeal, K-C's motion for withdrawal of the reference and the Company's motion to dismiss the appeal were dismissed by the District Court without prejudice to the right of either party within sixty days to re-open the actions if a settlement was not consummated. See "--IN RE PARAGON TRADE BRANDS, INC." below. Page 11 On May 26, 1998, the special master issued his report on the majority of the motions pending before him. His report included a finding, among other things, that Paragon, as the successor-in-interest to the disposable diaper business of Pope & Talbot, has a fully paid-up license to one of the three asserted K-C inner-leg gather patents, which license runs from the date of the acquisition by the Company of Pope & Talbot. Pope & Talbot had previously obtained the license from K-C. The special master also found that K-C should be held to the narrow interpretation of its patent applied by Judge Dwyer in the Western District of Washington in earlier litigation between P&G and K-C on the patent. In addition, the special master also recommended that the Company's antitrust counterclaim and any discovery-related matters in connection therewith be dismissed. Effective September 1, 1998, the Texas action was reassigned to Judge Lindsey, a newly-appointed judge on the Dallas District Court bench. Judge Lindsey asked the parties to report on the status of the case and the likelihood of settlement. The parties responded on November 6, 1998, that negotiations were underway and that they believed considerable progress was being made. The Company has previously disclosed that should K-C prevail on its claims, an award of all or a substantial portion of the relief requested by K-C could have a material adverse effect on the Company's financial condition and its results of operations. Based on the advice of patent counsel, the Company believes that the Company's products do not infringe any valid patent asserted by K-C. K-C filed alleged claims in the Company's Chapter 11 reorganization proceeding ranging from approximately $893 million (without trebling) to $2.3 billion (with trebling). See "--IN RE PARAGON TRADE BRANDS, INC.," below. On March 19, 1999, the Company entered into a Settlement Agreement with K-C which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Texas action, including the Company's counterclaims, and K-C's proof of claim filed in the Company's Chapter 11 reorganization proceeding. Under the terms of the K-C Settlement Agreement, the Company grants K-C an allowed unsecured prepetition claim of $110 million and an allowed administrative claim of $5 million. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to the patents asserted by K-C in the Texas action. The patent rights licensed by the Company from K-C will allow the Company to manufacture a dual cuff diaper design. In exchange for these patent rights, the Company has agreed to pay K-C annual running royalties on net sales of the licensed products in the U.S. and Canada equal to: 2.5 percent of the first $200 million of net sales of the covered diaper products and 1.5 percent of such net sales in excess of $200 million in each calendar year commencing January 1999 through November 2004. In addition, the Company has agreed to pay a minimum annual royalty for diaper sales of $5 million, but amounts due on the running royalties will be offset against this minimum. The Company will also pay K-C running royalties of 5 percent of net sales of covered training pant products for the same period, but there is no minimum royalty for training pants. As part of the settlement, the Company has granted a royalty-free license to K-C for three patents which the Company in the Texas action claimed K-C infringed. While the Company believes that, based on its projected level of sales, the overall effective royalty rate that the Company will pay to K-C is less than the royalty rate that will be paid by the Company's major store brand competitors for similar patent rights, these royalties will, together with royalties to be paid to P&G described above, have a material adverse impact on the Company's future financial condition and results of operations. While these royalty costs are expected to be partially offset by projected raw material cost savings related to the conversion to a dual cuff product, the Company's overall raw material costs are expected to increase. These royalty costs are also expected to be partially offset by price increases announced by the Company in the fourth quarter of 1998 to the extent such price increases are realized. As a part of the K-C License Agreement, K-C has agreed not to sue the Company on two of K-C's patents related to the use of super-absorbent polymers ("SAP") in diapers and training pants, so long as the Company uses SAP which exhibits certain performance characteristics (the "SAP Safe Harbor"). The Company has experienced certain product performance issues the Company believes may be related to such SAP. As a result, the Company expects that it will incur increased marketing and selling, general and administrative expenses ("SG&A") expenditures in 1999 to address product performance issues. These increased expenditures are expected to have a material adverse impact on the Company's financial position and results of operations in 1999. The Company is encountering increased product costs due to the increased price and usage of the new Page 12 SAP. While the Company is working diligently with its SAP supplier to develop a better performing alternative which is still within the SAP Safe Harbor, the Company cannot predict at this time whether or when such an alternative SAP would be available. The Company expects that these increased product costs will have a material adverse impact on its financial condition and results of operations for at least 1999 and potentially beyond. Upon the Effective Date, as defined in the K-C Settlement Agreement, K-C will dismiss with prejudice its complaint in the Texas action, as well as its related filings in the District Court in Georgia, and the Company will simultaneously dismiss with prejudice its counterclaims in the Texas action. The Company intends to file shortly a motion with the Bankruptcy Court to seek approval of the settlement. If the K-C Settlement Agreement is not approved by an order of the Bankruptcy Court entered before August 1, 1999, the K-C License Agreement described above will terminate automatically. The Company intends to vigorously pursue approval of the settlement but cannot predict when, or if, such approval will be granted. See "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES." IN RE PARAGON TRADE BRANDS, INC. -- As described above, on December 30, 1997, the Delaware District Court issued a Judgment and Opinion in the Company's lawsuit with P&G which found, in essence, two of P&G's diaper patents to be valid and infringed by the Company's "Ultra" disposable baby diapers, while also rejecting the Company's patent infringement claim against P&G. Judgment was entered on January 6, 1998. While a final damages number was not entered by the District Court until June 2, 1998, the Company originally estimated the liability and associated litigation costs to be approximately $200 million. The amount of the award resulted in violation of certain covenants under the Company's bank loan agreements. As a result, the issuance of the Judgment and the uncertainty it created caused an immediate and critical liquidity issue for the Company which necessitated the Chapter 11 filing. Subsequently, damages of approximately $178.4 million were entered against Paragon by the District Court on June 2, 1998. At the same time, the District Court entered injunctive relief agreed upon by P&G and the Company. See "--THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC.," above. The Chapter 11 filing prevented P&G from placing liens on the Company's assets, permitted the Company to appeal the District Court's decision in an orderly fashion and affords the Company the opportunity to resolve liquidated and unliquidated claims against the Company, which arose prior to the Chapter 11 filing. The Company is currently operating as a debtor-in-possession under the Bankruptcy Code. The bar date for the filing of proofs of claim (excluding administrative claims) by creditors was June 5, 1998. P&G filed alleged claims ranging from approximately $2.3 billion (without trebling) to $6.5 billion (with trebling), which included a claim of $178.4 million for the Delaware judgment. See "--THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC.," above. The remaining claims include claims for, among other things, alleged patent infringement by the Company in foreign countries where it has operations. On February 2, 1999, the Company entered into a Settlement Agreement with P&G which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Delaware Judgment, the Company's appeal of the Delaware Judgment, P&G's motion to find the Company in contempt of the Delaware Judgment and P&G's proof of claim filed in the Company's Chapter 11 reorganization proceeding. As a part of the P&G settlement, Paragon grants P&G an allowed unsecured prepetition claim of $158.5 million and an allowed administrative claim of $5 million. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to certain of the patents asserted by P&G in its proof of claim, including those asserted in the Delaware Action. The U.S. and Canadian patent rights licensed by the Company will allow the Company to manufacture a dual cuff baby diaper design. In exchange for these rights, the Company has agreed to pay P&G running royalties on net sales of the licensed products equal to 2 percent through October 2005, .75 percent thereafter through October 2006 and .375 percent thereafter through March 2007 in the U.S.; and 2 percent through October 2008 and 1.25 percent thereafter through December 2009 in Canada. The Settlement Agreement also provides, among other things, that P&G will grant the Company and/or its affiliates "most favored licensee" status with respect to patents owned by P&G on the date of the Settlement Agreement or for which an application was pending on that date. In addition, the Company has agreed with P&G that prior to litigating any future patent dispute, the parties will engage in good faith negotiations and will consider arbitrating the dispute before resorting to litigation. Page 13 While the Company believes that the royalty rates being charged by P&G are the same royalties that will be paid by the Company's major store brand competitors for similar patent rights, these royalties, together with royalties to be paid to K-C described below, will have a material adverse impact on the Company's future financial condition and results of operations. While these royalty costs are expected to be partially offset by projected raw material cost savings related to the conversion to a dual cuff design, the Company's overall raw material costs are expected to increase. These royalty costs are also expected to be partially offset by price increases announced by the Company in the fourth quarter of 1998 to the extent such price increases are realized. Under the terms of the P&G Settlement Agreement, the Company and P&G jointly requested modification of the injunction entered in Delaware District Court so as to allow the Company to begin converting to a dual cuff design pursuant to the License Agreements described above. The injunction was modified as requested on February 22, 1999 and the product conversion is substantially complete. As also provided under the terms of the P&G Settlement Agreement, once a Final Order, as defined therein, has been entered by the Bankruptcy Court approving the settlement, the Company will withdraw with prejudice its appeal of the Delaware Judgment to the Federal Circuit, and P&G will withdraw with prejudice its motion in Delaware District Court to find the Company in contempt of the Delaware Judgment. A hearing on the Company's motion to seek approval from the Bankruptcy Court of this settlement was commenced on March 22 and 23, 1999 and is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have objected to the P&G settlement. The Company intends to continue to pursue approval of the P&G Settlement by the Bankruptcy Court. Should the P&G Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by July 31, 1999, however, the License Agreements described above will become terminable at P&G's option. The Company cannot predict when, or if, such approval will be granted. See "ITEM 3: LEGAL PROCEEDINGS: --IN RE PARAGON TRADE BRANDS, INC.," and "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES" below. K-C filed alleged claims ranging from approximately $893 million (without trebling) to $2.3 billion (with trebling), including claims related to the litigation in the Dallas District Court described above. See "--KIMBERLY-CLARK CORPORATION V. PARAGON TRADE BRANDS, INC.," above. K-C's claims in the Bankruptcy case include an attempt to recover alleged lost profits for infringement of the patents asserted in the Dallas District Court, despite the fact that a lost profits theory of damages was not pursued by K-C in the Dallas District Court. On March 19, 1999, the Company entered into a Settlement Agreement with K-C which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Texas action, including the Company's counterclaims, and K-C's proof of claim filed in the Company's Chapter 11 reorganization proceeding. Under the terms of the K-C Settlement Agreement, the Company grants K-C an allowed unsecured prepetition claim of $110 million and an allowed administrative claim of $5 million. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to the patents asserted by K-C in the Texas action. The patent rights licensed by the Company from K-C will allow the Company to manufacture a dual cuff diaper design. In exchange for these patent rights, the Company has agreed to pay K-C annual running royalties on net sales of the licensed products in the U.S. and Canada equal to: 2.5 percent of the first $200 million of net sales of the covered diaper products and 1.5 percent of such net sales in excess of $200 million in each calendar year commencing January 1999 through November 2004. In addition, the Company has agreed to pay a minimum annual royalty for diaper sales of $5 million, but amounts due on the running royalties will be offset against this minimum. The Company will also pay K-C running royalties of 5 percent of net sales of covered training pant products for the same period, but there is no minimum royalty for training pants. As part of the settlement, the Company has granted a royalty-free license to K-C for three patents which the Company in the Texas action claimed K-C infringed. While the Company believes that, based on its projected level of sales, the overall effective royalty rate that the Company will pay to K-C is less than the royalty rate that will be paid by the Company's major store brand competitors for similar patent rights, these royalties will, together with royalties to be paid to P&G described above, have a material adverse impact on the Company's future financial condition and results of operations. While these royalty costs are expected to be partially offset by projected raw material cost savings related to the conversion to a dual cuff product, the Company's overall raw material costs are expected to increase. These royalty costs are also expected to be partially offset by price increases announced by the Company in the fourth quarter of 1998 to the extent such price increases are realized. Page 14 As a part of the K-C License Agreement, K-C has agreed not to sue the Company on two of K-C's patents related to the use of SAP in diapers and training pants, so long as the Company stays within the SAP Safe Harbor. The Company has experienced certain product performance issues the Company believes may be related to such SAP. As a result, the Company expects that it will incur increased marketing and SG&A expenditures in 1999 to address product performance issues. These increased expenditures are expected to have a material adverse impact on the Company's financial position and results of operations in 1999. The Company is encountering increased product costs due to the increased price and usage of the new SAP. While the Company is working diligently with its SAP suppliers to develop a better performing alternative which is still within the SAP Safe Harbor, the Company cannot predict at this time whether or when such an alternative SAP would be available. The Company expects that these increased product costs will have a material adverse impact on its financial condition and results of operations for at least 1999 and potentially beyond. Upon the Effective Date, as defined in the K-C Settlement Agreement, K-C will dismiss with prejudice its complaint in the Texas action, as well as its related filings in the District Court in Georgia, and the Company will simultaneously dismiss with prejudice its counterclaims in the Texas action. The Company intends to file shortly a motion with the Bankruptcy Court to seek approval of the settlement. If the K-C Settlement Agreement is not approved by an order of the Bankruptcy Court entered before August 1, 1999, the K-C License Agreement described above will terminate automatically. The Company intends to vigorously pursue approval of the settlement but cannot predict when, or if, such approval will be granted. See "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES." On February 17, 1999, the Company, P&G, K-C, the Creditors' and Equity Committees stipulated to an extension of the Company's exclusivity period to April 19, 1999 during which time only the Company can propose a plan of reorganization. On March 29, 1999, the Company filed a motion seeking to extend this period, initially, to May 19, 1999 and, subsequently, to June 19, 1999. A hearing on this motion is scheduled to occur on April 16, 1999. On January 30, 1998, the Company received Bankruptcy Court approval of a $75 million financing facility with a bank group led by The Chase Manhattan Bank. This facility is designed to supplement the Company's cash on hand and operating cash flow and to permit the Company to continue to operate its business in the ordinary course. As of December 27, 1998, there were no outstanding direct borrowings under this facility. The Company had an aggregate of $1.3 million in letters of credit issued under the DIP Credit Facility at December 27, 1998. The DIP Credit Facility contains customary covenants. The Company for a period of time has been unable to fully comply with certain reporting requirements of such covenants. The Company has obtained waivers with respect to these events of default which are effective through May 10, 1999. The Company believes that it will be in compliance with the reporting requirements of the DIP Credit Facility by May 10, 1999. See "Note 12 of Notes to Financial Statements." Legal fees and costs in connection with the Chapter 11 case have been and will continue to be significant. The Company is unable to predict at this time when it will emerge from Chapter 11 protection. OTHER -- The Company is also a party to other legal activities generally incidental to its activities. Although the final outcome of any legal proceeding or dispute is subject to a great many variables and cannot be predicted with any degree of certainty, the Company presently believes that any ultimate liability resulting from any or all legal proceedings or disputes to which it is a party, except for the Chapter 11 filing and the P&G and K-C matters discussed above, will not have a material adverse effect on its financial condition or results of operations. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the 1998 fiscal year. Page 15 PART II ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS As of March 31, 1999, there were 250 holders of record of the Company's common stock. The Company has not paid dividends on its common stock. The Board of Directors will determine future dividend policy based upon the Company's results of operations, financial condition, capital requirements and other circumstances. The Company's DIP Credit Facility prohibits the Company from paying cash dividends. The Company's common stock is listed on the New York Stock Exchange, Inc. under the symbol "PTB." See "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES." See "Note 19 of Notes to Financial Statements" regarding the quarterly high and low price range of the Company's common stock. The Company did not sell any securities of the Company that were not registered under the Securities Act of 1933, as amended, during the fiscal year ended December 27, 1998. ITEM 6: SELECTED FINANCIAL DATA The following table sets forth selected consolidated financial data of the Company on a historical basis as described below. The selected consolidated financial data as of December 27, 1998 and December 28, 1997, and for the three years in the period ended December 27, 1998 have been derived from the audited consolidated financial statements of the Company which are included in Item 8 of this annual report on Form 10-K. The selected consolidated financial data as of December 29, 1996, December 31, 1995 and December 25, 1994, and for the years then ended have been derived from the audited consolidated financial statements of the Company. The Company uses a 52/53-week year for financial reporting purposes. The fiscal year ended December 31, 1995 reflects 53 weeks of operations. The audited consolidated financial statements from which the selected financial data has been derived have been prepared assuming that the Company will continue as a going concern. As more fully described in "Notes 1 and 15 of Notes to Financial Statements" and "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--RISK FACTORS: REORGANIZATION CASE," the Company is unable to predict when it will submit a plan of reorganization that will be acceptable to the Bankruptcy Court. In the event a plan of reorganization is confirmed and consummated, continuation of the business thereafter is dependent on the Company's ability to execute the underlying business plan. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. Page 16 (Dollar amounts in millions, except per share data)
1998 1997 1996 1995 1994 -------------- --------------- ------------ -------------- ------------ EARNINGS STATEMENT DATA(1) Net Sales $ 535.2 $ 562.0 $ 581.9 $ 518.8 $ 578.6 EBITDA(2) $ 58.4 $ 62.5 $ 91.5 $ 46.2 $ 73.6 Operating profit (loss) $ (58.0)(3) $ (183.8)(4) $ 35.7(5) $ (3.6)(6) $ 42.5 Net earnings (loss) $ (65.4)(3)(7)$ (212.7)(4)(8) $ 21.1(5) $ (3.4)(6) $ 25.0 PER SHARE DATA(1) Basic earnings (loss) per $ (5.48)(3)(7)$(17.86)(4)(8) $ 1.76(5) $ (.29)(6) $ 2.16 share BALANCE SHEET DATA(1) Total assets $ 429.3 $ 376.1 $ 373.1 $ 266.7 $ 275.4 Liabilities subject to compromise $ 406.9 - - - - Long-term debt $ - $ 70.0 $ 70.0 - $ 6.0 Shareholders' equity (deficit) $ (61.8) $ 5.0 $ 214.7 $ 191.7 $ 195.7 OTHER DATA(1) Capital spending $ 28.3 $ 49.4 $ 48.9 $ 17.4 $ 74.9 Depreciation and amortization $ 34.5 $ 35.5 $ 38.8 $ 36.0 $ 31.1 Units sold (millions) 3,463 3,689 3,761 3,378 3,595 - --------------- (1) See Notes 1, 3 and 15 of Notes to Financial Statements. (2) Operating profit (loss) before interest, taxes, depreciation and amortization and nonrecurring charges discussed in footnotes 3, 4, 5 and 6 below ("EBITDA"). (3) Includes settlement contingencies of $78.5 for the estimated settlement costs of P&G's and K-C's claims asserted in the Company's Chapter 11 reorganization proceeding, including the settlement of the P&G patent judgment and the K-C Texas action, and a $3.4 asset impairment of the Company's tampon manufacturing line. See Notes 1, 3 and 15 of Notes to Financial Statements and "ITEM 3: LEGAL PROCEEDINGS." (4) Includes settlement contingency of $200 for an adverse judgment in a patent litigation matter with P&G and $10.6 of asset impairments and inventory adjustments related to the write-off of software and consulting costs and the discontinuation of the Company's tampon manufacturing operation. See Notes 1, 3 and 15 of Notes to Financial Statements. (5) Includes costs for the integration of Pope & Talbot's disposable diaper business purchased in February 1996 and costs related to the relocation of the corporate headquarters to Atlanta. Excluding these costs, operating profit would be $52.7, net earnings would be $31.7 and basic earnings per share would be $2.64. (6) Includes restructuring and charges taken in the first quarter of 1995 for the closure of the La Puente, California plant, corporate headquarters staff reductions, and other charges. Excluding these charges, operating profit would be $10.1, net earnings would be $5.4 and basic earnings per share would be $.46. (7) Includes a $32.9 reserve against deferred and other tax-related assets. (8) Includes a $100.2 reserve against deferred and other tax-related assets.
Page 17 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company has previously disclosed that "P&G" had filed a lawsuit against it in the United States District Court for the District of Delaware alleging that the Company's "Ultra" disposable baby diaper products infringe two of P&G's dual cuff diaper patents. The lawsuit sought injunctive relief, lost profit and royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by P&G. The Company also disclosed that if P&G were to prevail on its claims, an award of all or a substantial amount of the relief requested by P&G could have a material adverse effect on the Company's financial condition and results of operations. On December 30, 1997, the District Court issued a Judgment and Opinion which found, in essence, two of P&G's dual cuff diaper patents to be valid and infringed by certain of the Company's disposable diaper products, while also rejecting the Company's patent infringement claims against P&G. The District Court had earlier dismissed the Company's antitrust counterclaim on summary judgment. The Judgment entitled P&G to damages based on sales of the Company's diapers containing the "inner-leg gather" feature. While the final damages number of approximately $178.4 million was not entered by the District Court until June 2, 1998, the Company originally estimated the liability and associated litigation costs to be approximately $200 million. The amount of the award resulted in violation of certain covenants under the Company's then-existing bank loan agreements. As a result, the issuance of the Judgment and the uncertainty it created caused an immediate and critical liquidity issue for the Company. On January 6, 1998, the Judgment was entered on the docket in Delaware in such a manner that P&G would have been able to begin placing liens on the Company's assets. As a result, the Company filed for relief under Chapter 11 of the Bankruptcy Code, 11 U.S.C. Section 101 et seq., in the United States Bankruptcy Court for the Northern District of Georgia (Case No. 98-60390) on January 6, 1998 (the "Chapter 11 filing"). None of the Company's subsidiaries were included in the Chapter 11 filing. The Chapter 11 filing was designed to prevent P&G from placing liens on Company property, permit the Company to appeal the Delaware District Court's decision on the P&G case in an orderly fashion and give the Company the opportunity to resolve liquidated and unliquidated claims against the Company, which arose prior to the Chapter 11 filing. The Company is currently operating as a debtor-in-possession under the Bankruptcy Code. On February 2, 1999, the Company entered into a Settlement Agreement with P&G which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Delaware Judgment, the Company's appeal of the Delaware Judgment, P&G's motion to find the Company in contempt of the Delaware Judgment and P&G's proof of claim filed in the Company's Chapter 11 reorganization proceeding. As a part of the P&G settlement, Paragon grants P&G an allowed unsecured prepetition claim of $158.5 million and an allowed administrative claim of $5 million. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to certain of the patents asserted by P&G in its proof of claim, including those asserted in the Delaware Action. The U.S. and Canadian patent rights licensed by the Company will allow the Company to manufacture a dual cuff baby diaper design. In exchange for these rights, the Company has agreed to pay P&G running royalties on net sales of the licensed products equal to 2 percent through October 2005, .75 percent thereafter through October 2006 and .375 percent thereafter through March 2007 in the U.S.; and 2 percent through October 2008 and 1.25 percent thereafter through December 2009 in Canada. The Settlement Agreement also provides, among other things, that P&G will grant the Company and/or its affiliates "most favored licensee" status with respect to patents owned by P&G on the date of the Settlement Agreement or for which an application was pending on that date. In addition, the Company has agreed with P&G that prior to litigating any future patent dispute, the parties will engage in good faith negotiations and will consider arbitrating the dispute before resorting to litigation. While the Company believes that the royalty rates being charged by P&G are the same royalties that will be paid by the Company's major store brand competitors for similar patent rights, these royalties, together with royalties to be paid to K-C described below, will have a material adverse impact on the Company's future financial condition and results of operations. While these royalty costs are expected to be partially offset by projected raw material cost savings related to the conversion to a dual cuff design, the Company's overall raw material costs Page 18 are expected to increase. These royalty costs are also expected to be partially offset by price increases announced by the Company in the fourth quarter of 1998 to the extent such price increases are realized. Under the terms of the P&G Settlement Agreement, the Company and P&G jointly requested modification of the injunction entered in Delaware District Court so as to allow the Company to begin converting to a dual cuff design pursuant to the License Agreements described above. The injunction was modified as requested on February 22, 1999 and the product conversion is substantially complete. As also provided under the terms of the P&G Settlement Agreement, once a Final Order, as defined therein, has been entered by the Bankruptcy Court approving the settlement, the Company will withdraw with prejudice its appeal of the Delaware Judgment to the Federal Circuit, and P&G will withdraw with prejudice its motion in Delaware District Court to find the Company in contempt of the Delaware Judgment. A hearing on the Company's motion to seek approval from the Bankruptcy Court of this settlement was commenced on March 22 and 23, 1999 and is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have objected to the P&G settlement. The Company intends to continue to pursue approval of the P&G Settlement by the Bankruptcy Court. Should the P&G Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by July 31, 1999, however, the License Agreements described above will become terminable at P&G's option. The Company cannot predict when, or if, such approval will be granted. See "--Risks and Uncertainties" below, and "ITEM 3: LEGAL PROCEEDINGS: --IN RE PARAGON TRADE BRANDS, INC." On October 26, 1995, K-C filed a lawsuit against the Company in U.S. District Court in Dallas, Texas, alleging infringement by the Company's products of two K-C patents relating to dual cuffs. The lawsuit sought injunctive relief, royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by K-C. In addition, K-C sued the Company on another patent issued to K-C which is based upon a further continuation of one of the K-C dual cuff patents asserted in the case. On March 19, 1999, the Company entered into a Settlement Agreement with K-C which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Texas action, including the Company's counterclaims, and K-C's proof of claim filed in the Company's Chapter 11 reorganization proceeding. Under the terms of the K-C Settlement Agreement, the Company grants K-C an allowed unsecured prepetition claim of $110 million and an allowed administrative claim of $5 million. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to the patents asserted by K-C in the Texas action. The patent rights licensed by the Company from K-C will allow the Company to manufacture a dual cuff diaper design. In exchange for these patent rights, the Company has agreed to pay K-C annual running royalties on net sales of the licensed products in the U.S. and Canada equal to: 2.5 percent of the first $200 million of net sales of the covered diaper products and 1.5 percent of such net sales in excess of $200 million in each calendar year commencing January 1999 through November 2004. In addition, the Company has agreed to pay a minimum annual royalty for diaper sales of $5 million, but amounts due on the running royalties will be offset against this minimum. The Company will also pay K-C running royalties of 5 percent of net sales of covered training pant products for the same period, but there is no minimum royalty for training pants. As part of the settlement, the Company has granted a royalty-free license to K-C for three patents which the Company in the Texas action claimed K-C infringed. While the Company believes that, based on its projected level of sales, the overall effective royalty rate that the Company will pay to K-C is less than the royalty rate that will be paid by the Company's major store brand competitors for similar patent rights, these royalties will, together with royalties to be paid to P&G described above, have a material adverse impact on the Company's future financial condition and results of operations. While these royalty costs are expected to be partially offset by projected raw material cost savings related to the conversion to a dual cuff product, the Company's overall raw material costs are expected to increase. These royalty costs are also expected to be partially offset by price increases announced by the Company in the fourth quarter of 1998 to the extent such price increases are realized. As a part of the K-C License Agreement, K-C has agreed not to sue the Company on two of K-C's patents related to the use of super-absorbent polymers ("SAP") in diapers and training pants, so long as the Company uses SAP which exhibits certain performance characteristics (the "SAP Safe Harbor"). The Company has experienced certain product performance issues the Company believes may be related to such SAP. As a result, the Company expects that it will incur increased marketing and selling, general and administrative expenses Page 19 ("SG&A") expenditures in 1999 to address product performance issues. These increased expenditures are expected to have a material adverse impact on the Company's financial position and results of operations in 1999. The Company is encountering increased product costs due to the increased price and usage of the new SAP. While the Company is working diligently with its SAP supplier to develop a better performing alternative which is still within the SAP Safe Harbor, the Company cannot predict at this time whether or when such an alternative SAP would be available. The Company expects that these increased product costs will have a material adverse impact on its financial condition and results of operations for at least 1999 and potentially beyond. Upon the Effective Date, as defined in the K-C Settlement Agreement, K-C will dismiss with prejudice its complaint in the Texas action, as well as its related filings in the District Court in Georgia, and the Company will simultaneously dismiss with prejudice its counterclaims in the Texas action. The Company intends to file shortly a motion with the Bankruptcy Court to seek approval of the settlement. If the K-C Settlement Agreement is not approved by an order of the Bankruptcy Court entered before August 1, 1999, the K-C License Agreement described above will terminate automatically. The Company intends to vigorously pursue approval of the settlement but cannot predict when, or if, such approval will be granted. See "--Risks and Uncertainties." The Company is unable to predict at this time when it will emerge from Chapter 11 protection. See "Notes 1 and 15 of Notes to Financial Statements" and "ITEM 3: LEGAL PROCEEDINGS" herein. The Company operates principally in two segments that are organized based on the nature of the products sold: (i) infant care and (ii) feminine care and adult incontinence. Each operating segment contains closely related products that are unique to that particular segment. The results of Changing Paradigms, Inc. ("Changing Paradigms"), the Company's household cleaners and air freshener business that was sold in 1998, and the Company's international investments in joint ventures in Mexico, Argentina, Brazil and China are reported in the corporate and other segment. YEAR ENDED DECEMBER 27, 1998 VS. YEAR ENDED DECEMBER 28, 1997 RESULTS OF OPERATIONS A net loss of $65.4 million was incurred during 1998 compared to a net loss of $212.7 million in 1997. Included in the results for 1998 were accrued settlement contingencies of $78.5 million representing the balance of the estimated settlement costs of P&G's and K-C's claims in the Company's Chapter 11 reorganization proceeding, including the settlement of the P&G patent judgment and the K-C Texas action. See "Notes 1 and 15 of Notes to Financial Statements" and "ITEM 3: LEGAL PROCEEDINGS" herein. Also included in the results for 1998 was $6.3 million of bankruptcy costs and a $3.4 million asset impairment writedown relating to the Company's tampon manufacturing line that was taken out of service in early 1998 and is currently held for sale. The total of the settlement contingency, bankruptcy costs and asset impairment writedown was $54.2 million, net of the effect of income taxes. The results in 1998 were also negatively impacted by a reserve of $32.9 million taken against the Company's net deferred and other tax-related assets. Included in the 1997 results was an estimated accrued settlement contingency of $200 million for the P&G patent litigation judgment and associated litigation costs. See "Notes 1 and 15 of Notes to Financial Statements" and "ITEM 3: LEGAL PROCEEDINGS" herein. Also included in the results for 1997 were asset impairments and other write-offs totaling $10.6 million related to the write-off of software and consulting costs related to the enterprise-wide information system installation and discontinuation of the Company's tampon production. The total of the loss contingency and asset impairments was $129.5 million, net of the effect of income taxes. The results in 1997 were also negatively impacted by a reserve of $100.2 million taken against the Company's net deferred and other tax-related assets. Basic loss per share in 1998 was $5.48 compared to basic loss per share of $17.86 in 1997. Basic earnings per share was $1.52 in 1998 compared to $1.43 in 1997, excluding charges discussed above in both periods and bankruptcy costs and adjusting for the Company's contractual interest charges in 1998. Infant care operating loss totaled $42.2 million in 1998 compared to an operating loss of $155.0 million in 1997. The $78.5 million of settlement contingencies in 1998 and the $200.0 million settlement contingency in 1997 Page 20 discussed above, materially impacted infant care operating results. Excluding these contingencies, infant care operating profits were $36.3 million in 1998 compared to $45.0 million in 1997. Reduced volume and increased SG&A were the major factors contributing to this decline. Feminine care and adult incontinence operating loss totaled $16.9 million in 1998 compared to an operating loss of $23.7 million in 1997. Operating loss includes asset impairments related to a tampon manufacturing operation that was shut down in 1998 of $3.4 million in 1998 and $4.4 million in 1997. The reduction of the operating loss resulted from increased volume, the discontinuation of the tampon manufacturing operation and cost management initiatives. The Company experienced greater than anticipated operating losses in its feminine care and adult incontinence businesses in 1998 and 1997 and expects these losses to continue near-term. The Company has developed a business plan that supports the realization of its investment in its feminine care and adult incontinence business. Accordingly, the Company has not recorded any adjustments in its financial statements relating to the recoverability of the operating assets of the feminine care and adult incontinence business The Company's ability to recover its investment is dependent upon a prompt emergence from Chapter 11 and the successful execution of the Company's feminine care and adult incontinence business plan. The Company cannot predict at this time when it will emerge from Chapter 11 protection. The Company believes that once it emerges from Chapter 11 the feminine care and adult incontinence business will see an increase in sales and improved results. The Company cannot predict, however, whether or when such improved results will be realized. NET SALES Overall net sales were $535.2 million in 1998, a 4.8 percent decrease from the $562.0 million reported in 1997. Infant care net sales decreased 5.9 percent to $512.8 million from $545.2 million in 1997. Unit sales decreased 7.5 percent to 3,413 million diapers in 1998 compared to 3,689 million diapers in 1997. The decrease in sales was primarily due to uncertainties related to the Company's Chapter 11 proceeding and the temporary discontinuation of shipments to a customer during the second half of the year due to product design issues associated with a new product rollout. The Company believes these product design issues have been resolved. The Company resumed shipments to that customer in the first quarter of 1999. Volume remained under pressure from discounts and promotional allowances by branded manufacturers and value segment competitors and by customer losses to store brand diaper competitors. 1999 infant care volume and sales price are expected to remain under pressure due to product performance issues until remedied, continued competitive initiatives from store brand competitors and a prolonged Chapter 11 case. Excluding the effect of a favorable product mix, average sales prices for the Company's products during 1998 were lower compared to 1997. The decrease in prices was primarily due to the use of multi-packs by the branded manufacturers and value segment competitors, competitive pressure from store brand diaper competitors and price decreases in Canada. The Company began to implement a price increase of approximately 5 percent during the fourth quarter of 1998 in response to increases announced by K-C and P&G. It is difficult to predict the amount of the final realization of this price increase due to competitive factors previously discussed. Feminine care and adult incontinence sales increased to $6.6 million in 1998 from $4.3 million in 1997 due to the initiation of shipments of product to new customers. However, the uncertainty caused by the Company's Chapter 11 filing has significantly impacted the ability to attract additional sales. The Company expects this condition to persist until the Company's emergence from Chapter 11. See "--RISKS AND UNCERTAINTIES." Corporate and other net sales increased to $15.8 million in 1998 from $12.5 million in 1997 and relate to Changing Paradigms, which was sold in October of 1998. COST OF SALES Overall cost of sales in 1998 was $428.6 million compared to $454.9 million in 1997, a 5.8 percent decrease. As a percentage of net sales, cost of sales was 80.1 percent in 1998 compared to 80.9 percent in 1997. Page 21 Infant care costs were $397.1 million in 1998 compared to $423.4 million in 1997, a decrease of 6.4 percent. As a percentage of net sales, infant care cost of sales was 77.4 percent in 1998 compared to 77.8 percent in 1997. This improvement was primarily due to lower raw material costs, improved operating efficiencies and lower overhead costs. The lower costs were partially offset by the sourcing of products from PMI under a supply contract and charges related to royalties payable to P&G under a product conversion agreement. Costs were also higher due to the product design costs associated with the Company's conversion to a single leg cuff diaper in June of 1998. Costs will increase significantly in 1999 due to the payment of royalties in accordance with various licensing agreements included in the settlements of certain patent litigation with P&G and K-C. See "ITEM 3: LEGAL PROCEEDINGS" and "Risks and Uncertainties." Infant care raw material costs, primarily pulp and SAP, were at lower price levels in 1998 compared to 1997. Raw material prices, primarily pulp and SAP, are expected to increase in 1999. Product costs are expected to increase significantly during 1999 due to the increased price and utilization of SAP, the introduction of an improved Ultra diaper, which incorporates stretch tabs and a hook and loop closure system, and rising fluff pulp prices. See "Risks and Uncertainties." Infant care labor costs were lower during 1998 compared to 1997. The lower costs reflect increased manufacturing efficiencies including the use of automated packaging. Infant care overhead costs were lower during 1998 compared to 1997 due to cost management efforts. Labor costs are expected to increase during 1999 due to inefficiencies related to new product designs and product introductions. Infant care depreciation costs were $25.8 million in 1998 compared to $29.1 million in 1997. Feminine care and adult incontinence cost of sales were $18.6 million in 1998 compared to $20.4 million in 1997, a decrease of 4.1 percent. As a percentage of net sales, cost of sales was 281.8 percent in 1998 compared to 451.2 percent in 1997. Increased volume, lower labor and overhead costs resulting from cost management initiatives and the shut down of tampon-related production equipment were offset by an increase in depreciation to $4.7 million in 1998 from $2.3 million in 1997. Feminine care and adult incontinence cost of sales are expected to remain greater than net sales until volume is significantly increased to absorb existing manufacturing capacity. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE SG&A expenses were $78.4 million in 1998 compared to $76.3 million in 1997. As a percentage of net sales, these expenses were 14.6 percent in 1998 compared to 13.6 percent in 1997. The increase in costs is primarily attributable to an increase in trade merchandising expenses, incentive-based accruals, selling expenses and information system costs related to the Company's new information system installation, which is part of the Company's Year 2000 remediation project discussed below. These increased costs were partially offset by lower legal expenses, excluding bankruptcy costs, and packaging artwork and design costs. It is anticipated that SG&A expenses will increase significantly in 1999 due to increased marketing expenditures and packaging costs due to new product introductions. RESEARCH AND DEVELOPMENT Research and development expenses were $4.2 million in 1998 compared to $5.1 million in 1997. The decrease was primarily due to a reduction of infant care product development and testing in the second half of 1998. SETTLEMENT CONTINGENCIES The settlement contingencies of $78.5 million recorded in 1998 represent additional accruals for the balance of the estimated settlement costs of P&G's and K-C's claims in the Company's Chapter 11 reorganization proceeding, including the settlement of the P&G patent judgment and the K-C Texas action. The settlement contingency of $200 million in 1997 represents the accrual of the estimated liability and associated litigation costs from the adverse judgment in the P&G patent litigation. See "Notes 1 and 15 of Notes to Financial Statements" and "ITEM 3: LEGAL PROCEEDINGS" herein. Page 22 ASSET IMPAIRMENTS Asset impairments were $3.4 million in 1998 compared to $9.4 million in 1997. The 1998 asset impairment related to the Company's feminine care and adult incontinence business tampon manufacturing line which was removed from service in early 1998 and is currently held for sale. The 1997 asset impairments included a $5.0 million write-off of software and associated consulting costs related to the Company's enterprise-wide information system installation, which was charged to the corporate and other segment. The write-off was due to the inability of the software to perform as represented during the software selection process. The Company is currently evaluating its options, including legal action, to recover the costs of the software and consulting. Also included in 1997 was a write-down of $4.4 million for the shut down of the feminine care and adult incontinence business' tampon-related production equipment. In conjunction with the shut down of the tampon manufacturing operation write-offs of $.9 million were taken for raw material, finished goods and spare-part inventories which were charged to cost of sales. INTEREST EXPENSE Interest expense was $.5 million in 1998 compared to $4.7 million in 1997. The decrease resulted from the suspension of interest on the Company's prepetition credit facilities due to the Chapter 11 filing. There were no direct borrowings under the DIP Credit Facility during 1998. 1997 included interest on approximate average borrowings of $80.2 million under the prepetition revolving credit facility and lines of credit. EQUITY IN EARNINGS OF UNCONSOLIDATED SUBSIDIARIES The equity in earnings of unconsolidated subsidiaries, which is included in the corporate and other segment, was $4.1 million in 1998 compared to $1.0 million in 1997. The increase primarily reflects improved operating results of PMI and earnings of Stronger Corporation S.A. DIVIDEND INCOME Dividend income of $.9 million was recorded in 1998 compared to $1.1 million in 1997. The dividend represented a distribution from Mabesa, an unconsolidated subsidiary accounted for using the cost method and included in the corporate and other segment. BANKRUPTCY COSTS Bankruptcy costs were $6.3 million during 1998. These costs were primarily related to professional fees and are expected to continue at similar levels until the Company emerges from Chapter 11 protection. The Company cannot predict at this time when it will emerge from Chapter 11 protection. See "--RISKS AND UNCERTAINTIES." INCOME TAXES Income tax expense was $8.1 million in 1998 as the Company recorded a reserve of $32.9 million against its net deferred and other tax-related assets. The reserve is necessary as the utilization of the Company's loss carryforwards is dependent upon sufficient future taxable income to offset the loss carryforwards. See "FUTURE REALIZATION OF NET DEFERRED TAX ASSET." YEAR ENDED DECEMBER 28, 1997 VS. YEAR ENDED DECEMBER 29, 1996 RESULTS OF OPERATIONS A net loss of $212.7 million was incurred during 1997 compared with net earnings of $21.1 million in 1996. Included in the results for 1997 was an accrued settlement contingency of $200 million for the P&G patent litigation judgment and associated litigation costs. See "Notes 1 and 15 of Notes to Financial Statements" and "ITEM 3: LEGAL PROCEEDINGS" herein. Also included in the results for 1997 were asset impairments and other write-offs totaling $10.6 million related to the write-off of software and consulting costs related to the enterprise-wide information system installation and discontinuation of the Company's tampon production. The Page 23 total of the settlement contingency and asset impairments was $129.5 million, net of the effect of income taxes. The results in 1997 were also negatively impacted by a reserve of $100.2 million taken against the Company's net deferred and other tax-related assets. Included in the results in 1996 were charges of $10.6 million, net of the effect of income taxes, associated with integrating the acquisition of Pope & Talbot and costs to relocate the corporate headquarters to Atlanta. Excluding charges discussed here and in the preceding paragraph, net earnings in 1997 were $17.0 million compared to $31.7 million in 1996. This decrease in profits in 1997 compared to 1996 was primarily due to continued price pressure in the infant care business, operating losses associated with the feminine care and adult incontinence business, sourcing of products from PMI under a supply contract and legal costs associated with patent litigation with P&G and K-C. See "ITEM 3: LEGAL PROCEEDINGS." These negative impacts were partially offset by lower overall raw material prices, lower trade merchandising expenses and lower manufacturing overhead in the infant care business. Basic loss per share in 1997 was $17.86 compared to basic earnings per share of $1.76 in 1996. Basic earnings per share was $1.43 in 1997 compared to $2.64 in 1996, excluding the charges discussed above for both periods. Infant care operating loss totaled $155.0 million in 1997 compared to an operating profit of $52.8 million in 1996. The $200.0 million settlement contingency in 1997 discussed above and $8.1 million of costs associated with the integration of the Pope & Talbot acquisition in 1996, materially impacted infant care operating results. Excluding the settlement contingency and integration costs, infant care operating profits were $45.0 million compared to $60.9 million in 1996. Reduced selling price and volume and higher product costs were the major factors contributing to this decline. Feminine care and adult incontinence operating loss totaled $23.7 million in 1997 compared to $8.0 million in 1996. 1997 operating loss includes an asset impairment and other charges of $4.4 million related to the discontinuation of the tampon manufacturing operation. 1997 was the first full year of operation for the feminine care and adult incontinence business. NET SALES Overall net sales were $562.0 million in 1997, a 3.4 percent decrease from the $581.9 million reported in 1996. Infant care net sales decreased 5.0 percent to $545.2 in 1997 from $574.3 million in 1996. Infant care unit sales decreased 1.9 percent from 3,689 million diapers in 1997 compared to 3,761 million diapers in 1996. Infant care volume in the first half of 1997 was negatively impacted by increased discounts and promotional allowances by the branded manufacturers and value segment competitors, especially the use of multi-packs. Infant care volume was also further negatively impacted during the same period by product improvements added by the branded manufacturers. Infant care volume during the second half of 1997 was positively impacted by the rollout of the Company's breathable baby diaper product which increased the competitiveness of the Company's products. Infant care volume, however, was negatively impacted during the second half of the year by the loss of a major customer in Canada. Excluding the effect of a more favorable product mix, average infant care sales prices during 1997 decreased approximately 5.0 percent compared to 1996, despite price increases associated with reduced count packages on some of the Company's products. The decrease in prices was primarily due to the increased discounts and promotional allowances discussed above, the use of multi-packs by the branded manufacturers and value segment competitors and the existence of a new competitor to the store brand baby diaper business. Feminine care and adult incontinence sales increased to $4.3 million in 1997. Sales were negligible in 1996. Corporate and other net sales increased to $12.5 million in 1997 from $7.1 million in 1996 and relate to Changing Paradigms. Page 24 COST OF SALES Overall cost of sales in 1997 was $454.9 million compared to $449.9 million in 1996, a 1.1 percent increase. As a percentage of net sales, cost of sales was 80.9 percent in 1997 compared to 77.3 percent in 1996. Infant care cost of sales was $423.4 million in 1997 compared to $438.7 million in 1996. As a percentage of net sales, infant care cost of sales was 77.8 percent in 1997 compared to 76.4 percent in 1996. 1996 included $5.4 million in charges for costs primarily associated with the integration of the acquisition of Pope & Talbot into the Company's existing business. As a percentage of net sales, excluding such charges, infant care cost of sales was 75.5 percent in 1996. Costs were higher in 1997 compared to 1996 due to the sourcing of products from PMI under a supply contract, a higher cost product mix and higher product design costs associated with the breathable baby diaper product introduction. These higher costs were partially offset by lower overall raw material and packaging costs. Pulp prices were approximately 7 percent lower in 1997 compared to 1996. Packaging costs, including bags and corrugated boxes, were also lower in 1997 compared to 1996. Other raw material prices were generally at similar price levels in 1997 compared to 1996, except for those materials associated with the higher product design costs associated with the breathable baby diaper product. Infant care labor costs were lower in 1997 compared to 1996. The higher costs of inefficiencies related to the new product rollouts during the first half of 1997 were more than offset by improved operating results during the second half of the year. Infant care overhead costs, excluding the charges discussed below, were lower during 1997 compared to 1996 due to the closure during 1996 of the manufacturing facilities acquired from Pope & Talbot and cost management efforts. During 1996, $2.9 million of charges were incurred to support the integration of the acquisition of Pope & Talbot. Infant care depreciation costs, excluding charges discussed below, were $29.1 million in 1997 compared to $36.5 million in 1996. The decrease is partially due to the closure during 1996 of the acquired Pope & Talbot facilities. Depreciation costs were higher in 1996 due to accelerated depreciation attributable to obsolescence caused by product innovations. During 1996, $1.6 million of charges were incurred due to the accelerated depreciation of existing infant care equipment that was to be replaced by equipment acquired from Pope & Talbot. Feminine care and adult incontinence cost of sales was $20.4 million in 1997 compared to $4.7 million in 1996. Operating inefficiencies due to the start-up nature of this operation resulted in a cost of sales significantly in excess of net sales in 1997 and 1996. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES SG&A expenses were $76.3 million in 1997 compared to $92.2 million in 1996. As a percentage of net sales, these expenses were 13.6 percent in 1997 compared to 15.8 percent in 1996. Included in 1996 were charges of $11.7 million, of which $9.0 million related to the corporate headquarters relocation to Atlanta, including severance, outplacement and relocation expenses. The charges also included $2.7 million in costs associated with the integration of the Pope & Talbot acquisition. Excluding the charges discussed above, SG&A expenses were $76.3 million in 1997 compared to $80.5 million in 1996. As a percentage of net sales, these expenses, excluding the charges, were 13.6 percent in 1997 compared to 13.8 percent in 1996. The decrease in costs was primarily attributable to a decrease in trade merchandising expenses, lower incentive-based compensation accruals and lower bad debt expenses. These decreases were partially offset by an increase in legal expenses, packaging artwork and design and information system costs. The lower trade merchandising expenses were primarily related to a decrease in coupon-related expenses. The increase in legal expenses was related to the P&G and K-C patent litigation. See "ITEM 3: LEGAL PROCEEDINGS." Information system costs were higher in 1997 compared to 1996. Packaging artwork and design costs in infant care were higher during 1997 compared to 1996 as a result of product rollouts and changes Page 25 in package counts. Lower incentive-based compensation accruals resulted from lower operating results for 1997 compared to 1996. RESEARCH AND DEVELOPMENT Research and development expenses were $5.1 million in 1997 compared to $4.2 million in 1996. The increase was primarily attributable to a general increase in infant care product development activity and increased feminine care and adult incontinence business activity. DIVIDEND INCOME Dividend income of $1.1 million was recorded in 1997. The dividend represented a distribution from Mabesa, an unconsolidated subsidiary accounted for using the cost method, and is included in the corporate and other segment. SETTLEMENT CONTINGENCY The settlement contingencies of $200 million in 1997 represents the accrual of the estimated liability and associated litigation costs from the adverse judgment in the P&G patent litigation. See "Notes 1 and 15 of Notes to Financial Statements" and "ITEM 3: LEGAL PROCEEDINGS" herein. ASSET IMPAIRMENTS Asset impairments were $9.4 million in 1997. There were no asset impairments in 1996. The 1997 asset impairments included a $5.0 million write-off of software and associated consulting costs related to the Company's enterprise-wide information system installation, which was charged to the corporate and other segment. The write-off was due to the inability of the software to perform as represented during the software selection process. The Company is currently evaluating its options, including legal action, to recover the costs of the software and consulting. Also included in 1997 was a write-down of $4.4 million for the shut down of the feminine care and adult incontinence business' tampon-related production equipment. Also included in the shut down of the tampon manufacturing operation were write-offs of $.9 million for raw material, finished goods and spare-part inventories which were charged to cost of sales. INTEREST EXPENSE Interest expense was $4.7 million in 1997 compared to $2.9 million in 1996. The increase resulted from higher average borrowings during 1997. OTHER INCOME The corporate and other segment reported income of $1.7 million in 1997 compared to $.6 million in 1996. The increase reflects higher interest income from loans to PMI, an unconsolidated subsidiary accounted for on the equity method. INCOME TAXES Income tax expense was $27.9 million in 1997 as the Company recorded a reserve of $100.2 million against its net deferred and other tax-related assets. The reserve is necessary as the utilization of the Company's loss carryforwards is dependent upon sufficient future taxable income to offset the loss carryforwards. See "FUTURE REALIZATION OF NET DEFERRED TAX ASSET." LIQUIDITY AND CAPITAL RESOURCES During 1998, cash flow from earnings and noncash charges to earnings was $60.7 million compared to $54.1 million in 1997. Cash flow was negatively impacted by reduced infant care operating profits and continues to be negatively impacted by operating losses in the feminine care and adult incontinence business. Working capital, exclusive of cash, short-term borrowings, current deferred taxes and the settlement contingencies decreased $6.1 million. 1998 cash flow Page 26 was positively impacted by an increase of approximately $37.6 million in postpetition accounts payable and checks issued but not cleared. Cash flow was also positively impacted by a $6.8 million increase in accrued liabilities, primarily related to incentive-based compensation accruals. Cash flow has been negatively impacted by a $16.0 million increase in receivables primarily due to an electronic billing issue related to a few large customers which has subsequently been resolved. Cash was also used by an increase in finished goods and prepaid expenses, primarily prepaid insurance and deposits to suppliers due to the bankruptcy proceedings. The Company expects the feminine care and adult incontinence business to continue to generate operating losses and to use cash throughout 1999. The cash produced from operations supported capital expenditures of $37.3 million and $55.0 million in 1998 and 1997, respectively. These capital expenditures include approximately $9.0 million and $5.6 million in 1998 and 1997, respectively, of computer software and consulting costs related to the installation of a new business information system, which is a primary component of the Company's Year 2000 remediation efforts discussed below. Capital spending is expected to be approximately $46.0 million in 1999, which the Company expects will be funded through a combination of internally-generated funds and borrowings under the DIP Credit Facility. Cash produced from operations supported the initial investment of $4.0 million in the Company's Goodbaby joint venture in China and additional consideration payments of $2.8 million to Mabesa and $.6 million to Serenity based on their previous year's performance. In connection with the Chapter 11 filing, on January 30, 1998, the Bankruptcy Court entered a Final Order approving the DIP Credit Facility as provided under the Revolving Credit and Guarantee Agreement dated as of January 7, 1998, among the Company, as Borrower, certain subsidiaries of the Company, as guarantors, and a bank group led by The Chase Manhattan Bank ("Chase"). Pursuant to the terms of the DIP Credit Facility, as amended by the First Amendment dated January 30, 1998, the Second Amendment dated March 23, 1998, the Third Amendment dated April 15, 1998 and the Fourth Amendment dated September 28, 1998, Chase and a syndicate of banks has made available to the Company a revolving credit and letter of credit facility in an aggregate principal amount of $75 million. The Company's maximum borrowing under the DIP Credit Facility may not exceed the lesser of $75 million or an available amount as determined by a borrowing base formulation. The borrowing base formulation is comprised of certain specified percentages of eligible accounts receivable, eligible inventory, equipment and personal and real property of the Company. The DIP Credit Facility has a sublimit of $10 million for the issuance of letters of credit. The DIP Credit Facility expires on the earlier of July 7, 1999, or the date of entry of an order by the Bankruptcy Court confirming a plan of reorganization. The Company is currently negotiating an extension of the maturity date of the DIP Credit Facility. Obligations under the DIP Credit Facility are secured by the security interest, pledge and lien on substantially all of the Company's assets and properties and the proceeds thereof, granted pursuant to the Final Order under Sections 364(c)(2) and 364(c)(3) of the Bankruptcy Code. Borrowings under the DIP Credit Facility may be used to fund working capital and for other general corporate purposes. The DIP Credit Facility contains restrictive covenants, including among other things, limitations on the creation of additional liens and indebtedness, limitations on capital expenditures, limitations on transactions with affiliates including investments, loans and advances, the sale of assets, and the maintenance of minimum earnings before interest, taxes, depreciation, amortization and reorganization items, as well as a prohibition on the payment of dividends. The DIP Credit Facility provides that advances made will bear interest at a rate of 0.5 percent per annum in excess of Chase's Alternative Base Rate, or at the Company's option, a rate of 1.5 percent per annum in excess of the reserve adjusted London Interbank Offered Rate for the interest periods of one, two or three months. The Company pays a commitment fee of 0.5 percent per annum on the unused portion thereof, a letter of credit fee equal to 1.5 percent per annum of average outstanding letters of credit and certain other fees. The Company may utilize, in accordance with certain covenants, its DIP Credit Facility for continued investments in its foreign subsidiaries. The DIP Credit Facility, in combination with internally-generated funds, is anticipated to be adequate to finance these investments and the Company's 1999 capital expenditures. At December 27, 1998, there were no outstanding direct borrowings under the DIP Credit Facility. The Company had an aggregate of $1.3 million in letters of credit issued under the DIP Credit Facility at December 27, 1998. The DIP Credit Facility contains customary covenants. The Company for a period of time has been unable to fully comply with certain reporting requirements of such covenants. The Company has obtained waivers with Page 27 respect to these events of default which are effective through May 10, 1999. The Company believes that it will be in compliance with the reporting requirements of the DIP Credit Facility by May 10, 1999. See "Note 12 of Notes to Financial Statements." At December 28, 1997, the Company maintained a $150 million revolving credit facility with a group of nine financial institutions available through February 2001. At December 28, 1997, borrowings under this credit facility totaled $70 million. The Company also had access to short-term lines of credit on an uncommitted basis with several major banks. At December 28, 1997, the Company had approximately $50 million in uncommitted lines of credit. Borrowings under these lines of credit totaled $12.8 million at December 28, 1997. As a result of the Chapter 11 filing, the Company is prohibited from paying any prepetition liabilities without Bankruptcy Court approval. The Chapter 11 filing resulted in a default under the Company's prepetition revolving credit facility and its borrowings under uncommitted lines of credit. See "Note 12 of Notes to Financial Statements." FUTURE REALIZATION OF NET DEFERRED TAX ASSET The Company accounts for income taxes based on the liability method and, accordingly, deferred income taxes are provided to reflect temporary differences between financial and tax reporting. Significant components of deferred income taxes include temporary differences due to goodwill ($7.2 million) and reserves not currently deductible ($113.5 million). To realize the full benefit of the deferred tax asset, the Company needs to generate approximately $343.0 million in future taxable income before considering the availability of carryback periods, if any. The Company currently has fully reserved its net deferred tax asset of $131.9 million. See "--Income Taxes." YEAR 2000 The "Year 2000 issue" is generally defined as the inability of computer hardware, software and embedded systems to properly recognize and process date-related information for dates after December 31, 1999. The Company began its efforts to address this problem as early as 1995. The Company's efforts generally are separated into three areas: (i) business information systems ("Business Systems"), (ii) non-information technology systems, including real estate facilities and manufacturing equipment ("Infrastructure Systems"), and (iii) vendors, suppliers, customers and third party information interfaces ("Third Party Dependencies"). The Company has established a formal "Y2K Project Office" to assess, manage and implement its Year 2000 activities. The Company has also established a formal "Y2K Steering Committee" to oversee the Company's Year 2000 efforts, including the efforts of the Project Office. The Company has also engaged Deloitte Consulting/ICS to assist with implementation of certain Year 2000 related Business Systems and the GartnerGroup to assist with its Year 2000 efforts for Infrastructure Systems and Third Party Dependencies. THE COMPANY'S STATE OF READINESS Most of the Year 2000 issues arising with respect to the Business Systems of the Company have been addressed by replacement of the majority of those systems with SAP R/3 enterprise resource planning software. The SAP software was implemented and operating at the Company's corporate headquarters and in its U.S. infant care plants in early November of 1998 and is warranted to be Year 2000 compliant by its manufacturer. The SAP implementation should help significantly minimize any Year 2000 related disruptions for approximately 80 percent of the Company's Business Systems at those locations. The Company estimates that the SAP implementation and its other Year 2000 efforts thus far have addressed 75 percent of the critical Year 2000 exposures related to its Business Systems as a whole. The remaining systems are being addressed and are expected to be fully assessed, remediated or replaced, tested and implemented prior to the fourth quarter of 1999. With respect to Business Systems that will not be addressed by the overall SAP implementation, the Company is currently addressing certain issues with certain of its desktop computer operating systems. Approximately half of the desktop computers used by the Company have currently been addressed and the Company expects to complete the remaining half by the end of the second quarter of 1999. Overall, the Company currently anticipates completion of remediation and testing of all of its critical Business Systems by the end of the third quarter of 1999. Page 28 The Company has engaged the GartnerGroup to evaluate and analyze the Company's overall Year 2000 preparedness. The Company has received formal reports from the GartnerGroup and has initiated remediation/replacement procedures for certain processes and systems identified in such reports. The Company has also internally evaluated certain of its Infrastructure Systems for Year 2000 related problems. These systems include the manufacturing capacity for the Company's products and are therefore critical to the Company's ability to produce products and realize revenue from sales. The manufacturing capacity of the Company includes any number of automated systems which may include embedded chips that are difficult to identify and remediate in the event of Year 2000 related problems. While difficult to assess, evaluation of these systems currently indicates that the Company should not encounter Year 2000 related problems that would significantly affect the Company's ability to manufacture products. As part of the evaluation process, the Company has surveyed critical machinery, equipment and systems suppliers, and significant product and service vendors for its material real estate facilities and security systems. Responses to such surveys have not indicated any problems which, taken on their own, should materially adversely affect the Company's ability to manufacture products. The Company is continuing to follow up with suppliers and vendors who have not yet responded to the survey and has also addressed Infrastructure Systems in its contingency planning process. Year 2000 problems with respect to certain material customers that prevent the taking or filling of orders for products or interfere with the collections process could have a material impact on the Company's revenues. Approximately 80 percent of the Company's orders for products are delivered via electronic data interchange facilities ("EDI"). The SAP implementation is designed to address Year 2000 related issues for Company systems required for these EDI exchanges, but the Company is not able to control the EDI facilities of its customers. The Company surveyed its customer base as to their EDI facilities and their overall Year 2000 state of preparedness during the fourth quarter of 1998. The Company has received survey responses from customers who, in the aggregate, represent more than 90 percent of its 1998 revenues. The Company has also conducted Year 2000 testing of EDI with approximately 60 percent of those customers. Neither the survey results nor the testing revealed significant Year 2000 related problems which would materially impair the Company's ability to conduct EDI exchanges with its customers, although such testing should not be considered a conclusive indicator of how EDI exchanges will perform in the future. The Company is attempting to obtain survey responses from those material customers who have not yet responded and conduct testing with those remaining material customers with whom it has not yet tested prior to the end of the third quarter of 1999. The Company has also prepared an inventory and surveyed those vendors, service providers and raw materials suppliers that may have a material impact on the Company in the event of Year 2000 problems. Approximately 60 percent of the suppliers surveyed have responded and have not indicated any anticipated Year 2000 problems which, taken on their own, should significantly adversely affect operations critical to the Company's ability to realize revenues. The Company is continuing to follow up with suppliers who have not yet responded to the survey and is otherwise addressing related issues in its contingency planning process. Contingency planning for Business Systems, Infrastructure Systems and Third Party Dependencies was substantially completed during the first quarter of 1999. This process attempted to address critical Year 2000 issues presently known to the Company and other currently unanticipated (but reasonably possible) internal and external Year 2000 related events that may have a material impact on the Company's ability to conduct its operations. The Company expects to continue to revise these contingency plans as circumstances dictate during 1999. COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES The total costs associated with required modifications to address Year 2000 related issues for the Company is expected to be material to the Company's financial position. The cost of the project through December 27, 1998 was $18.6 million, all of which was related to the SAP implementation. It is not possible to identify what portion of the total SAP cost is attributable to the Year 2000 remediation. The Company planned to implement an enterprise resource planning system for its Business Systems, regardless of Year 2000 issues with respect to its former Business Systems. The future cost of the Year 2000 project is estimated to be approximately $5.0 million. All of the costs are expected to be funded through operating cash flow and/or bank borrowings. Page 29 RISKS PRESENTED BY YEAR 2000 ISSUES The Year 2000 presents a number of risks and uncertainties that could affect the Company. These include, but are not limited to, failure of the Company to identify and address material issues associated with non-SAP related Business Systems or with its Infrastructure Systems, failure or inability of customers to place orders for Year 2000 related reasons, failure of necessary raw materials manufacturers to deliver their products to the Company in a timely fashion and the inability of either the Company to collect its receivables or its customers to process payments for goods. Survey responses submitted to the Company may also be inaccurate or incomplete; however, the Company currently believes that the SAP implementation and completion of the Year 2000 project as scheduled will reduce the incidence and severity of Year 2000 related disturbances in systems that are within the control of the Company. The Company also has certain financial investments in foreign joint ventures. If the operations of these joint ventures were significantly affected by Year 2000 related issues, such could have a material adverse impact on the Company's results of operations and its financial position. Information currently known to the Company indicates that internal operations of these joint ventures should not be materially adversely affected by Year 2000 related issues; however, the Company is attempting to further confirm this information. Problems in public utilities and infrastructure systems such as power supply, telecommunications, transportation and other possible disturbances related to the Year 2000 in the United States and abroad may have unexpected, material impacts on the Company's ability to do business in the normal course and therefore may also have a material adverse impact on the Company's results of operations and financial position. Public infrastructure and utility systems outside of the United States are widely reported to be less adequately prepared than similar systems in the United States. Any combination of the foregoing risks or other adverse Year 2000 related events which would not in and of themselves constitute a material adverse event may, in the aggregate, materially and adversely affect the Company's results of operations, liquidity and overall financial position. All statements made herein regarding the Company's Year 2000 efforts are Year 2000 Readiness Disclosures made pursuant to the Year 2000 Information and Readiness Disclosure Act and, to the extent applicable, are entitled to the protections of such act. RISKS AND UNCERTAINTIES INCREASED COSTS. As a part of the License Agreements entered into in connection with the Company's settlements with P&G and K-C, the Company will incur significant added costs in the form of running royalties payable to both parties for sales of the licensed diaper and training pant products. While the Company believes that the royalties being charged by P&G and K-C under their respective License Agreements are approximately the same royalties that will be paid by the Company's major store brand competitors for similar patent rights, the royalties will have a material adverse impact on the Company's future financial condition and results of operations. While these royalty costs are expected to be partially offset by projected raw material cost savings related to the conversion to a dual cuff product, the Company's overall raw material costs are expected to increase. These royalties are also expected to be partially offset by the price increases discussed below to the extent such increases are realized. In addition, as a part of the License Agreement entered into in connection with the K-C Settlement Agreement, the Company had to change to a new SAP for its diapers and training pants which exhibits certain performance characteristics. The Company has experienced product performance issues which it believes have impacted volume for the first quarter of 1999. As a result, the Company expects that it will incur increased marketing and SG&A expenditures in 1999 to address product performance issues. These increased expenditures are expected to have a material adverse impact on the Company's financial position and results of operations in 1999. The Company is encountering increased product costs due to the increased price and usage of the new SAP. While the Company is working diligently with its SAP suppliers to develop a better performing alternative, the Company cannot predict at this time whether or when such an alternative SAP will be available. The Company expects that these increased product costs will have a material adverse impact on its financial condition and results of operations for at least 1999 and potentially beyond. Page 30 REORGANIZATION. The ability of the Company to effect a successful reorganization will depend, in significant part, upon the Company's ability to formulate a plan of reorganization that is approved by the Bankruptcy Court. The Company cannot predict at this time the effect of the material adverse impact related to the increased costs described above on the Company's enterprise valuation and on the Company's ability to timely formulate a plan of reorganization. The Company believes, however, that it may be impossible to satisfy in full all of the claims against the Company. Investment in securities of, and claims against, the Company, therefore, should be regarded as highly speculative. As a result of the Chapter 11 filing, the Company has incurred and will continue to incur significant costs for professional fees as the reorganization plan is developed. The Company is also required to pay certain expenses of the Committees, including professional fees, to the extent allowed by the Bankruptcy Court. The Company is unable to predict at this time when it will emerge from Chapter 11 protection. See "ITEM 1: BUSINESS: REORGANIZATION CASE." TERMINATION OF LICENSE AGREEMENTS. The License Agreements with each of P&G and K-C provide that if the related Settlement Agreements are not approved, as specified in each respective agreement, by July 31, 1999 and August 1, 1999, respectively, the P&G License Agreements will become terminable at P&G's option and the K-C License Agreement will terminate automatically. If the P&G and K-C License Agreements are terminated because the respective Settlement Agreements are not approved in a timely manner, the Company could be faced with having to convert to a diaper design other than the dual cuff design covered by the licenses. At this time, the Company's only viable alternative product design is the single cuff product which is the subject of P&G's Contempt Motion in Delaware. While the Company intends to vigorously pursue approval of both settlements, it cannot predict when, or if, such approval will be granted. See "ITEM 3: LEGAL PROCEEDINGS." PRICING. The Company announced in the fourth quarter of 1998 that it would implement a price increase of 5 percent. A significant part of this price increase is required to offset the increased costs of certain of the Company's infant care product designs. Additional price increases are needed to fully offset the added royalty cost to be incurred by the Company pursuant to the P&G and K-C settlements described above. Should the Company not be able to realize these price increases, its margins are expected to continue to be negatively impacted. REALIZATION OF INVESTMENT IN FEMININE CARE AND ADULT INCONTINENCE BUSINESS. Given the slow start up of the feminine care and adult incontinence business, which was exacerbated by the Company's Chapter 11 filing, and given the resulting feminine care and adult incontinence losses, the Company's ability to recover its investment in such business is highly uncertain. The Company's ability to recover its investment is dependent upon a prompt emergence from Chapter 11 and the successful execution of the Company's feminine care and adult incontinence business plan. The Company believes that the P&G and K-C Settlement Agreements will provide the cornerstone for what it intends to be a consensual plan of reorganization. The Company cannot predict at this time, however, when it will emerge from Chapter 11 protection. The Company believes that once it emerges from Chapter 11 the feminine care and adult incontinence business will see an increase in sales and improved results. The Company cannot predict, however, whether or when such improved results will be realized. MARKET FOR THE COMPANY'S COMMON STOCK. During 1998, the Company was notified by the New York Stock Exchange ("NYSE") that as a result of the $200 million settlement contingency and the Company's net loss in 1997, certain minimum listing requirements had not been maintained. After a review of the Company's business and prospects, the NYSE agreed to continue the Company's listing subject to future developments. There can be no assurances that the NYSE will continue to list the Company's stock. BRANDED PRODUCT INNOVATIONS. Because of the emphasis on product innovations in the disposable diaper, feminine care and adult incontinence markets, patents and other intellectual property rights are an important competitive factor. The national branded manufacturers have sought to vigorously enforce their patent rights. Patents held by the national branded manufacturers could severely limit the Company's ability to keep up with branded product innovations by prohibiting the Company from introducing products with comparable features. P&G and K-C have also heavily promoted diapers in the multi-pack configuration. These packages offer a lower unit price to the retailer and consumer. It is possible that the Company may continue to realize lower selling prices and/or lower volumes as a result of these initiatives. Page 31 FORWARD-LOOKING STATEMENTS From time to time, information provided by the Company, statements made by its employees or information included in its filings with the Securities and Exchange Commission (including the Annual Report on Form 10-K) may include statements that are not historical facts, so-called "forward-looking statements." The words "believes," "anticipates," "expects" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in the Company's forward-looking statements. Factors which could affect the Company's financial results, including but not limited to: the Company's Chapter 11 filing; increased raw material prices and product costs; new product and packaging introductions by competitors; increased price and promotion pressure from competitors; year 2000 compliance issues; and patent litigation, are described herein. Readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date hereof, and which are made by management pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. NEW ACCOUNTING STANDARDS The Financial Accounting Standards Board has issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which must be adopted by the Company's fiscal year 2000. This statement establishes accounting and reporting standards for derivative instruments - including certain derivative instruments embedded in other contracts - and for hedging activities. Adoption of this statement is not expected to have a material impact on the Company's financial statements. In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued a new Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This statement requires capitalization of certain costs of internal-use software. The Company adopted this statement in the first fiscal quarter of 1999, and it did not have a material impact on the financial statements. In April 1998, the AICPA issued a new Statement of Position 98-5, "Reporting on the Costs of Start-up Activities." This statement requires that the costs of start-up activities and organizational costs be expensed as incurred. Any of these costs previously capitalized by a company must be written off in the year of adoption. The Company adopted this statement in the first fiscal quarter of 1999, and it did not have a material impact on the financial statements. INFLATION Inflation has not been a significant factor in the Company's results of operations in recent years due to the modest rate of price increases in the United States and Canada. ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company's market risk-sensitive instruments and foreign currency exchange rate risks do not subject the Company to material market risk exposures. Page 32 ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS AND SCHEDULES PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES: PAGE Responsibility for Financial Reporting 34 Report of Independent Public Accountants 35 Consolidated Earnings (Loss) Statements for the three years in the period ended December 27, 1998 37 Consolidated Balance Sheets as of December 27,1998 and December 28, 1997 38 Consolidated Statements of Cash Flows for the three years in the period ended December 27, 1998 39 Consolidated Statements of Comprehensive Income for the three years in the period ended December 27, 1998 40 Consolidated Statements of Changes in Shareholders' Equity for the three years in the period ended December 27, 1998 41 Notes to Financial Statements 42 Financial Statement Schedule Schedule II - Valuation and Qualifying Accounts 68 Page 33 RESPONSIBILITY FOR FINANCIAL REPORTING Management is responsible for the preparation of the Company's consolidated financial statements appearing in this Annual Report. The financial statements have been prepared in accordance with generally accepted accounting principles and, in the opinion of management, present fairly the Company's financial position, results of operations and cash flows. The financial statements necessarily contain amounts that are based on the best estimates and judgments of management. The Company maintains a system of internal controls which management believes is adequate to provide reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition and the prevention and detection of fraudulent financial reporting. The selection and training of qualified personnel, the establishment and communication of accounting and administrative policies and procedures, and a program of internal audit are important elements of these control systems. The Company maintains a strong internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. Management has considered the internal auditors' recommendations concerning the Company's system of internal controls and has taken actions that management believes are cost-effective in the circumstances to respond appropriately to these recommendations. The Audit Committee of the Board of Directors, comprised entirely of outside directors, oversees the fulfillment by management of its responsibilities over financial controls and the preparation of financial statements. The Committee meets regularly with representatives of management and internal and external auditors to review accounting, auditing and financial reporting matters. As part of their audit of the Company's consolidated financial statements, Arthur Andersen LLP considered the Company's system of internal controls to the extent they deemed necessary to determine the nature, timing and extent of their audit tests. Alan J. Cyron Executive Vice President & Chief Financial Officer Page 34 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders of Paragon Trade Brands, Inc.: We have audited the accompanying consolidated balance sheets of Paragon Trade Brands, Inc., a Delaware Corporation, and subsidiaries, as of December 27, 1998 and December 28, 1997, and the related consolidated statements of earnings (loss), comprehensive income (loss), changes in shareholders' equity (deficit) and cash flows for each of the three years in the period ended December 27, 1998. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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, the financial statements referred to above present fairly, in all material respects, the financial position of Paragon Trade Brands, Inc. and subsidiaries as of December 27, 1998 and December 28, 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 27, 1998, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Notes 1 and 15 to the accompanying financial statements, on December 30, 1997, the District Court for the District of Delaware issued a judgment (the "Judgment") finding that the Company's diaper products infringe certain patents held by The Procter & Gamble Company ("P&G"). Also, as more fully described in Notes 1 and 15 to the accompanying financial statements, on January 6, 1998, the Company filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code. On February 2, 1999, the Company entered into a settlement agreement with P&G which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Judgment. In addition, as more fully described in Notes 1 and 15 to the accompanying financial statements, on October 26, 1995, the Kimberly-Clark Corporation ("K-C") filed a lawsuit against the Company alleging infringement by the Company's products of certain patents held by K-C. On March 19, 1999, the Company entered into a settlement agreement with K-C which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to K-C's lawsuit against the Company. The Company has recorded litigation settlement losses related to the P&G and K-C matters discussed above of $278,500,000. After giving effect to these losses, the Company has a total shareholders' deficit of $61,840,000 as of December 27, 1998. These matters, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters, including its intent to file a plan of reorganization that will be acceptable to the Bankruptcy Court and to the Company's creditors, are also described in Notes 1 and 15 to the accompanying financial statements. In the event a plan of reorganization is accepted, continuation of the business thereafter is dependent upon the Company's ability to achieve successful future operations. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. Page 35 Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedule listed in the index to financial statements and schedules is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. Arthur Andersen LLP Atlanta, Georgia April 9, 1999 Page 36 PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) CONSOLIDATED EARNINGS (LOSS) STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Year Ended -------------------------------------------------------------- December 27, 1998 December 28, 1997 December 29, 1996 ----------------- ----------------- ----------------- Sales, net of discounts and allowances $ 535,207 $ 561,975 $ 581,929 Cost of sales 428,572 454,911 449,885 ---------- ----------- ----------- Gross profit 106,635 107,064 132,044 Selling, general and administrative expense 78,447 76,347 92,212 Research and development expense 4,248 5,063 4,163 Asset impairments 3,416 9,442 - Settlement contingencies (Notes 1 and 15) 78,500 200,000 - ---------- ----------- ----------- Operating profit (loss) (57,976) (183,788) 35,669 Equity in earnings of unconsolidated subsidiaries 4,077 953 423 Dividend income from unconsolidated subsidiary 922 1,055 - Interest expense(1) 450 4,667 2,864 Other income, net 2,437 1,664 581 ---------- ----------- ----------- Earnings (loss) before income taxes and bankruptcy costs (50,990) (184,783) 33,809 Bankruptcy costs 6,302 - - Provision for income taxes 8,091 27,934 12,687 ---------- ----------- ----------- Net earnings (loss) $ (65,383) $ (212,717) $ 21,122 ========== =========== =========== Basic earnings (loss) per common share $ (5.48) $ (17.86) $ 1.76 ========== =========== =========== Diluted earnings (loss) per common share $ (5.48) $ (17.86) $ 1.74 ========== =========== =========== Dividends paid $ - $ - $ - ========== =========== =========== - --------------- (1) Contractual interest $ 5,836 ==========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. Page 37 PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) CONSOLIDATED BALANCE SHEETS (DOLLAR AMOUNTS IN THOUSANDS)
December 27, 1998 December 28, 1997 ----------------- ----------------- ASSETS Cash and short-term investments $ 22,625 $ 991 Receivables 79,156 70,616 Inventories 53,282 48,257 Current portion of deferred income taxes 4,260 1,800 Prepaid expenses 4,323 697 --------- --------- Total current assets 163,646 122,361 Property and equipment, net 106,200 118,383 Construction in progress 19,626 11,154 Assets held for sale 4,691 11,073 Investment in unconsolidated subsidiary at cost 22,743 19,964 Investment in and advances to unconsolidated subsidiaries, at equity 66,041 53,844 Goodwill 32,819 34,739 Other assets, net 13,521 4,624 --------- --------- Total assets $ 429,287 $ 376,142 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Short-term borrowings $ - $ 14,185 Checks issued but not cleared 12,433 9,375 Accounts payable 32,416 40,305 Accrued liabilities 33,646 32,392 Accrued settlement contingency (Notes 1, 15 and 16) - 200,000 --------- --------- Total current liabilities 78,495 296,257 Liabilities subject to compromise 406,859 - Long-term debt - 70,000 Deferred compensation - 1,275 Deferred income taxes 5,773 3,656 --------- --------- Total liabilities 491,127 371,188 Commitments and contingencies (Notes 1, 15 and 16) Shareholders' equity (deficit): Preferred stock: authorized 10,000,000 shares, no shares issued, $.01 par value - - Common stock: authorized 25,000,000 shares, issued 12,378,616 and 12,343,324, $.01 par value 124 123 Capital surplus 143,918 144,368 Accumulated other comprehensive loss (1,840) (1,066) Retained earnings (deficit) (193,758) (128,376) Less: treasury stock, 429,696 and 388,658 shares, at cost (10,284) (10,095) --------- --------- Total shareholders' equity (deficit) (61,840) 4,954 --------- --------- Total liabilities and shareholders' equity (deficit) $ 429,287 $ 376,142 ========= =========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. Page 38 PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLAR AMOUNTS IN THOUSANDS)
Year Ended ------------------------------------------------------- December 27, 1998 December 28, 1997 December 29, 1996 ----------------- ----------------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings (loss) $ (65,383) $ (212,717) $ 21,122 Non-cash charges to earnings: Depreciation and amortization 34,459 35,514 38,828 Deferred income taxes (343) 36,464 1,656 Equity in (earnings) loss of unconsolidated subsidiaries (2,807) 615 (34) Write-down of assets 3,408 7,967 69 Changes in working capital: Accounts receivable (16,010) (5,430) (12,300) Inventories and prepaid expenses (12,230) (3,997) 8,117 Accounts payable 34,529 3,238 (224) Accrued liabilities and loss contingency 85,255 192,615 11,777 Prepetition reclamation payment authorized by court (1,034) - - Checks issued but not cleared 3,058 (858) 1 Other (1,598) 652 (723) ---------- ---------- ---------- Net cash provided by operating activities 61,304 54,063 68,289 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Expenditures for property and equipment (28,283) (49,420) (48,867) Proceeds from sale of property and equipment 3,435 10,266 3,822 Proceeds from sale of Changing Paradigms, Inc. 5,163 - - Acquisition of Pope & Talbot, Inc.'s disposable diaper business assets - - (56,963) Investment in Grupo P.I. Mabe, S.A. de C.V. (2,779) (3,433) (15,908) Investment in and advances to unconsolidated subsidiaries, at equity (5,375) (24,102) (11,033) Other (9,043) (9,104) (1,731) ---------- ---------- ---------- Net cash used by investing activities (36,882) (75,793) (130,680) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in short-term borrowings (921) 14,185 (1,760) Prepetition debt payment authorized by court (1,867) - - Proceeds from U.S. bank credit facility - 25,000 85,000 Repayments of U.S. bank credit facility - (25,000) (15,000) Sale of common stock - 239 641 Purchases of treasury stock - - (10,083) ---------- ---------- ---------- Net cash provided (used) by financing activities (2,788) 4,424 58,798 ---------- ---------- ---------- NET INCREASE (DECREASE) IN CASH 21,634 (7,306) (3,593) Cash at beginning of period 991 8,297 11,890 ---------- ---------- ---------- Cash at end of period $ 22,625 $ 991 $ 8,297 ========== ========== ========== Cash paid (received) during the year for: Interest (net of amounts capitalized) $ 1,557 $ 4,259 $ 2,961 ========== ========== ========== Income taxes $ 78 $ (4,242) $ 15,189 ========== ========== ========== Bankruptcy costs $ 2,461 $ - $ - ========== ========== ==========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. Page 39 PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (DOLLAR AMOUNTS IN THOUSANDS)
Year Ended ------------------------------------------------------- December 27, 1998 December 28, 1997 December 29, 1996 ----------------- ----------------- ----------------- Net earnings (loss) $ (65,383) $ (212,717) $ 21,122 Other comprehensive income (loss), net of tax Foreign currency translation adjustments(1) (774) (452) 47 ----------- ------------ ------------ Comprehensive income (loss) $ (66,157) $ (213,169) $ 21,169 =========== ============ ============ - --------------- (1) Tax expense (benefit) $ (485) $ (283) $ 29 =========== ============ ============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. Page 40 PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DOLLAR AMOUNTS IN THOUSANDS)
Accumulated Other Retained Common Capital Comprehensive Earnings Treasury Stock Surplus Income (Loss) (Loss) Stock ------- -------- -------------- -------- --------- BALANCE, December 31, 1995 $ 119 $132,722 $ (661) $ 63,219 $ (3,710) Net earnings - - - 21,122 - Issue common stock 4 10,483 - - 1,443 Translation adjustment - - 47 - - Purchase of treasury stock - - - - (10,083) ------- -------- -------- ---------- --------- BALANCE, December 29, 1996 123 143,205 (614) 84,341 (12,350) Net loss - - - (212,717) - Issue common stock - 1,163 - - 2,255 Translation adjustment - - (452) - - ------- -------- -------- ---------- --------- BALANCE, December 28, 1997 123 144,368 (1,066) (128,376) (10,095) Net loss - - - (65,383) - Issue common stock 1 150 - - - Translation adjustment - - (774) - - Restricted stock forfeiture - (600) - - (189) ------- -------- -------- ---------- --------- BALANCE, December 27, 1998 $ 124 $143,918 $ (1,840) $ (193,758) $ (10,284) ======= ======== ======== ========== =========
The following summarizes the changes in the number of shares of capital stock:
Common Stock Treasury Stock -------------------- ------------------- BALANCE, December 31, 1995 11,851,504 245,322 Issue common stock - Pope & Talbot disposable diaper business 387,800 - Issue common stock - 1995 Incentive Compensation Plan 26,157 (3,000) Issue common stock - 1996 Non-Officer Employee Incentive Compensation Plan - (30,000) Issue common stock - Profit Sharing and Savings Plan - (54,372) Issue common stock - Exercise of stock options 22,832 (10,500) Purchase of treasury stock - 387,800 ---------- ------- BALANCE, December 29, 1996 12,288,293 535,250 Issue common stock - 1995 Incentive Compensation Plan 36,655 - Issue common stock - 1996 Non-Officer Employee Incentive Compensation Plan 12,279 - Issue common stock - Profit Sharing and Savings Plan 3,597 (135,845) Issue common stock - Exercise of stock options 2,500 (10,747) ---------- ------- BALANCE, December 28, 1997 12,343,324 388,658 Issue common stock - Profit Sharing and Savings Plan 35,292 - Restricted stock forfeiture - 41,038 ---------- ------- BALANCE, December 27, 1998 12,378,616 429,696 ========== =======
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. Page 41 PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) NOTES TO FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1: CHAPTER 11 PROCEEDINGS On January 6, 1998, Paragon Trade Brands, Inc. ("Paragon" or the "Company") filed for relief under Chapter 11 of the United States Bankruptcy Code (the "Chapter 11 filing"), in the United States Bankruptcy Court for the Northern District of Georgia. The Company is currently operating as a debtor-in-possession under the Bankruptcy Code. The Procter & Gamble Company ("P&G") had filed a lawsuit against the Company in the United States District Court for the District of Delaware, alleging that the Company's disposable baby diaper products infringe two of P&G's dual cuff diaper patents. The lawsuit sought injunctive relief, lost profit and royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by P&G. On December 30, 1997, the District Court issued a Judgment and Opinion finding that P&G's dual cuff diaper patents were valid and infringed by certain of the Company's disposable diaper products, while also rejecting the Company's patent infringement claims against P&G. The District Court had earlier dismissed the Company's antitrust counterclaim on summary judgment. The Judgment entitled P&G to damages based on sales of the Company's diapers containing the "inner-leg gather" feature. While the final damages number of approximately $178,400 was not entered by the District Court until June 2, 1998, the Company originally estimated the liability and associated litigation costs to be approximately $200,000. The amount of the award resulted in violation of certain covenants under the Company's then-existing bank loan agreements. As a result, the issuance of the Judgment and the uncertainty it created caused an immediate and critical liquidity issue for the Company. The Chapter 11 filing was designed to prevent P&G from placing liens on Company property, permit the Company to appeal the Delaware District Court's decision on the P&G case in an orderly fashion and give the Company the opportunity to resolve liquidated and unliquidated claims against the Company which arose prior to the Chapter 11 filing. Substantially all liabilities outstanding as of the date of the Chapter 11 filing are subject to resolution under a plan of reorganization to be voted upon by those of the Company's creditors and shareholders entitled to vote and confirmed by the Bankruptcy Court. Schedules were filed by the Company on March 3, 1998 with the Bankruptcy Court setting forth the assets and liabilities of the Company as of the date of the Chapter 11 filing, as shown by the Company's accounting records. Amended schedules were filed by the Company on March 30, 1998 with the Bankruptcy Court. The Bankruptcy Court set a bar date of June 5, 1998 by which time creditors must have filed proofs of claim setting forth any claims which arose prior to the Chapter 11 filing. On February 2, 1999, the Company entered into a Settlement Agreement with P&G which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Delaware Judgment, the Company's appeal of the Delaware Judgment, P&G's motion to find the Company in contempt of the Delaware Judgment and P&G's proof of claim filed in the Company's Chapter 11 reorganization proceeding. As a part of the P&G settlement, Paragon grants P&G an allowed unsecured prepetition claim of $158,500 and an allowed administrative claim of $5,000. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to certain of the patents asserted by P&G in its proof of claim, including those asserted in the Delaware Action. The U.S. and Canadian patent rights licensed by the Company will allow the Company to manufacture a dual cuff baby diaper design. In exchange for these rights, the Company has agreed to pay P&G running royalties on net sales of the licensed products equal to 2 percent through October 2005, .75 percent thereafter through October 2006 and .375 percent thereafter through March 2007 in the U.S.; and 2 percent through October 2008 and 1.25 percent thereafter through December 2009 in Canada. The Settlement Agreement also provides, among other things, that P&G will grant the Company and/or its affiliates "most favored licensee" status with respect to patents owned by P&G on the date of the Settlement Agreement or for which an application was pending on that date. In addition, the Page 42 Company has agreed with P&G that prior to litigating any future patent dispute, the parties will engage in good faith negotiations and will consider arbitrating the dispute before resorting to litigation. The Company believes that the royalty rates being charged by P&G, together with royalties to be paid to Kimberly-Clark Corporation ("K-C") described below, will have a material adverse impact on the Company's future financial condition and results of operations. Under the terms of the P&G Settlement Agreement, the Company and P&G jointly requested modification of the injunction entered in Delaware District Court so as to allow the Company to begin converting to a dual cuff design pursuant to the License Agreements described above. The injunction was modified as requested on February 22, 1999 and the product conversion is substantially complete. As also provided under the terms of the P&G Settlement Agreement, once a Final Order, as defined therein, has been entered by the Bankruptcy Court approving the settlement, the Company will withdraw with prejudice its appeal of the Delaware Judgment to the Federal Circuit, and P&G will withdraw with prejudice its motion in Delaware District Court to find the Company in contempt of the Delaware Judgment. A hearing on the Company's motion to seek approval from the Bankruptcy Court of this settlement was commenced on March 22 and 23, 1999 and is scheduled to resume on April 13, 1999. Both the Official Committee of Equity Security Holders and K-C have objected to the P&G settlement. The Company intends to continue to pursue approval of the P&G Settlement by the Bankruptcy Court. Should the P&G Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by July 31, 1999, however, the License Agreements described above will become terminable at P&G's option. The Company cannot predict when, or if, such approval will be granted. On October 26, 1995, K-C filed a lawsuit against the Company in U.S. District Court in Dallas, Texas, alleging infringement by the Company's products of two K-C patents relating to dual cuffs. The lawsuit sought injunctive relief, royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by K-C. In addition, K-C sued the Company on another patent issued to K-C which is based upon a further continuation of one of the K-C dual cuff patents asserted in the case. On March 19, 1999, the Company entered into a Settlement Agreement with K-C which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Texas action, including the Company's counterclaims, and K-C's proof of claim filed in the Company's Chapter 11 reorganization proceeding. Under the terms of the K-C Settlement Agreement, the Company grants K-C an allowed unsecured prepetition claim of $110,000 and an allowed administrative claim of $5,000. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to the patents asserted by K-C in the Texas action. The patent rights licensed by the Company from K-C will allow the Company to manufacture a dual cuff diaper design. In exchange for these patent rights, the Company has agreed to pay K-C annual running royalties on net sales of the licensed products in the U.S. and Canada equal to: 2.5 percent of the first $200,000 of net sales of the covered diaper products and 1.5 percent of such net sales in excess of $200,000 in each calendar year commencing January 1999 through November 2004. In addition, the Company has agreed to pay a minimum annual royalty for diaper sales of $5,000, but amounts due on the running royalties will be offset against this minimum. The Company will also pay K-C running royalties of 5 percent of net sales of covered training pant products for the same period, but there is no minimum royalty for training pants. As part of the settlement, the Company has granted a royalty-free license to K-C for three patents which the Company in the Texas action claimed K-C infringed. The Company believes that these royalties will, together with royalties to be paid to P&G described above, have a material adverse impact on the Company's future financial condition and results of operations. As a part of the K-C License Agreement, K-C has agreed not to sue the Company on two of K-C's patents related to the use of super-absorbent polymers ("SAP") in diapers and training pants, so long as the Company uses SAP which exhibits certain performance characteristics (the "SAP Safe Harbor"). The Company has experienced certain product performance issues the Company believes may be related to such SAP. As a result, the Company expects that it will incur increased marketing and selling, general and administrative expenses ("SG&A") expenditures in 1999 to address product performance issues. These increased expenditures are expected to have a material adverse impact on the Company's financial position and results of operations in 1999. The Company is encountering increased product costs due to the increased price and usage of the new Page 43 SAP. While the Company is working diligently with its SAP suppliers to develop a better performing alternative which is still within the SAP Safe Harbor, the Company cannot predict at this time whether or when such an alternative SAP would be available. The Company expects that these increased product costs will have a material adverse impact on its financial condition and results of operations for at least 1999 and potentially beyond. Upon the Effective Date, as defined in the K-C Settlement Agreement, K-C will dismiss with prejudice its complaint in the Texas action, as well as its related filings in the District Court in Georgia, and the Company will simultaneously dismiss with prejudice its counterclaims in the Texas action. The Company intends to file shortly a motion with the Bankruptcy Court to seek approval of the settlement. If the K-C Settlement Agreement is not approved by an order of the Bankruptcy Court entered before August 1, 1999, the K-C License Agreement described above will terminate automatically. The ability of the Company to effect a successful reorganization will depend, in significant part, upon the Company's ability to formulate a plan of reorganization that is approved by the Bankruptcy Court and meets the standards for plan confirmation under the Bankruptcy Code. The Company cannot predict at this time the effect of the material adverse impact related to the increased costs described above on the Company's enterprise valuation and on the Company's ability to timely formulate a plan of reorganization. The Company believes, however, that it may be impossible to satisfy in full all of the claims against the Company. As a result of the Chapter 11 filing, the Company has incurred and will continue to incur significant costs for professional fees as the reorganization plan is developed. The Company is also required to pay certain expenses of the Committees, including professional fees, to the extent allowed by the Bankruptcy Court. The License Agreements with each of P&G and K-C provide that if the related Settlement Agreements are not approved, as specified in each respective agreement, by July 31, 1999 and August 1, 1999, respectively, the P&G License Agreements will become terminable at P&G's option and the K-C License Agreement will terminate automatically. If the P&G and K-C License Agreements are terminated because the respective Settlement Agreements are not approved in a timely manner, the Company could be faced with having to convert to a diaper design other than the dual cuff design covered by the licenses. At this time, the Company's only viable alternative product design is the single cuff product which is the subject of P&G's Contempt Motion in Delaware. While the Company intends to vigorously pursue approval of both settlements, it cannot predict when, or if, such approval will be granted. The Chapter 11 filing did not include the Company's wholly owned subsidiaries including Paragon Trade Brands (Canada) Inc., Paragon Trade Brands International, Inc., Paragon Trade Brands FSC, Inc. and Changing Paradigms, Inc. The following information summarizes the combined results of operations for the fiscal years ended December 27, 1998, December 28, 1997 and December 29, 1996, as well as the combined balance sheets as of December 27, 1998 and December 28, 1997 for these subsidiaries. This information has been prepared on the same basis as the consolidated financial statements.
DECEMBER 27, 1998 DECEMBER 28, 1997 DECEMBER 29, 1996 ----------------- ----------------- ----------------- Sales, net of discounts and allowances $ 55,338 $ 53,523 $ 60,948 Gross profit $ 10,161 $ 8,649 $ 15,069 Earnings before income taxes $ 10,034 $ 4,814 $ 11,695 Net earnings $ 7,277 $ 4,121 $ 7,982
DECEMBER 27, 1998 DECEMBER 28, 1997 ----------------- ----------------- Current assets $ 17,863 $ 14,782 Non-current assets $ 54,734 $ 48,840 Current liabilities $ 5,700 $ 8,424 Non-current liabilities $ 8,495 $ 8,873
Page 44 NOTE 2: BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES BASIS OF PRESENTATION AND RELATED INFORMATION Paragon is the leading manufacturer of store brand infant disposable diapers in the United States and Canada. Paragon manufactures a line of premium and economy diapers, training pants, and feminine care and adult incontinence products, which are distributed throughout the United States and Canada, primarily through grocery and food stores, mass merchandisers, warehouse clubs, toy stores and drug stores that market the products under their own store brand names. Paragon has also established international joint ventures in Mexico, Argentina, Brazil and China for the manufacture and sale of infant disposable diapers and other absorbent personal care products. The consolidated financial statements include the accounts of Paragon Trade Brands, Inc. and its wholly owned subsidiaries, Paragon Trade Brands (Canada) Inc. and Paragon Trade Brands International, Inc. ("PTBI"). All significant intercompany transactions and accounts have been eliminated. The consolidated financial statements were prepared in conformity with generally accepted accounting principles and necessarily include amounts based on management's estimates and assumptions. The estimates and assumptions of management affect the reported amounts of assets, liabilities, revenues and expenses, including disclosures regarding contingent assets and liabilities. Actual results may differ from those reported due to these estimates and assumptions. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Notes 1 and 15, the Company is unable to predict when it will submit a plan of reorganization that will be acceptable to the Bankruptcy Court. In the event a plan of reorganization is confirmed and consummated, continuation of the business thereafter is dependent on the Company's ability to successfully execute the underlying business plan. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company uses a 52/53-week year. The fiscal years ended December 27, 1998, December 28, 1997 and December 29, 1996 include 52 weeks. CASH AND SHORT-TERM INVESTMENTS For purposes of cash flow and fair value reporting, short-term investments with original maturities of 90 days or less are considered as cash equivalents. Short-term investments are stated at cost, which approximates fair value. The obligation for outstanding checks is reflected as checks issued, but not cleared. FINANCIAL INSTRUMENTS - FOREIGN CURRENCY FORWARD CONTRACTS The Company occasionally enters into forward contracts to hedge certain foreign currency denominated purchase commitments for periods consistent with the terms of the underlying transactions. While the forward contracts affect the Company's results of operations, they do so only in connection with the underlying transactions. Gains and losses on these contracts are deferred and offset exchange gains and losses on the transactions hedged. At December 27, 1998 and December 28, 1997, the Company did not have any forward contracts outstanding. The Company's other off-balance sheet risks are not material. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company estimates that the fair value of its financial instruments approximate their carrying values as of the balance sheet dates, other than the guarantees of PTB International, Inc. discussed below. The Company has determined that it is not practicable to determine the fair value of such guarantees. Accordingly, no separate disclosure of fair value is made. Page 45 NONCASH TRANSACTIONS During the fiscal years ended December 27, 1998 and December 28, 1997, the Company issued 35,292 and 188,376, respectively, shares of common stock to key management and employees through the Company's Long-Term Incentive Compensation Plan and its Profit Sharing and Savings Plan (see Note 7). The balance sheet effect of issuing these shares of common stock was a decrease in accrued liabilities of $150 and $3,354, respectively, and an increase in equity by an equal amount without the use of cash. INVENTORIES Inventories are stated at the lower of cost or market. Cost includes labor, materials and production overhead. The last-in, first-out ("LIFO") method is used to cost domestic pulp and diaper-related finished goods inventories. The first-in, first-out ("FIFO") method is used to cost all other inventories. Had the FIFO method been used to cost the domestic pulp and finished goods inventories, the amounts at which they are stated would have been $346 and $509 greater at December 27, 1998 and December 28, 1997, respectively. During 1996, the Company liquidated certain LIFO inventories that were carried at higher costs prevailing in prior years. The effect of this liquidation was to decrease earnings before taxes by approximately $1,100. PROPERTY AND EQUIPMENT Paragon's property accounts are maintained on an individual asset basis. Betterments and replacements of major units are capitalized. Maintenance, repairs and minor replacements are expensed. Depreciation is provided on the straight-line method at rates based upon estimated useful lives as follows: Buildings 20 to 40 years Building improvements 10 years Machinery, equipment, furniture and fixtures 2 to 10 years The cost and related depreciation of property sold or retired is removed from the property and allowance for depreciation accounts and the gain or loss is recorded. PATENTS AND TRADEMARKS The Company operates in a commercial field in which patents relating to the products, processes, apparatus and materials are more numerous than in many other fields. The Company takes careful steps in designing, producing and selling its products to avoid infringing any valid patents of its competitors. However, there can be no assurance that the Company will not be challenged with respect to patents in the future (see Notes 1 and 15). Purchased patents and trademarks are amortized on a straight-line basis over a five- to ten-year life. In 1997, the Company evaluated the remaining value of one of the purchased patents and wrote-off the entire amount of $255. Amortization expense was $676 for the year ended December 28, 1997, including the write-off. Amortization expense was $501 for the year ended December 29, 1996. Accumulated amortization was $5,523 at December 27, 1998 and December 28, 1997, respectively. All purchased patents were fully amortized as of December 28, 1997. INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES On January 26, 1996, the Company through its wholly owned subsidiary PTB International, Inc. ("PTBI") completed the purchase of a 15 percent interest in Grupo P.I. Mabe, S.A. de C.V. ("Mabesa"), a diaper manufacturer located in Mexico, for $15,300 in cash plus additional consideration based on Mabesa's future financial results through 2001. In 1998, based on Mabesa's 1997 financial results, the Company paid additional consideration of $2,800. In 1997, based on Mabesa's 1996 financial results, the Company paid additional consideration of $3,400. The Company also acquired the option to purchase an additional 34 percent interest in Mabesa at a contractually determined price. The investment is carried at cost in the accompanying consolidated balance sheets. Page 46 The Company also owns a 49 percent interest in Paragon-Mabesa International, S.A. de C.V. ("PMI"). The investment is accounted for using the equity method. On August 26, 1997, PTBI purchased a 49 percent interest in Stronger Corporation S.A. ("Stronger"), a financial investment corporation incorporated under Uruguayan law. An affiliate of Mabesa owns the remaining 51 percent. Stronger will be used to establish additional Latin American joint ventures. The investment is accounted for using the equity method. On August 26, 1997, Stronger acquired 70 percent of Serenity S.A. ("Serenity"), a diaper manufacturer in Argentina, for approximately $11,600 in cash plus earn-out payments based on Serenity's future financial results over the next three years. Stronger also acquired an option to purchase the remaining 30 percent interest in Serenity by 2002 at a contractually determined exercise price. Serenity manufactures infant disposable diapers, sanitary napkins and adult incontinence products in two facilities. PTBI advanced $5,700 to Stronger, its pro-rata share of the purchase price, and made a $601 earn-out payment in 1998. PTBI has guaranteed earn-out payments estimated not to exceed $2,300 through 2000. On November 10, 1997, Stronger acquired 99 percent of the disposable diaper business of MPC Productos para Higiene Ltda.("MPC") for approximately $10,500 in cash from Cremer S.A., a Brazilian textile manufacturer. MPC is engaged in the manufacture, distribution, and sale of disposable diapers, skin lotions for children and other personal care products. PTBI advanced $5,100 to Stronger, its pro-rata share of the purchase price. In 1998, the Company converted $2,000 of outstanding notes receivable and accumulated interest for equipment sales into an additional capital contribution. The investment in Stronger exceeds the underlying net assets by $6,392. The difference is being amortized over a 20 year life. On December 31, 1997, the Company completed the acquisition of its share of Goodbaby Paragon Hygenic Products Ltd., a diaper manufacturing joint venture in China. The joint venture partners are Goodbaby Group and First Shanghai Investment of Hong Kong. Paragon maintains a 40 percent ownership position in the venture with Goodbaby Group and First Shanghai Investment at 30 percent each. Initial registered capital of the venture was approved by the Chinese government at $15,000, to be funded over a two-year period. During the year ended December 27, 1998, the Company contributed $4,000 of capital to Goodbaby. There have been no dividend distributions to the Company from PMI, Stronger or Goodbaby. The Company has recorded a dividend of $922 declared by Mabesa in the year ended December 27, 1998 to be paid in 1999. The Company received a dividend distribution of $1,055 from Mabesa in the year ended December 28, 1997. There was no dividend distribution from Mabesa for the year ended December 29, 1996. GOODWILL On February 8, 1996, the Company completed the purchase of substantially all of the assets of Pope & Talbot, Inc.'s ("P&T") disposable diaper business. Goodwill represents the excess of the cost of these assets over their estimated fair value at the date of acquisition and is amortized on a straight-line basis over 20 years. Management continually evaluates whether events or circumstances have occurred that indicate the remaining useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be realizable. When factors indicate that goodwill should be evaluated for possible impairment, the Company compares an estimate of the related business segment's undiscounted net cash flow over the remaining life of the related goodwill to determine whether the goodwill is recoverable. Amortization expense was $1,919, $1,919 and $1,735 for the years ended December 27, 1998, December 28, 1997 and December 29, 1996, respectively. Accumulated amortization was $5,573 and $3,654 as of December 27, 1998 and December 28, 1997, respectively. OTHER ASSETS - SOFTWARE The primary component of other assets is capitalized software and development costs. During 1998, the Company implemented SAP-R3 software at corporate headquarters and in its U.S. infant care plants. Page 47 The SAP-R3 software and development costs are being amortized on a straight-line basis over a 10-year life. Other software and development costs related to the project are being primarily amortized on a straight-line basis over a one- to three-year life. Amortization expense was $442 for the year ended December 27, 1998. Accumulated amortization was $442 at December 27, 1998. TREASURY STOCK In July 1995, the Board of Directors authorized the repurchase of up to 1.0 million shares of the Company's outstanding common stock. Purchases may be made periodically in the open market or in privately-negotiated transactions over an extended period of time, if and when management believes market conditions warrant. The Company reissued 135,845 of these shares through its Long-Term Incentive and Profit Sharing Plans in the year ended December 28, 1997. The Company also reissued 10,747 shares for the exercise of stock options in the year ended December 28, 1997 (see Note 7). During the fiscal year ended December 27, 1998, the Company acquired 41,038 shares through employee forfeiture of restricted stock. SIGNIFICANT CUSTOMER During the years ended December 27, 1998, December 28, 1997 and December 29, 1996, the percentages of net sales to an individual customer whose sales represent in excess of 10 percent of net sales were 19 percent, 15 percent and 13 percent, respectively. These sales consisted entirely of infant care products. INCOME TAXES The Company accounts for income taxes based on the liability method and, accordingly, deferred income taxes are provided to reflect temporary differences between financial and tax reporting. Deferred tax assets and liabilities are measured based on enacted tax laws and rates without anticipation of future changes. Effects on deferred taxes of enacted changes in tax laws are recognized in income for financial statement purposes in the period of enactment. As of December 27, 1998, there were approximately $19,158 of cumulative undistributed earnings of the Company's foreign subsidiaries and investments accounted for by the equity method. U.S. taxes have not been provided for on these earnings. Under existing law, undistributed earnings are not subject to U.S. tax until distributed as dividends. Any future earnings are intended to be indefinitely reinvested in these operations. Furthermore, any taxes that are paid to foreign governments on such future earnings may be used, in whole or in part, as credits against the U.S. tax on any distributions from such earnings. Income taxes have been provided for all items included in the consolidated earnings (loss) statements, regardless of the period when such items will be deductible for tax purposes. The principal temporary differences between financial and tax reporting arise from tax-basis goodwill and reserves not currently deductible. FOREIGN CURRENCY Non-U.S. assets and liabilities are translated into U.S. dollars using period-end exchange rates. Revenues and expenses are translated at average rates during the period. PROFIT SHARING AND 401(K) PLANS Effective February 2, 1993, Paragon adopted both a defined contribution profit sharing plan and a 401(k) savings plan covering most of its employees. On October 1, 1993, the two plans were merged, amended and restated into one plan, the Paragon Trade Brands, Inc. Profit Sharing and Savings Plan. The name of the plan was changed by resolution of the Board of Directors in December 1995 to Paragon Retirement Investment Savings Management Plan ("PRISM"). The plan provides for both employer-matching contributions based on voluntary salary deferrals of employees and discretionary employer contributions. Plan participants are fully vested with respect to employer contributions after three years of service. Employee contributions vest immediately. Contributions to the plan are based on various levels of employee participation. Plan expense for the fiscal Page 48 years ended December 27, 1998, December 28, 1997 and December 29, 1996 was $2,589, $1,141 and $2,607, respectively. NEW ACCOUNTING STANDARDS The Financial Accounting Standards Board has issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which must be adopted by the Company's fiscal year 2000. This statement establishes accounting and reporting standards for derivative instruments - including certain derivative instruments embedded in other contracts - and for hedging activities. Adoption of this statement is not expected to have a material impact on the Company's financial statements. In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued a new Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This statement requires capitalization of certain costs of internal-use software. The Company adopted this statement in the first fiscal quarter of 1999, and it did not have a material impact on the financial statements. In April 1998, the AICPA issued a new Statement of Position 98-5, "Reporting on the Costs of Start-up Activities." This statement requires that the costs of start-up activities and organizational costs be expensed as incurred. Any of these costs previously capitalized by a company must be written off in the year of adoption. The Company adopted this statement in the first fiscal quarter of 1999, and it did not have a material impact on the financial statements. RECLASSIFICATIONS Certain reclassifications have been made to the prior years' financial statements to conform them to the current year's presentation. NOTE 3: ASSET IMPAIRMENTS Asset impairments were $3,416 and $9,442 for the years ended December 27, 1998 and December 28, 1997, respectively. There were no asset impairments for the year ended December 29, 1996. The asset impairment for the year ended December 27, 1998 represented a further write down of the tampon-related manufacturing equipment that was shutdown in early 1998. The equipment has been written down to estimated net selling price and is categorized as assets held for sale on the accompanying consolidated balance sheet. The asset impairments for the year ended December 28, 1997 include a $5,000 write-off of software and associated consulting costs related to the Company's enterprise-wide information system installation. The write off was due to the inability of the software to perform as represented during the software selection process. The asset impairments also include a write-down of $4,442 for the shut-down of the tampon-related manufacturing equipment at the feminine care products operation. Also included in the shut-down of the tampon producing operation were write-offs of $900 for raw material, finished goods and spare-part inventories which were charged to cost of sales for the year ended December 28, 1997. The Company experienced operating losses in its feminine care and adult incontinence business in 1998 and 1997 and expects these losses to continue in the near-term. The Company has developed a business plan that supports the realization of its investment in its feminine care and adult incontinence business. Accordingly, the Company has not recorded any adjustments in its financial statements relating to the recoverability of the operating assets of the feminine care and adult incontinence business. The Company's ability to recover its investment is dependent upon a prompt emergence from Chapter 11 and the successful execution of the Company's feminine care and adult incontinence business plan. The Company cannot predict at this time when it will emerge from Chapter 11 protection. The Company believes that once it emerges from Chapter 11 the feminine care and adult incontinence business will see an increase in sales and improved results. The Company cannot predict, however, whether or when such improved results will be realized. Page 49 NOTE 4: OTHER INCOME, NET Other income was $2,437, $1,664 and $581 in 1998, 1997 and 1996, respectively, and consisted primarily of interest income from PMI. NOTE 5: BANKRUPTCY COSTS Bankruptcy costs were directly associated with the Company's Chapter 11 reorganization proceeding and consisted of the following:
YEAR ENDED ---------- DECEMBER 27, 1998 ----------------- Professional fees $ 6,772 Amortization of DIP credit facility deferred financing costs 813 Other 160 Interest Income (1,443) ----------- $ 6,302 ===========
NOTE 6: INCOME TAXES Taxes on income are based on earnings (losses) before taxes as follows:
December 27, 1998 December 28, 1997 December 29, 1996 ------------------- ------------------- ------------------- Domestic $ (62,239) $ (188,784) $ 22,035 Foreign 4,947 4,001 11,774 ------------ ------------- ------------ $ (57,292) $ (184,783) $ 33,809 ============ ============= ============
Provisions for (benefits from) income taxes include the following:
December 27, 1998 December 28, 1997 December 29, 1996 ----------------- ----------------- ----------------- Federal: Current $ 4,647 $ (6,594) $ 8,651 Deferred 967 33,494 (1,098 ---------- ---------- --------- 5,614 26,900 7,553 ---------- ---------- --------- State: Current 598 (1,197) 1,496 Deferred 161 833 (200) ---------- ---------- --------- 759 (364) 1,296 ---------- ---------- --------- Foreign: Current 2,096 1,803 1,578 Deferred (378) (405) 2,260 ---------- ---------- --------- 1,718 1,398 3,838 ---------- ---------- --------- $ 8,091 $ 27,934 $ 12,687 ========== ========== =========
Page 50 A reconciliation between the federal statutory rate and the effective tax rate follows:
December 27, 1998 December 28, 1997 December 29, 1996 ----------------- ----------------- ----------------- Expected provision (benefit) at the statutory rate $ (20,052) $ (64,674) $ 11,833 State income taxes, net of federal tax benefit (2,005) (6,640) 1,319 Undistributed earnings of subsidiaries (983) 215 (12) Change in valuation allowance 32,585 99,052 (78) All other, net (1,454) (19) (375) --------- ---------- ---------- $ 8,091 $ 27,934 $ 12,687 ========= ========== ==========
Net deferred tax liabilities at December 27, 1998 and December 28, 1997 were $1,513 and $1,856, respectively. The amounts recorded primarily reflect the following: (1) reserves not currently deductible and (2) deferred tax assets due to the enactment of the Omnibus Budget Reconciliation Act of 1993, which allows amortization of intangibles, including goodwill. Net deferred income taxes are attributable to the following temporary differences:
December 27, 1998 December 28, 1997 ----------------- ----------------- Intangible assets $ (1,992) $ (2,127) ---------- ---------- Deferred tax liabilities (1,992) (2,127) ---------- ---------- Depreciation/amortization (1,737) 389 Goodwill 7,168 9,902 Reserves not currently deductible 113,465 85,814 Package design costs 2,045 2,099 Land 392 393 Net operating loss carryforwards 3,057 648 Credit carryforwards 9,045 344 All other, net (1,038) 15 ---------- ---------- Deferred tax assets 132,397 99,604 ---------- ---------- Deferred tax assets valuation allowance (131,918) (99,333) ---------- ---------- Total deferred taxes, net $ (1,513) $ (1,856) ========== ==========
The Company has recorded a valuation allowance with respect to its net deferred tax assets as realization is dependent upon sufficient future taxable income. NOTE 7: LONG-TERM INCENTIVE, DEFERRED COMPENSATION, PROFIT SHARING AND PENSION PLANS, INCLUDING 401(K) LONG-TERM INCENTIVE PLANS The Company's Long-Term Incentive Compensation Plan ("LTIC Plan") and its 1995 Incentive Compensation Plan ("1995 Plan") are administered by the Compensation Committee of the Board of Directors. In February 1996, the Company adopted its 1996 Non-Officer Employee Incentive Compensation Plan ("1996 Plan"). The 1996 Plan is administered by an Administrative Committee appointed by the Board of Directors. The LTIC, 1995 and 1996 Plans are designed to link management rewards with the long-term interests of Paragon's shareholders. Given the uncertainties related to the Company's Chapter 11 filing, the Compensation Committee of the Company's Board of Directors decided in early 1998 to suspend the grant of stock option awards or stock appreciation rights ("SARs") until the Company successfully emerges from Chapter 11. As a result, no options or SARs were granted in 1998. Page 51 RESTRICTED STOCK GRANTS In 1997, restricted shares of common stock were issued at a discounted value in lieu of some or all of cash bonuses for key employees, at the employee's discretion. During the fiscal year ended December 28, 1997, there were 12,279 shares of common stock issued under the 1996 Plan as restricted shares and 36,655 shares of common stock issued under the 1995 Plan as restricted and bonus shares. The restricted shares are non-transferable for two years. During the year ended December 27, 1998, 41,038 shares of restricted stock previously granted under the various plans were forfeited by employees. The 1995 and 1996 Plans provide that a maximum of 150,000 and 250,000 shares, respectively, are available for grant thereunder as restricted shares or other stock based awards. Compensation expense is recorded for the stock grants at their discounted amounts. Compensation expense (income) recorded for the fiscal years ended December 27, 1998, December 28, 1997 and December 29, 1996 was $(788), $856 and $800, respectively. The weighted average fair value per share of stock granted was $17.50 and $24.52 for the years ended December 28, 1997 and December 29, 1996, respectively. The weighted average fair value per share at the date of grant of stock forfeited for the year ended December 27, 1998 was $19.20. STOCK OPTIONS AND SARS The LTIC, 1995 and 1996 Plans have a maximum of 800,000, 450,000 and 400,000 shares available, respectively, for grant as stock options or SARs. Stock options, when granted to key management, are granted at amounts that approximate market value at the date of the grant. Awards, when made, vest 25 percent per year for four years and have a term of 10 years. The Company also has a maximum of 100,000 shares available for grant under the Stock Option Plan for Non-Employee Directors ("Director Plan"). Stock options are awarded to directors at amounts that approximate market value at the date of the grant. Awards vest 100 percent after one year and have a term of 10 years. Awards under the Director Plan were also suspended in 1998 until the Company successfully emerges from Chapter 11. ACCOUNTING FOR STOCK-BASED COMPENSATION The Company applies APB Opinion 25 in accounting for stock options granted under the 1995, LTIC and Director Plans. Accordingly, no compensation cost has been recognized for these plans in 1998, 1997 or 1996. Had compensation cost been recognized on the basis of fair value pursuant to FASB Statement No. 123, net earnings (loss) and earnings (loss) per share would have been affected as follows:
December 27, 1998 December 28, 1997 December 29, 1996 ----------------- ----------------- ----------------- NET EARNINGS (LOSS) - ------------------ As reported $ (65,383) $ (212,717) $ 21,122 Pro forma $ (65,646) $ (213,265) $ 20,486 BASIC EARNINGS (LOSS) PER SHARE - ------------------------------- As reported $ (5.48) $ (17.86) $ 1.76 Pro forma $ (5.50) $ (17.90) $ 1.70 DILUTED EARNINGS (LOSS) PER SHARE - ------------------------------------ As reported $ (5.48) $ (17.86) $ 1.74 Pro forma $ (5.50) $ (17.90) $ 1.68
The fair value of each option grant was estimated on the date of the grant using the Black-Scholes multiple option pricing model with the following assumptions for the years ended December 28, 1997 and December 29, 1996: a range of risk-free interest rates of 6.15 - 6.43 percent was used for the years ended December 28, 1997, and December 29, 1996; a dividend yield of 0.0 percent was used for both years; and an estimated volatility of 40 percent was used for the year ended December 28, 1997, and 44 percent was used for the year ended December 29, 1996. Page 52 Following is a summary of the status of the 1995, LTIC and Director Plans during the years ended December 27, 1998, December 28, 1997 and December 29, 1996.
December 27, 1998 December 28, 1997 December 29, 1996 ----------------------- ----------------------- ----------------------- Weighted Weighted Weighted Number Average Number Average Number Average of Exercise of Exercise of Exercise Shares Price Shares Price Shares Price ------------ --------- ------------ --------- ------------ --------- Outstanding, beginning of period 774,935 $20.46 735,932 $21.00 703,678 $20.40 Granted - - 91,000 $16.42 89,000 $24.78 Exercised - - 13,247 $18.03 33,332 $19.00 Forfeited 75,444 $20.54 38,750 $22.10 23,414 $20.30 Expired - - - - - - ------- ------ ------- ------ ------- ------ Outstanding, end of period 699,491 $20.45 774,935 $20.46 735,932 $21.00 ======= ======= ======= Options exercisable end of period 569,407 $20.96 518,103 $21.18 368,361 $21.53 ======= ======= ======= Weighted average fair value of options granted during the period - $ 8.95 $ 14.05 ======= ======= =======
Following is a summary of the status of options granted under the 1995, LTIC and Director Plans at December 27, 1998:
Outstanding Options Exercisable Options ---------------------------------------------------- ---------------------------- Weighted Average Remaining Weighted Exercise Price Contractual Weighted Average Average Range Number Life (Years) Exercise Price Number Exercise Price - -------------- ------ ------------ -------------- ------ -------------- $12.69-$16.44 242,447 6.94 $14.62 151,363 $14.15 $19.00-$22.13 245,500 4.10 $19.80 245,500 $19.80 $22.25-$31.13 211,544 5.96 $27.88 172,544 $28.57 ------- ------- $12.69-$31.13 699,491 5.64 $20.45 569,407 $20.96 ======= =======
Page 53 The following summarizes transactions involving SARs granted to key management during the years ended:
December 27, 1998 December 28, 1997 December 29, 1996 ------------------------- ---------------------- ---------------------- Number Weighted Number Weighted Number Weighted of Average of Average of Average SARs Exercise SARs Exercise SARs Exercise Price Price Price ---------- ------------ --------- ---------- --------- ---------- Outstanding, beginning of period 235,660 $20.35 121,330 $24.32 Granted - - 122,330 $16.64 121,330 $24.32 Forfeited 84,920 $20.63 8,000 $23.82 - - ------- ------- ------- Outstanding, end of period 150,740 $20.19 235,660 $20.35 121,330 $24.32 Exercisable, end of period 61,917 $21.26 28,585 $24.28 - -
SARs, when granted, are granted at amounts that approximate market value at the date of the grant. Awards, when made, vest 25 percent per year for four years and have a term of 10 years. Compensation expense (income) is recorded based on the period-ending stock price in relation to the SAR exercise price. Compensation expense (income) recorded in 1998, 1997 and 1996 was $(184), $(34) and $220, respectively. Redemption of the SARs, when exercised, will be in cash. DEFERRED COMPENSATION PLAN The Company adopted a Paragon Trade Brands, Inc. Deferred Compensation Plan ("DCP") in April 1997. The DCP was an unfunded, non-qualified deferred compensation plan under which eligible employees of the Company and members of the Board of Directors could elect, on a voluntary basis, to defer compensation until retirement or termination from the Company or the Board. Eligible participants were selected for participation by a committee (the "Plan Committee") which consisted of the Board or a committee appointed by the Board. As of December 31, 1997, the DCP was terminated and no further compensation deferrals were permitted under the DCP. Under the DCP, eligible participants could elect to defer up to 50 percent of their annual base salary, up to 100 percent of their annual bonus or, in case of the directors, up to 100 percent of their director fees. A participant would be fully vested in their elective deferrals. If a participant were employed at the end of the calendar year, the Company would credit the participant's account 50 percent of their elective deferrals not to exceed 25 percent of the participant's combined base salary and annual bonus for the calendar year. Participants would become fully vested in the Company contribution after five years of service with the Company. Participants, at the discretion of the Plan Committee, could request that their account be invested in one or more Measurement Funds, which were chosen by the Plan Committee and were based on one or more mutual funds. To the extent that the request was approved by the Plan Committee, the funds credited to a participant's account would be adjusted to reflect gain, loss, income and expense as though the account had actually been invested in such Measurement Funds. In this regard, the Company also adopted in April 1997 a so called "rabbi trust" known as the Paragon Trade Brands, Inc. Deferred Compensation Plan Master Trust Agreement (the "Trust Agreement") with Wachovia Bank, N.A. as Trustee which was intended to serve as a funding vehicle for the DCP. However, as of December 28, 1997, the Company had not transferred any funds to the Trustee under the Trust Agreement. The expense recorded for the DCP was $16 and $247 in the years ended December 27, 1998 and December 28, 1997, respectively. PROFIT SHARING AND 401(K) PLANS To further encourage the ownership of common stock by all employees, the Company maintains the PRISM Plan, formerly known as the Profit Sharing and Savings Plan, that offers both profit sharing and 401(k) features. There were no profit sharing contributions made during the fiscal year ended December 27, 1998. Profit sharing Page 54 contributions made during the fiscal years ended December 28, 1997 and December 29, 1996 consisted of 110,520 and 29,613 shares of common stock, respectively. For the years ended December 27, 1998 and December 28, 1997, the Company's 401(k) contributions consisted of 35,292 and 28,915 shares of common stock, respectively and cash. The Company's 401(k) contributions consisted of 24,759 shares of common stock for the year ended December 29, 1996. NOTE 8: RECEIVABLES Receivables consist of the following:
December 27, 1998 December 28, 1997 ----------------- ----------------- Accounts receivable - trade $ 71,079 $ 52,583 Other receivables 16,777 24,568 ---------- ---------- 87,856 77,151 Less: Allowance for doubtful accounts (8,700) (6,535) ---------- ---------- Net receivables $ 79,156 $ 70,616 ========== ==========
NOTE 9: INVENTORIES Inventories consist of the following:
December 27, 1998 December 28, 1997 ----------------- ----------------- LIFO: Raw materials - pulp $ 232 $ 381 Finished goods 31,417 25,770 FIFO: Raw materials - other 7,346 8,561 Materials and supplies 20,924 20,942 ---------- ---------- 59,919 55,654 Reserve for excess and obsolete items (6,637) (7,397) ---------- ---------- Net Inventories $ 53,282 $ 48,257 ========== ==========
NOTE 10: PROPERTY AND EQUIPMENT Property and equipment, at cost, are as follows:
December 27, 1998 December 28, 1997 ----------------- ----------------- Land $ 3,715 $ 3,741 Buildings and improvements 40,150 40,191 Machinery and equipment 227,433 226,951 ----------- ---------- 271,298 270,883 Less: Allowance for depreciation (165,098) (152,500) ----------- ---------- Net property and equipment $ 106,200 $ 118,383 =========== ==========
Page 55 NOTE 11: ACCRUED LIABILITIES Accrued liabilities are as follows:
December 27, 1998 December 28, 1997 ----------------- ----------------- Payroll - wages and salaries, incentive awards, retirement, vacation and severance pay $ 16,977 $ 10,375 Coupons and promotions 5,994 7,826 Integration/relocation reserves - 2,575 Income taxes payable - current - 195 Other 10,675 11,421 ---------- ---------- Total $ 33,646 $ 32,392 ========== ==========
NOTE 12: BANK CREDIT FACILITIES On January 30, 1998, the Bankruptcy Court entered a final order (the "Final Order") approving the Credit Agreement (the "DIP Credit Facility") as provided under the Revolving Credit and Guaranty Agreement dated as of January 7, 1998, among the Company, as borrower, certain subsidiaries of the Company as guarantors, and The Chase Manhattan Bank, as agent ("Chase"). Pursuant to the terms of the DIP Credit Facility, as amended by the First Amendment dated January 30, 1998, the Second Amendment dated March 23, 1998, the Third Amendment dated April 15, 1998 and the Fourth Amendment dated September 28, 1998, Chase and a syndicate of banks have made available to the Company a revolving credit and letter of credit facility in an aggregate principal amount of $75,000. The Company's maximum borrowing under the DIP Credit Facility may not exceed the lesser of $75,000 or an available amount as determined by a borrowing base formula. The borrowing base formula is comprised of certain specified percentages of eligible accounts receivable, eligible inventory, equipment and personal and real property of the Company. The DIP Credit Facility has a sublimit of $10,000 for the issuance of letters of credit. The DIP Credit Facility expires on the earlier of July 7, 1999, or the date of entry of an order by the Bankruptcy Court confirming a plan of reorganization. The Company is currently negotiating an extension of the maturity date on the DIP Credit Facility with Chase. Obligations under the DIP Credit Facility are secured by the security interest in, pledge and lien on substantially all of the Company's assets and properties and the proceeds thereof, granted pursuant to the Final Order under Sections 364(c)(2) and 364(c)(3) of the Bankruptcy Code. Borrowings under the DIP Credit Facility may be used to fund working capital and for other general corporate purposes. The DIP Credit Facility contains restrictive covenants, including among other things, limitations on the creation of additional liens and indebtedness, limitations on capital expenditures, limitations on transactions with affiliates including investments, loans and advances, the sale of assets, and the maintenance of minimum earnings before interest, taxes, depreciation, amortization and reorganization items, as well as a prohibition on the payment of dividends. The DIP Credit Facility provides that advances made will bear interest at a rate of 0.5 percent per annum in excess of Chase's Alternative Base Rate, or at the Company's option, a rate of 1.5 percent per annum in excess of the reserve adjusted London Interbank Offered Rate for the interest periods of one, two or three months. The Company pays a commitment fee of 0.5 percent per annum on the unused portion thereof, a letter of credit fee equal to 1.5 percent per annum of average outstanding letters of credit and certain other fees. At December 27, 1998, there were no outstanding direct borrowings under the DIP Credit Facility. The Company had an aggregate of $1,300 in letters of credit issued under the DIP Credit Facility at December 27, 1998. The DIP Credit Facility contains customary covenants. The Company for a period of time has been unable to fully comply with certain reporting requirements of such covenants. The Company has obtained waivers with respect to these events of default which are effective through May 10, 1999. The Company believes that it will be in compliance with the reporting requirements of the DIP Credit Facility by May 10, 1999. At December 28, 1997, the Company maintained a $150,000 revolving credit facility with a group of nine financial institutions available through February 2001. At December 28, 1997, borrowings under this credit Page 56 facility totaled $70,000. Borrowings under this credit facility are reflected as long-term debt in the accompanying balance sheet at December 28, 1997. Interest was at fixed or floating rates based on the financial institution's cost of funds. Paragon Trade Brands (Canada) Inc. has guaranteed obligations under this revolving credit facility. The Company also had access to short-term lines of credit on an uncommitted basis with several major banks. At December 28, 1997, the Company had approximately $50,000 in uncommitted lines of credit. Borrowings under these lines of credit totaled $12,800 at December 28, 1997. Borrowings under these lines of credit were reflected as short-term borrowings in the accompanying balance sheet at December 28, 1997. As a result of the Chapter 11 filing, the Company is prohibited from paying any prepetition liabilities without Bankruptcy Court approval. The Chapter 11 filing resulted in a default under the Company's prepetition revolving credit facility and its borrowings under uncommitted lines of credit. The terms of the revolving credit facility and the short-term lines of credit above provide that a voluntary filing of a Chapter 11 petition results in an event of default on such indebtedness. Amounts outstanding under these facilities are reflected as Liabilities Subject to Compromise in the accompanying consolidated balance sheet as of December 27, 1998. As a result of its Chapter 11 filing, the Company is prohibited from paying any prepetition liabilities without Bankruptcy Court approval. Accordingly, no interest expense has been recorded with respect to prepetition debt balances in the accompanying financial statements for the period subsequent to January 6, 1998. Paragon Trade Brands (Canada) Inc. entered into a new $3,000 Cdn operating credit facility with a financial institution dated February 11, 1998. Borrowings under the prior Canadian revolving credit facility were repaid in full with the proceeds from borrowings under the new Canadian operating credit facility. Borrowings under this Canadian operating credit facility are secured by substantially all of Paragon Trade Brands (Canada) Inc.'s assets and will bear interest at a rate of 1 percent over the financial institution's prime rate. The Company does not guaranty borrowings under the Canadian operating credit facility. The maximum borrowings under the Canadian operating credit facility are limited to the lesser of $3,000 Cdn or 75 percent of Paragon Trade Brands (Canada) Inc.'s trade accounts receivable. There were no borrowings outstanding under this operating credit facility on December 27, 1998. NOTE 13: LIABILITIES SUBJECT TO COMPROMISE Liabilities subject to compromise under the Company's reorganization proceeding include substantially all current and long-term unsecured debt as of the date of the Chapter 11 filing. Pursuant to the Bankruptcy Code, payment of these liabilities may not be made except pursuant to a plan of reorganization or Bankruptcy Court order while the Company continues to operate as a debtor-in-possession. The Company has received approval from the Bankruptcy Court to pay or otherwise honor certain of its prepetition obligations including a portion of short-term borrowings, claims subject to reclamation and employee wages, benefits and expenses. Liabilities subject to compromise are comprised of the following:
December 27, 1998 ----------------- Accrued settlement contingencies $ 278,500 Bank debt 81,397 Accounts payable 39,752 Accrued liabilities 5,920 Deferred compensation 1,290 ---------- $ 406,859 ==========
NOTE 14: RELATED PARTY TRANSACTIONS The Company has entered into various agreements with its subsidiaries and affiliates to sell certain diaper making equipment and purchase a portion of its diaper needs. Prices for the various transactions are established through negotiations between the related parties. The following is a summary of significant transactions and balances with its subsidiaries and affiliates as of or for the years ended December 27, 1998, December 28, 1997 and December 29, 1996: Page 57 PMI Pursuant to the Joint Venture Agreement dated January 26, 1996 whereby the Company acquired a 49 percent interest in PMI, the Company agreed to sell to PMI certain diaper manufacturing equipment, finance the construction of a building and purchase a portion of its diaper needs from PMI.
December 27, 1998 December 28, 1997 December 29, 1996 ----------------- ----------------- ----------------- Sale of equipment $ - $ 194 $ 14,650 Purchase of diapers from PMI $ 67,346 $ 40,823 $ 11,860 Due from PMI $ 43,381 $ 39,725 $ 27,857 Due to PMI $ 7,340 $ 5,313 $ -
The amounts due from PMI are primarily for equipment purchased, the financing of the building construction and working capital funding. They are evidenced by an interest-bearing promissory note and corresponding Purchase Loan and Security Agreements. The amounts due under these agreements are carried as investments in and advances to unconsolidated subsidiaries, at equity on the balance sheet. Amounts due to PMI are carried as accounts payable and liabilities subject to compromise on the balance sheets. Loans due from PMI are evidenced by interest-bearing promissory notes. The notes bore an interest rate of 10 percent until December 1, 1997. The notes currently bear an interest rate of approximately 6 percent. MABESA The Company has purchased certain diaper product needs from Mabesa and also sold excess diaper making equipment to Mabesa.
December 27, 1998 December 28, 1997 ----------------- ----------------- Sale of equipment $ - $ 4,843 Purchase of diapers from Mabesa $ 1,733 $ 2,196 Due from Mabesa $ 2,732 $ 3,623 Due to Mabesa $ 312 $ 119
The amounts due from Mabesa for equipment purchased are classified as receivables on the balance sheets. The amounts due to Mabesa are classified as accounts payable and liabilities subject to compromise on the balance sheets. Depending on the expected payment terms under the purchase agreements, certain amounts due bear an interest rate of approximately 7 percent. MPC The Company has sold certain diaper making equipment to MPC.
December 27, 1998 December 28, 1997 ----------------- ----------------- Sale of equipment and technology transfer $ - $ 2,400 Due from MPC $ 287 $ 2,000
The amounts due from MPC for equipment purchased are classified as receivables on the balance sheets. The loan to MPC, which bore an interest rate of LIBOR plus 4 percent, was converted into an additional capital contribution in 1998. Page 58 GOODBABY The Company has sold certain diaper making equipment to Goodbaby.
December 27, 1998 December 28, 1997 ----------------- ----------------- Sale of equipment $ - $ 2,415 Due from Goodbaby $ 1,182 $ 2,710
The amounts due from Goodbaby are classified as receivables on the balance sheets. At December 27, 1998 and December 28, 1997, the Company had deferred gains on the sales of equipment of $3,927 and $4,583, respectively. These gains will be amortized to income over the depreciable life of the equipment. NOTE 15: LEGAL PROCEEDINGS THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC. - P&G filed a lawsuit in January 1994 in the District Court for the District of Delaware alleging that the Company's "Ultra" infant disposable diaper products infringed two of P&G's dual cuff diaper patents. The lawsuit sought injunctive relief, lost profit and royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by P&G. In March 1996, the District Court granted P&G's motion for summary judgment to dismiss the Company's antitrust counterclaim. The trial was completed in February 1997, the parties submitted post-trial briefs and closing arguments were conducted on October 22, 1997. Legal fees and costs for this litigation have been significant. On December 30, 1997, the Delaware District Court issued a Judgment and Opinion finding that P&G's dual cuff patents were valid and infringed, while at the same time finding the Company's patent to be invalid, unenforceable and not infringed by P&G's products. Judgment was entered on January 6, 1998. Damages of approximately $178,400 were entered against Paragon by the District Court on June 2, 1998. At the same time, the District Court entered injunctive relief agreed upon by P&G and the Company. The Company had previously filed with the District Court a motion under Rule 59 for a new trial or to alter or amend the Judgment. The District Court denied Paragon's motion by order entered August 4, 1998. The District Court also denied a motion by P&G seeking to recover attorneys' fees it expended in defending itself against Paragon's patent infringement counterclaim. On August 4, 1998, the Company filed with the Federal Circuit Court of Appeals its amended notice of appeal. The appeal was fully briefed, and oral argument was scheduled for February 5, 1999. On September 22, 1998, P&G filed a motion in the Delaware District Court seeking to have the Court find Paragon in contempt of the injunction entered in the case on account of Paragon's manufacture and sale of its single cuff diaper product. P&G asserted in its claim that Paragon's single cuff diaper design (i) is no more than just colorably different from the design found to infringe the P&G patents at issue in the case and (ii) also infringes such patents. The Company opposed P&G's motion. Based on the advice of counsel, the Company believes that P&G's motion is without merit. If the motion were granted, however, the Company would be forced to discontinue the manufacture and sale of its single cuff design. In addition, P&G in its motion asked that the Court order the Company to send letters to all of its customers advising them that the continued resale by them of its single cuff design would also constitute patent infringement. Consequently, the Company believes that if the motion were granted it would have a material adverse effect on the Company's financial condition and results of operations and would seriously jeopardize the Company's future viability. The Judgment has had a material adverse effect on the Company's financial position and its results of operations. As a result of the District Court's Judgment, the Company filed for relief under Chapter 11 of the Bankruptcy Code, 11 U.S.C. Section 101 et seq., in the United States Bankruptcy Court for the Northern District of Georgia (Case No. 98-60390) on January 6, 1998. See "--IN Re PARAGON TRADE BRANDS, INC.," below. Page 59 P&G filed alleged claims in the Company's Chapter 11 reorganization proceeding ranging from approximately $2,300,000 (without trebling) to $6,500,000 (with trebling), which included a claim of $178,400 for the Delaware judgment. See "--IN RE PARAGON TRADE BRANDS, INC.," below. The remaining claims include claims for, among other things, alleged patent infringement by the Company in foreign countries where it has operations. On February 2, 1999, the Company entered into a Settlement Agreement with P&G which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Delaware Judgment, the Company's appeal of the Delaware Judgment, P&G's motion to find the Company in contempt of the Delaware Judgment and P&G's proof of claim filed in the Company's Chapter 11 reorganization proceeding. As a part of the P&G settlement, Paragon grants P&G an allowed unsecured prepetition claim of $158,500 and an allowed administrative claim of $5,000. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to certain of the patents asserted by P&G in its proof of claim, including those asserted in the Delaware Action. The U.S. and Canadian patent rights licensed by the Company will allow the Company to manufacture a dual cuff baby diaper design. In exchange for these rights, the Company has agreed to pay P&G running royalties on net sales of the licensed products equal to 2 percent through October 2005, .75 percent thereafter through October 2006 and .375 percent thereafter through March 2007 in the U.S.; and 2 percent through October 2008 and 1.25 percent thereafter through December 2009 in Canada. The Settlement Agreement also provides, among other things, that P&G will grant the Company and/or its affiliates "most favored licensee" status with respect to patents owned by P&G on the date of the Settlement Agreement or for which an application was pending on that date. In addition, the Company has agreed with P&G that prior to litigating any future patent dispute, the parties will engage in good faith negotiations and will consider arbitrating the dispute before resorting to litigation. The Company believes that the royalty rates being charged by P&G, together with royalties to be paid to K-C described above, will have a material adverse impact on the Company's future financial condition and results of operations. Under the terms of the P&G Settlement Agreement, the Company and P&G jointly requested modification of the injunction entered in Delaware District Court so as to allow the Company to begin converting to a dual cuff design pursuant to the License Agreements described above. The injunction was modified as requested on February 22, 1999 and the product conversion is substantially complete. As also provided under the terms of the P&G Settlement Agreement, once a Final Order, as defined therein, has been entered by the Bankruptcy Court approving the settlement, the Company will withdraw with prejudice its appeal of the Delaware Judgment to the Federal Circuit, and P&G will withdraw with prejudice its motion in Delaware District Court to find the Company in contempt of the Delaware Judgment. A hearing on the Company's motion to seek approval from the Bankruptcy Court of this settlement was commenced on March 22 and 23, 1999 and is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have objected to the P&G settlement. The Company intends to continue to pursue approval of the P&G Settlement by the Bankruptcy Court. Should the P&G Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by July 31, 1999, however, the License Agreements described above will become terminable at P&G's option. The Company cannot predict when, or if, such approval will be granted. KIMBERLY-CLARK CORPORATION V. PARAGON TRADE BRANDS, INC. -- On October 26, 1995, K-C filed a lawsuit against the Company in U.S. District Court in Dallas, Texas, alleging infringement by the Company's products of two K-C patents relating to dual cuffs. The lawsuit sought injunctive relief, royalty damages, treble damages and attorneys' fees and costs. The Company denied liability under the patents and counterclaimed for patent infringement and violation of antitrust laws by K-C. Several pre-trial motions were filed by each party, including a motion for summary judgment filed by K-C with respect to the Company's antitrust counterclaim and a motion for summary judgment filed by the Company on one of the patents asserted by K-C. In addition, K-C sued the Company on another patent issued to K-C which is based upon a further continuation of one of the K-C dual cuff patents asserted in the case. That action was consolidated with the pending action. The Court appointed a special master to rule on the various pending motions. Legal fees and costs in connection with this litigation have been significant. As a result of the Company's Chapter 11 filing, the proceedings in the K-C litigation were stayed. The Bankruptcy Court issued an order on April 10, 1998 permitting, among other things, a partial lifting of the stay to allow the issuance of the special master's report on the items under his consideration. K-C filed with the Page 60 Bankruptcy Court a motion for reconsideration of the Bankruptcy Court's April 10, 1998 order, which was denied on June 15, 1998. K-C has appealed this denial of reconsideration to the District Court for the Northern District of Georgia. The Company objected to K-C's Appeal and sought to have it dismissed. K-C also filed a motion with the District Court in Atlanta to withdraw the reference with respect to all matters pertaining to its proof of claim from the jurisdiction of the Bankruptcy Court. By order executed February 18, 1999, the appeal, K-C's motion for withdrawal of the reference and the Company's motion to dismiss the appeal were dismissed by the District Court without prejudice to the right of either party within sixty days to re-open the actions if a settlement was not consummated. See "--IN RE PARAGON TRADE BRANDS, INC." below. On May 26, 1998, the special master issued his report on the majority of the motions pending before him. His report included a finding, among other things, that Paragon, as the successor-in-interest to the disposable diaper business of Pope & Talbot, has a fully paid-up license to one of the three asserted K-C inner-leg gather patents, which license runs from the date of the acquisition by the Company of Pope & Talbot. Pope & Talbot had previously obtained the license from K-C. The special master also found that K-C should be held to the narrow interpretation of its patent applied by Judge Dwyer in the Western District of Washington in earlier litigation between P&G and K-C on the patent. In addition, the special master also recommended that the Company's antitrust counterclaim and any discovery-related matters in connection therewith be dismissed. Effective September 1, 1998, the Texas action was reassigned to Judge Lindsey, a newly-appointed judge on the Dallas District Court bench. Judge Lindsey asked the parties to report on the status of the case and the likelihood of settlement. The parties responded on November 6, 1998, that negotiations were underway and that they believed considerable progress was being made. The Company has previously disclosed that should K-C prevail on its claims, an award of all or a substantial portion of the relief requested by K-C could have a material adverse effect on the Company's financial condition and its results of operations. Based on the advice of patent counsel, the Company believes that the Company's products do not infringe any valid patent asserted by K-C. K-C filed alleged claims in the Company's Chapter 11 reorganization proceeding ranging from approximately $893,000 (without trebling) to $2,300,000 (with trebling). See "--IN RE PARAGON TRADE BRANDS, INC.," below. On March 19, 1999, the Company entered into a Settlement Agreement with K-C which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Texas action, including the Company's counterclaims, and K-C's proof of claim filed in the Company's Chapter 11 reorganization proceeding. Under the terms of the K-C Settlement Agreement, the Company grants K-C an allowed unsecured prepetition claim of $110,000 and an allowed administrative claim of $5,000. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to the patents asserted in the Texas action. In addition, the patent rights licensed by the Company from K-C will allow the Company to manufacture a dual cuff diaper design. In exchange for these patent rights, the Company has agreed to pay K-C annual running royalties on net sales of the licensed products in the U.S. and Canada equal to: 2.5 percent of the first $200,000of net sales of the covered diaper products and 1.5 percent of such net sales in excess of $200,000 in each calendar year commencing January 1999 through November 2004. In addition, the Company has agreed to pay a minimum annual royalty for diaper sales of $5,000, but amounts due on the running royalties will be offset against this minimum. The Company will also pay K-C running royalties of 5 percent of net sales of covered training pant products for the same period, but there is no minimum royalty for training pants. As part of the settlement, the Company has granted a royalty-free license to K-C for three patents which the Company in the Texas action claimed K-C infringed. The Company believes that the overall effective royalty rate that the Company will pay to K-C will, together with royalties to be paid to P&G described above, have a material adverse impact on the Company's future financial condition and results of operations As a part of the K-C License Agreement, K-C has agreed not to sue the Company on two of K-C's patents related to the use of super-absorbent polymers ("SAP") in diapers and training pants, so long as the Company uses SAP which exhibits certain performance characteristics (the "SAP Safe Harbor"). The Company has experienced certain product performance issues the Company believes may be related to such SAP. As a result, the Company expects that it will incur increased marketing and selling, general and administrative expenses Page 61 ("SG&A") expenditures in 1999 to address product performance issues. These increased expenditures are expected to have a material adverse impact on the Company's financial position and results of operations in 1999. The Company is encountering increased product costs due to the increased price and usage of the new SAP. While the Company is working diligently with its SAP supplier to develop a better performing alternative which is still within the SAP Safe Harbor, the Company cannot predict at this time whether or when such an alternative SAP would be available. The Company expects that these increased product costs will have a material adverse impact on its financial condition and results of operations for at least 1999 and potentially beyond. Upon the Effective Date, as defined in the K-C Settlement Agreement, K-C will dismiss with prejudice its complaint in the Texas action, as well as its related filings in the District Court in Georgia, and the Company will simultaneously dismiss with prejudice its counterclaims in the Texas action. The Company intends to file shortly a motion with the Bankruptcy Court to seek approval of the settlement. If the K-C Settlement Agreement is not approved by an order of the Bankruptcy Court entered before August 1, 1999, the K-C License Agreement described above will terminate automatically. The Company intends to vigorously pursue approval of the settlement but cannot predict when, or if, such approval will be granted. IN RE PARAGON TRADE BRANDS, INC. -- As described above, on December 30, 1997, the Delaware District Court issued a Judgment and Opinion in the Company's lawsuit with P&G which found, in essence, two of P&G's diaper patents to be valid and infringed by the Company's "Ultra" disposable baby diapers, while also rejecting the Company's patent infringement claim against P&G. Judgment was entered on January 6, 1998. While a final damages number was not entered by the District Court until June 2, 1998, the Company originally estimated the liability and associated litigation costs to be approximately $200,000. The amount of the award resulted in violation of certain covenants under the Company's bank loan agreements. As a result, the issuance of the Judgment and the uncertainty it created caused an immediate and critical liquidity issue for the Company which necessitated the Chapter 11 filing. Subsequently, damages of approximately $178,400 were entered against Paragon by the District Court on June 2, 1998. At the same time, the District Court entered injunctive relief agreed upon by P&G and the Company. See "--THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC.," above. The Chapter 11 filing prevented P&G from placing liens on the Company's assets, permitted the Company to appeal the District Court's decision in an orderly fashion and affords the Company the opportunity to resolve liquidated and unliquidated claims against the Company, which arose prior to the Chapter 11 filing. The Company is currently operating as a debtor-in-possession under the Bankruptcy Code. The bar date for the filing of proofs of claim (excluding administrative claims) by creditors was June 5, 1998. P&G filed alleged claims ranging from approximately $2,300,000 (without trebling) to $6,500,000 (with trebling), which included a claim of $178,400 for the Delaware judgment. See "--THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC.," above. The remaining claims include claims for, among other things, alleged patent infringement by the Company in foreign countries where it has operations. On February 2, 1999, the Company entered into a Settlement Agreement with P&G which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Delaware Judgment, the Company's appeal of the Delaware Judgment, P&G's motion to find the Company in contempt of the Delaware Judgment and P&G's proof of claim filed in the Company's Chapter 11 reorganization proceeding. As a part of the P&G settlement, Paragon grants P&G an allowed unsecured prepetition claim of $158,500 and an allowed administrative claim of $5,000. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to the patents asserted by P&G in its proof of claim, including those asserted in the Delaware Action. The U.S. and Canadian patent rights licensed by the Company will allow the Company to manufacture a dual cuff baby diaper design. In exchange for these rights, the Company has agreed to pay P&G running royalties on net sales of the licensed products equal to 2 percent through October 2005, .75 percent thereafter through October 2006 and .375 percent thereafter through March 2007 in the U.S.; and 2 percent through October 2008 and 1.25 percent thereafter through December 2009 in Canada. The Settlement Agreement also provides, among other things, that P&G will grant the Company and/or its affiliates "most favored licensee" status with respect to patents owned by P&G on the date of the Settlement Agreement or for which an application was pending on that date. In addition, the Company has agreed with P&G Page 62 that prior to litigating any future patent dispute, the parties will engage in good faith negotiations and will consider arbitrating the dispute before resorting to litigation. The Company believes that the royalty rates being charged by P&G, together with royalties to be paid to Kimberly-Clark Corporation ("K-C") described below, will have a material adverse impact on the Company's future financial condition and results of operations. Under the terms of the P&G Settlement Agreement, the Company and P&G jointly requested modification of the injunction entered in Delaware District Court so as to allow the Company to begin converting to a dual cuff design pursuant to the License Agreements described above. The injunction was modified as requested on February 22, 1999 and the product conversion is substantially complete. As also provided under the terms of the P&G Settlement Agreement, once a Final Order, as defined therein, has been entered by the Bankruptcy Court approving the settlement, the Company will withdraw with prejudice its appeal of the Delaware Judgment to the Federal Circuit, and P&G will withdraw with prejudice its motion in Delaware District Court to find the Company in contempt of the Delaware Judgment. A hearing on the Company's motion to seek approval from the Bankruptcy Court of this settlement was commenced on March 22 and 23, 1999 and is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have objected to the P&G settlement. The Company intends to continue to pursue approval of the P&G Settlement by the Bankruptcy Court. Should the P&G Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by July 31, 1999, however, the License Agreements described above will become terminable at P&G's option. The Company cannot predict when, or if, such approval will be granted. K-C filed alleged claims ranging from approximately $893,000 (without trebling) to $2,300,000 (with trebling), including claims related to the litigation in the Dallas District Court described above. See "--KIMBERLY-CLARK CORPORATION V. PARAGON TRADE BRANDS, INC.," above. K-C's claims in the Bankruptcy case include an attempt to recover alleged lost profits for infringement of the patents asserted in the Dallas District Court, despite the fact that a lost profits theory of damages was not pursued by K-C in the Dallas District Court. On March 19, 1999, the Company entered into a Settlement Agreement with K-C which, if approved by the Bankruptcy Court, will fully and finally settle all matters related to the Texas action, including the Company's counterclaims, and K-C's proof of claim filed in the Company's Chapter 11 reorganization proceeding. Under the terms of the K-C Settlement Agreement, the Company grants K-C an allowed unsecured prepetition claim of $110,000 and an allowed administrative claim of $5,000. As a part of the settlement, the Company has entered into License Agreements for the U.S. and Canada, which are exhibits to the Settlement Agreement, with respect to the patents asserted in the Texas action. In addition, the patent rights licensed by the Company from K-C will allow the Company to manufacture a dual cuff diaper design. In exchange for these patent rights, the Company has agreed to pay K-C annual running royalties on net sales of the licensed products in the U.S. and Canada equal to: 2.5 percent of the first $200,000 of net sales of the covered diaper products and 1.5 percent of such net sales in excess of $200,000 in each calendar year commencing January 1999 through November 2004. In addition, the Company has agreed to pay a minimum annual royalty for diaper sales of $5,000, but amounts due on the running royalties will be offset against this minimum. The Company will also pay K-C running royalties of 5 percent of net sales of covered training pant products for the same period, but there is no minimum royalty for training pants. As part of the settlement, the Company has granted a royalty-free license to K-C for three patents which the Company in the Texas action claimed K-C infringed. The Company believes that the overall effective royalty rates that the Company will pay to K-C will, together with royalties to be paid to P&G described above, have a material adverse impact on the Company's future financial condition and results of operations. As a part of the K-C License Agreement, K-C has agreed not to sue the Company on two of K-C's patents related to the use of SAP in diapers and training pants, so long as the Company stays within the SAP Safe Harbor. The Company has experienced certain product performance issues the Company believes may be related to such SAP. As a result, the Company expects that it will incur increased marketing and SG&A expenditures in 1999 to address product performance issues. These increased expenditures are expected to have a material adverse impact on the Company's financial position and results of operations in 1999. The Company is encountering increased product costs due to the increased price and usage of the new SAP. While the Company is working diligently with its SAP suppliers to develop a better performing alternative which is still within the SAP Safe Page 63 Harbor, the Company cannot predict at this time whether or when such an alternative SAP would be available. The Company expects that these increased product costs will have a material adverse impact on its financial condition and results of operations for at least 1999 and potentially beyond. Upon the Effective Date, as defined in the K-C Settlement Agreement, K-C will dismiss with prejudice its complaint in the Texas action, as well as its related filings in the District Court in Georgia, and the Company will simultaneously dismiss with prejudice its counterclaims in the Texas action. The Company intends to file shortly a motion with the Bankruptcy Court to seek approval of the settlement. If the K-C Settlement Agreement is not approved by an order of the Bankruptcy Court entered before August 1, 1999, the K-C License Agreement described above will terminate automatically. The Company intends to vigorously pursue approval of the settlement but cannot predict when, or if, such approval will be granted. On February 17, 1999, the Company, P&G, K-C, the Creditors' and Equity Committees stipulated to an extension of the Company's exclusivity period to April 19, 1999 during which time only the Company can propose a plan of reorganization. On March 29, 1999, the Company filed a motion seeking to extend this period, initially, to May 19, 1999 and, subsequently, to June 19, 1999. A hearing on this motion is scheduled to occur on April 16, 1999. On January 30, 1998, the Company received Bankruptcy Court approval of a $75,000 financing facility with a bank group led by The Chase Manhattan Bank. This facility is designed to supplement the Company's cash on hand and operating cash flow and to permit the Company to continue to operate its business in the ordinary course. As of December 27, 1998, there were no outstanding direct borrowings under this facility. The Company had an aggregate of $1,300 in letters of credit issued under the DIP Credit Facility at December 27, 1998. The DIP Credit Facility contains customary covenants. The Company for a period of time has been unable to fully comply with certain reporting requirements of such covenants. The Company has obtained waivers with respect to these events of default which are effective through May 10, 1999. The Company believes that it will be in compliance with the reporting requirements of the DIP Credit Facility by May 10, 1999. See Note 12. Legal fees and costs in connection with the Chapter 11 case have been and will continue to be significant. The Company is unable to predict at this time when it will emerge from Chapter 11 protection. OTHER -- The Company is also a party to other legal activities generally incidental to its activities. Although the final outcome of any legal proceeding or dispute is subject to a great many variables and cannot be predicted with any degree of certainty, the Company presently believes that any ultimate liability resulting from any or all legal proceedings or disputes to which it is a party, except for the Chapter 11 filing and the P&G and K-C matters discussed above, will not have a material adverse effect on its financial condition or results of operations. NOTE 16: COMMITMENTS Paragon has operating lease agreements for certain facilities that expire during the years 1999 through 2001. Future minimum lease payments required under these noncancelable operating leases are: $391 in 1999, $134 in 2000 and $46 in 2001. Rental expense for facilities and equipment was $2,676, $3,015 and $2,967 for the years ended December 27, 1998, December 28, 1997 and December 29, 1996, respectively. Commitments for capital expenditures as of December 27, 1998 are $13,780. Other Company commitments include purchase commitments for raw materials at prevailing market rates. In early 1996, the Company entered into an agreement with Clariant International Ltd. (subsequently purchased by BASF Corporation) whereby it agreed, subject to certain limitations, to purchase 100 percent of its requirements of SAP through December 31, 2001. Fluff pulp, a product made from wood fibers, is another primary raw material. The Company's agreement with Weyerhaeuser whereby it purchased 100 percent of its requirements of bleached chemical fluff pulp expired August 31, 1998. The Company believes that at least two other sources of supply exist for fluff pulp. As a result of the Chapter 11 filing, the Company is prohibited from paying any prepetition liabilities. Pursuant to the Bankruptcy Code, the Company can seek Bankruptcy Court approval for the rejection of executory contracts or unexpired leases, including real property leases. Any such rejection may give rise to a prepetition unsecured claim for damages arising therefrom. Page 64 NOTE 17: NET EARNINGS PER COMMON SHARE Following is a reconciliation of the numerators and denominators of the basic and diluted earnings (loss) per common share:
Year Ended -------------------------------------------------------- December 27, 1998 December 28, 1997 December 29, 1996 ----------------- ----------------- ----------------- Net earnings (loss) $ (65,838) $ (212,717) $ 21,122 ========== ========== =========== Weighted average number of common shares used in basic EPS (000's) 11,9387 11,913 12,022 Effect of dilutive securities: Stock options (000's) - - 139 ---------- ---------- ----------- Weighted average number of common shares and potentially dilutive common shares in diluted EPS (000's) 11,937 11,913 12,161 ========== ========== =========== Basic earnings (loss) per common share $ (5.48) $ (17.86) $ 1.76 Diluted earnings (loss) per common share $ (5.48) $ (17.86) $ 1.74
Options to purchase 699,491, 313,612 and 223,987 shares of common stock outstanding during the years ended December 27, 1998, December 28, 1997 and December 29, 1996, respectively, were not included in the calculation because the options' exercise price was greater than the average market price of the common shares. Diluted and basic earnings per share are the same for the years ended December 27, 1998 and December 28, 1997 because the computation of diluted earnings per share was anti-dilutive. NOTE 18: SEGMENT REPORTING Basis of Presentation. The Company operates principally in two segments that are organized based on the nature of the products sold: (i) infant care and (ii) feminine care and adult incontinence. Each operating segment contains closely related products that are unique to that particular segment. The results of Changing Paradigms, Inc. and the Company's international investment in joint ventures in Mexico, Argentina, Brazil and China are reported in the corporate and other segment. Identifiable assets included in the corporate and other segment include deferred tax assets, international investments in joint ventures and cash and other financial instruments managed by the corporate treasury department. Inter-segment net sales are not significant. Segment accounting policies are the same as those described in Note 2. Management evaluates the performance of its operating segments separately to individually monitor the different factors impacting financial performance. Segment operating profit is comprised of net sales less cost of sales and selling, general and administrative expense. Loss contingencies and asset impairments are recorded in the appropriate operating segment. Certain administrative expenses common to all operating segments are currently allocated to the infant care operating segment. International investments, financial costs, such as interest income and expense, and income taxes are managed by, and recorded in, the corporate and other operating segment. Page 65 Corporate and other capital expenditures include substantially all of the Company's spending for Year 2000 and information technology. Related depreciation and amortization is allocated to each operating segment.
Feminine Adult/Care Corporate/ 1998 Infant Care Incontinence Other Total - ---- ----------- ------------ ----- ---------- Net sales $ 512,759 $ 6,608 $ 15,840 $ 535,207 Operating profit (loss) (42,209)(1) (16,916)(2) 1,149 (57,976) Equity in earnings of unconsolidated - - 4,077 4,077 subsidiaries Dividend income from unconsolidated subsidiary - - 922 922 Interest expense - - 450 450 Other income - - 2,437 2,437 Earnings (loss)before income taxes and bankruptcy costs (42,209) (16,916) 8,135 (50,990) Identifiable assets 245,772 39,614 55,118 340,503 Investments - - 88,783 88,784 Capital expenditures 24,410 1,256 11,655 36,453 Depreciation and amortization 29,536 4,742 181 34,459 Feminine Adult/Care Corporate/ 1997 Infant Care Incontinence Other Total - ---- ----------- ------------ ----- ---------- Net sales $ 545,225 $ 4,264 $ 12,486 $ 561,975 Operating profit (loss) (154,989)(3) (23,721)(4) (5,078)(5) (183,788) Equity in earnings of unconsolidated - - 953 953 subsidiaries Dividend income from unconsolidated subsidiary - - 1,055 1,055 Interest expense - - 4,667 4,667 Other income - - 1,664 1,664 Earnings (loss) before income taxes (154,989) (23,721) (6,073) (184,783) Identifiable assets 234,707 45,540 22,087 302,334 Investments - - 73,808 73,808 Capital expenditures 31,607 12,415 11,013 55,035 Depreciation and amortization 33,127 2,294 93 35,514 Feminine Adult/Care Corporate/ 1996 Infant Care Incontinence Other Total - ---- ----------- ------------ ----- ---------- Net sales $ 574,297 $ 470 $ 7,162 $ 581,929 Operating profit (loss) 52,852(6) (7,999) (9,184)(7) 35,669 Equity in earnings of unconsolidated - - 423 423 subsidiaries Interest expense - - 2,864 2,864 Other income, net - - 581 581 Earnings (loss) before income taxes 52,852 (7,999) (11,044) 33,809 Identifiable assets 231,926 36,825 58,324 327,075 Investments - - 46,015 46,015 Capital expenditures 15,160 24,223 9,484(8) 48,867 Depreciation and amortization 38,187 587 54 38,828 - --------------- (1) Includes $78,500 accrued settlement contingency for estimated settlement costs. (2) Includes asset impairment of $3,408 related to tampon-related machinery. (3) Includes $200,000 accrued settlement contingency for P&G patent litigation. Page 66 (4) Includes asset impairment of $4,442 related to tampon-related machinery. (5) Includes $5,000 write-off of software and associated consulting. (6) Includes $8,032 in cost for the integration of the Pope & Talbot acquisition. (7) Includes $9,005 in costs related to the corporate headquarters relocation to Atlanta. (8) Includes $6,844 for purchase of the corporate headquarters in Atlanta.
The following table presents net sales by country based on the country of origin, including exports from such countries:
1998 1997 1996 ---- ---- ---- United States $ 497,919 $ 521,487 $ 528,143 Canada 37,288 40,488 53,786 --------- --------- --------- Consolidated 535,207 561,975 581,929 ========= ========= =========
The following table presents net property, plant and equipment, including assets held for sale, based on location of the asset:
1998 1997 1996 ---- ---- ---- United States $ 106,705 $ 123,313 $ 122,140 Canada 4,186 6,143 8,619 --------- --------- --------- Consolidated 110,891 129,456 130,759 ========= ========= =========
NOTE 19: QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) FISCAL YEAR ENDED DECEMBER 27, 1998
First Second Third Fourth ----- ------ ----- ------ Net sales $ 138,297 $ 126,991 $ 136,993 $ 132,926 Gross profit 27,498 24,647 27,912 26,578 Net earnings (loss) 6,006 3,369 4,024 (78,782) Basic earnings (loss) per share of common stock $ .50 $ .28 $ .34 $ (6.59) Diluted earnings (loss) per share of common stock $ .50 $ .28 $ .34 $ (6.59) Price Range of the Company's common stock: High $ 20.25 $ 6.81 $ 4.63 $ 3.63 Low $ 4.19 $ 2.63 $ 2.63 $ 1.75
FISCAL YEAR ENDED DECEMBER 28, 1997
First Second Third Fourth ----- ------ ----- ------ Net sales $ 135,685 $ 135,819 $ 154,066 $ 136,405 Gross profit 27,838 23,929 28,601 26,696 Net earnings (loss) 3,802 2,652 5,761 (224,932) Basic earnings (loss) per share of common stock $ .32 $ .22 $ .48 $ (18.82) Diluted earnings (loss) per share of common stock $ .32 $ .22 $ .48 $ (18.82) Price Range of the Company's common stock: High $ 30.00 $ 18.00 $ 19.13 $ 23.50 Low $ 14.88 $ 15.25 $ 15.38 $ 17.50
Page 67 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES FOR THE THREE YEARS IN THE PERIOD ENDED DECEMBER 27, 1998 (DOLLAR AMOUNTS IN THOUSANDS)
Balance at Charged Deductions Balance at Beginning to From End of Description of Period Earnings Reserve Period - --------------------------------------------- --------- -------- -------- ------ Reserve deducted from related assets: Doubtful accounts - accounts receivable 1998............................... $ 6,535 $ 3,787 $ (1,622) $ 8,700 ======== ======== ========= ========= 1997............................... $ 7,637 $ (587) $ (515) $ 6,535 ======== ======== ========= ========= 1996............................... $ 5,866 $ 2,965 $ (1,194) $ 7,637 ======== ======== ========= ========= Excess and obsolete items - inventories 1998............................... $ 7,397 $ 3,000 $ (3,760) $ 6,637 ======== ======== ========= ========= 1997............................... $ 7,803 $ 6,140 $ (6,546) $ 7,397 ======== ======== ========= ========= 1996............................... $ 5,051 $ 6,841 $ (4,089) $ 7,803 ======== ======== ========= =========
Page 68 ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS The following table sets forth certain information regarding the Company's Board of Directors:
Name Age Principal Occupation ------------------------- ----- --------------------------------------------------------------- Bobby V. Abraham 57 Chief Executive Officer and Chairman of the Board, Paragon Trade Brands, Inc. Adrian D.P. Bellamy 57 Nonexecutive Director of Companies Thomas B. Boklund 59 Chief Executive Officer, Oregon Steel Mills Robert L. Schuyler 63 Retired
BOBBY V. ABRAHAM has been a director and the Chief Executive Officer of the Company since its initial public offering in February 1993, has been Chairman of the Company's Board of Directors since August 1993 and served as President of the Company from its inception until November 1993. Prior to the Company's initial public offering, Mr. Abraham had been President of the Personal Care Products Division of Weyerhaeuser since February 1988. ADRIAN D.P. BELLAMY has been a director of the Company since February 1996 and has served as a member of the Compensation Committee of the Company's Board of Directors since February 1996 and as its Chairman since November 1996. Mr. Bellamy has also served as a member of the Governance Committee of the Company's Board of Directors and as a member of the Company's Audit Committee since November 1996. Mr. Bellamy formerly served as Chairman and Chief Executive Officer of DFS Group Limited, an international specialty retailer, from 1983 to 1995. Mr. Bellamy currently serves on the Boards of Directors of Airport Group International Holdings LLC, an airport management company; The Gap, Inc., a clothing retailer; Gucci Group NV, a manufacturer and retailer; The Body Shop International PLC and its USA subsidiary, Buth-Na-Bodhaige Inc., a skin and hair care products manufacturer and retailer; Williams-Sonoma Inc., a home products retailer; Shaman Pharmaceuticals, Inc., a pharmaceutical developer, and Benckiser N.V., a home products company. Mr. Bellamy has served as Chairman of Gucci Group NV since January 1996, and Airport Group International Holdings LLC since July 1995. THOMAS B. BOKLUND has been a director of the Company since April 1993 and served as Chairman of the Compensation Committee of the Company's Board of Directors from May 1993 until November 1996. Mr. Boklund has served as a member of the Company's Audit Committee since November 1996 and as its Chairman from November 1996 to February 1999. Mr. Boklund has also served as a member of the Governance Committee of the Company's Board of Directors since November 1996, and was appointed its Chairman in February of 1999. Mr. Boklund continues to serve as a member of Compensation Committee. Mr. Boklund has been the Chief Executive Officer of Oregon Steel Mills, an industrial steel manufacturer, since 1985, and also serves as its Chairman of the Board. ROBERT L. SCHUYLER has been a director of the Company since April 1993 and served as Chairman of the Audit Committee of the Company's Board of Directors from May 1993 until November 1996. Mr. Schuyler has also served as a member of the Compensation Committee of the Company's Board of Directors since February 1995, and as Chairman of the Governance Committee of the Company's Board of Directors from November 1996 to February 1999. Mr. Schuyler continues to serve as a member of the Governance Committee, and was Page 69 reappointed as Chairman of the Audit Committee in February 1999. Mr. Schuyler formerly served as the President of Nisqually Partners, an investment company, from 1991 through 1997. Mr. Schuyler currently serves on the Boards of Montrail, a manufacturer and wholesaler of outdoor footwear; and Grande Alberta Paper, a Canadian pulp and paper development company. EXECUTIVE OFFICERS The following table sets forth certain information regarding the Company's executive officers:
Name Age Position ------------------------- ----- --------------------------------------------------------------- Bobby V. Abraham 57 Chief Executive Officer and Chairman of the Board David W. Cole 51 President, Sales and Marketing Alan J. Cyron 46 Executive Vice President and Chief Financial Officer Catherine O. Hasbrouck 34 Vice President, General Counsel and Secretary Robert E. McClain 49 Executive Vice President - Sales and Marketing
BOBBY V. ABRAHAM has been a director and the Chief Executive Officer of the Company since its initial public offering in February 1993 and has been the Chairman of the Company's Board of Directors since August 1993. DAVID W. COLE has served the Company as President, Sales and Marketing since March 1998. Prior to assuming his current responsibilities, Mr. Cole had served the Company as President and Chief Operating Officer from November 1993 to March 1998, and as Executive Vice President and Chief Operating Officer from February 1993 to November 1993. ALAN J. CYRON has been the Executive Vice President, Chief Financial Officer and Assistant Secretary of the Company since February 1997. Prior to assuming his current responsibilities, Mr. Cyron had served as Vice President since April 1995 and as Treasurer from May through July 1995. Prior to joining the Company, Mr. Cyron served as Managing Director of Chemical Securities, Inc., a subsidiary of Chemical Banking Corp., from January 1992 through March 1995. CATHERINE O. HASBROUCK has been the Vice President, General Counsel and Secretary of the Company since June 1996. Prior to joining the Company, Ms. Hasbrouck practiced law as an associate with the law firm of Troutman Sanders LLP from January 1992 to June 1996. ROBERT E. MCCLAIN has served the Company as Executive Vice President - Sales and Marketing since March 1997. Prior to March 1997, Mr. McClain served the Company as Vice President - Business Development from September 1996 to March 1997. Before joining the Company, Mr. McClain was the Senior Vice President, Sales and Marketing for Nice Pak Products from 1992 to 1996. ITEM 11: EXECUTIVE COMPENSATION The following table discloses information concerning the compensation of those persons who were, at December 27, 1998, the last day of the Company's 1998 fiscal year, the Company's Chief Executive Officer and four other most highly compensated executive officers on that date (the "named executive officers"). Page 70 SUMMARY COMPENSATION TABLE
LONG-TERM ANNUAL COMPENSATION COMPENSATION AWARDS ------------------- ------------------- OTHER RESTRICTED SECURITIES ANNUAL STOCK UNDERLYING NAME AND FISCAL BONUS COMPENSATION AWARD(S) OPTIONS/ ALL OTHER PRINCIPAL POSITION YEAR SALARY($) ($)(1)(2) ($)(3) ($)(4) SARS(#) COMPENSATION ------------------ ---- --------- --------- ------------ -------- ------- ------------ Bobby V. Abraham... 1998 519,237 561,004 0 0 0 234,191 Chief Executive 1997 500,006 0 0 0 30,000 104,885 Officer and 1996 472,151 525,000 186,590 186,562 30,000 215,382 Chairman of the Board David W. Cole...... 1998 269,537 224,400 9,230 0 0 18,143 President 1997 304,954 0 13,985 0 20,000 3,146 1996 290,658 221,265 97,244 124,375 20,000 14,459 Alan J. Cyron...... 1998 228,422 210,375 0 0 0 16,318 Executive Vice 1997 206,612 0 4,615 0 15,000 3,158 President and 1996 193,865 156,450 212,626 49,750 15,000 12,614 Chief Financial Officer Arrigo D. Jezzi(6). 1998 224,423 210,375 0 0 0 18,289 Executive Vice 1997 173,679 0 32,179 0 10,000 4,250 President, Operations, Technology and International Robert E. McClain . 1998 177,355 196,350 0 0 0 12,974 Executive Vice President, Sales and Marketing - ------------------ (1) As a result of the Company's performance in fiscal 1997, no annual bonus payment was made to any of the named executive officers for 1997. (2) In addition to amounts earned under the Company's Annual Bonus program, Mr. McClain earned a sales bonus in the amount of $71,210. (3) Messrs. Cole and Cyron received tax gross-up payments in 1997 for reimbursements by the Company of taxable relocation expenses incurred in connection with their relocation in 1996 from Washington to Georgia. Amounts paid to Mr. Jezzi include $14,365 for reimbursement of taxable relocation expenses, $6,904 for reimbursement of nontaxable relocation expenses and $10,190 for tax gross-up payments, each made in connection with his relocation in 1997 from Pennsylvania to Georgia. Included in such taxable and nontaxable relocation expenses reported above for Mr. Jezzi were $6,583 in payment of moving expenses and $9,873 reimbursement for loss on the sale of his Pennsylvania residence. Messrs. Abraham, Cole and Cyron recognized income in 1997 in the amounts of $84,721, $13,748 and $24,825, respectively, on the difference between the price paid for shares of the Company's common stock purchased in lieu of the 1996 bonus and the fair market value of those shares on the date of purchase. Additional amounts paid in 1996 to Mr. Abraham were $64,359, $12,725 and $24,786; to Mr. Cole were $37,035, $20,733 and $25,728; and to Mr. Cyron were $118,250, $5,579 and $63,971; in each case, for reimbursement of taxable and nontaxable relocation expenses, and tax gross-up payments, respectively. Payments to Messrs. Abraham and Cole were made in 1996 in connection with relocation of the Company's corporate headquarters from Washington to Georgia. Payments to Mr. Cyron were made in 1996 in connection with his relocation from New York to Washington as a result of joining the Company in 1995, and with his subsequent relocation from Washington to Georgia. Included in such taxable and nontaxable relocation expenses reported above for Mr. Abraham were $29,000 in payment of a home sale bonus and $57,101 in closing costs on the sale of his Washington residence; for Mr. Cole were $21,498 in payment of a home sale bonus, $42,726 in closing costs on the sale of his Washington residence and Page 71 $20,231 in moving expenses; and for Mr. Cyron were $41,662 in payment for loss on the sale of his Washington residence and $40,707 in closing costs on the sale of his Washington residence. (4) Restricted stock is valued at the closing price of the Common Stock as reported on the New York Stock Exchange, Inc. (the "NYSE") on the date of grant. Restricted stock awards are forfeitable and vest, generally, in either two or three equal annual installments from the date of grant, subject to acceleration in the event of certain mergers or consolidations involving the Company, a sale, lease, exchange or other transfer of all or substantially all of the Company's assets, or a liquidation or dissolution of the Company. Such awards may be granted at up to a 20% discount to the market price of the Common stock on the date of award. A restricted stock award in the amount of $186,562 was made in 1996 in recognition of Mr. Abraham's efforts relating to the Company's acquisition of the Pope & Talbot disposable diaper business and the investment in Mabesa.. A restricted stock award in the amount of $49,750 was made in 1996 in recognition of Mr. Cyron's efforts in connection with the investment in Mabesa, and such award vested 33.4% on February 19, 1997, 33.3% on February 19, 1998 and 33.3% on February 19, 1999. A restricted stock award in the amount of $124,375 was made in 1996 in recognition of Mr. Cole's efforts in connection with the integration of the Pope & Talbot disposable diaper business. Under ordinary circumstances, recipients of restricted stock are able to pay the tax liability arising upon vesting out of the proceeds of the sale of Company stock. Since the filing of the Company's Chapter 11 proceeding, however, certain corporate insiders have been unable to trade in the Company's stock. As a result, on January 31, 1999 and February 18, 1999, in order to avoid incurring a tax liability in connection with the vesting of certain restricted stock awards, Mr. Abraham forfeited 4,887 shares awarded February 1, 1994 and scheduled to vest on February 1, 1999, and 2,500 shares awarded February 19, 1996 and scheduled to vest on February 19, 1999; and on February 18, 1999, Mr. Cole forfeited 1,666 shares awarded February 19, 1996 and scheduled to vest on February 19, 1999. In addition, on February 13, 1998, Messrs. Abraham and Cole forfeited 22,505 and 13,506 shares of restricted stock, respectively, awarded February 14, 1995 and February 19, 1996 and scheduled to vest on February 16, 1998 and February 19, 1998, respectively. On December 27, 1998, Messrs. Abraham, Cole and Cyron held 7,387 shares, 1,666 shares and 666 shares, respectively, of restricted Common Stock, with market values, based on the closing price of the Common Stock as reported on the NYSE on such date, of $17,544, $3,957 and $1,582, respectively. Dividends are payable on restricted stock at the same rate payable to all stockholders. (5) The amounts shown for fiscal 1998 represent: (i) matching 401(k) contributions under the Paragon Retirement Savings Investment Management Program (the "PRISM Plan") in the amounts of $4,250, $4,250, $4,276, $4,396 and $932 for Messrs. Abraham, Cole, Cyron, Jezzi and McClain, respectively; (ii) profit sharing contributions under the PRISM Plan in the amounts of $13,893, $13,893, $12,042, $13,893 and $12,042 for Messrs. Abraham, Cole, Cyron, Jezzi and McClain; and (iii) a $216,048 deferred compensation award for Mr. Abraham under the terms of his employment agreement and as approved by the Creditors' Committee and the Bankruptcy Court. (6) Mr. Jezzi resigned effective as of April 15, 1999.
1998 OPTION GRANTS AND EXERCISES There were no option grants under any of the Company's incentive compensation plans in 1998. SEE "BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION: LONG-TERM INCENTIVES," BELOW. Page 72 The following table provides information on the aggregated option/SAR exercises by named executive officers in 1998 and the value of the named executive officers' unexercised options/SARs at December 27, 1998. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES UNDERLYING UNEXERCISED NUMBER OF SECURITIES OPTION/SAR OPTIONS AT UNDERLYING UNEXERCISED SARS EXERCISES FISCAL YEAR-END(#) AT FISCAL YEAR END(#) --------- ------------------ --------------------- SHARES ACQUIRED ON VALUE NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- -------- -------- ----------- ------------- ----------- ------------- Bobby V. Abraham...... 0 0 170,411 81,249 0 0 David W. Cole......... 0 0 93,750 53,750 0 0 Alan J. Cyron......... 0 0 13,750 36,250 0 0 Arrigo D. Jezzi....... 0 0 20,000 0 7,500 12,500 Robert E. McClain..... 0 0 0 0 22,500 17,500
VALUE OF UNEXERCISED IN-THE -MONEY OPTIONS/SARS AT FISCAL YEAR-END($)(1) --------------------- NAME EXERCISABLE UNEXERCISABLE ---- ----------- ------------- Bobby V. Abraham...... 0 0 David W. Cole......... 0 0 Alan J. Cyron......... 0 0 Arrigo D. Jezzi....... 0 0 Robert E. McClain..... 0 0 - --------------- (1) The value of the options/SARs on December 27, 1998 is based on the average of the high and low sales prices per share of the Common Stock as reported on the NYSE on December 24, 1998 ($2.375). None of the outstanding options or SARs were in the money at December 27, 1998.
COMPENSATION OF DIRECTORS FEES. Directors who are employees of the Company do not receive any fees for their services as directors. Directors who are not employees of the Company are paid an annual retainer of $13,000 for serving on the Board of Directors and $2,500 for serving on a committee of the Board of Directors. Each nonemployee director receives an additional fee of $1,000 per day for attending each meeting of the Board of Directors and $750 for attending each meeting of a committee of the Board of Directors. A nonemployee director serving as a committee chairman receives an additional $1,000 per annum. OPTIONS. Directors who are not employees of the Company are eligible to receive grants of options to purchase Common Stock under the Company's Stock Option Plan for Non-Employee Directors (the "Director Plan"). Under the Director Plan, each nonemployee director is eligible to automatically receive an option to purchase 5,000 shares of Common Stock on the first business day following his or her initial election as a director of the Company and thereafter is eligible to receive annually, on the first business day following the date of each annual meeting of stockholders of the Company, an option to purchase 2,000 shares of Common Stock, at an Page 73 exercise price for all grants equal to the fair market value of the Common Stock on the date of grant. The Board has suspended the Director Plan until the Company emerges from Chapter 11 protection and, as such, no options were granted to Directors in 1998. EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE - IN - CONTROL ARRANGEMENTS CONFIRMATION RETENTION PLAN FOR TOP EIGHT EXECUTIVES. In August 1998, the Company received Bankruptcy Court approval of its Confirmation Retention Plan for Top Eight Executives (the "Confirmation Retention Plan"), which had previously been adopted by the Compensation Committee of the Company's Board of Directors (the "Committee"). The Confirmation Retention Plan is designed to provide additional incentive for the Company's top eight executives to remain with the Company through the conclusion of the Company's Chapter 11 reorganization proceeding and to ensure their continued dedication and efforts without undue concern for their personal financial and employment security in order to expedite the Company's emergence from Chapter 11. In particular, the Confirmation Retention Plan includes a bonus payable to the top eight executives upon emergence from Chapter 11 (the "Confirmation Bonus") and enhanced severance protection, as described below. In conjunction with the Confirmation Retention Plan, each of the top eight executives of the Company, including Mr. Abraham and the other named executive officers, entered into Employment Agreements with the Company which provide, among other things, that the executives are eligible to participate in the Confirmation Retention Plan. These Employment Agreements supersede any prior employment agreement that any of the top eight executives had with the Company. Under the Confirmation Retention Plan, the Company shall be obligated to pay the Confirmation Bonus to the eligible executives upon confirmation of a plan of reorganization by the Bankruptcy Court. In order to receive a Confirmation Bonus, an executive must (i) be an active employee of the Company on the date of confirmation of a plan by the Bankruptcy Court, and (ii) must not have been terminated for Cause, as defined in the Confirmation Retention Plan, or have voluntarily resigned from employment on or before the date such Confirmation Bonus is paid. Notwithstanding the foregoing, if an executive's employment with the Company is terminated by reason of death, retirement or disability, or if the executive is terminated for any reason other than Cause, as defined in the Confirmation Retention Plan, the Executive shall receive the Confirmation Bonus if such termination occurs no earlier than three (3) months before the confirmation of a plan of reorganization. If such termination occurs more than three (3) moths before the confirmation of a plan of reorganization, the Board, as defined in the Confirmation Retention Plan, shall have the discretion to award the executive a pro-rata portion of his or her Confirmation Bonus. The Confirmation Bonus for each eligible executive shall be equal to the executive's then base salary plus any amounts for which the executive qualified under the Company's 1998 Bonus Plan , subject to enhancement based on the date the Bankruptcy Court confirms a plan of reorganization. If a plan of reorganization is confirmed on or before May 15, 1999, the Confirmation Bonus shall be multiplied by a factor of 1.25. For each full month prior to May 15, 1999 that a plan of reorganization is confirmed by the Bankruptcy Court, this enhancement shall be increased by 10 percent. Likewise, for each full month after May 15, 1999 during which a plan of reorganization is confirmed, enhancement shall be decreased by 10 percent to a floor of 1.00 times the Confirmation Bonus should a plan be confirmed on or after July 16, 1999. A minimum aggregate Confirmation Bonus of $2 million shall be immediately paid in cash upon consummation of the plan of reorganization. If the aggregate of all the executives' Confirmation Bonuses exceeds $2 million, the Board shall pay any or all of the excess in common stock of the Company unless the Board determines, in its complete discretion, to pay such amount in cash. Any stock received as part of the Confirmation Bonus shall be fully vested, and the Company shall provide a loan program, secured solely by the shares of stock issued, to assist recipients of the stock with any tax liabilities arising from the receipt of the stock. The Confirmation Retention Plan also contains a severance program pursuant to which an eligible executive shall be entitled to receive severance benefits from the Company equal to two times base salary, plus a continuation of benefits for two years, upon a Board Requested Termination, Resignation for Good Reason, or upon a termination based on Permanent Disability or death (each such capitalized term as defined in the Confirmation Retention Plan). In general, severance benefits shall be paid in a lump sum on the last day of employment. No severance benefits shall be paid upon a termination for Cause or upon voluntary termination of employment for any reason other than very limited circumstances specified in the Confirmation Retention Plan Page 74 Under the Confirmation Retention Plan, an executive may voluntarily resign and still receive severance benefits if (i) the Company does not make an offer to the executive of continued employment of at least one additional year during the tenth month after confirmation of a plan of reorganization; (ii) the Company does make such an offer, but such offer contains terms that would provide the executive with the option to Resign for Good Reason; or (iii) the executive Resigns for Good Reason. Should the Company make an offer to the executive of continued employment of at least one additional year during the tenth month after confirmation of a plan, which offer does not contain terms that would provide the executive with the option to Resign for Good Reason, and the executive resigns anyway, then the executive shall receive a lump sum equal to only one times the executive's base salary upon termination of employment. The remainder of the severance benefits shall be paid in 12 monthly installments and shall be reduced in an amount equal to the salary compensation received by the executive due to other employment, including fees from consulting services. In addition to the above, the terms of the individual employment agreements with the top eight executives also require that each executive diligently perform all acts and duties and furnish such services as are customary for the position that such executive holds. Each of the top eight executives must also comply with a noncompete provision contained in their respective employment agreements which runs during the tenure of the executive's employment and for a period of two years thereafter. Each of the top eight executives was also required, as part of their respective employment agreements, to enter into a confidentiality agreement with the Company. A breach by the executive of his or her obligations under either the employment agreement or the confidentiality agreement will result in a forfeiture of the executive's rights under their employment agreement and will make the executive ineligible to participate in the Confirmation Retention Plan. 1993 LONG-TERM PLAN. In the event of a merger, consolidation or acquisition of the Company, a sale or transfer of all or substantially all of the Company's assets, a tender or exchange offer for shares of Common Stock (other than offers by the Company) or other reorganization, as a result of which the Company is not likely to continue as an independent, publicly owned corporation, the 1993 Long-Term Plan provides that the Committee may take such action as it determines necessary or advisable, and fair and equitable to participants, with respect to stock options, SARs and other awards under the 1993 Long-Term Plan. In addition, shares of restricted stock awarded for 1995 in lieu of cash bonuses will become fully exercisable, subject to certain exceptions, in the event of certain mergers or consolidations involving the Company, a sale, lease, exchange or other transfer of all or substantially all of the Company's assets or a liquidation or dissolution of the Company. 1995 INCENTIVE PLAN. In the event of certain mergers or consolidations involving the Company, a sale, lease, exchange or other transfer of all or substantially all of the Company's assets or a liquidation or dissolution of the Company, outstanding options, SARs and restricted stock under the 1995 Incentive Plan will become fully exercisable, subject to certain exceptions. In addition, the Committee may take such further action as it deems necessary or advisable, and fair to participants, with respect to outstanding awards under the 1995 Incentive Plan. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During the fiscal year ended December 27, 1998, members of the Committee were Adrian D.P. Bellamy (Chairman), Thomas B. Boklund and Robert L. Schuyler. No executive officers or employees of the Company served on the Compensation Committee. BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION The Committee, as noted above, is composed entirely of nonemployee directors. The Committee is responsible for establishing and administering the Company's executive compensation programs. COMPENSATION POLICIES The Committee establishes compensation according to the following guiding principles: (a) Compensation should be directly linked to the Company's operating and financial performance. Page 75 (b) Total compensation should be competitive when compared to compensation levels of executives of companies against which the Company competes for management. (c) Performance-related pay should be a significant component of total compensation, placing a substantial portion of an executive's compensation at risk. COMPENSATION PRACTICES Compensation for executives includes base salary, annual bonuses and long-term incentive awards, including stock options, SARs and restricted stock awards. Consistent with the above principles, a substantial proportion of executive compensation depends on Company performance and on enhancing stockholder value. BASE SALARY. The Company uses externally-developed compensation surveys to assign a competitive salary range to each salaried position, including executive positions. The companies included in the survey are selected by the Company's outside compensation consultants and include companies engaged in nondurable manufacturing with annual revenues of between $400 million and $1 billion. The Committee sets actual base salary levels for the Company's executives based on recommendations by management. The Committee bases its decisions on the executive's performance, the executive's position in the salary range, the executive's experience and the Company's salary budget. ANNUAL BONUS. The Company employs a formal system for developing measures of and evaluating executive performance. Bonuses are determined with reference to quantitative measures established by the Committee each year. At the beginning of each year, the Committee also approves performance targets relating to the quantitative measures that, if achieved, will establish a bonus pool equal to the sum of the individual target bonuses for all executives. The Committee also establishes performance targets that could result in a range of bonus payouts from a minimum of zero to a maximum bonus payout of 200 percent of target bonus. At the end of the year, Company performance, as compared to the quantitative measures described above, determines the bonus pool for the executive group. Target bonuses for individual executives are in the range of 25 percent to 60 percent of base salary. The Committee retains the discretion to adjust any individual bonus if deemed appropriate. In the event Company performance exceeds the performance targets established for the maximum 200 percent bonus payout, the bonus pool is funded in excess of such 200 percent payout. Such excess bonus funding is retained by the Company and may be paid out, at the Committee's discretion, in any year in which performance targets are not achieved, if the Committee determines such event to be the result of factors unrelated to management performance. In 1998, the quantitative measure for bonus payments was earnings before interest, taxes, depreciation and amortization ("EBITDA"). The maximum possible bonus payout was 200 percent of target. The Company's performance in fiscal 1998, with EBITDA of $58.4 million, satisfied the quantitative measures designed to fund bonuses at 187.3 percent of target, and the Committee accordingly awarded such bonuses. As a result of the Chapter 11 filing, and in recognition of the need to drive the operating performance of the Company and to incent employees to remain with the Company throughout the course of the Chapter 11 proceeding, the Committee altered the Company's existing incentive compensation plans. The revised plans include (i) a retention incentive for employees of the Company, other than the top eight executives, following the Chapter 11 filing and (ii) the Confirmation Retention Plan described above. These revised plans were approved by the Bankruptcy Court in August 1998. For 1999, the Committee has determined that the quantitative measure for bonus payments will again be EBITDA. The plan will provide minimum and target payout levels. There is no upward limit on the maximum payout level. LONG-TERM INCENTIVES. Long-term incentives are designed to link management reward with the long-term interests of the Company's stockholders. Through 1997, the Committee granted stock options, stock appreciation rights ("SARs") and restricted stock as long-term incentives. Individual stock option awards and Page 76 SARs were based on level of responsibility, the Company's stock ownership objectives for management and upon the Company's performance versus the financial performance objectives set each year for the annual bonus plan described above. The Company's long-term performance ultimately determines the level of compensation resulting from stock options and SARs, since stock option and SAR value is entirely dependent on the long-term growth of the Common Stock price. In 1998, the Committee determined, in connection with the Confirmation Retention Plan described above, that in light of the uncertainties associated with the Chapter 11 process, the Company should discontinue future stock option, SAR grants and restricted stock awards until its emergence from Chapter 11 and, as such, no options, SARs or restricted stock awards were granted to employees for 1998. Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"), limits the Company's ability to deduct compensation in excess of $1 million paid during a tax year to the Chief Executive Officer and the four other highest paid executive officers of the Company. Certain performance-based compensation is not subject to such deduction limit. Total 1998 compensation for Mr. Abraham exceeded $1 million. The Company intends, at the appropriate time, to qualify stock option and SAR awards for the "performance-based" exception to the $1 million limitation on deductibility and otherwise to maximize the deductibility of executive compensation while retaining the discretion necessary to compensate executive officers in a manner commensurate with performance and the competitive market of executive talent. CHIEF EXECUTIVE OFFICER COMPENSATION Mr. Abraham has served as the Company's Chief Executive Officer since its initial public offering in February 1993. Prior to such time, Mr. Abraham was in charge of the Company's operations as a division of Weyerhaeuser. Mr. Abraham's base salary was realigned in 1996 from prior year levels to $500,000. Pursuant to Mr. Abraham's previous employment agreement entered into at the time of the Company's initial public offering, as amended and restated in 1997, and pursuant to the discretion afforded the Board and the Committee pursuant to Mr. Abraham's current Employment Agreement described above (SEE "--CONFIRMATION RETENTION PLAN FOR TOP EIGHT EXECUTIVES"), Mr. Abraham is entitled to receive additional deferred compensation for the first seven years of service as Chief Executive Officer equal to 20 percent of his base salary and incentive awards. As such, a reserve of $216,048 was taken by the Company which represents Mr. Abraham's deferred compensation award for 1998. Given the challenges presented by the Company's Chapter 11 filing, the Committee determined to pay all 1998 bonuses based on the corporate EBITDA performance factor, with no adjustment for personal performance. Mr. Abraham's target bonus was $300,000. Based on the Company's EBITDA performance, Mr. Abraham received a 1998 bonus payout of $561,690. Mr. Abraham will also participate in any Confirmation Bonus payable under the Confirmation Retention Plan described above. SEE "--CONFIRMATION RETENTION PLAN FOR TOP EIGHT EXECUTIVES." The Committee has discontinued the use of annual grants of stock options, SARs and restricted stock as incentive compensation for Mr. Abraham until the Company emerges from Chapter 11 protection. In the past, annual stock option grants were determined by reference to the external compensation survey data discussed above, as well as the Company's performance versus the financial performance objectives set each year for the annual bonus plan described above. COMPENSATION COMMITTEE Adrian D.P. Bellamy, Chairman Thomas B. Boklund Robert L. Schuyler Page 77 STOCK PRICE PERFORMANCE GRAPH Set forth below is a line graph comparing the cumulative total return on the Common Stock during the period beginning on December 26, 1993 and ending on December 27, 1998, the last day of the Company's 1998 fiscal year, with the cumulative total return on the Standard & Poor's 500 Index and the combined Value Line Household Products and Toiletries/Cosmetics Indices (weighted equally). The comparison assumes $100 was invested on December 26, 1993 in the Common Stock, the Standard & Poor's 500 Index and the combined Value Line Household Products and Toiletries/Cosmetics Indices and assumes reinvestment of dividends. The stock price performance shown on the graph is not necessarily indicative of future price performance. [OBJECT OMITTED] PERFORMANCE GRAPH DATA POINTS
CUMULATIVE TOTAL RETURN AS OF: ------------------------------ NAME 26-DEC-93 25-DEC-94 31-DEC-95 29-DEC-96 28-DEC-97 27-DEC-98 - ---- --------- --------- --------- --------- --------- --------- PARAGON TRADE BRANDS, INC. 100.00 44.92 79.24 101.70 43.64 7.20 Standard & Poor's 500 100.00 101.60 139.71 172.18 229.65 294.87 Combined Value Line 100.00 109.45 147.08 196.16 269.10(1) 305.20 Household Products and Toiletries/Cosmetics Indices - ---------- (1) Tambrands, Inc. ("Tambrands") was a member of the Combined Value Line Household Products and Toiletries/Cosmetics Indices ("Peer Group") for the years 1993-1996. Tambrands was acquired by P&G during 1997 and total return data for 1997 is not available. Tambrands was removed from the Value Line Household Products and Toiletries/Cosmetics Indices as of 1997.
Page 78 ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth the beneficial ownership of the Common Stock as of March 31, 1999, by (a) each stockholder known by the Company to be the beneficial owner of more than 5 percent of the Common Stock, (b) the Company's directors, (c) the Company's named executive officers, as defined herein, and (d) all the Company's directors and executive officers, as a group. Each of the named persons and members of the group has sole voting and investment power with respect to the shares shown, except as otherwise stated.
BENEFICIAL OWNERSHIP -------------------- AMOUNT AND NATURE OF PERCENTAGE NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP OUTSTANDING - ------------------------------------ -------------------- ----------- Wellington Management Company, LLP........ 1,637,800 (1) 13.71% 75 State Street Boston, MA 02109 Vanguard Specialized Funds ............... Vanguard Health Care Fund 1,124,100 (2) 9.41% P.O. Box 2600 Valley Forge, PA 19482-2600 Capital Guardian Trust Company............ 1,042,700 (3) 8.73% 333 South Hope Street, 55th Floor Los Angeles, CA 90071 Appaloosa Management L.P.................. 965,200 (4) 8.08% 26 Main Street, 1st Floor Chatam, NJ 07928 Bobby V. Abraham.......................... 282,563 (5) 2.32% Adrian D.P. Bellamy....................... 12,000 (6) * Thomas B. Boklund......................... 14,000 (7) * Robert L. Schuyler........................ 13,100 (7) * David W. Cole............................. 149,505 (8) 1.24% Alan J. Cyron............................. 62,241 (9) * Arrigo D. Jezzi........................... 35,198 (10) * Robert E. McClain......................... 5,017 (11) * All directors and executive officers as a group (10 persons) ....................... 602,985 (12) 4.84% - --------------- * Represents holdings of less than 1%. (1) Wellington Management Company, LLP has shared power to vote 513,700 shares and shared power to dispose of 1,637,800 shares of Common Stock, based on a Schedule 13G filed with the SEC and dated January 29, 1999. (2) Vanguard Specialized Funds - Vanguard Health Care Fund has sole power to vote 1,124,100 shares and shared power to dispose of 1,124,100 shares of Common Stock, based on a Schedule 13G filed with the SEC and dated February 10, 1999. (3) Capital Guardian Trust Company has sole power to vote 1,042,700 shares and sole power to dispose of 1,042,700 shares of Common Stock, based on a Schedule 13G filed with the SEC and dated February 8, 1999. Page 79 (4) Appaloosa Management L.P. ("AMLP") has sole power to vote 965,200 shares and sole power to dispose of 965,200 shares of Common Stock, based on a Schedule 13G filed with the SEC and dated February 5, 1999. AMLP is the general partner of Appaloosa Investment Limited Partnership I, the investment advisor to Palomino Fund Ltd., and the managing member of Tersk LLC, which are the holders of record of the reported securities (419,947, 491,765 and 53,488 shares, respectively). David A. Tepper is the sole stockholder and president of Appaloosa Partners Inc. ("API"). API is the general partner of AMLP, and Mr. Tepper owns a majority of the limited partnership interests of AMLP. (5) Includes options to purchase 229,160 shares of Common Stock, exercisable within 60 days of the date hereof. (6) Includes options to purchase 9,000 shares of Common Stock, exercisable within 60 days of the date hereof. (7) Includes options to purchase 13,000 shares of Common Stock, exercisable within 60 days of the date hereof. (8) Includes options to purchase 132,500 shares of Common Stock, exercisable within 60 days of the date hereof. (9) Includes options to purchase 38,750 shares of Common Stock, exercisable within 60 days of the date hereof. (10) Includes options to purchase 20,000 shares of Common Stock, exercisable within 60 days of the date hereof, and stock appreciation rights on 12,500 shares of Common Stock, exercisable within 60 days of the date hereof. (11) Includes stock appreciation rights on 10,000 shares of Common Stock exercisable within 60 days of the date hereof. (12) Includes options to purchase 476,820 shares of Common Stock, exercisable within 60 days of the date hereof, and stock appreciation rights on 22,500 shares of Common Stock exercisable within 60 days of the date of this document.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE Report of Independent Public Accountants Consolidated Earnings (Loss) Statements for the three years in the period ended December 27, 1998 Consolidated Balance Sheets as of December 27, 1998 and December 28, 1997 Consolidated Statements of Cash Flows for the three years in the period ended December 27, 1998 Page 80 Consolidated Statements of Comprehensive Income for the three years in the period ended December 27, 1998 Consolidated Statements of Changes in Shareholders' Equity for the three years in the period ended December 27, 1998 Notes to Financial Statements FINANCIAL STATEMENT SCHEDULE: Schedule II: Valuation and Qualifying Accounts (b) The registrant filed no Reports on Form 8-K during the fiscal quarter ended December 27, 1998. (c) EXHIBITS
EXHIBIT DESCRIPTION ------- ----------- Exhibit 3.1 Certificate of Incorporation of Paragon Trade Brands, Inc. 4 Exhibit 3.2 By-Laws of Paragon Trade Brands, Inc., as amended through July 31, 1995 5 Exhibit 4.1 Certificate of Incorporation of Paragon Trade Brands, Inc. (see Exhibit 3.1) Exhibit 10.1 Asset Transfer Agreement, dated as of January 26, 1993, by and between Weyerhaeuser and Paragon 1 Exhibit 10.2 Intellectual Property Agreement, dated as of February 2, 1993, between Weyerhaeuser and Paragon 1 Exhibit 10.3 License, dated as of February 2, 1993, between Weyerhaeuser and Paragon 1 Exhibit 10.4 Sublicense, dated as of February 2, 1993, between Weyerhaeuser and Paragon 1 Exhibit 10.5 Technology Agreement, dated as of October 15, 1987, by and between Weyerhaeuser and Johnson and Johnson, as amended 1 Exhibit 10.6.1 Letter Supply Agreement between Weyerhaeuser and Paragon dated as of October 22, 1997 9 Exhibit 10.7* Stock Option Plan for Non-Employee Director 1 Exhibit 10.8* Annual Incentive Compensation Plan 1 Exhibit 10.9* 1993 Long-Term Incentive Compensation Plan 1 Exhibit 10.10* Employment Agreement, dated as of August 11, 1998, between Paragon and Bobby V. Abraham 12 Exhibit 10.11* Employment Agreement, dated as of August 11, 1998, between Paragon and David W. Cole 12 Exhibit 10.12* Employment Agreement, dated as of August 11, 1998, between Paragon and Alan J. Cyron 12 Exhibit 10.13* Employment Agreement, dated as of August 11, 1998, between Paragon and Arrigo D. (Rick) Jezzi 12 Page 81 Exhibit 10.14* Employment agreement, dated as of August 11, 1998, between Paragon and Robert E. McClain 12 Exhibit 10.15* Employment Agreement, dated as of August 11, 1998, between Paragon and Catherine O. Hasbrouck 12 Exhibit 10.16* Employment Agreement, dated as of August 11, 1998, between Paragon and Kevin P. Higgins 12 Exhibit 10.17* 1995 Incentive Compensation Plan5 Exhibit 10.18* Paragon Trade Brands, Inc. Confirmation Retention Plan for Top Eight Executives and Summary Plan Description 12 Exhibit 10.19 Amended and Restated Credit Agreement, dated as of February 6, 1996 7 Exhibit 10.19.1 Amendment Agreement, dated December 13, 1996, to Amended and Restated Credit Agreement, dated as of February 6, 1996 8 Exhibit 10.20 Revolving Credit and Guaranty Agreement Among Paragon Trade Brands, Inc., a Debtor-in-Possession, as Borrower, the Subsidiaries of the Borrower Named Herein, as Guarantors, the Banks Party hereto, and Chase Manhattan Bank, as Agent, dated as of January 7, 1998, as Amended (Conformed to Reflect the First Amendment to the Revolving Credit and Guaranty Agreement dated as of January 30, 1998, the Second Amendment to the Revolving Credit and Guaranty Agreement dated as of March 23, 1998, and the Third Amendment to Revolving Credit and Guaranty Agreement dated as of April 15, 1998) 10 Exhibit 10.20.1 Fourth Amendment to Revolving Credit and Guaranty Agreement dated as of September 28, 1998 Exhibit 10.21 Security and Pledge Agreement, dated as of January 7, 1998 10 Exhibit 10.22 Revolving Canadian Credit Facility and Parent Guarantee 2 Exhibit 10.23 Indemnification Agreements, dated as of February 2, 1993, between Weyerhaeuser and Bobby V. Abraham and Gary M. Arnts1 Exhibit 10.24 Rights Agreement dated December 14, 1994 between Paragon Trade Brands, Inc. and Chemical Bank, as Rights Agent3 Exhibit 10.25 Asset Purchase Agreement dated December 11, 1995 by and among Paragon Trade Brands, Inc., PTB Acquisition Sub, Inc., Pope & Talbot, Inc. and Pope & Talbot, Wis., Inc. 6 Exhibit 10.26** Sales Contract, dated as of January 30, 1996, between Hoechst Celanese Corporation and Paragon Trade Brands, Inc.7 Exhibit 10.26.1** Sales Contract, dated as of April 30, 1998, between Clariant Corporation and Paragon Trade Brands, Inc. 11 Exhibit 10.27 Lease Agreement between Cherokee County, South Carolina and Paragon Trade Brands, Inc., dated as of October 1, 1996 8 Page 82 Exhibit 10.28 Settlement Agreement, dated as of February 2, 1999 between Paragon Trade Brands, Inc. and The Procter & Gamble Company. Exhibit 10.29 U.S. License Agreement, dated as of February 2, 1999 between The Procter & Gamble Company and Paragon Trade Brands, Inc. Exhibit 10.30 Canadian License Agreement, dated as of February 2, 1999 between The Procter & Gamble Company and Paragon Trade Brands, Inc. Exhibit 10.31 U.S. License Agreement, dated as of February 2, 1999 between The Procter & Gamble Company and Paragon Trade Brands, Inc. Exhibit 10.32 Canadian License Agreement, dated as of February 2, 1999 between The Procter & Gamble Company and Paragon Trade Brands, Inc. Exhibit 10.33 Settlement Agreement, dated as of March 19, 1999 between Kimberly-Clark Corporation and Paragon Trade Brands, Inc. Exhibit 10.34 License Agreement Between Kimberly-Clark Corporation and Paragon Trade Brands, Inc., dated as of March 15, 1999 Exhibit 10.35 License Agreement Between Kimberly-Clark Corporation and Paragon Trade Brands, Inc., dated as of March 15, 1999 Exhibit 11 Computation of Per Share Earnings (See Note 17 to Financial Statements) Exhibit 21.1 Subsidiaries of the Company Exhibit 23.1 Consent of Independent Public Accountants Exhibit 27 Financial Data Schedule (for SEC use only) - -------------------------- *Management contract or compensatory plan or arrangement. **Confidential treatment has been requested as to a portion of this document. (1) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 26, 1993. (2) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 26, 1994. (3) Incorporated by reference from Paragon Trade Brands, Inc.'s Current Report on Form 8-K, dated as of December 14, 1994. (4) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 25, 1994. (5) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 25, 1995. (6) Incorporated by reference from Paragon Trade Brands, Inc.'s Current Report on Form 8-K, dated as of February 8, 1996. (7) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995. Page 83 (8) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 29, 1996. (9) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 28, 1997. (10) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended March 29, 1998. (11) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 28, 1998. (12) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 27, 1998.
Page 84 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 on this 12th day of April, 1999. PARAGON TRADE BRANDS, INC. By: /S/ BOBBY V. ABRAHAM ------------------------- Bobby V. Abraham Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on this 12th day of April, 1999. /S/ BOBBY V. ABRAHAM ---------------------------- Bobby V. Abraham Chairman and Chief Executive Officer /S/ ALAN J. CYRON ---------------------------- Alan J. Cyron Executive Vice President and Chief Financial Officer (Principal Financial Officer) /S/ GARY M. ARNTS ---------------------------- Gary M. Arnts Vice President and Controller (Principal Accounting Officer) /S/ ADRIAN D.P. BELLAMY ---------------------------- Adrian D.P. Bellamy Director /S/ THOMAS B. BOKLUND ---------------------------- Thomas B. Boklund Director /S/ ROBERT L. SCHUYLER ---------------------------- Robert L. Schuyler Director Page 85 EXHIBIT INDEX
EXHIBIT DESCRIPTION ------- ----------- Exhibit 3.1 Certificate of Incorporation of Paragon Trade Brands, Inc. 4 Exhibit 3.2 By-Laws of Paragon Trade Brands, Inc., as amended through July 31, 1995 5 Exhibit 4.1 Certificate of Incorporation of Paragon Trade Brands, Inc. (see Exhibit 3.1) Exhibit 10.1 Asset Transfer Agreement, dated as of January 26, 1993, by and between Weyerhaeuser and Paragon 1 Exhibit 10.2 Intellectual Property Agreement, dated as of February 2, 1993, between Weyerhaeuser and Paragon 1 Exhibit 10.3 License, dated as of February 2, 1993, between Weyerhaeuser and Paragon 1 Exhibit 10.4 Sublicense, dated as of February 2, 1993, between Weyerhaeuser and Paragon 1 Exhibit 10.5 Technology Agreement, dated as of October 15, 1987, by and between Weyerhaeuser and Johnson and Johnson, as amended 1 Exhibit 10.6.1 Letter Supply Agreement between Weyerhaeuser and Paragon dated as of October 22, 1997 9 Exhibit 10.7* Stock Option Plan for Non-Employee Directors 1 Exhibit 10.8* Annual Incentive Compensation Plan 1 Exhibit 10.9* 1993 Long-Term Incentive Compensation Plan 1 Exhibit 10.10* Employment Agreement, dated as of August 11, 1998, between Paragon and Bobby V. Abraham 12 Exhibit 10.11* Employment Agreement, dated as of August 11, 1998, between Paragon and David W. Cole 12 Exhibit 10.12* Employment Agreement, dated as of August 11, 1998, between Paragon and Alan J. Cyron 12 Exhibit 10.13* Employment Agreement, dated as of August 11, 1998, between Paragon and Arrigo D. (Rick) Jezzi 12 Exhibit 10.14* Employment agreement, dated as of August 11, 1998, between Paragon and Robert E. McClain 12 Exhibit 10.15* Employment Agreement, dated as of August 11, 1998, between Paragon and Catherine O. Hasbrouck 12 Exhibit 10.16* Employment Agreement, dated as of August 11, 1998, between Paragon and Kevin P. Higgins 12 Exhibit 10.17* 1995 Incentive Compensation Plan 5 Page 86 Exhibit 10.18* Paragon Trade Brands, Inc. Confirmation Retention Plan for Top Eight Executives and Summary Plan Description 12 Exhibit 10.19 Amended and Restated Credit Agreement, dated as of February 6, 1996 7 Exhibit 10.19.1 Amendment Agreement, dated December 13, 1996, to Amended and Restated Credit Agreement, dated as of February 6, 1996 8 Exhibit 10.20 Revolving Credit and Guaranty Agreement Among Paragon Trade Brands, Inc., a Debtor-in-Possession, as Borrower, the Subsidiaries of the Borrower Named Herein, as Guarantors, the Banks Party hereto, and Chase Manhattan Bank, as Agent, dated as of January 7, 1998, as Amended (Conformed to Reflect the First Amendment to the Revolving Credit and Guaranty Agreement dated as of January 30, 1998, the Second Amendment to the Revolving Credit and Guaranty Agreement dated as of March 23, 1998, and the Third Amendment to Revolving Credit and Guaranty Agreement dated as of April 15, 1998) 10 Exhibit 10.20.1 Fourth Amendment to Revolving Credit and Guaranty Agreement dated as of September 28, 1998 Exhibit 10.21 Security and Pledge Agreement, dated as of January 7, 1998 10 Exhibit 10.22 Revolving Canadian Credit Facility and Parent Guarantee 2 Exhibit 10.23 Indemnification Agreements, dated as of February 2, 1993, between Weyerhaeuser and Bobby V. Abraham and Gary M. Arnts 1 Exhibit 10.24 Rights Agreement dated December 14, 1994 between Paragon Trade Brands, Inc. and Chemical Bank, as Rights Agent 3 Exhibit 10.25 Asset Purchase Agreement dated December 11, 1995 by and among Paragon Trade Brands, Inc., PTB Acquisition Sub, Inc., Pope & Talbot, Inc. and Pope & Talbot, Wis., Inc. 6 Exhibit 10.26** Sales Contract, dated as of January 30, 1996, between Hoechst Celanese Corporation and Paragon Trade Brands, Inc. 7 Exhibit 10.26.1** Sales Contract, dated as of April 30, 1998, between Clariant Corporation and Paragon Trade Brands, Inc. 11 Exhibit 10.27 Lease Agreement between Cherokee County, South Carolina and Paragon Trade Brands, Inc., dated as of October 1, 1996 8 Exhibit 10.28 Settlement Agreement, dated as of February 2, 1999 between Paragon Trade Brands, Inc. and The Procter & Gamble Company. Exhibit 10.29 U.S. License Agreement, dated as of February 2, 1999 between The Procter & Gamble Company and Paragon Trade Brands, Inc. Exhibit 10.30 Canadian License Agreement, dated as of February 2, 1999 between The Procter & Gamble Company and Paragon Trade Brands, Inc. Exhibit 10.31 U.S. License Agreement, dated as of February 2, 1999 between The Procter & Gamble Company and Paragon Trade Brands, Inc. Exhibit 10.32 Canadian License Agreement, dated as of February 2, 1999 between The Procter & Gamble Company and Paragon Trade Brands, Inc. Page 87 Exhibit 10.33 Settlement Agreement, dated as of March 19, 1999 between Kimberly-Clark Corporation and Paragon Trade Brands, Inc. Exhibit 10.34 License Agreement Between Kimberly-Clark Corporation and Paragon Trade Brands, Inc., dated as of March 15, 1999 Exhibit 10.35 License Agreement Between Kimberly-Clark Corporation and Paragon Trade Brands, Inc., dated as of March 15, 1999 Exhibit 11 Computation of Per Share Earnings (See Note 17 to Financial Statements) Exhibit 21.1 Subsidiaries of the Company Exhibit 23.1 Consent of Independent Public Accountants Exhibit 27 Financial Data Schedule (for SEC use only) - -------------------------- *Management contract or compensatory plan or arrangement. **Confidential treatment has been requested as to a portion of this document. (1) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 26, 1993. (2) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 26, 1994. (3) Incorporated by reference from Paragon Trade Brands, Inc.'s Current Report on Form 8-K, dated as of December 14, 1994. (4) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 25, 1994. (5) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 25, 1995. (6) Incorporated by reference from Paragon Trade Brands, Inc.'s Current Report on Form 8-K, dated as of February 8, 1996. (7) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995. (8) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 29, 1996. (9) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 28, 1997. (10) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended March 29, 1998. (11) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 28, 1998. (12) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 27, 1998.
Page 88 EX-10.20.1 2 4TH AMEND. TO REVOLVING CREDIT AND GUARANTY AGMT. FOURTH AMENDMENT TO REVOLVING CREDIT AND GUARANTY AGREEMENT FOURTH AMENDMENT, dated as of September 28, 1998 (the "AMENDMENT"), to the REVOLVING CREDIT AND GUARANTY AGREEMENT dated as of January 7, 1998 among PARAGON TRADE BRANDS, INC., a Delaware corporation (the "BORROWER"), a debtor and debtor-in-possession under Chapter 11 of the Bankruptcy Code, the Guarantors named therein (the "GUARANTORS"), THE CHASE MANHATTAN BANK, a New York banking corporation ("CHASE"), each of the other financial institutions party thereto (together with Chase, the "BANKS") and THE CHASE MANHATTAN BANK, as Agent for the Banks (in such capacity, the "AGENT"): W I T N E S S E T H: WHEREAS, the Borrower, the Guarantors, the Banks and the Agent are parties to that certain Revolving Credit and Guaranty Agreement, dated as of January 7, 1998 (as heretofore amended pursuant to the First Amendment to Revolving Credit and Guaranty Agreement dated as of January 30, 1998, the Second Amendment to Revolving Credit and Guaranty Agreement dated as of March 23, 1998 and the Third Amendment to Revolving Credit and Guaranty Agreement dated as of April 15, 1998 and as the same may be further amended, modified or supplemented from time to time, the "CREDIT AGREEMENT"); and WHEREAS, the Borrower and the Guarantors have requested that from and after the Effective Date (as hereinafter defined) of this Amendment, the Credit Agreement be amended subject to and upon the terms and conditions set forth herein; NOW, THEREFORE, it is agreed: 1. As used herein all terms that are defined in the Credit Agreement shall have the same meanings herein. 2. Section 6.09 of the Credit Agreement is hereby amended by inserting the words (a) "and in Section 6.13" immediately following the parenthetical phrase "(the "SECTION 6.09 AGREEMENTS")" set forth in the first sentence thereof, (b) "or any of the Guarantors" immediately following the words "the Borrower" set forth in clause (y) of the second sentence thereof, and (c) "and Section 6.11(iv)" immediately following the words "Section 6.11(ii)" set forth in subclause (y). 3. Section 6.10 of the Credit Agreement is hereby amended by deleting the word "and" immediately preceding clause (v) appearing therein and inserting in lieu thereof a comma, and by inserting the following new clause (vi) at the end thereof: "and (vi) loans and advances, not to exceed one year in duration, to employees of the Borrower and the Guarantors that are being relocated and which are made in the ordinary course of business in an aggregate principal amount not in excess of $1,000,000 at any one time outstanding." 4. Section 6.11 of the Credit Agreement is hereby amended by deleting the word "and" immediately preceding clause (iii) appearing therein and by inserting the following new clause (iv) at the end thereof: "and (iv) the sale or disposition, upon the terms of that certain Asset Purchase Agreement dated as of September 1, 1998, among the Borrower, Changing Paradigms, Inc. ("CP") and House, Home and Hardware, LLC (or pursuant to a higher and better offer that is approved by the Bankruptcy Court from such purchaser or another Person), of substantially all of the assets (and assumption of certain trade payables) of CP." 5. Section 6 of the Credit Agreement is hereby amended by inserting the following new Section 6.13 at the end thereof: "SECTION 6.13 CHANGING PARADIGMS TRANSACTION. Notwithstanding anything to the contrary set forth in Sections 6.03, 6.09 and 6.10 of the Credit Agreement , the Borrower, CP and PTB International shall be permitted, in connection with the sale of substantially all of CP's assets described in Section 6.11(iv), to enter into a series of intercompany transactions pursuant to which (x) the Borrower may assign to PTB International an intercompany receivable owing by CP to the Borrower in the amount of approximately $7,800,000, with PTB International to be obligated under an intercompany payable to the Borrower in the same amount in consideration of such assignment and (y) CP shall use the proceeds of such asset sale to repay such intercompany receivable owing by CP. It is understood and agreed that such intercompany payable from PTB International to the Borrower shall not be treated as a loan or advance by the Borrower to PTB International for purposes of the formulas appearing in the "PROVIDED" clause of the first sentence of Section 6.09 and in the "PROVIDED" clause of Section 6.10." 6. This Amendment shall not become effective until the date (the "EFFECTIVE DATE") on which this Amendment shall have been executed by the Borrower, the Guarantors and Banks constituting the Required Banks and the Agent, and the Agent shall have received evidence satisfactory to it of such execution. 2 7. The Borrower agrees that its obligations set forth in Section 10.05 of the Credit Agreement shall extend to the preparation, execution and delivery of this Amendment. 8. This Amendment shall be limited precisely as written and shall not be deemed (a) to be a consent granted pursuant to, or a waiver or modification of, any other term or condition of the Credit Agreement or any of the instruments or agreements referred to therein or (b) to prejudice any right or rights which the Agent or the Banks may now have or have in the future under or in connection with the Credit Agreement or any of the instruments or agreements referred to therein. Whenever the Credit Agreement is referred to in the Credit Agreement or any of the instruments, agreements or other documents or papers executed or delivered in connection therewith, such reference shall be deemed to mean the Credit Agreement as modified by this Amendment. 9. This Amendment may be executed in any number of counterparts and by the different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which taken together shall constitute but one and the same instrument. 10. This Amendment shall in all respects be construed in accordance with and governed by the laws of the State of New York applicable to contracts made and to be performed wholly within such State. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the day and the year first above written. PARAGON TRADE BRANDS, INC. By: /s/ Title: PTB INTERNATIONAL, INC. By: /s/ Title: 3 CHANGING PARADIGMS, INC. By: /s/ Title: PARAGON TRADE BRANDS FSC, INC. By: /s/ Title: PTB ACQUISITION SUB, INC. By: /s/ Title: THE CHASE MANHATTAN BANK, INDIVIDUALLY AND AS AGENT By: /s/ Title: AMSOUTH BANK By: /s/ Title: THE BANK OF NOVA SCOTIA By: /s/ Title: 4 BHF-BANK AKTIENGESELLSCHAFT By: /s/ Title: By: /s/ Title: HELLER FINANCIAL, INC. By: /s/ Title: IBJ BUSINESS CREDIT CORPORATION By: /s/ Title: PNC BANK, NATIONAL ASSOCIATION By: /s/ Title: WACHOVIA, N.A. By: /s/ Title: 5 EX-10.28 3 SETTLEMENT AGREEMENT DATED AS OF FEBRUARY 2, 1999 SETTLEMENT AGREEMENT This Settlement Agreement is made and entered into as of February 2, 1999, between Paragon Trade Brands, Inc., a Delaware corporation, debtor and debtor in possession ("Paragon"), and The Procter & Gamble Company, an Ohio corporation ("P&G"). W I T N E S S E T H: WHEREAS, Paragon and P&G are partie to an action entitled THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC., C.A. No. 94-16 (LON), filed in the United States District Court for the District of Delaware (the "Action"), in which, among other things (a) an Opinion and Judgment was issued on December 30, 1997, and entered on the court's docket on January 6, 1998, in favor of P&G and against Paragon; a Money Judgment was entered on June 2, 1998; and a Permanent Injunction was entered on June 2, 1998 (collectively, the "Final Judgment"); and (b) an Opinion and Order was entered on August 4, 1998 (as more fully defined below, the "Rule 59 Denial"), denying Paragon's motion pursuant to Fed. R. Civ. P. 59; WHEREAS, Paragon has appealed both the Final Judgment and the Rule 59 Denial; WHEREAS, on January 6, 1998, Paragon filed a voluntary petition for relief under chapter 11 of title 11 of the United States Code with the United States Bankruptcy Court for the Northern District of Georgia, Atlanta Division, which chapter 11 case currently is pending; WHEREAS, on or about June 5, 1998, P&G filed a proof of claim (the "Bankruptcy Claim") in Paragon's chapter 11 case asserting, among other things, both unsecured prepetition claims in excess of $1.8 billion (without trebling) and unsecured administrative claims in excess of $300 million (without trebling) against Paragon in respect of Paragon's alleged infringement of certain P&G patents; WHEREAS, P&G served a motion, dated September 22, 1998, in the United States District Court for the District of Delaware for a finding of contempt against Paragon regarding the Permanent Injunction entered by that court on June 2, 1998, which motion Paragon is opposing; WHEREAS, Paragon and P&G have agreed to effectuate a settlement of the claims and disputes relating to the Bankruptcy Claim and as otherwise set forth in the Ancillary Agreements (as defined below) in accordance with the terms and conditions set forth herein; and WHEREAS, this Settlement Agreement is essential to, and an integral part of, Paragon's efforts to emerge successfully from its chapter 11 case; NOW, THEREFORE, for good and valuable consideration, and in order to settle the Bankruptcy Claim and as otherwise set forth in the Ancillary Agreements, and to facilitate Paragon's expeditious and effective reorganization, the parties hereto agree as follows: 1. DEFINITIONS. In addition to such other terms as are defined in other sections of this Settlement Agreement, the following terms (which appear in the Settlement Agreement as capitalized terms) have the following meanings as used in the Settlement Agreement: 1.1. "Action" shall have the meaning ascribed to such term in the first "WHEREAS" clause of this Settlement Agreement. 1.2. "Administrative Expense Claim" means a Claim for costs and expenses of administration that is entitled to administrative expense priority under sections 503(b) and 507(a)(1) of the Bankruptcy Code. 1.3. "Affiliate" means any Entity that is (a) an affiliate as such term is defined in section 101(2) of the Bankruptcy Code, (b) an existing or future direct or indirect subsidiary or parent corporation of Paragon or P&G (as the case may be), or (c) an existing or future joint venture or general or limited partnership in which (i) Paragon or P&G (as the case may be) or any existing or future direct or indirect subsidiary or parent corporation of Paragon or P&G (as the case may be) is a joint venturer or general or limited partner, as the case may be, or (ii) a joint venture or general or limited partnership in which Paragon or P&G (as the case may be) is a joint venturer or general or limited partner, as the case may be. The defined term "Affiliate" also includes all successors and assigns of each of the foregoing. 1.4. "Allowed Claim" means any Claim (a) proof of which was filed within the applicable period of limitation fixed by the Bankruptcy Court and (i) as to which no objection to the allowance thereof has been interposed within the applicable period of limitation fixed by the Bankruptcy Code, the Bankruptcy Rules, order of the Bankruptcy Court, or any plan of reorganization for the Debtor, or (ii) as to which an objection has been interposed, to the extent such Claim has been allowed by a Final Order, (b) if no proof of which was so filed, which has been listed by the Debtor in its schedules of assets and liabilities filed with the Bankruptcy Court (as amended from time to time) as liquidated in amount and not disputed or contingent as to liability, or (c) arising from the recovery of property under section 550 or 553 of the Bankruptcy Code and allowed in accordance with section 502(h) of the Bankruptcy Code. -2- 1.5. "Ancillary Agreements" means the P&G Licenses annexed hereto as Exhibit A, the Paragon Release annexed hereto as Exhibit B, and the P&G Release annexed hereto as Exhibit C. 1.6. "Appeal" means that certain appeal taken by Paragon from the Final Judgment and Rule 59 Denial, which appeal is evidenced by Paragon's Notice of Appeal, filed July 2, 1998, and Paragon's Amendment to Notice of Appeal, filed August 4, 1998, which appeal is docketed in the United States Court of Appeals for the Federal Circuit as No. 98-1480. 1.7. "Bankruptcy Claim" shall have the meaning ascribed to such term in the fourth "WHEREAS" clause of this Settlement Agreement. 1.8. "Bankruptcy Code" means the Bankruptcy Reform Act of 1978, 11 U.S.C. Sections 101, ET seq., as the same was in effect on the Petition Date, as amended by any amendments applicable to the Chapter 11 Case. 1.9. "Bankruptcy Court" means the United States Bankruptcy Court for the Northern District of Georgia, Atlanta Division, or, to the extent that such court ceases to exercise jurisdiction over the Chapter 11 Case, such other court or adjunct thereof that exercises jurisdiction over the Chapter 11 Case. 1.10. "Bankruptcy Court Approval Order" means an order (which may be a Confirmation Order) of the Bankruptcy Court approving this Settlement Agreement and the Ancillary Agreements pursuant to, INTER ALIA, Bankruptcy Rule 9019 and Bankruptcy Code sections 105, 363, 365, 1123 and/or 1129. 1.11. "Bankruptcy Rules" means the Federal Rules of Bankruptcy Procedure, effective August 1, 1991, in accordance with the provisions of 28 U.S.C. ss. 2075, as now in effect or hereafter amended. 1.12. "Business Day" means any day, other than a Saturday, Sunday or "legal holiday" (as such term is defined in Bankruptcy Rule 9006(a)). 1.13. "Chapter 11 Case" means Paragon's case pending in the Bankruptcy Court pursuant to chapter 11 of the Bankruptcy Code and administered under case number 98 B 60390 (Murphy, J.). 1.14. "Claim" means a claim as such term is defined in section 101(5) of the Bankruptcy Code. 1.15. "Confirmation Date" means the date on which the Bankruptcy Court enters an order confirming, pursuant to section 1129 of the Bankruptcy Code, a Plan proposed for Paragon. -3- 1.16. "Confirmation Order" means an order of the Bankruptcy Court confirming a Plan pursuant to section 1129 of the Bankruptcy Code. 1.17. "Contempt Motion" means The Procter & Gamble Company's Motion For A Finding Of Contempt Against Paragon Trade Brands, Inc., dated September 22, 1998, which, by Order dated September 24, 1998, was filed by P&G in the Delaware District Court on January 8, 1999. 1.18. "Creditors' Committee" means the Official Committee of Unsecured Creditors in the Chapter 11 Case, as appointed by the Office of the United States Trustee for the Northern District of Georgia, Atlanta Division, and reconstituted from time to time. 1.19. "Debtor" means Paragon. 1.20. "Delaware District Court" means the United States District Court for the District of Delaware. 1.21. "Effective Date" means the first Business Day that the Plan becomes effective in accordance with its terms by the commencement of distributions thereunder. 1.22. "Entity" means an entity as such term is defined in section 101(15) of the Bankruptcy Code (including defined terms used in such section of the Bankruptcy Code). 1.23. "Estate" means the estate created in the Chapter 11 Case for Paragon by section 541 of the Bankruptcy Code. 1.24. "Federal Circuit Court" means the United States Court of Appeals for the Federal Circuit. 1.25. "Final Judgment" shall have the meaning ascribed to such term in the first "WHEREAS" clause of this Settlement Agreement. 1.26. "Final Order" means an order or judgment of the Bankruptcy Court, as entered on the docket in the Chapter 11 Case, that has not been reversed, stayed, modified or amended and as to which the time to appeal or seek review, rehearing, reargument or certiorari has expired and as to which no appeal or petition for review, rehearing, reargument, stay or certiorari is pending, or as to which any right to appeal or to seek certiorari, review, or rehearing has been waived, or, if an appeal, reargument, petition for review, certiorari or rehearing has been sought, the order or judgment of the Bankruptcy Court that has been affirmed by the highest court to which the order was appealed or from which the reargument, review or rehearing was sought, or certiorari has been denied, and as to which the time to take any further appeal or seek further reargument, -4- review or rehearing has expired; PROVIDED, HOWEVER, that for purposes of this Settlement Agreement, the Bankruptcy Court Approval Order approving this Settlement Agreement and allowing the P&G Allowed Unsecured Claim and the P&G Allowed Administrative Expense Claim (each as defined in Section 2.1 of this Settlement Agreement) shall be deemed a Final Order upon the occurrence of the Effective Date. 1.27. "Impaired" means impaired within the meaning of section 1124 of the Bankruptcy Code. 1.28. "Paragon Release" means the general release annexed hereto as Exhibit B. 1.29. "Parties" means Paragon and P&G, and their respective successors and assigns, collectively. 1.30. "Plan" means a plan of reorganization for Paragon confirmed by the Bankruptcy Court pursuant to section 1129 of the Bankruptcy Code in the Chapter 11 Case, as the same may be amended or modified, relying upon and/or incorporating and, INTER ALIA, implementing the terms of this Settlement Agreement. 1.31. "Petition Date" means January 6, 1998. 1.32. "P&G Allowed Claims" shall have the meaning ascribed to such term in Section 2.1 of this Settlement Agreement. 1.33. "P&G Licenses" means the license agreements annexed hereto as Exhibit A. 1.34. "P&G Patents" means the patents identified on Exhibit D hereto. 1.35. "P&G Release" means the general release annexed hereto as Exhibit C. 1.36. "Rule 59 Denial" means that certain Opinion and Order of the Delaware District Court, both entered August 4, 1998, denying Paragon's Motion for a New Trial or, in the Alternative, for the Court to Alter or Amend Its Judgment pursuant to Federal Rule of Civil Procedure 59. 1.37. "Unimpaired" means not impaired within the meaning of section 1124 of the Bankruptcy Code. 2. ALLOWED AMOUNT AND TREATMENT OF P&G CLAIMS. 2.1. ALLOWED AMOUNT OF CLAIMS. P&G shall be granted on account of its agreements hereunder and account of, and in full settlement and satisfaction of, the Bankruptcy Claim, two Allowed Claims in the Chapter 11 Case as follows: (a) an Allowed Claim -5- (the "P&G Allowed Unsecured Claim") in an amount equal to the sum of (i) one hundred fifty eight million five hundred thousand dollars and zero cents ($158,500,000.00) plus (ii) to the extent permitted in accordance with Section 2.3 of this Settlement Agreement, interest on the principal amount of $158,500,000.00 from April 15, 1999 and through and including the Effective Date; and (b) an Allowed Claim (the "P&G Allowed Administrative Claim" and together with the P&G Allowed Unsecured Claim, the "P&G Allowed Claims")) in an amount equal to the sum of five million dollars and zero cents ($5,000,000.00). For purposes of the preceding clause (a)(ii), interest shall accrue at six percent (6%) on a per annum 365 day year basis. 2.2. TREATMENT OF THE P&G ALLOWED UNSECURED CLAIM. The P&G Allowed Unsecured Claim shall be treated as a prepetition, general unsecured claim under the Plan. Nothing contained herein shall in any way limit, or be construed to limit, P&G's rights to object to the classification or treatment of the P&G Allowed Unsecured Claim under the Plan; provided, however, that P&G shall not contest the status or priority of the P&G Allowed Unsecured Claim as a prepetition, general unsecured claim. 2.3. LIMITATION ON THE PAYMENT OF POSTPETITION INTEREST. Notwithstanding anything to the contrary set forth in Section 2.1 of this Settlement Agreement, the P&G Allowed Unsecured Claim shall include interest calculated in accordance with Section 2.1(a)(ii) above only if (a) the Plan provides for the payment of postpetition interest to substantially all holders of Allowed Claims against Paragon that arose or accrued prior to the Petition Date, or (b) Kimberly-Clark Corporation receives interest on its Allowed Claims, if any, against Paragon that arose or accrued prior to the Petition Date. 2.4. TREATMENT OF THE P&G ALLOWED ADMINISTRATIVE CLAIM. The P&G Allowed Administrative Claim shall be afforded treatment under the Plan as an Administrative Expense Claim in accordance with section 1129(a)(9)(A) of the Bankruptcy Code; PROVIDED, HOWEVER, that if the Effective Date does not occur on or before July 1, 1999, then Paragon shall pay to P&G one million eight hundred thousand dollars and zero cents ($1,800,000.00) of the P&G Allowed Administrative Claim on July 1, 1999. 3. STAY AND WITHDRAWAL OF THE APPEAL. 3.1. Upon execution of this Settlement Agreement, Paragon and P&G shall file a joint motion in the Federal Circuit requesting that the Appeal be stayed pending entry of a Final Order approving the Settlement Agreement. 3.2. As soon as reasonably practicable (but in no event later than five (5) Business Days) after the Bankruptcy Court Approval Order becomes a Final Order, Paragon shall, with P&G's written consent, and with each party to bear its own costs on appeal, withdraw the Appeal with prejudice. -6- 3.3. Neither Party shall seek to vacate the Final Judgment. 3.4. As provided in the P&G Licenses, P&G shall waive any and all rights to sue (including, but not limited to, actions to enjoin and/or recover damages from) Paragon from making, having made with the prior written consent of P&G, using, offering for sale or selling Licensed Products (as such term is defined in the P&G Licenses) in the United States or Canada, provided: (a) the P&G Licenses have not been terminated by either Paragon or P&G; (b) Paragon is in full compliance with the material terms of this Settlement Agreement and the Ancillary Agreements and is current in meeting its material obligations to pay the running royalties under the respective P&G Licenses; and (c) Paragon is otherwise in full compliance with the material terms of the respective P&G Licenses. As soon as reasonably practicable (but in no event later than five (5) Business Days) after the date of execution of this Settlement Agreement, Paragon and P&G shall file a joint motion in the Delaware District Court requesting that the Permanent Injunction referenced in the first "WHEREAS" clause hereof be modified for the purpose of permitting Paragon's sale of its products in accordance with the terms of the P&G Licenses. 4. STAY AND WITHDRAWAL OF THE CONTEMPT MOTION. 4.1. Upon execution of this Settlement Agreement, P&G shall file a letter motion in the Delaware District Court requesting that the Contempt Motion be stayed pending entry of a Final Order approving the Settlement Agreement. 4.2. As soon as reasonably practicable (but in no event later than five (5) Business Days) after the Bankruptcy Court Approval Order becomes a Final Order, P&G shall withdraw the Contempt Motion with prejudice. 5. DISCONTINUANCE OF CURRENT ULG DIAPER. Paragon shall discontinue its manufacture of the product annexed hereto as Exhibit E (the "ULG Diaper") as soon as commercially reasonable. Commencing January 7, 1999, Paragon shall be required to pay to P&G royalties at the agreed upon rate and in accordance with the terms and conditions set forth in the P&G Licenses. 6. LICENSES. 6.1. Contemporaneously with the execution of this Settlement Agreement, P&G shall execute and deliver to Paragon the P&G Licenses. The provisions of this Section 6 shall be deemed a part of each of the P&G Licenses. The P&G Licenses shall be effective as of January 7, 1999; PROVIDED, THAT, if the Bankruptcy Court Approval Order is not obtained on or before July 31, 1999, then the P&G Licenses shall be terminable by P&G in accordance with the terms set forth therein. -7- 6.2. P&G represents, warrants and covenants that the P&G Patents are the only patents owned by P&G in the United States, Canada, Mexico, Brazil, Argentina or China (collectively, including any territories of any of the foregoing, the "Approved Countries"), or as to which P&G has any right to assert or prosecute against an alleged infringer in the Approved Countries, that P&G asserts have been infringed by products of Paragon and/or its Affiliates made, used or sold in the Approved Countries as of the date of execution of this Settlement Agreement. P&G further represents, warrants and covenants that (a) P&G shall not seek to assert or prosecute the P&G Patents or any claims relating to patents or patent applications pending, including continuations and continuations-in-part, owned or assertable by P&G as of the date of execution of this Settlement Agreement, or any reissues or reexaminations of such patents or patent applications (the "Additional P&G Patents"), in the Approved Countries with respect to the manufacture, use or sale of any products by Paragon and/or its Affiliates up to and including the date of execution of this Settlement Agreement, and (b) P&G shall not seek to assert Additional P&G Patents against either Paragon and/or its Affiliates after the date of execution of this Settlement Agreement with respect to the manufacture, use or sale of the product designs attached as exhibits to the P&G Licenses (collectively, the "Approved Products") in any Approved Country in which Paragon or its Affiliates have the right to make, use or sell the Approved Products under the P&G Licenses. Notwithstanding the foregoing, P&G shall be entitled to assert or prosecute against Paragon and/or its Affiliates (i) claims related to the P&G Patents or the Additional P&G Patents in any Approved Country in which Paragon or its Affiliates do not have the right to make, use or sell the Approved Products under the P&G Licenses with respect to any Approved Products manufactured, used or sold after the date of execution of this Settlement Agreement, (ii) claims related to either the P&G Patents or the Additional P&G Patents in any country or territory not included within the definition of Approved Countries (collectively, the "Non-Approved Countries") with respect to any products of Paragon and/or its Affiliates manufactured, used or sold after the date of execution of this Settlement Agreement, (iii) claims related to patent rights acquired by P&G after the date of execution of this Settlement Agreement (other than the Additional P&G Patents) with respect to any products of Paragon and/or its Affiliates manufactured, used or sold in any country after the date of execution of this Settlement Agreement, or (iv) claims related to either the P&G Patents or the Additional P&G Patents with respect to the manufacture, use or sale by Paragon and/or its Affiliates in any country after the date of execution of this Settlement Agreement of a product design other than the Approved Products unless manufactured, used or sold pursuant to a license from P&G. 6.3. To the extent that (i) Paragon or its Affiliates make, use or sell any products, including the Approved Products, in any country or territory in which Paragon or its Affiliates do not have the right to make, use or sell such products under the -8- P&G Licenses or (ii) Paragon or its Affiliates alter the designs of the Approved Products after the date hereof such that P&G believes any of the P&G Patents or the Additional P&G Patents, as the case may be, are infringed, if P&G, at that time, has licensed the patent(s) in question to other Entities, then P&G shall make available to Paragon and/or its Affiliates a license (an "MFL License") on such patent(s) on terms and conditions no less favorable than those P&G licenses. If there is an unresolved dispute between the Parties regarding whether a product infringes a P&G Patent or an Additional P&G Patent, any such dispute shall be handled pursuant to the provisions of Section 8 of this Settlement Agreement. Notwithstanding the foregoing, (a) this Section 6.3 shall not apply to licenses (i) given by P&G in connection with litigation settlements or cross-licenses or (ii) given with respect to patents other than the P&G Patents and the Additional P&G Patents, the rights to which are acquired by P&G after the date hereof, (b) P&G shall not be required to make available an MFL License if the effect of the license would be to allow an Affiliate of Paragon to make, have made, import, use, offer for sale and/or sell licensed products without entering into a mutually agreeable settlement agreement with P&G for any past infringing activity by such Affiliate with respect to the patents to be so licensed. 6.4. The P&G Licenses shall be personal to Paragon and shall be nontransferable and nonassignable to third parties without the prior written consent of P&G, which consent P&G shall not unreasonably withhold or unreasonably delay. It shall not be unreasonable for P&G to withhold or delay its consent if the effect of the proposed transfer or assignment would be to allow a transferee or assignee to obtain the prospective right to make, import, use, offer for sale or sell Licensed Products without entering into a mutually agreeable settlement agreement for any past infringing activity by the transferee or assignee. In addition, subject to Section 6.3 hereof, the P&G Licenses shall not apply to the manufacture, import, use or sale of Licensed Products by any other business entity acquired by Paragon, by which Paragon is acquired, merged with Paragon, consolidated with Paragon, partnered with Paragon or in any other business arrangement with Paragon after the effective date of this Settlement Agreement without the prior written consent of P&G, which consent P&G shall not unreasonably withhold or unreasonably delay. It shall not be unreasonable for P&G to withhold or delay its consent if the effect of the proposed transaction would be to allow an acquiring, merging or consolidating entity or partner to obtain the prospective right to make, import, use, offer for sale or sell Licensed Products in the United States without entering into a mutually agreeable settlement agreement with P&G for any past infringing activity by the acquiring, merging or consolidating entity or partner with respect to the patents included in the definition of "Licensed Products." 6.5. If Paragon so elects in writing, Paragon and P&G shall arbitrate the issue of whether any of Paragon's products -9- infringe a valid claim of U.S. Patent No. 4,963,140 (the "Robertson Patent") and/or U.S. Patent No. 4,681,578 (the "Anderson Patent"). The arbitration(s) shall be binding and conducted before a panel of three arbitrators, one of which shall be selected by each of Paragon and P&G and the third of which shall be selected by the other two arbitrators. The arbitration(s) shall be conducted further pursuant to other terms to be agreed upon by the Parties. If the arbitrators find that one or more Paragon products infringe a valid claim of either the Robertson Patent and/or the Anderson Patent, as the case may be, then Paragon shall continue to pay royalties to P&G pursuant to the respective license(s) for such patent(s) for any infringing products manufactured and sold after the execution of this Settlement Agreement. If Paragon prevails in the arbitration(s), it shall not owe royalties under either the Robertson Patent and/or the Anderson Patent, as the case may be, for the products involved in the arbitration(s) manufactured or sold after the arbitration decision. Any P&G Claims under the Robertson Patent or Anderson Patent relating to products made or sold prior to the execution of this Settlement Agreement are compromised as part of the P&G Allowed Claims under Section 2.1 hereof. 7. ASSUMPTION OF THE VAN TILBERG LICENSE. As part of the procedures seeking the entry of the Bankruptcy Court Approval Order, Paragon shall seek the Bankruptcy Court's approval of Paragon's assumption, under section 365 of the Bankruptcy Code, of the non-exclusive License Agreement, dated April 23, 1997, between Paragon and P&G (the "Van Tilberg License") relating to United States Patent Nos. 4,589,876 (including its Reexamination Certificate B1 4,589,576) and 5,267,992 and Canadian Patent No. 1,232,702 owned by P&G. Paragon and P&G agree that, as of June 30, 1998, the date of the most recent annual accounting for the fiscal year ended December 28, 1997, in accordance with the terms of the Van Tilberg License, Paragon is owed a credit under the Van Tilberg License in an amount equal to $173,005.82 (the "Credit") and that there are no defaults under the Van Tilberg License that are required to be cured pursuant to section 365 of the Bankruptcy Code as of such date. Paragon shall be entitled to apply the Credit until exhausted against royalties becoming due under the Van Tilberg License from and after December 29, 1997, in accordance with the terms of the Van Tilberg License. 8. FUTURE PATENT DISPUTES. In order to potentially avoid the expense and delay of patent litigation going forward, both for themselves and for their Affiliates, Paragon and P&G agree that before any patent litigation is commenced (including declaratory judgment actions), any patent dispute that may arise following the execution of this Settlement Agreement will be subject to good faith negotiations, including escalation to a high-ranking business executive of each of Paragon and P&G or their respective Affiliate, as the case may be, for resolution; if the dispute remains unresolved after such good faith negotiation and escalation, then the parties will discuss in good faith whether some form of alternative dispute resolution ("ADR") -10- mechanism could be employed. If, after such good faith discussions, either Party rejects ADR in writing, litigation may be commenced. Notwithstanding the foregoing, none of the statements made or actions taken by any Party during good faith negotiations or discussions of ADR may be the basis of a declaratory judgment action. 9. CLAIMS ASSERTED BY P&G. P&G represents and warrants that (a) it has not filed any proofs of claim in the Chapter 11 Case other than the Bankruptcy Claim, and (b) it has not acquired or transferred or entered into any agreement to acquire or transfer any claims asserted against Paragon in the Chapter 11 Case. P&G represents, warrants and covenants that it (x) has not and will not amend, modify or supplement, or seek to amend, modify or supplement the Bankruptcy Claim, except in a manner consistent with the terms of this Settlement Agreement and (y) shall not acquire any claims asserted against Paragon in the Chapter 11 Case without Paragon's prior written consent. Notwithstanding the foregoing, nothing stated in this Settlement Agreement (i) shall restrict P&G's rights to assert Administrative Expense Claims that (1) P&G could not have, with the exercise of reasonable due diligence, discovered prior to the date of execution of this Settlement Agreement or (2) arise after the date of execution of this Settlement Agreement, or (ii) shall in any way limit, or be construed to limit, the legal effect of any Administrative Expense Claims bar date to be established in the Chapter 11 Case, or any discharge granted to Paragon pursuant to section 1141 of the Bankruptcy Code. 10. RELEASES. 10.1. Contemporaneously with the execution of this Settlement Agreement, Paragon shall execute and hold in escrow the Paragon Release. Paragon shall release and deliver to P&G the Paragon Release as soon as reasonably practicable (but in no event later than five (5) Business Days) after the Bankruptcy Court Approval Order becomes a Final Order. 10.2. Contemporaneously with the execution of this Settlement Agreement, P&G shall execute and hold in escrow the P&G Release. P&G shall release and deliver to Paragon the P&G Release as soon as reasonably practicable (but in no event later than five (5) Business Days) after the Bankruptcy Court Approval Order becomes a Final Order. 11. RESTRICTIONS ON TRANSFER OF P&G ALLOWED CLAIMS. P&G shall not sell or otherwise transfer all or any portion of the Bankruptcy Claim or the P&G Allowed Claims for a period of ninety (90) days following the filing of the motion to obtain the Bankruptcy Court Approval Order. Following such ninety (90) day period, P&G shall not sell or otherwise transfer all or any portion of the Bankruptcy Claim or the P&G Allowed Claims to any Entity or Entities unless such Entity or Entities (i) agree(s) to be bound to the terms and conditions of this Settlement -11- Agreement, and (ii) sign(s) an agreement that specifically provides that Paragon is an intended third party beneficiary of such Entity(ies)' agreement to be so bound to, and subject to the enforcement of, the terms and conditions of this Settlement Agreement. Notwithstanding any assignment or transfer by P&G of all or any portion of the Bankruptcy Claim or the P&G Allowed Claims in accordance with the terms hereof, P&G shall continue to remain bound by each of the provisions of this Settlement Agreement, including, but not limited to, P&G's obligations to execute, deliver and perform its obligations under each of the Ancillary Agreements. In the event that P&G sells or otherwise transfers all or any portion of the Bankruptcy Claim or the P&G Allowed Claims, and notwithstanding any provisions contained herein or in the P&G Licenses to the contrary, the P&G Licenses shall remain in full force and effect notwithstanding the lack of entry of the Bankruptcy Court Approval Order on or before July 31, 1999, or the reversal or modification of such order on appeal. 12. EXCLUSIVITY AND PLAN CONFIRMATION. 12.1. If Paragon complies with its obligations under this Settlement Agreement, P&G shall not oppose any requests by Paragon for extensions of its exclusive periods to file a plan of reorganization and to solicit acceptances thereto (collectively, the "Exclusive Periods") under section 1121 of the Bankruptcy Code through and including May 31, 1999 and July 31, 1999, respectively, as long as it appears reasonably probable that the Effective Date can occur on or before July 31, 1999. 12.2. Notwithstanding the provisions of section 12.1 hereof, P&G shall have the right to object to (a) any motion filed by Paragon seeking an extension of the Exclusive Periods if Paragon is not diligently pursuing final approval of this Settlement Agreement (including its obligations under Section 22 of this Settlement Agreement), or (b) confirmation of the Plan if the P&G Allowed Claims are not treated in accordance with the terms and conditions of this Settlement Agreement or the Plan does not otherwise comply with section 1129 of the Bankruptcy Code except to the extent such compliance has been waived by P&G with respect to the payment of interest under Section 2.3 of this Settlement Agreement. 13. AMENDMENT. This Settlement Agreement may not be amended except by an instrument in writing signed by both Parties hereto after prior written notice to counsel to the Creditors' Committee and, if such amendment constitutes a material modification of this Settlement Agreement, approval of the Bankruptcy Court if the Effective Date has not yet occurred. 14. NOTICES. Any notices or other communications hereunder or in connection herewith shall be in writing and shall be deemed to have been duly given when delivered in person, by facsimile -12- transmission or by registered or certified mail (postage prepaid, return receipt requested) addressed, as follows: If to Paragon, to: Paragon Trade Brands, Inc. 180 Technology Parkway Norcross, Georgia 30092 Telephone: 678-969-5000 Facsimile: 678-969-4959 Attention: Chairman of the Board Attention: General Counsel with a copy to: Willkie Farr & Gallagher 787 Seventh Avenue New York, New York 10019-6099 Telephone: 212-728-8000 Facsimile: 212-728-8111 Attention: Myron Trepper, Esq. Cravath Swaine & Moore Worldwide Plaza 825 Eighth Avenue New York, New York 10019 Telephone: 212-474-1000 Facsimile: 212-474-3700 Attention: Richard W. Clary, Esq. Alston & Bird LLP One Atlantic Center 1201 West Peachtree Street Atlanta, Georgia 30309 Telephone: 404-881-7000 Facsimile: 404-881-7777 Attention: Neal Batson, Esq. O'Melveny & Myers LLP Citicorp Center 153 East 53rd Street New York, New York 10022 Telephone: 212-326-2000 Facsimile: 212-326-2061 Attention: Joel B. Zweibel, Esq. If to P&G, to: The Procter and Gamble Company 6090 Center Hill Avenue Cincinnati, Ohio 45224 Telephone: 513-634-5142 -13- Facsimile: 513-634-1927 Attention: Patrick D. Lane with a copy to: Jones, Day, Reavis & Pogue North Point 901 Lakeside Avenue Cleveland, Ohio 44114 Telephone: 216-586-3939 Facsimile: 216-579-0212 Attention: David G. Heiman, Esq. O'Melveny & Myers LLP Citicorp Center 153 East 53rd Street New York, New York 10022 Telephone: 212-326-2000 Facsimile: 212-326-2061 Attention: Joel B. Zweibel, Esq. or such other address as shall be furnished in writing pursuant to these notice provisions by any Party. A notice of change of address shall not be deemed to have been given until received by the addressee. 15. EFFECT ON LITIGATION. Neither this Settlement Agreement, the Ancillary Agreements, nor any of the terms hereof or thereof, nor any negotiations, documents, pleadings, proceedings or public reports in respect of any of the foregoing, shall constitute or be construed as or be deemed to be evidence of an admission on the part of either Paragon or P&G of any liability or wrong doing whatsoever, or of the truth or untruth of any of the claims made by either Paragon or P&G in their disputes or of the merit or lack of merit of any of the defenses thereto; nor shall this Settlement Agreement (including the Ancillary Agreements), or any of the terms hereof, or any negotiations, documents, pleadings, proceedings or public reports in respect of any of the foregoing, be offered or received in evidence or used or referred to in any proceeding against either Paragon or P&G except with respect to (i) effectuation and enforcement of this Settlement Agreement or the Ancillary Agreements and the discontinuance of the Appeal or the Contempt Motion, or (ii) with respect to proceedings in the Chapter 11 Case to authorize and approve this Settlement Agreement and the execution and delivery hereof, and to confirm the Plan. 16. HEADINGS. The descriptive headings of the several sections of this Settlement Agreement are inserted for convenience of reference only and do not constitute a part of this Settlement Agreement, nor in any way affect the interpretation of any provisions hereof. -14- 17. APPLICABLE LAW. This Settlement Agreement shall be governed in all respects, including validity, interpretation and effect, by the Bankruptcy Code and the laws of the State of New York, without giving effect to the principles of conflicts of law thereof. 18. COUNTERPARTS. This Settlement Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 19. ENTIRE SETTLEMENT. This Settlement Agreement (including the other documents referred to herein) (a) constitutes the entire settlement, and supersedes all other prior agreements and understandings, both written and oral, between the parties with respect to the subject matter hereof, and (b) except as otherwise expressly provided herein, is not intended to confer upon any other person any rights or remedies hereunder. 20. RULES OF CONSTRUCTION. 20.1. Any term used in this Settlement Agreement that is not defined herein, but that is used in the Bankruptcy Code or the Bankruptcy Rules, shall have the meaning assigned to that term in (and shall be construed in accordance with the rules of construction under) the Bankruptcy Code or the Bankruptcy Rules. Without limiting the foregoing, the rules of construction set forth in section 102 of the Bankruptcy Code shall apply to the Settlement Agreement, unless superseded herein. 20.2. The words "herein", hereof," "hereto," "hereunder" and others of similar import refer to the Settlement Agreement as a whole and not to any particular section, subsection or clause contained in the Settlement Agreement, unless the context requires otherwise. 20.3. Any reference in this Settlement Agreement to an existing document or exhibit means such document or exhibit as it may be amended, modified or supplemented in writing by the Parties. 20.4. Whenever from the context it is appropriate, each term stated in either the singular or the plural shall include both the singular and the plural, and each pronoun stated in the masculine, feminine or neuter includes the masculine, feminine and neuter. 20.5. In computing any period of time prescribed or allowed by this Settlement Agreement, the provisions of Bankruptcy Rule 9006(a) shall apply. 21. CONDITIONS. As an express condition precedent to Paragon's obligations under this Settlement Agreement: -15- 21.1. BANKRUPTCY COURT APPROVAL. A Final Order shall have been entered approving this Settlement Agreement in all respects. In the event the Bankruptcy Court Approval Order does not become a Final Order, the terms of this Settlement Agreement shall not be binding on any of the Parties hereto, except that (a) Section 15 hereof shall remain binding and (b) the P&G Licenses shall continue to be effective and terminable by P&G in accordance with the terms of the P&G Licenses. 21.2. EXECUTION OF ANCILLARY AGREEMENTS. Paragon and P&G shall execute and deliver each of the Ancillary Agreements annexed hereto. 22. AGREEMENT TO COOPERATE. As soon as reasonably practicable after the date of execution of this Settlement Agreement, Paragon shall take reasonable good faith steps to promptly obtain the Bankruptcy Court Approval Order (either through the filing of a motion seeking approval of this Settlement Agreement, the confirmation of a Plan embodying the terms of the Settlement Agreement, and/or a combination of the foregoing), and P&G shall take such steps as reasonably requested by Paragon in good faith to obtain entry of the Bankruptcy Court Approval Order. 23. REQUISITE AUTHORITY. Each of the undersigned Parties represents and warrants that, except as affected by the requirements of the Bankruptcy Code for the approval of this Settlement Agreement, (a) this Settlement Agreement and all other documents executed or to be executed by such Party in accordance with this Settlement Agreement are valid and enforceable in accordance with their terms, (b) such Party has taken all necessary corporate action required to authorize the execution, performance and delivery of this Settlement Agreement and the related documents, and (c) upon this Settlement Agreement being approved by a Final Order of the Bankruptcy Court, it will perform this Settlement Agreement and consummate all of the transactions contemplated hereby. 24. ANNOUNCEMENTS. All press releases by any Party regarding this Settlement Agreement shall be approved by both Paragon and P&G prior to the issuance thereof; provided that either Party may make any public disclosure it believes in good faith is required by law or regulation (in which case the disclosing Party shall advise the other Party prior to making such disclosure and provide such other Party an opportunity to review and comment on the proposed disclosure). Paragon's filing of a motion with the Bankruptcy Court seeking approval of this Settlement Agreement shall not be considered a public announcement requiring P&G's approval for purposes of this Section 24. 25. CONFIDENTIALITY. Nothing contained in this Settlement Agreement modifies, or is intended to modify, the obligations of P&G or Paragon or their respective employees, advisors and agents -16- under any confidentiality agreements that such Entities have executed. 26. JURISDICTION. The Bankruptcy Court shall retain exclusive jurisdiction, and the Parties consent to such exclusive jurisdiction, to hear and determine any and all matters, claims or disputes arising from or relating to the interpretation and/or implementation of this Settlement Agreement; PROVIDED, HOWEVER, that the Bankruptcy Court shall not retain jurisdiction following the Effective Date to determine matters, claims and disputes concerning the interpretation and enforcement of the P&G Licenses. -17- IN WITNESS WHEREOF, each of the Parties hereto has caused this Settlement Agreement to be executed on its behalf by its officers thereunto duly authorized, all as of the day and year first above written. PARAGON TRADE BRANDS, INC. Debtor and Debtor in Possession By: /S/ BOBBY V. ABRAHAM ---------------------------- Name: B. V. Abraham Title: Chairman and Chief Executive Officer THE PROCTER & GAMBLE COMPANY By: /S/ MARK D. KETCHUM ----------------------------- Name: Mark D. Ketchum Title: President-Global Baby Care EX-10.29 4 U.S. LICENSE AGREEMENT (LAWSON, ET AL) U.S. LICENSE AGREEMENT This Agreement, effective as of the date of execution by both parties, is by and between THE PROCTER & GAMBLE COMPANY, an Ohio Corporation having a principal place of business at One Procter & Gamble Plaza, Cincinnati, Ohio 45202, (hereinafter referred to as "P&G") and PARAGON TRADE BRANDS, INC., a Delaware Corporation having a principal place of business at 180 Technology Parkway, Norcross, Georgia 30092 (hereinafter referred to as "Paragon"). P&G and Paragon will be jointly referred to as the "parties". WHEREAS, P&G is the owner of U.S. Patent 4,695,278 issued to Lawson on September 22, 1987 relating to an absorbent article having dual cuffs; WHEREAS, P&G owns patents corresponding to U.S. 4,695,278 in a number of other countries; WHEREAS, Paragon is aware that the presently extant claims of U.S. Patent 4,695,278 to Lawson are 3,8,9,13,15,17,21,25,27 and 28. WHEREAS, P&G is the owner of U.S. Patent 4,795,454 issued to Dragoo on January 3, 1989 relating to an absorbent article having dual leakage resistant cuffs; WHEREAS, P&G owns patents corresponding to U.S. Patent 4,795,454 in a number of other countries; 2 WHEREAS, P&G is the owner of U.S. Patent Re. 34,920 issued to Aziz et al. on April 25, 1995 relating to a disposable absorbent article having elasticized flaps provided with leakage resistant portions; WHEREAS, P&G owns patents corresponding to U.S. Patent Re. 34,920 in a number of other countries; WHEREAS, P&G is the owner of U.S. Patent 5,085,654 issued to Buell on February 4, 1992 relating to a disposable absorbent article having breathable leg cuffs; WHEREAS, P&G owns patents corresponding to U.S. Patent 5,085,654 in a number of other countries; WHEREAS, Paragon makes, uses, offers for sale and sells integral disposable infant diapers having barrier cuffs throughout the United States; WHEREAS, P&G believes that the diapers made and sold by Paragon fall within the scope of one or more of the extant claims of U.S. Patent 4,695,278 to Lawson, U.S. Patent 4,795,454 to Dragoo, U.S. Patent Re. 34,920 to Aziz et al. and U.S. Patent 5,085,654 to Buell; WHEREAS, the United States District Court for the District of Delaware has held that certain diapers made and sold by Paragon fall within the scope of one or more of the extant claims of U.S. Patent 4,695,278 to Lawson, and U.S. Patent 4,795,454 to Dragoo; and 3 WHEREAS, Paragon desires to obtain from P&G and P&G is willing to grant to Paragon a royalty bearing, non-exclusive right to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell in the United States integral disposable absorbent articles which are within the scope of one or more of the extant claims of U.S. Patent 4,695,278 to Lawson, U.S. Patent 4,795,454 to Dragoo, U.S. Patent Re. 34,920 to Aziz et al. and U.S. Patent 5,085,654 to Buell; NOW THEREFORE, in consideration of the promises, mutual covenants, and agreements contained herein, the parties agree as follows: DEFINITIONS "Licensed Product" as used herein, shall mean an integral disposable absorbent article comprising an infant diaper, an adult diaper, or a training pant falling within the scope of one or more, valid and enforceable claims of U.S. Patent 4,695,278 to Lawson, U.S. Patent 4,795,454 to Dragoo, U.S. Patent Re. 34,920 to Aziz et al., or U.S. Patent 5,085,654 to Buell, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. "Training Pant", as used herein, shall mean a disposable absorbent pant marketed for use in transitioning children from diapers to underwear. "Net Sales Price", as used herein, shall mean the revenue received by Paragon from the sale of Licensed Products to independent third parties in the United States less the following amounts: (i) discounts, including cash discounts, or rebates actually allowed or granted, (ii) credits or 4 allowances actually granted upon claims or returns regardless of the party requesting the return, (iii) freight charges paid for delivery, (iv) revenue for defective articles sold exclusively as scrap, and (v) taxes or other governmental charges levied on or measured by the invoiced amount whether absorbed by the billing or the billed party. "Settlement Agreement", as used herein, shall mean the Settlement Agreement entered into between Paragon and P&G concurrently with this License Agreement. REPRESENTATIONS AND WARRANTIES With the exception of non-exclusive license rights granted to others, P&G represents and warrants that: 1) it is the owner of all right, title and interest in and to U.S. Patent 4,695,278 to Lawson, U.S. Patent 4,795,454 to Dragoo, U.S. Patent Re. 34,920 to Aziz et al., and U.S. Patent 5,085,654 to Buell; and 2) it has the right to enter this Agreement without breaching any other agreement or obligation to a third party. Paragon represents and warrants that it is an independent entity and that it has the right to enter into this Agreement without breaching any other agreement or obligation to a third party. LICENSE GRANT 1. Upon execution of this License Agreement by both parties, and in consideration of Paragon's agreement to pay prospective running royalties on Licensed Products in accordance with Paragraph (2) below, P&G agrees to grant and hereby does grant to Paragon, as of January 7, 1999, a non-exclusive license to make, to have made for Paragon with the prior written 5 consent of P&G, to use, to offer for sale and to sell in the United States, without the right to grant sublicenses, Licensed Products. 2. As consideration for the prospective license rights herein granted by P&G, Paragon agrees that it will, commencing upon January 7, 1999, begin to pay to P&G a running royalty in accordance with each applicable provision of the following schedule: (A) For a restricted, non-exclusive license in the United States under P&G's U.S. Patent 4,695,278 to Lawson to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products restricted to the configuration and characteristics specifically depicted in attached Drawing No. 105674-2 identified as Appendix No. 1 -- One Percent (1.00%) of the Net Sales Price of Licensed Products; (B) For an unrestricted, non-exclusive license in the United States under P&G's U.S. Patent 4,695,278 to Lawson to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products which fall within the scope of one or more valid and enforceable claims of U.S. Patent 4,695,278 to Lawson, other than those exhibiting the configurations and characteristics specifically depicted in attached Drawing No. 105674-2 identified as Appendix No. 1 -- One and One Quarter Percent (1.25%) of the Net Sales Price of Licensed Products; 6 (C) For an unrestricted, non-exclusive license in the United States to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products which are within the scope of the license granted in section (B) above, but which also fall within the scope of one or more valid and enforceable claims of U.S. Patent 4,795,454 to Dragoo -- Two percent (2.00%) of the Net Sales Price of Licensed Products; (D) For an unrestricted, non-exclusive license in the United States under P&G's U.S. Patent Re. 34,920 to Aziz et al. to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products: (i) No additional royalty for Licensed Products for which Paragon has paid a royalty to P&G pursuant to Section (A), (B) or (C) above, for the period in question; or (ii) Three Eighths of One Percent (0.375%) of the Net Sales Price of Licensed Products which Licensed Products are within the scope of one or more valid and enforceable claims of the aforementioned Aziz et al. Patent, U.S. Patent Re. 34,920, and for which Paragon has paid no royalty to P&G under Section (A), (B) or (C), above, for the period in question. 7 (E) For an unrestricted, non-exclusive license in the United States under P&G's U.S. Patent 5,085,654 to Buell, to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products: (i) No additional royalty for Licensed Products for which Paragon has paid a royalty to P&G pursuant to Section (A), (B) or (C) above, for the period in question; or (ii) Three Eighths of One Percent (0.375%) of the Net Sales Price of Licensed Products for Licensed Products which are within the scope of one or more valid and enforceable claims of the aforementioned Buell Patent, U.S. Patent 5,085,654, and for which Paragon has paid no royalty to P&G under Section (A), (B) or (C) above, for the period in question. The parties agree that non-limiting examples of Licensed Products falling within subsection (C) are Paragon's Ultra products sold prior to July 6, 1998 (a sample of which is attached hereto as Appendix 2). In addition, it is Paragon's intention to transition from its current product design with a unitary cuff design, which it began manufacturing for sale on or about July 6, 1998 (a sample of which is attached hereto as Appendix 3), to the Ultra product design as described above. The parties, therefore, agree that Paragon will pay to P&G a royalty of two percent (2%) of the Net Sales Price for sales of the current Paragon product line with a unitary cuff design from January 7, 1999 until the transition to 8 the Ultra product design is complete and Paragon no longer sells such unitary cuff design product. Paragon agrees to notify P&G in writing within ten (10) days if it changes any of its product lines in such a way that it no longer intends to make running royalty payments pursuant to subsections (A), (B) or (C) hereof. 3. The license rights granted in Paragraph (1) under U.S. Patent 4,695,278 to Lawson shall automatically expire on the date of expiration of said patent, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. The license rights granted in Paragraph (1) under U.S. Patent 4,795,454 to Dragoo shall automatically expire on the date of expiration of said patent, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. The license rights granted in Paragraph (1) under U.S. Patent Re. 34,920 to Aziz et al. shall automatically expire on the date of expiration of said patent, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. The license rights granted in Paragraph (1) under U.S. Patent 5,085,654 to Buell shall automatically expire on the date of expiration of said patent, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. Should any patent licensed hereunder be held to have lapsed for the failure to pay maintenance fees, royalties for said patent shall not be due for the period of any such lapse. However, should any such lapsed patent subsequently be considered by the U.S. Patent and Trademark Office as not having expired by its acceptance of delayed payment of the maintenance fee, the license rights granted under said patent shall automatically revive and royalties shall again accrue beginning on the date that the term of the patent has been maintained as a result of the acceptance of a payment of the maintenance fee by the U.S. 9 Patent and Trademark Office. P&G agrees to provide written notice to Paragon of the lapse of any such patent, and if applicable, the date that the patent has been maintained as a result of the acceptance by the U.S. Patent and Trademark Office of a delayed payment of the maintenance fee. 4. Within thirty (30) days of June 28, 1999, Paragon shall provide P&G with an initial statement reporting Paragon's Net Sales Price of Licensed Products covered by this License Agreement for the period beginning on January 7, 1999 and ending on June 27, 1999 and be accompanied by the appropriate royalty payment. On an ongoing basis, the Paragon fiscal year ends on the last Sunday of December. Therefore, after making said initial report, Paragon shall, within 30 days after the end of each subsequent Paragon fiscal year, commencing on December 26, 1999, provide P&G with an annual statement reporting Paragon's Net Sales Price of Licensed Products covered by this License Agreement for the preceding one year period. The parties recognize that the report and payment for the 1999 fiscal year will cover only the six month period commencing on June 28, 1999 and ending on December 26, 1999 in light of the previous initial report and payment. Each report shall specify the Net Sales Price of Licensed Products attributable on an individual basis to each of the categories (A), (B), (C), (D)(i) and (ii) and (E)(i) and (ii) set forth in Paragraph (2) of this License Agreement. Each such report is due within thirty (30) days of the close of the fiscal year for which the report is made, and shall be accompanied by the royalty payment owed to P&G by Paragon. Each such report shall be treated as confidential and proprietary information of Paragon and shall only be used for the purposes set forth herein. The report shall only be shared within P&G with such persons at P&G who need to know such information for the 10 purposes set forth herein. Each such report may be shared with P&G's outside counsel or auditors who need to know such information for the purpose of verifying such report. 5. Once each year, at P&G's election and expense, Paragon's independent public accountant shall certify to P&G that the annual report for the previous period or year is true, complete and that royalties have been paid for Licensed Products sold during the previous year. Paragon shall keep correct and complete records containing all information required for computation and verification of the amounts to be paid hereunder for a period of at least three (3) years after making each such report. Upon reasonable notice, during regular business hours, independent "Big Six" public accountants selected by P&G, and paid for by P&G in the event the Paragon payment being verified proves accurate to within two percent (2.00%), may make such examinations of Paragon's records, not more frequently than once a year, as P&G deems necessary to verify such reports and payments provided for hereunder. Such examination shall occur at such location as designated by Paragon, and such verification shall only state the amount of payments due in each of categories (A), (B), (C), (D)(i) and (ii) and (E)(i) and (ii) of Paragraph (2) of this License Agreement. If the Paragon payment does not prove accurate to within two percent (2.00%), royalties being underpaid, then Paragon shall pay for such independent public accountants. 6. If Paragon shall be in default in making any payments hereunder at the times and in the manner herein provided or in complying with the financial obligations it assumed pursuant to the concurrently executed Settlement Agreement with P&G, P&G may give written notice to Paragon specifying the particulars of such default, and in the event Paragon does 11 not fully remedy such default within thirty (30) days after such notice, P&G may at its option, terminate this License Agreement by giving ten (10) days prior written notice to Paragon to that effect. In addition, P&G may proceed to enforce the defaulted obligation of Paragon by any legally available means. No waiver on the part of P&G in respect to a default by Paragon shall be construed as a waiver of P&G's right to proceed under this Paragraph with respect to subsequent defaults. 7. Neither expiration of this License Agreement in accordance with its provisions nor termination of this License Agreement shall relieve Paragon of its obligations for payment of unpaid royalties under Paragraph (2) or for enforcement of any other obligation or liability accrued hereunder prior to the effective date of such expiration or termination. 8. The failure of either party to strictly enforce this License Agreement, or to insist upon the strict compliance with its terms shall not at any time be considered a waiver or condonation by such party of the default or failure by the other party to strictly perform the covenants, conditions and agreements on its part to be performed. 9. Paragon agrees, when its existing supply of packaging has been exhausted, to mark the packages of its Licensed Products to be sold within the United States with the following statement: "Licensed under one or more of the following U.S. Patents (with appropriate patent numbers filled in per Paragraph (2))", and if a reexamination certificate or a reissue of any such patent occurs, to place on its packages appropriate statements relating to that reexamination certificate and/or that reissue patent. There shall be no reference to "The 12 Procter & Gamble Company", "Procter & Gamble", "P&G", any variation or affiliate thereof, or any trademark or tradename owned or controlled by P&G on the packaging. 10. No patent rights outside the United States are granted by P&G in this License Agreement. However, P&G agrees that it will, upon request by Paragon, negotiate in good faith in an attempt to establish mutually acceptable terms and conditions for Paragon to obtain non-exclusive royalty bearing license rights under P&G's foreign patents corresponding to the U.S. Patents licensed herein on a case by case basis. The parties recognize that the terms and conditions, including the royalty rates, for said foreign license rights may not be the same as those herein set forth nor the same with respect to one another. 11. Should U.S. Patent No. 4,695,278 to Lawson expire or all extant claims covering Licensed Products be held invalid or unenforceable in a decision by a court of competent jurisdiction from which no appeal can or has been taken, each provision of Paragraph (2) shall remain valid and enforceable with a royalty rate reduction of One Percent for Licensed Products in category (A) and One and One Quarter Percent (1.25%) for Licensed Products in category (B) or (C). Should U.S. Patent No. 4,795,454 to Dragoo expire or all claims covering Licensed Products be held invalid or unenforceable in a decision by a court of competent jurisdiction from which no appeal can or has been taken, each provision of Paragraph (2) shall remain valid and enforceable with a royalty rate reduction for Licensed Products in category (C) of Three Quarters of One Percent (.75%). Should U.S. Patent Re. 34,920 to Aziz et al. expire or all claims covering Licensed Products be held invalid or unenforceable in a decision by a court of competent jurisdiction from which no appeal can or has been taken, the royalty rate will be reduced 13 Three Eighths of One Percent (0.375%) for Licensed Products in category (D)(ii). Should U.S. Patent 5,085,654 to Buell expire or all claims covering Licensed Products be held invalid or unenforceable in a decision by a court of competent jurisdiction from which no appeal can or has been taken, the royalty rate will be reduced Three Eighths of One Percent (0.375%) for Licensed Products in category (E)(ii). Should all claims of the patents covering Licensed Products expire or be held invalid or unenforceable in a decision by a court of competent jurisdiction from which no appeal can or has been taken this License Agreement will terminate. Any such decision shall have no impact upon Paragon's liability to pay any running royalties accrued prior thereto pursuant to Paragraph (2), nor shall Paragon have any right to recover any portion of the running royalties already paid to P&G. Other than as expressly set forth in this License Agreement, P&G makes no warranties whatsoever with respect to Paragon's manufacture, use, offer for sale or sale of Licensed Products pursuant to this License Agreement. 12. P&G hereby waives any and all rights to sue (including, but not limited to, actions to enjoin and/or recover damages from) Paragon for making, having made for Paragon with the prior written consent of P&G, using, offering for sale, and/or selling Licensed Products in the United States, provided: (1) this License Agreement has not been terminated by either party; (2) Paragon is in full compliance with all material terms of the concurrently executed Settlement Agreement with P&G and is current in meeting its obligation to pay the running royalties provided in Paragraph (2) hereof; and (3) Paragon is otherwise in full compliance with the material terms of this License Agreement. 14 13. Notices relating to this Agreement shall be in writing and shall be considered served when deposited as certified or registered U.S. mail, return receipt requested, in a sealed envelope with sufficient postage affixed, addressed as follows: P&G: Attention: Vice President & General Counsel - Patents The Procter & Gamble Company Winton Hill Technical Center 6090 Center Hill Avenue Cincinnati, Ohio 45224 Paragon: Attention: Vice President & General Counsel Paragon Trade Brands, Inc. 180 Technology Parkway Norcross, GA 30092 14. The parties agree that this License shall be personal to Paragon and shall be nontransferable and nonassignable to third parties without the prior written consent of P&G, which consent P&G agrees not to unreasonably withhold or unreasonably delay. In this context, the parties agree that it is not an unreasonable ground for P&G to withhold or delay its consent if the effect of the proposed transfer or assignment would be to allow a transferee or assignee to obtain the prospective right to make, import, use, offer for sale and/or sell Licensed Products in the United States without entering into a mutually agreeable settlement agreement for any past infringing activity by the transferee or assignee with respect to the patents included in the definition of "Licensed Products". In addition, the parties agree that this License shall not apply to the manufacture, import, use or sale of Licensed Products by any other business entity acquired by Paragon, by which Paragon is acquired, merged with Paragon, consolidated with Paragon, partnered with Paragon, or in any other business arrangement with Paragon after the effective date of this Agreement without the prior written consent of P&G, which consent P&G agrees not to 15 unreasonably withhold or unreasonably delay. In this context, the parties agree that it is not an unreasonable ground for P&G to withhold or delay its consent if the effect of the proposed transaction would be to allow an acquiring, merging or consolidating entity or partner to obtain the prospective right to make, import, use, offer for sale and/or sell Licensed Products in the United States without entering into a mutually agreeable settlement agreement with P&G for any past infringing activity by the acquiring, merging or consolidating entity or partner with respect to the patents included in the definition of "Licensed Products". 15. In the event the Settlement Agreement executed concurrently herewith is not approved by the Bankruptcy Court (as defined in the Settlement Agreement) or in the event that the order approving the Settlement Agreement does not become a Final Order by July 31, 1999 (as defined in the Settlement Agreement), this License Agreement shall be terminable by P&G, at P&G's option. Termination in such circumstance shall not relieve Paragon of its obligation to pay royalties accrued hereunder for the period before termination. P&G agrees to provide Paragon with a three month conversion period after the date of termination. Royalties, as set forth above, shall be due on the Licensed Products manufactured and/or sold during the conversion period and such royalties shall be payable within 30 days of the end of the conversion period. 16. P&G agrees to give Paragon notice of all future running royalty based private label or brand manufacturer licenses granted under any of the P&G U.S. patents herein, and, upon written request, provide Paragon copies of all such subsequent running royalty based agreements within thirty (30) days of execution of any such agreements. Paragon shall be 16 entitled, upon thirty (30) days written request to P&G, to have this License Agreement brought into conformity with any such subsequent running royalty based license to any private label or brand manufacturer other than Paragon in the event P&G grants any license under any of the P&G U.S. patents herein under terms more favorable than those set forth herein. 17. This Agreement and the Settlement Agreement set forth the entire understanding of the parties with respect to the subject matter herein set forth. There are no ancillary understandings or agreements with respect to the subject matter of this License Agreement. 18. This Agreement may be executed in counterparts. Each part shall constitute an original. 19. This Agreement shall become effective as of the date of acceptance by the last party to sign. FOR: PARAGON TRADE BRANDS, INC. FOR: THE PROCTER & GAMBLE COMPANY By /S/ B.V. ABRAHAM By /S/ MARK D. KETCHUM -------------------------------- -------------------------------- Title CHAIRMAN AND CEO Title PRESIDENT - GLOBAL BABY CARE ------------------------------ ------------------------------ Date FEBRUARY 2, 1999 Date FEBRUARY 2, 1999 ------------------------------ ------------------------------ EX-10.30 5 CANADIAN LICENSE AGREEMENT (LAWSON, ET AL) CANADIAN LICENSE AGREEMENT This Agreement, effective as of the date of execution by both parties, is by and between THE PROCTER & GAMBLE COMPANY, an Ohio Corporation having a principal place of business at One Procter & Gamble Plaza, Cincinnati, Ohio 45202, (hereinafter referred to as "P&G") and PARAGON TRADE BRANDS, INC., a Delaware Corporation having a principal place of business at 180 Technology Parkway, Norcross, Georgia 30092 and its wholly-owned subsidiary, Paragon Trade Brands (Canada) Inc., a Canadian corporation having a principal place of business at 1600 Clark Boulevard, Brampton, Ontario, Canada L6T 3V7 (hereinafter collectively referred to as "Paragon"). P&G and Paragon will be jointly referred to as the "parties". WHEREAS, P&G is the owner of Canadian Patent 1,311,879 issued to Lawson on December 29, 1992 relating to an absorbent article having dual cuffs; WHEREAS, P&G owns patents corresponding to Canadian Patent 1,311,879 in a number of other countries; WHEREAS, P&G is the owner of Canadian Patent 1,290,501 issued to Dragoo on October 15, 1991 relating to an absorbent article having dual leakage resistant cuffs; WHEREAS, P&G owns patents corresponding to Canadian Patent 1,290,501 in a number of other countries; 2 WHEREAS, P&G is the owner of Canadian Patent 1,175,602 issued to Aziz et al. on October 9, 1984 relating to a disposable absorbent article having elasticized flaps provided with leakage resistant portions; WHEREAS, P&G owns patents corresponding to Canadian Patent 1,175,602 in a number of other countries; WHEREAS, P&G is the owner of Canadian Patent 1,216,702 issued to Buell on January 20, 1987 relating to a disposable absorbent article having breathable leg cuffs; WHEREAS, P&G owns patents corresponding to Canadian Patent 1,216,702 in a number of other countries; WHEREAS, Paragon makes, uses, offers for sale and sells integral disposable infant diapers having barrier cuffs throughout Canada; WHEREAS, P&G believes that the diapers made and sold by Paragon fall within the scope of one or more of the extant claims of Canadian Patent 1,311,879 to Lawson, Canadian Patent 1,290,501 to Dragoo, Canadian Patent 1,175,602 to Aziz et al. and Canadian Patent 1,216,702 to Buell; and WHEREAS, Paragon desires to obtain from P&G and P&G is willing to grant to Paragon a royalty bearing, non-exclusive right to make, to have made for Paragon with the prior written 3 consent of P&G, to use, to offer for sale and to sell in Canada integral disposable absorbent articles which are within the scope of one or more of the extant claims of Canadian Patent 1,311,879 to Lawson, Canadian Patent 1,290,501 to Dragoo, Canadian Patent 1,175,602 to Aziz et al. and Canadian Patent 1,216,702 to Buell; NOW THEREFORE, in consideration of the promises, mutual covenants, and agreements contained herein, the parties agree as follows: DEFINITIONS "Licensed Product" as used herein, shall mean an integral disposable absorbent article comprising an infant diaper, an adult diaper, or a training pant falling within the scope of one or more extant, valid and enforceable claims of Canadian Patent 1,311,879 to Lawson, Canadian Patent 1,290,501 to Dragoo, Canadian Patent 1,175,602 to Aziz et al., or Canadian Patent 1,216,702 to Buell, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. "Training Pant", as used herein, shall mean a disposable absorbent pant marketed for use in transitioning children from diapers to underwear. "Net Sales Price", as used herein, shall mean the revenue received by Paragon from the sale of Licensed Products to independent third parties in the Canada less the following amounts: (i) discounts, including cash discounts, or rebates actually allowed or granted, (ii) credits or allowances actually granted upon claims or returns regardless of the party requesting the return, (iii) freight charges paid for delivery, (iv) revenue for defective articles sold exclusively as scrap, 4 and (v) taxes or other governmental charges levied on or measured by the invoiced amount whether absorbed by the billing or the billed party. "Settlement Agreement", as used herein, shall mean the Settlement Agreement entered into between Paragon and P&G concurrently with this License Agreement. REPRESENTATIONS AND WARRANTIES With the exception of non-exclusive license rights granted to others, P&G represents and warrants that: 1) it is the owner of all right, title and interest in and to Canadian Patent 1,311,879 to Lawson, Canadian Patent 1,290,501 to Dragoo, Canadian Patent 1,175,602 to Aziz et al., and Canadian Patent 1,216,702 to Buell; and 2) it has the right to enter this Agreement without breaching any other agreement or obligation to a third party. Paragon represents and warrants that it is an independent entity and that it has the right to enter into this Agreement without breaching any other agreement or obligation to a third party. LICENSE GRANT 1. Upon execution of this License Agreement by both parties, and in consideration of Paragon's agreement to pay prospective running royalties on Licensed Products in accordance with Paragraph (2), below, P&G agrees to grant and hereby does grant to Paragon, as of January 7, 1999, a non-exclusive license to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell in Canada, without the right to grant sublicenses, Licensed Products. 5 2. As consideration for the prospective license rights herein granted by P&G, Paragon agrees that it will, commencing upon January 7, 1999, begin to pay to P&G a running royalty in accordance with each applicable provision of the following schedule: (A) For a restricted, non-exclusive license in Canada under P&G's Canadian Patent 1,311,879 to Lawson to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products restricted to the configuration and characteristics specifically depicted in attached Drawing No. 105674-2 identified as Appendix No. 1 -- One Percent (1.00%) of the Net Sales Price of Licensed Products; (B) For an unrestricted, non-exclusive license in Canada under P&G's Canadian Patent 1,311,879 to Lawson to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products which fall within the scope of one or more valid and enforceable claims of Canadian Patent 1,311,879 to Lawson, other than those exhibiting the configurations and characteristics specifically depicted in attached Drawing No. 105674-2 identified as Appendix No. 1 -- One and One Quarter Percent (1.25%) of the Net Sales Price of Licensed Products; (C) For an unrestricted, non-exclusive license in Canada to make, have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products which are within the scope of the license granted in section (B) above, but which also fall within the 6 scope of one or more valid and enforceable claims of Canadian Patent 1,290,501 to Dragoo -- Two percent (2.00%) of the Net Sales Price of Licensed Products; (D) For an unrestricted, non-exclusive license in Canada under P&G's Canadian Patent 1,175,602 to Aziz et al. to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products: (i) No additional royalty for Licensed Products for which Paragon has paid a royalty to P&G pursuant to Section (A), (B) or (C) above, for the period in question; or (ii) Three Eighths of One Percent (0.375%) of the Net Sales Price of Licensed Products which Licensed Products are within the scope of one or more valid and enforceable claims of the aforementioned Aziz et al. Patent and for which Paragon has paid no royalty to P&G under Section (A), (B) or (C) above, for the period in question. (E) For an unrestricted, non-exclusive license in Canada under P&G's Canadian Patent 1,216,702 to Buell, to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products: 7 (i) No additional royalty for Licensed Products for which Paragon has paid a royalty to P&G pursuant to Section (A), (B) or (C) above, for the period in question; or (ii) Three Eighths of One Percent (0.375%) of the Net Sales Price of Licensed Products for Licensed Products which are within the scope of one or more valid and enforceable claims of the aforementioned Buell Patent and for which Paragon has paid no royalty to P&G under Section (A), (B) or (C), above, for the period in question. The parties agree that non-limiting examples of Licensed Products falling within subsection (C) are Paragon's Ultra products sold prior to July 6, 1998 (a sample of which is attached hereto as Appendix 2). In addition, it is Paragon's intention to transition from its current product design with a unitary cuff design, which it began manufacturing for sale on or about July 6, 1998 (a sample of which is attached hereto as Appendix 3), to the Ultra product design as described above. The parties, therefore, agree that Paragon will pay to P&G a royalty of two percent (2%) of the Net Sales Price for sales of the current Paragon product line with a unitary cuff design from January 7, 1999 until the transition to the Ultra product design is complete and Paragon no longer sells such unitary cuff design product. Paragon agrees to notify P&G in writing within ten (10) days if it changes any of its product lines in such a way that it no longer intends to make running royalty payments pursuant to subsections (A), (B) or (C) hereof. 8 3. The license rights granted in Paragraph (1) under Canadian Patent 1,311,879 to Lawson shall automatically expire on the date of expiration of said patent, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. The license rights granted in Paragraph (1) under Canadian Patent 1,290,501 to Dragoo shall automatically expire on the date of expiration of said patent, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. The license rights granted in Paragraph (1) under Canadian Patent 1,175,602 to Aziz et al. shall automatically expire on the date of expiration of said patent, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. The license rights granted in Paragraph (1) under Canadian Patent 1,216,702 to Buell shall automatically expire on the date of expiration of said patent, including any continuations, continuations- in-part, divisionals, reexaminations, reissues or extensions thereof. Should any patent licensed hereunder be held to have lapsed for the failure to pay maintenance fees, royalties for said patent shall not be due for the period of any such lapse. However, should any such lapsed patent subsequently be considered as not having expired by the acceptance by the relevant Canadian Patent Authority of delayed payment of the maintenance fee, the license rights granted under said patent shall automatically revive and royalties shall again accrue beginning on the date that the term of the patent has been maintained as a result of the acceptance by the relevant Canadian Patent Authority of a payment of the maintenance fee. P&G agrees to provide written notice to Paragon of the lapse of any such patent, and if applicable, the date that the patent has been maintained as a result of the acceptance by the relevant Canadian Patent Authority of a delayed payment of the maintenance fee. 9 4. Within thirty (30) days of June 28, 1999, Paragon shall provide P&G with an initial statement reporting Paragon's Net Sales Price of Licensed Products covered by this License Agreement for the period beginning on January 7, 1999 and ending on June 27, 1999 and be accompanied by the appropriate royalty payment. On an ongoing basis, the Paragon fiscal year ends on the last Sunday of December. Therefore, after making said initial report, Paragon shall, within 30 days after the end of each subsequent Paragon fiscal year, commencing on December 26, 1999, provide P&G with an annual statement reporting Paragon's Net Sales Price of Licensed Products covered by this License Agreement for the preceding one year period. The parties recognize that the report and payment for the 1999 fiscal year will cover only the six month period commencing on June 28, 1999 and ending on December 26, 1999 in light of the previous initial report and payment. Each report shall specify the Net Sales Price of Licensed Products attributable on an individual basis to each of the categories (A), (B), (C), (D)(i) and (ii) and (E)(i) and (ii) set forth in Paragraph (2) of this License Agreement. Each such report is due within thirty (30) days of the close of the fiscal year for which the report is made, and shall be accompanied by the royalty payment owed to P&G by Paragon. Each such report shall be treated as confidential and proprietary information of Paragon and shall only be used for the purposes set forth herein. The report shall only be shared within P&G with such persons at P&G who need to know such information for the purposes set forth herein. Each such report may be shared with P&G's outside counsel or auditors who need to know such information for the purpose of verifying such report. 10 5. Once each year, at P&G's election and expense, Paragon's independent public accountant shall certify to P&G that the annual report for the previous period or year is true, complete and that royalties have been paid for Licensed Products sold during the previous year. Paragon shall keep correct and complete records containing all information required for computation and verification of the amounts to be paid hereunder for a period of at least three (3) years after making each such report. Upon reasonable notice, during regular business hours, independent "Big Six" public accountants selected by P&G, and paid for by P&G in the event the Paragon payment being verified proves accurate to within two percent (2.00%), may make such examinations of Paragon's records, not more frequently than once a year, as P&G deems necessary to verify such reports and payments provided for hereunder. Such examination shall occur at such location as designated by Paragon, and such verification shall only state the amount of payments due in each of categories (A), (B), (C), (D)(i) and (ii) and (E)(i) and (ii) of Paragraph (2) of this License Agreement. If the Paragon payment does not prove accurate to within two percent (2.00%), royalties being underpaid, then Paragon shall pay for such independent public accountants. 6. If Paragon shall be in default in making any payments hereunder at the times and in the manner herein provided or in complying with the financial obligations it assumed pursuant to the concurrently executed Settlement Agreement with P&G, P&G may give written notice to Paragon specifying the particulars of such default, and in the event Paragon does not fully remedy such default within thirty (30) days after such notice, P&G may at its option, terminate this License Agreement by giving ten (10) days prior written notice to Paragon to that effect. In addition, P&G may proceed to enforce the defaulted obligation 11 of Paragon by any legally available means. No waiver on the part of P&G in respect to a default by Paragon shall be construed as a waiver of P&G's right to proceed under this Paragraph with respect to subsequent defaults. 7. Neither expiration of this License Agreement in accordance with its provisions nor termination of this License Agreement shall relieve Paragon of its obligations for payment of unpaid royalties under Paragraph (2) or for enforcement of any other obligation or liability accrued hereunder prior to the effective date of such expiration or termination. 8. The failure of either party to strictly enforce this License Agreement, or to insist upon the strict compliance with its terms shall not at any time be considered a waiver or condonation by such party of the default or failure by the other party to strictly perform the covenants, conditions and agreements on its part to be performed. 9. Paragon agrees, when its existing supply of packaging has been exhausted, to mark the packages of its Licensed Products to be sold within Canada with the following statement: "Licensed under one or more of the following Canadian Patents (with appropriate patent numbers filled in per Paragraph (2))", and if a reexamination certificate or a reissue of any such patent occurs, to place on its packages appropriate statements relating to that reexamination certificate and/or that reissue patent. There shall be no reference to "The Procter & Gamble Company", "Procter & Gamble", "P&G", any variation or affiliate thereof, or any trademark or tradename owned or controlled by P&G on the packaging. 12 10. No patent rights outside Canada are granted by P&G in this License Agreement. However, P&G agrees that it will, upon request by Paragon, negotiate in good faith in an attempt to establish mutually acceptable terms and conditions for Paragon to obtain non-exclusive royalty bearing license rights under P&G's foreign patents corresponding to the Canadian Patents licensed herein on a case by case basis. The parties recognize that the terms and conditions, including the royalty rates, for said foreign license rights may not be the same as those herein set forth nor the same with respect to one another. 11. Should Canadian Patent No. 1,311,879 to Lawson expire or all extant claims covering Licensed Products be held invalid or unenforceable in a decision by a court of competent jurisdiction from which no appeal can or has been taken, each provision of Paragraph (2) shall remain valid and enforceable with a royalty rate reduction of One Percent for Licensed Products in category (A) and One and One Quarter Percent (1.25%) for Licensed Products in category (B) or (C). Should Canadian Patent 1,290,501 to Dragoo expire or all claims covering Licensed Products be held invalid or unenforceable in a decision by a court of competent jurisdiction from which no appeal can or has been taken, each provision of Paragraph (2) shall remain valid and enforceable with a royalty rate reduction for Licensed Products in category (C) of Three Quarters of One Percent (.75%). Should Canadian Patent 1,175,602 to Aziz et al. expire or all claims covering Licensed Products be held invalid or unenforceable in a decision by a court of competent jurisdiction from which no appeal can or has been taken, the royalty rate will be reduced Three Eighths of One Percent (0.375%) for Licensed Products in category (D)(ii). Should Canadian Patent 1,216,702 to Buell expire or all claims covering Licensed Products be held invalid or unenforceable in a decision by a court of competent jurisdiction from which 13 no appeal can or as been taken, the royalty rate will be reduced Three Eighths of One Percent (0.375%) for Licensed Products in category (E)(ii). Should all claims of the patents covering Licensed Products expire or be held invalid or unenforceable in a decision by a court of competent jurisdiction from which no appeal can or has been taken this License Agreement will terminate. Any such decision shall have no impact upon Paragon's liability to pay any running royalties accrued prior thereto pursuant to Paragraph (2), nor shall Paragon have any right to recover any portion of the running royalties already paid to P&G. Other than as expressly set forth in this License Agreement, P&G makes no warranties whatsoever with respect to Paragon's manufacture, use, offer for sale or sale of Licensed Products pursuant to this License Agreement. 12. P&G hereby waives any and all rights to sue (including, but not limited to, actions to enjoin and/or recover damages from) Paragon for making, having made for Paragon with the prior written consent of P&G, using, offering for sale, and/or selling Licensed Products in Canada, provided: (1) this License Agreement has not been terminated by either party; (2) Paragon is in full compliance with all material terms of the concurrently executed Settlement Agreement with P&G and is current in meeting its obligation to pay the running royalties provided in Paragraph (2) hereof; and (3) Paragon is otherwise in full compliance with the material terms of this License Agreement. 13. Notices relating to this Agreement shall be in writing and shall be considered served when deposited as certified or registered U.S. mail, return receipt requested, in a sealed envelope with sufficient postage affixed, addressed as follows: 14 P&G: Attention: Vice President & General Counsel - Patents The Procter & Gamble Company Winton Hill Technical Center 6090 Center Hill Avenue Cincinnati, Ohio 45224 Paragon: Attention: Vice President & General Counsel Paragon Trade Brands, Inc. 180 Technology Parkway Norcross, GA 30092 14. The parties agree that this License shall be personal to Paragon and shall be nontransferable and nonassignable to third parties without the prior written consent of P&G, which consent P&G agrees not to unreasonably withhold or unreasonably delay. In this context, the parties agree that it is not an unreasonable ground for P&G to withhold or delay its consent if the effect of the proposed transfer or assignment would be to allow a transferee or assignee to obtain the prospective right to make, import, use, offer for sale and/or sell Licensed Products in Canada without entering into a mutually agreeable settlement agreement for any past infringing activity by the transferee or assignee with respect to the patents included in the definition of "Licensed Products". In addition, the parties agree that this License shall not apply to the manufacture, import, use or sale of Licensed Products by any other business entity acquired by Paragon, by which Paragon is acquired, merged with Paragon, consolidated with Paragon, partnered with Paragon, or in any other business arrangement with Paragon after the effective date of this Agreement without the prior written consent of P&G, which consent P&G agrees not to unreasonably withhold or unreasonably delay. In this context, the parties agree that it is not an unreasonable ground for P&G to withhold or delay its consent if the effect of the proposed transaction would be to allow an acquiring, merging or consolidating entity or partner to obtain the prospective right to make, import, use, offer for sale and/or sell 15 Licensed Products in Canada without entering into a mutually agreeable settlement agreement with P&G for any past infringing activity by the acquiring, merging or consolidating entity or partner with respect to the patents included in the definition of "Licensed Products". 15. In the event the Settlement Agreement executed concurrently herewith is not approved by the Bankruptcy Court (as defined in the Settlement Agreement) or in the event that the order approving the Settlement Agreement does not become a Final Order by July 31, 1999 (as defined in the Settlement Agreement), this License Agreement shall be terminable by P&G, at P&G's option. Termination in such circumstance shall not relieve Paragon of its obligation to pay royalties accrued hereunder for the period before termination. P&G agrees to provide Paragon with a three month conversion period after the date of termination. Royalties, as set forth above, shall be due on the Licensed Products manufactured and/or sold during the conversion period and such royalties shall be payable within 30 days of the end of the conversion period. 16. P&G agrees to give Paragon notice of all future running royalty based private label or brand manufacturer licenses granted under any of the P&G Canadian patents herein, and, upon written request, provide Paragon copies of all such subsequent running royalty based agreements within thirty (30) days of execution of any such agreements. Paragon shall be entitled, upon thirty (30) days written request to P&G, to have this License Agreement brought into conformity with any such subsequent running royalty based license to any private label or brand manufacturer other than Paragon in the event P&G grants any 16 license under any of the P&G Canadian patents herein under terms more favorable than those set forth herein. 17. This Agreement and the Settlement Agreement set forth the entire understanding of the parties with respect to the subject matter herein set forth. There are no ancillary understandings or agreements with respect to the subject matter of this License Agreement. 18. This Agreement may be executed in counterparts. Each part shall constitute an original. 19. This Agreement shall become effective as of the date of acceptance by the last party to sign. FOR: PARAGON TRADE BRANDS, INC. FOR: THE PROCTER & GAMBLE COMPANY By /S/ B.V. ABRAHAM By /S/ MARK D. KETCHUM -------------------------------- -------------------------------- Title CHAIRMAN AND CEO Title PRESIDENT - GLOBAL BABY CARE ------------------------------ ------------------------------ Date FEBRUARY 2, 1999 Date FEBRUARY 2, 1999 ------------------------------ ------------------------------ FOR: PARAGON TRADE BRANDS (CANADA), INC. By /S/ CHRIS OLIVER -------------------------------- Title PRESIDENT ------------------------------ Date FEBRUARY 2, 1999 ------------------------------ EX-10.31 6 U.S. LICENSE AGREEMENT (ROBERTSON, ET AL) U.S. LICENSE AGREEMENT This Agreement, effective as of the date of execution by both parties, is by and between THE PROCTER & GAMBLE COMPANY, an Ohio Corporation having a principal place of business at One Procter & Gamble Plaza, Cincinnati, Ohio 45202, (hereinafter referred to as "P&G") and PARAGON TRADE BRANDS, INC., a Delaware Corporation having a principal place of business at 180 Technology Parkway, Norcross, Georgia 30092 (hereinafter referred to as "Paragon"). P&G and Paragon will be jointly referred to as the "parties". WHEREAS, P&G is the owner of U.S. Patent 4,963,140 issued to Robertson et al. on October 16, 1990 relating to an absorbent article having a mechanical fastening system with disposal means; WHEREAS, P&G owns patents corresponding to U.S. 4,963,140 in a number of other countries; WHEREAS, P&G is the owner of U.S. Patent 4,681,578 issued to Anderson et al. on July 21, 1987 relating to an absorbent article having ventilation areas; WHEREAS, P&G owns patents corresponding to U.S. Patent 4,681,578 in a number of other countries; WHEREAS, Paragon makes, uses, offers for sale and sells a Supreme line of disposable infant diapers having breathable ear panels and a mechanical fastening system with a nonwoven outer cover; 2 WHEREAS, P&G believes that the Supreme diapers made and sold by Paragon fall within the scope of one or more of the claims of U.S. Patent 4,963,140 to Robertson et al. and U.S. Patent 4,681,578 to Anderson et al.; and WHEREAS, Paragon desires to obtain from P&G and P&G is willing to grant to Paragon a royalty bearing, non-exclusive right to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell in the United States certain integral disposable absorbent articles with a mechanical fastening system having a disposal means consisting of a nonwoven outer cover which are within the scope of one or more of the claims of U.S. Patent 4,963,140 to Robertson et al. and U.S. Patent 4, 681,578 to Anderson et al.; NOW THEREFORE, in consideration of the promises, mutual covenants, and agreements contained herein, the parties agree as follows: DEFINITIONS "Licensed Product" as used herein, shall mean an integral disposable absorbent article comprising an infant diaper or an adult diaper having a mechanical fastening system consisting of (i) a closure member of a hook fastening member; (ii) a landing member of a loop fastening member; and (iii) disposal means consisting of a nonwoven outer cover having a limited degree of engageability with the hook fastening member of less than 750 grams as defined by the Test Method designated "Strength Of Attachment Of Mechanical Fastening Member To Diaper Backsheet" (attached hereto as Appendix 1) and falling within the scope of one or more of the valid and enforceable claims 1, 2, 5, 6, 7, 8, 10, 11, 13, 14, 15, 16, 17, 19 and 20 of U.S. Patent 4,963,140 3 to Robertson et al. and/or any of the claims of U.S. Patent 4,681,578 to Anderson et al., including any continuations, continuation-in-part, divisionals, reissues, reexaminations, or extensions thereof. "Net Sales Price", as used herein, shall mean the revenue received by Paragon from the sale of Licensed Products to independent third parties in the United States less the following amounts: (i) discounts, including cash discounts, or rebates actually allowed or granted, (ii) credits or allowances actually granted upon claims or returns regardless of the party requesting the return, (iii) freight charges paid for delivery, (iv) revenue for defective articles sold exclusively as scrap, and (v) taxes or other governmental charges levied on or measured by the invoiced amount whether absorbed by the billing or the billed party. "Settlement Agreement", as used herein, shall mean the Settlement Agreement entered into between Paragon and P&G concurrently with this License Agreement. REPRESENTATIONS AND WARRANTIES With the exception of non-exclusive license rights granted to others, P&G represents and warrants that: 1) it is the owner of all right, title and interest in and to U.S. Patent 4,963,140 to Robertson et al. and U.S. Patent 4,681,578 to Anderson et al. and 2) it has the right to enter this Agreement without breaching any other agreement or obligation to a third party. Paragon represents and warrants that it is an independent entity and that it has the right to enter into this Agreement without breaching any other agreement or obligation to a third party. 4 LICENSE GRANT 1. Upon execution of this License Agreement by both parties, and in consideration of Paragon's agreement to pay prospective running royalties on Licensed Products in accordance with Paragraph (2) below, P&G agrees to grant and hereby does grant to Paragon, as of January 7, 1999, a non-exclusive license to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell in the United States, without the right to grant sublicenses, Licensed Products. 2. As consideration for the prospective license rights herein granted by P&G, Paragon agrees that it will, commencing upon January 7, 1999, begin to pay to P&G a running royalty in accordance with each applicable provision of the following schedule: (A) For a restricted, non-exclusive license in the United States under P&G's U.S. Patent 4,963,140 to Robertson et al. to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products which fall within the scope of one or more valid and enforceable claims 1, 2, 5, 6, 7, 8, 10, 11, 13, 14, 15, 16, 17, 19 and 20 of U.S. Patent 4,963,140 to Robertson et al. having an engageability between the hook fastening member and the nonwoven outer cover, as defined by the Test Method attached hereto, of less than 500 grams - Three Eighths of One Percent (0.375%) of the Net Sales Price of Licensed Products; 5 (B) For a restricted, non-exclusive license in the United States under P&G's U.S. Patent 4,963,140 to Robertson et al. to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products which fall within the scope of one or more valid and enforceable claims 1, 2, 5, 6, 7, 8, 10, 11, 13, 14, 15, 16, 17, 19 and 20 of U.S. Patent 4,963,140 to Robertson et al. having an engageability between the hook fastening member and the nonwoven outer cover, as defined by the Test Method attached hereto, of between 500 grams and 750 grams -- One Half of One Percent (0.5%) of the Net Sales Price of Licensed Products; (C) For an unrestricted, non-exclusive license in the United States under P&G's U.S. Patent 4,681,578 to Anderson et al. to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products: (i) No additional royalty for Licensed Products for which Paragon has paid a royalty to P&G pursuant to Section (A) or (B) above, for the period in question; or (ii) One Tenth of One Percent (0.1%) of the Net Sales Price of Licensed Products which Licensed Products are within the scope of one or more valid and enforceable claims of the aforementioned Anderson et al. Patent and for which Paragon has paid no royalty to P&G under Section (A) or (B) above, for the period in question. 6 Subject to Paragraph 6.5 of the Settlement Agreement, the parties agree that a non-limiting example of Licensed Products falling within subsection (A) and (C) is Paragon's Supreme product (a sample of which is attached hereto as Appendix 2). Paragon agrees to notify P&G in writing within ten (10) days if it changes any of its products in such a way that it no longer intends to make running royalty payments pursuant to subsections (A), (B) or (C) hereof. 3. The license rights granted in Paragraph (1) under U.S. Patent 4,963,140 to Robertson et al. shall automatically expire on the date of expiration of said patent, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. The license rights granted in Paragraph (1) under U.S. Patent 4,681,578 to Anderson et al. shall automatically expire on the date of expiration of said patent, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. Should any patent licensed hereunder be held to have lapsed for the failure to pay maintenance fees, royalties for said patent shall not be due for the period of any such lapse. However, should any such lapsed patent subsequently be considered by the U.S. Patent and Trademark Office as not having expired by its acceptance of delayed payment of the maintenance fee, the license rights granted under said patent shall automatically revive and royalties shall again accrue beginning on the date that the term of the patent has been maintained as a result of the acceptance by the U.S. Patent and Trademark Office of a payment of the maintenance fee. P&G agrees to provide written notice to Paragon of the lapse of any such patent, and if applicable, the date that the patent has been maintained as a result of the acceptance by the U.S. Patent and Trademark Office 7 of a delayed payment of the maintenance fee. P&G acknowledges that as of the date hereof, U.S. Patent 4,963,140 to Robertson et al. has lapsed due to failure to pay maintenance fees, and, therefore, that royalties under U.S. Patent 4,963,140 to Robertson et al. are not presently due in accordance with this Paragraph. 4. Within thirty (30) days of June 28, 1999, Paragon shall provide P&G with an initial statement reporting Paragon's Net Sales Price of Licensed Products covered by this License Agreement for the period beginning on January 7, 1999 and ending on June 27, 1999 and be accompanied by the appropriate royalty payment. On an ongoing basis, the Paragon fiscal year ends on the last Sunday of December. Therefore, after making said initial report, Paragon shall, within 30 days after the end of each subsequent Paragon fiscal year, commencing on December 26, 1999, provide P&G with an annual statement reporting Paragon's Net Sales Price of Licensed Products covered by this License Agreement for the preceding one year period. The parties recognize that the report and payment for the 1999 fiscal year will cover only the six month period commencing on June 28, 1999 and ending on December 26, 1999 in light of the previous initial report and payment. Each report shall specify the Net Sales Price of Licensed Products attributable on an individual basis to each of the categories (A), (B) or (C) set forth in Paragraph (2) of this License Agreement. Each such report is due within thirty (30) days of the close of the fiscal year for which the report is made, and shall be accompanied by the royalty payment owed to P&G by Paragon. Each such report shall be treated as confidential and proprietary information of Paragon and shall only be used for the purposes set forth herein. The report shall only be 8 shared within P&G with such persons at P&G who need to know such information for the purposes set forth herein. Each such report may be shared with P&G's outside counsel or auditors who need to know such information for the purpose of verifying such report. 5. Once each year, at P&G's election and expense, Paragon's independent public accountant shall certify to P&G that the annual report for the previous period or year is true, complete and that royalties have been paid for Licensed Products sold during the previous year. Paragon shall keep correct and complete records containing all information required for computation and verification of the amounts to be paid hereunder for a period of at least three (3) years after making each such report. Upon reasonable notice, during regular business hours, independent "Big Six" public accountants selected by P&G, and paid for by P&G in the event the Paragon payment being verified proves accurate to within two percent (2.00%), may make such examinations of Paragon's records, not more frequently than once a year, as P&G deems necessary to verify such reports and payments provided for hereunder. Such examination shall occur at such location as designated by Paragon, and such verification shall only state the amount of payments due in each of categories (A), (B) or (C) of Paragraph (2) of this License Agreement. If the Paragon payment does not prove accurate to within two percent (2.00%), royalties being underpaid, then Paragon shall pay for such independent public accountants. 6. If Paragon shall be in default in making any payments hereunder at the times and in the manner herein provided or in complying with the financial obligations it assumed pursuant to the concurrently executed Settlement Agreement with P&G, P&G may give written notice to Paragon specifying the particulars of such default, and in the event Paragon does 9 not fully remedy such default within thirty (30) days after such notice, P&G may at its option, terminate this License Agreement by giving ten (10) days prior written notice to Paragon to that effect. In addition, P&G may proceed to enforce the defaulted obligation of Paragon by any legally available means. No waiver on the part of P&G in respect to a default by Paragon shall be construed as a waiver of P&G's right to proceed under this Paragraph with respect to subsequent defaults. 7. Neither expiration of this License Agreement in accordance with its provisions nor termination of this License Agreement shall relieve Paragon of its obligations for payment of unpaid royalties under Paragraph (2) or for enforcement of any other obligation or liability accrued hereunder prior to the effective date of such expiration or termination. 8. The failure of either party to strictly enforce this License Agreement, or to insist upon the strict compliance with its terms shall not at any time be considered a waiver or condonation by such party of the default or failure by the other party to strictly perform the covenants, conditions and agreements on its part to be performed. 9. Paragon agrees, when its existing supply of packaging has been exhausted, to mark the packages of its Licensed Products to be sold within the United States with the following statement: "Licensed under one or more of the following U.S. Patents (with appropriate patent numbers filled in per Paragraph (2))", and if a reexamination certificate or a reissue of any such patent occurs, to place on its packages appropriate statements relating to that reexamination certificate and/or that reissue patent. There shall be no reference to "The 10 Procter & Gamble Company", "Procter & Gamble", "P&G", any variation or affiliate thereof, or any trademark or tradename owned or controlled by P&G on the packaging. 10. No patent rights outside the United States are granted by P&G in this License Agreement. However, P&G agrees that it will, upon request by Paragon, negotiate in good faith in an attempt to establish mutually acceptable terms and conditions for Paragon to obtain non-exclusive royalty bearing license rights under P&G's foreign patents corresponding to the U.S. Patents licensed herein on a case by case basis. The parties recognize that the terms and conditions, including the royalty rates, for said foreign license rights may not be the same as those herein set forth nor the same with respect to one another. 11. P&G hereby waives any and all rights to sue (including, but not limited to, actions to enjoin and/or recover damages from) Paragon for making, having made for Paragon with the prior written consent of P&G, using, offering for sale, and/or selling Licensed Products in the United States, provided: (1) this License Agreement has not been terminated by either party; (2) Paragon is in full compliance with all material terms of the concurrently executed Settlement Agreement with P&G and is current in meeting its obligation to pay the running royalties provided in Paragraph (2) hereof; and (3) Paragon is otherwise in full compliance with the material terms of this License Agreement. 12. Notices relating to this Agreement shall be in writing and shall be considered served when deposited as certified or registered U.S. mail, return receipt requested, in a sealed envelope with sufficient postage affixed, addressed as follows: P&G: Attention: Vice President & General Counsel - Patents The Procter & Gamble Company 11 Winton Hill Technical Center 6090 Center Hill Avenue Cincinnati, Ohio 45224 Paragon: Attention: Vice President & General Counsel Paragon Trade Brands, Inc. 180 Technology Parkway Norcross, GA 30092 13. The parties agree that this License shall be personal to Paragon and shall be nontransferable and nonassignable to third parties without the prior written consent of P&G, which consent P&G agrees not to unreasonably withhold or unreasonably delay. In this context, the parties agree that it is not an unreasonable ground for P&G to withhold or delay its consent if the effect of the proposed transfer or assignment would be to allow a transferee or assignee to obtain the prospective right to make, import, use, offer for sale and/or sell Licensed Products in the United States without entering into a mutually agreeable settlement agreement for any past infringing activity by the transferee or assignee with respect to the patents included in the definition of "Licensed Products". In addition, the parties agree that this License shall not apply to the manufacture, import, use or sale of Licensed Products by any other business entity acquired by Paragon, by which Paragon is acquired, merged with Paragon, consolidated with Paragon, partnered with Paragon, or in any other business arrangement with Paragon after the effective date of this Agreement without the prior written consent of P&G, which consent P&G agrees not to unreasonably withhold or unreasonably delay. In this context, the parties agree that it is not an unreasonable ground for P&G to withhold or delay its consent if the effect of the proposed transaction would be to allow an acquiring, merging or consolidating entity or partner to obtain the prospective right to make, import, use, offer for sale and/or sell Licensed Products in the United States without entering into a mutually agreeable 12 settlement agreement with P&G for any past infringing activity by the acquiring, merging or consolidating entity or partner with respect to the patents included in the definition of "Licensed Products". 14. In the event the Settlement Agreement executed concurrently herewith is not approved by the Bankruptcy Court (as defined in the Settlement Agreement) or in the event that the order approving the Settlement Agreement does not become a Final Order by July 31, 1999 (as defined in the Settlement Agreement), this License Agreement shall be terminable by P&G, at P&G's option. Termination in such circumstance shall not relieve Paragon of its obligation to pay royalties accrued hereunder for the period before termination. P&G agrees to provide Paragon with a three month conversion period after the date of termination. Royalties, as set forth above, shall be due on the Licensed Products manufactured and/or sold during the conversion period and such royalties shall be payable within 30 days of the end of the conversion period. 15. P&G agrees to give Paragon notice of all future running royalty based private label or brand manufacturer licenses granted under any of the P&G U.S. patents herein, and, upon written request, provide Paragon copies of all such subsequent running royalty based agreements within thirty (30) days of execution of any such agreements. Paragon shall be entitled, upon thirty (30) days written request to P&G, to have this License Agreement brought into conformity with any such subsequent running royalty based license to any private label or brand manufacturer other than Paragon in the event P&G grants any license under any of the P&G U.S. patents herein under terms more favorable than those set forth herein. 13 16. This Agreement and the Settlement Agreement set forth the entire understanding of the parties with respect to the subject matter herein set forth. There are no ancillary understandings or agreements with respect to the subject matter of this License Agreement. 17. This Agreement may be executed in counterparts. Each part shall constitute an original. 18. This Agreement shall become effective as of the date of acceptance by the last party to sign. FOR: PARAGON TRADE BRANDS, INC. FOR: THE PROCTER & GAMBLE COMPANY By /S/ B.V. ABRAHAM By /S/ MARK D. KETCHUM -------------------------------- -------------------------------- Title CHAIRMAN AND CEO Title PRESIDENT - GLOBAL BABY CARE ------------------------------ ------------------------------ Date FEBRUARY 2, 1999 Date FEBRUARY 2, 1999 ------------------------------ ------------------------------ EX-10.32 7 CANADIAN LICENSE AGREEMENT (ROBERTSON) CANADIAN LICENSE AGREEMENT This Agreement, effective as of the date of execution by both parties, is by and between THE PROCTER & GAMBLE COMPANY, an Ohio Corporation having a principal place of business at One Procter & Gamble Plaza, Cincinnati, Ohio 45202, (hereinafter referred to as "P&G") and PARAGON TRADE BRANDS, INC., a Delaware Corporation having a principal place of business at 180 Technology Parkway, Norcross, Georgia 30092, and its wholly-owned subsidiary, Paragon Trade Brands (Canada) Inc., a Canadian corporation having a principal place of business at 1600 Clark Boulevard, Brampton, Ontario, Canada L6T 3V7 (hereinafter collectively referred to as "Paragon"). P&G and Paragon will be jointly referred to as the "parties". WHEREAS, P&G is the owner of Canadian Patent Application 585,807, "Mechanical Fastening Means With Disposal Means For Disposable Absorbent Articles" filed on December 13, 1988 to Robertson et al. (the Canadian counterpart of U.S. Patent 4,963,140) relating to an absorbent article having a mechanical fastening system with disposal means; WHEREAS, P&G owns patents corresponding to Canadian Patent Application 585,807 in a number of other countries; WHEREAS, Paragon makes, uses, offers for sale and sells a Supreme line of disposable infant diapers having a mechanical fastening system with a nonwoven outer cover; 2 WHEREAS, P&G believes that the Supreme diapers made and sold by Paragon fall within the scope of one or more of the pending claims of Canadian Patent Application 585,807 to Robertson et al.; and WHEREAS, Paragon desires to obtain from P&G and P&G is willing to grant to Paragon a royalty bearing, non-exclusive right to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell in Canada certain integral disposable absorbent articles with a mechanical fastening system having a disposal means consisting of a nonwoven outer cover which are within the scope of one or more of any issued claims of any patent issuing from Canadian Patent Application 585,807 to Robertson et al.; NOW THEREFORE, in consideration of the promises, mutual covenants, and agreements contained herein, the parties agree as follows: DEFINITIONS "Licensed Product" as used herein, shall mean an integral disposable absorbent article comprising an infant diaper or an adult diaper having a mechanical fastening system consisting of (i) a closure member of a hook fastening member; (ii) a landing member of a loop fastening member; and (iii) disposal means consisting of a nonwoven outer cover having a limited degree of engageability with the hook fastening member of less than 750 grams as defined by the Test Method designated "Strength Of Attachment Of Mechanical Fastening Member To Diaper Backsheet" (attached hereto as Appendix 1) and falling within the scope of one or more of any valid and enforceable claims of any patent issuing from Canadian Patent Application 585,807 to Robertson et al. 3 including any continuations, continuation-in-part, divisionals, reissues, reexaminations, or extensions thereof. "Net Sales Price", as used herein, shall mean the revenue received by Paragon from the sale of Licensed Products to independent third parties in Canada less the following amounts: (i) discounts, including cash discounts, or rebates actually allowed or granted, (ii) credits or allowances actually granted upon claims or returns regardless of the party requesting the return, (iii) freight charges paid for delivery, (iv) revenue for defective articles sold exclusively as scrap, and (v) taxes or other governmental charges levied on or measured by the invoiced amount whether absorbed by the billing or the billed party. "Settlement Agreement", as used herein, shall mean the Settlement Agreement entered into between Paragon and P&G concurrently with this License Agreement. REPRESENTATIONS AND WARRANTIES With the exception of non-exclusive license rights granted to others, P&G represents and warrants that: 1) it is the owner of all right, title and interest in and to Canadian Patent Application 585,807 to Robertson et al. and 2) it has the right to enter this Agreement without breaching any other agreement or obligation to a third party. Paragon represents and warrants that it is an independent entity and that it has the right to enter into this Agreement without breaching any other agreement or obligation to a third party. LICENSE GRANT 4 1. Upon execution of this License Agreement by both parties, and in consideration of Paragon's agreement to pay prospective running royalties on Licensed Products in accordance with Paragraph (2) below, P&G agrees to grant and hereby does grant to Paragon, as of January 7, 1999, a non-exclusive license to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell in Canada, without the right to grant sublicenses, Licensed Products. 2. As consideration for the prospective license rights herein granted by P&G, Paragon agrees that it will, commencing upon the issuance of any patent issuing from Canadian Patent Application 585,807 to Robertson et al., begin to pay to P&G a running royalty in accordance with each applicable provision of the following schedule: (A) For a restricted, non-exclusive license in Canada under P&G's Canadian Patent Application 585,807 to Robertson et al. to make, to have made for Paragon with the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products which fall within the scope of one or more valid and enforceable claims of any patent issuing from Canadian Patent Application 585,807 to Robertson et al. having an engageability between the hook fastening member and the nonwoven outer cover, as defined by the Test Method attached hereto, of less than 500 grams - Three Eighths of One Percent (0.375%) of the Net Sales Price of Licensed Products; (B) For a restricted, non-exclusive license in Canada under P&G's Canadian Patent Application 585,807 to Robertson et al. to make, to have made for Paragon with 5 the prior written consent of P&G, to use, to offer for sale and to sell, without the right to grant sublicenses, Licensed Products which fall within the scope of one or more valid and enforceable claims of any patent issuing from Canadian Patent Application 585,807 to Robertson et al. having an engageability between the hook fastening member and the nonwoven outer cover, as defined by the Test Method attached hereto, of between 500 grams and 750 grams -- One Half of One Percent (0.5%) of the Net Sales Price of Licensed Products. Subject to Paragraph 6.5 of the Settlement Agreement, the parties agree that a non-limiting example of Licensed Products falling within subsection (A) is Paragon's Supreme product (a sample of which is attached hereto as Appendix 2). Paragon agrees to notify P&G in writing within ten (10) days if it changes any of its products in such a way that it no longer intends to make running royalty payments pursuant to subsections (A) or (B) hereof. 3. The license rights granted in Paragraph (1) under Canadian Patent Application 585,807 to Robertson et al. shall automatically expire on the date of expiration of any said patent issuing therefrom, including any continuations, continuations-in-part, divisionals, reexaminations, reissues or extensions thereof. Should any patent licensed hereunder be held to have lapsed for the failure to pay maintenance fees, royalties for said patent shall not be due for the period of any such lapse. However, should any such lapsed patent subsequently be considered as not having expired by the acceptance by the relevant Canadian Patent Authority of delayed payment of the maintenance fee, the license rights granted under said patent shall automatically revive and royalties shall again accrue 6 beginning on the date that the term of the patent has been maintained as a result of the acceptance by the relevant Canadian Patent Authority of a payment of the maintenance fee. P&G agrees to provide written notice to Paragon of the lapse of any such patent, and if applicable, the date that the patent has been maintained as a result of the acceptance by the relevant Canadian Patent Authority of a delayed payment of the maintenance fee. 4. Within thirty (30) days of June 28, 1999, Paragon shall provide P&G with an initial statement reporting Paragon's Net Sales Price of Licensed Products covered by this License Agreement for the period beginning on January 7, 1999 and ending on June 27, 1999 and be accompanied by the appropriate royalty payment. On an ongoing basis, the Paragon fiscal year ends on the last Sunday of December. Therefore, after making said initial report, Paragon shall, within 30 days after the end of each subsequent Paragon fiscal year, commencing on December 26, 1999, provide P&G with an annual statement reporting Paragon's Net Sales Price of Licensed Products covered by this License Agreement for the preceding one year period. The parties recognize that the report and payment for the 1999 fiscal year will cover only the six month period commencing on June 28, 1999 and ending on December 26, 1999 in light of the previous initial report and payment. Each report shall specify the Net Sales Price of Licensed Products attributable on an individual basis to each of the categories (A) and (B) set forth in Paragraph (2) of this License Agreement. Each such report is due within thirty (30) days of the close of the fiscal year for which the report is made, and shall be accompanied by the royalty payment owed to P&G by Paragon. Each such report shall be treated as confidential and proprietary information of Paragon and shall only be used for the purposes set forth herein. The report shall only be 7 shared within P&G with such persons at P&G who need to know such information for the purposes set forth herein. Each such report may be shared with P&G's outside counsel or auditors who need to know such information for the purpose of verifying such report. 5. Once each year, at P&G's election and expense, Paragon's independent public accountant shall certify to P&G that the annual report for the previous period or year is true, complete and that royalties have been paid for Licensed Products sold during the previous year. Paragon shall keep correct and complete records containing all information required for computation and verification of the amounts to be paid hereunder for a period of at least three (3) years after making each such report. Upon reasonable notice, during regular business hours, independent "Big Six" public accountants selected by P&G, and paid for by P&G in the event the Paragon payment being verified proves accurate to within two percent (2.00%), may make such examinations of Paragon's records, not more frequently than once a year, as P&G deems necessary to verify such reports and payments provided for hereunder. Such examination shall occur at such location as designated by Paragon, and such verification shall only state the amount of payments due in each of categories (A) or (B) of Paragraph (2) of this License Agreement. If the Paragon payment does not prove accurate to within two percent (2.00%), royalties being underpaid, then Paragon shall pay for such independent public accountants. 6. If Paragon shall be in default in making any payments hereunder at the times and in the manner herein provided or in complying with the financial obligations it assumed pursuant to the concurrently executed Settlement Agreement with P&G, P&G may give written notice to Paragon specifying the particulars of such default, and in the event Paragon does 8 not fully remedy such default within thirty (30) days after such notice, P&G may at its option, terminate this License Agreement by giving ten (10) days prior written notice to Paragon to that effect. In addition, P&G may proceed to enforce the defaulted obligation of Paragon by any legally available means. No waiver on the part of P&G in respect to a default by Paragon shall be construed as a waiver of P&G's right to proceed under this Paragraph with respect to subsequent defaults. 7. Neither expiration of this License Agreement in accordance with its provisions nor termination of this License Agreement shall relieve Paragon of its obligations for payment of unpaid royalties under Paragraph (2) or for enforcement of any other obligation or liability accrued hereunder prior to the effective date of such expiration or termination. 8. The failure of either party to strictly enforce this License Agreement, or to insist upon the strict compliance with its terms shall not at any time be considered a waiver or condonation by such party of the default or failure by the other party to strictly perform the covenants, conditions and agreements on its part to be performed. 9. Paragon agrees, when its existing supply of packaging after the issuance of any patent from Canadian Patent Application 585,807 to Robertson et al. has been exhausted, to mark the packages of its Licensed Products to be sold within Canada with the following statement: "Licensed under one or more of the following Canadian Patents (with appropriate patent numbers filled in per Paragraph (2))", and if a reexamination certificate or a reissue of any such patent occurs, to place on its packages appropriate statements relating to that reexamination certificate and/or that reissue patent. There shall be no 9 reference to "The Procter & Gamble Company", "Procter & Gamble", "P&G", any variation or affiliate thereof, or any trademark or tradename owned or controlled by P&G on the packaging. 10. No patent rights outside Canada are granted by P&G in this License Agreement. However, P&G agrees that it will, upon request by Paragon, negotiate in good faith in an attempt to establish mutually acceptable terms and conditions for Paragon to obtain non-exclusive royalty bearing license rights under P&G's foreign patents corresponding to the Canadian Patent Application licensed herein on a case by case basis. The parties recognize that the terms and conditions, including the royalty rates, for said foreign license rights may not be the same as those herein set forth nor the same with respect to one another. 11. P&G hereby waives any and all rights to sue (including, but not limited to, actions to enjoin and/or recover damages from) Paragon for making, having made for Paragon with the prior written consent of P&G, using, offering for sale, and/or selling Licensed Products in Canada, provided: (1) this License Agreement has not been terminated by either party; (2) Paragon is in full compliance with all material terms of the concurrently executed Settlement Agreement with P&G and is current in meeting its obligation to pay the running royalties provided in Paragraph (2) hereof; and (3) Paragon is otherwise in full compliance with the material terms of this License Agreement. 12. Notices relating to this Agreement shall be in writing and shall be considered served when deposited as certified or registered U.S. mail, return receipt requested, in a sealed envelope with sufficient postage affixed, addressed as follows: 10 P&G: Attention: Vice President & General Counsel - Patents The Procter & Gamble Company Winton Hill Technical Center 6090 Center Hill Avenue Cincinnati, Ohio 45224 Paragon: Attention: Vice President & General Counsel Paragon Trade Brands, Inc. 180 Technology Parkway Norcross, GA 30092 13. The parties agree that this License shall be personal to Paragon and shall be nontransferable and nonassignable to third parties without the prior written consent of P&G, which consent P&G agrees not to unreasonably withhold or unreasonably delay. In this context, the parties agree that it is not an unreasonable ground for P&G to withhold or delay its consent if the effect of the proposed transfer or assignment would be to allow a transferee or assignee to obtain the prospective right to make, import, use, offer for sale and/or sell Licensed Products in Canada without entering into a mutually agreeable settlement agreement for any past infringing activity by the transferee or assignee with respect to the patents included in the definition of "Licensed Products". In addition, the parties agree that this License shall not apply to the manufacture, import, use or sale of Licensed Products by any other business entity acquired by Paragon, by which Paragon is acquired, merged with Paragon, consolidated with Paragon, partnered with Paragon, or in any other business arrangement with Paragon after the effective date of this Agreement without the prior written consent of P&G, which consent P&G agrees not to unreasonably withhold or unreasonably delay. In this context, the parties agree that it is not an unreasonable ground for P&G to withhold or delay its consent if the effect of the proposed transaction would be to allow an acquiring, merging or consolidating entity or 11 partner to obtain the prospective right to make, import, use, offer for sale and/or sell Licensed Products in Canada without entering into a mutually agreeable settlement agreement with P&G for any past infringing activity by the acquiring, merging or consolidating entity or partner with respect to the patents included in the definition of "Licensed Products". 14. In the event the Settlement Agreement executed concurrently herewith is not approved by the Bankruptcy Court (as defined in the Settlement Agreement) or in the event that the order approving the Settlement Agreement does not become a Final Order by July 31, 1999 (as defined in the Settlement Agreement), this License Agreement shall be terminable by P&G, at P&G's option. Termination in such circumstance shall not relieve Paragon of its obligation to pay royalties accrued hereunder for the period before termination. P&G agrees to provide Paragon with a three month conversion period after the date of termination. Royalties, as set forth above, shall be due on the Licensed Products manufactured and/or sold during the conversion period and such royalties shall be payable within 30 days of the end of the conversion period. 15. P&G agrees to give Paragon notice of all future running royalty based private label or brand manufacturer licenses granted under the P&G Canadian Patent Application herein, and, upon written request, provide Paragon copies of all such subsequent running royalty based agreements within thirty (30) days of execution of any such agreements. Paragon shall be entitled, upon thirty (30) days written request to P&G, to have this License Agreement brought into conformity with any such subsequent running royalty based license to any private label or brand manufacturer other than Paragon in the event P&G 12 grants any license under any of the P&G Canadian Patent Applications herein under terms more favorable than those set forth herein. 16. This Agreement and the Settlement Agreement set forth the entire understanding of the parties with respect to the subject matter herein set forth. There are no ancillary understandings or agreements with respect to the subject matter of this License Agreement. 17. This Agreement may be executed in counterparts. Each part shall constitute an original. 18. This Agreement shall become effective as of the date of acceptance by the last party to sign. FOR: PARAGON TRADE BRANDS, INC. FOR: THE PROCTER & GAMBLE COMPANY By /S/ B.V. ABRAHAM By /S/ MARK D. KETCHUM -------------------------------- -------------------------------- Title CHAIRMAN AND CEO Title PRESIDENT - GLOBAL BABY CARE ------------------------------ ------------------------------ Date FEBRUARY 2, 1999 Date FEBRUARY 2, 1999 ------------------------------ ------------------------------ FOR: PARAGON TRADE BRANDS (CANADA), INC. By /S/ CHRIS OLIVER -------------------------------- Title PRESIDENT ------------------------------ Date FEBRUARY 2, 1999 ------------------------------ EX-10.33 8 SETTLEMENT AGREEMENT DATED AS OF MARCH 19, 1999 SETTLEMENT AGREEMENT This Settlement Agreement is made and entered into as of March 19, 1999, between Paragon Trade Brands, Inc., a Delaware corporation, debtor and debtor in possession ("Paragon") and Kimberly-Clark Corporation, a Delaware corporation ("K-C"). W I T N E S S E T H: WHEREAS, Paragon and K-C are parties to an action entitled KIMBERLY-CLARK CORPORATION V. PARAGON TRADE BRANDS, INC., Case No. 3:95-cv-2574 (N.D. Tex.) filed by K-C on or about October 25, 1995, in the United States District Court for the Northern District of Texas (the "Action"); WHEREAS, Paragon has denied liability in the Action and asserted counterclaims therein; WHEREAS, on January 6, 1998, Paragon filed a voluntary petition for relief under chapter 11 of title 11 of the United States Code with the United States Bankruptcy Court for the Northern District of Georgia, Atlanta Division, which chapter 11 case currently is pending; WHEREAS, on or about June 5, 1998, K-C filed a proof of claim in Paragon's chapter 11 case asserting, among other things, unsecured prepetition claims in excess of approximately $890 million (without trebling) against Paragon in respect of Paragon's alleged infringement of certain K-C patents (as further defined in Section 1.31 hereof, the "K-C Proof of Claim"); WHEREAS, on or about June 5, 1998, K-C filed the Withdrawal Motion (as defined below) seeking withdrawal of the reference to the United States Bankruptcy Court for the Northern District of Georgia, Atlanta Division, with respect to all matters relating to the K-C Proof of Claim; WHEREAS, Paragon and K-C have agreed to effectuate a settlement of all claims, counterclaims and disputes asserted or assertable by and against the other, including, but not limited to, the Action and the K-C Proof of Claim, in accordance with the terms and conditions set forth herein; and WHEREAS, this Settlement Agreement is essential to Paragon's efforts to emerge successfully from its chapter 11 case; NOW, THEREFORE, for good and valuable consideration, and in order to settle all claims and disputes between Paragon and K-C, and to facilitate Paragon's expeditious and effective reorganization, the parties hereto agree as follows: 1. DEFINITIONS. In addition to such other terms as are defined in other sections of this Settlement Agreement, the following terms (which appear in the Settlement Agreement as capitalized terms) have the following meanings as used in the Settlement Agreement: 1.1. "Action" shall have the meaning ascribed to such term in the first "WHEREAS" clause of this Settlement Agreement. 1.2. "Administrative Expense Claim" means a Claim for costs and expenses of administration which is entitled to administrative expense priority under sections 503(b) and 507(a)(1) of the Bankruptcy Code. 1.3. "Affiliate" means any Person that is (a) an affiliate as such term is defined in section 101(2) of the Bankruptcy Code, (b) an existing or future direct or indirect subsidiary or parent corporation of Paragon or K-C (as the case may be), or (c) an existing or future joint venture or general or limited partnership governed by any applicable law in which (i) Paragon or K-C (as the case may be) or any existing or future direct or indirect subsidiary or parent corporation of Paragon or K-C (as the case may be) is a joint venturer or general or limited partner or (ii) a joint venture or general or limited partnership governed by any applicable law in which Paragon or K-C (as the case may be) is a joint venturer or general or limited partner, as the case may be. The defined term "Affiliate" also includes all successors and assigns of each of the foregoing. 1.4. "Allowed Claim" means a Claim which is finally allowed in the Chapter 11 Case and is not subject to further allowance or disallowance by the Bankruptcy Court or an objection being filed by any party in interest. 1.5. "Ancillary Agreements" means the K-C License Agreement annexed hereto as Exhibit A, the Paragon License Agreement annexed hereto as Exhibit B, the Paragon Release annexed hereto as Exhibit C, and the K-C Release annexed hereto as Exhibit D. 1.6. "Appeal" means that certain appeal taken by K-C from the April 10th Order. 1.7. "April 10th Order" means (a) that certain order of the Bankruptcy Court, dated April 10, 1998, and entered on the Bankruptcy Court's docket on April 10, 1998, as evidenced by docket number 619, together with (b) that certain order of the Bankruptcy Court, dated June 17, 1998, and entered on the Bankruptcy Court's docket on June 18, 1998, as evidenced by docket number 841, denying K-C's motion for reconsideration of the order referenced in clause (a) of this definition. -2- 1.8. "Bankruptcy Code" means the Bankruptcy Reform Act of 1978, 11 U.S.C. ss.ss. 101, ET seq., as the same was in effect on the Petition Date, as amended by any amendments applicable to the Chapter 11 Case. 1.9. "Bankruptcy Court" means the United States Bankruptcy Court for the Northern District of Georgia, Atlanta Division, or, to the extent that such court ceases to exercise jurisdiction over the Chapter 11 Case, such other court or adjunct thereof that exercises jurisdiction over the Chapter 11 Case. 1.10. "Bankruptcy Court Approval Order" means an order (which, if not previously entered as a separate order despite Paragon's reasonable good faith efforts, may be a Confirmation Order) of the Bankruptcy Court, in form and substance acceptable to Paragon and K-C, approving this Settlement Agreement, the Paragon Release and the K-C Release; PROVIDED, that if the Bankruptcy Court Approval Order also is a Confirmation Order, (i) only those provisions relating to approval of this Settlement Agreement must be in form and substance acceptable to K-C, and (ii) K-C shall have the right to object to the other provisions of any such Confirmation Order. 1.11. "Bankruptcy Rules" means the Federal Rules of Bankruptcy Procedure, effective August 1, 1991, in accordance with the provisions of 28 U.S.C. ss. 2075, as now in effect or hereafter amended. 1.12. "Business Day" means any day, other than a Saturday, Sunday or "legal holiday" (as such term is defined in Bankruptcy Rule 9006(a)). 1.13. "Chapter 11 Case" means Paragon's case pending in the Bankruptcy Court pursuant to chapter 11 of the Bankruptcy Code and administered under case number 98 - 60390 (Murphy, J.). 1.14. "Claim" means a claim as such term is defined in section 101(5) of the Bankruptcy Code. 1.15. "Confirmation Date" means the date on which the Bankruptcy Court enters an order confirming, pursuant to section 1129 of the Bankruptcy Code, a Plan for Paragon. 1.16. "Confirmation Order" means an order of the Bankruptcy Court confirming a Plan pursuant to section 1129 of the Bankruptcy Code. 1.17. "Creditors' Committee" means the Official Committee of Unsecured Creditors in the Chapter 11 Case, as appointed by the Office of the United States Trustee for the -3- Northern District of Georgia, Atlanta Division, as reconstituted from time to time. 1.18. "Debtor" means Paragon. 1.19. "Effective Date" means the first Business Day that the Plan becomes effective in accordance with its terms. 1.20. "Estate" means the estate created in the Chapter 11 Case for Paragon by section 541 of the Bankruptcy Code. 1.21. "Federal Circuit Court" means the United States Court of Appeals for the Federal Circuit, or, to the extent that such court ceases to exercise jurisdiction over the P&G Appeal, such other court or adjunct thereof that exercises jurisdiction over the P&G Appeal. 1.22. "Final Order" means an order or judgment which has not been reversed, stayed, modified or amended and as to which the time to appeal or seek review, rehearing, reargument or certiorari has expired and as to which no appeal or petition for review, rehearing, reargument, stay or certiorari is pending, or as to which any right to appeal or to seek certiorari, review, or rehearing has been waived, or, if an appeal, reargument, petition for review, certiorari or rehearing has been sought, the order or judgment which has been affirmed by the highest court to which the order was appealed or from which the reargument, review or rehearing was sought, or certiorari has been denied, and as to which the time to take any further appeal or seek further reargument, review or rehearing has expired. 1.23. "Georgia District Court" means the United States District Court for the Northern District of Georgia, Atlanta Division, or, to the extent that such court ceases to exercise jurisdiction over the Appeal or the Withdrawal Motion, such other court or adjunct thereof that exercises jurisdiction over the Appeal or Withdrawal Motion, as applicable. 1.24. "Impaired" means impaired within the meaning of section 1124 of the Bankruptcy Code. 1.25. "K-C Allowed Administrative Claim" shall have the meaning set forth in Section 2.1 hereof. 1.26. "K-C Allowed Claims" means, collectively, the K-C Conditionally Allowed Claim, the K-C Fixed Allowed General Unsecured Claim and the K-C Allowed Administrative Claim. -4- 1.27. "K-C Conditionally Allowed Claim" shall have the meaning set forth in Section 2.1 hereof. 1.28. "K-C Fixed Allowed General Unsecured Claim" shall have the meaning set forth in Section 2.1 hereof. 1.29. "K-C License Agreement" means the license agreement annexed hereto as Exhibit A. 1.30. "K-C Licensed Patents" means the patents identified in Exhibit E hereto. 1.31. "K-C Proof of Claim" shall have the meaning ascribed to such term in the fourth "WHEREAS" clause of this Settlement Agreement, which proof of claim has been assigned claim number 469 in the Chapter 11 Case. As used herein, K-C Proof of Claim also shall include the proof of claim number 110 filed by K-C in the Chapter 11 Case on or about January 21, 1998. 1.32. "K-C Release" means the general release annexed hereto as Exhibit D. 1.33. "License Agreements" means the Paragon License Agreement and the K-C License Agreement. 1.34. "Paragon License Agreement" means the license agreement annexed hereto as Exhibit B. 1.35. "Paragon Patents" means the patents identified in Exhibit F hereto. 1.36. "Paragon Release" means the general release annexed hereto as Exhibit C. 1.37. "Parties" means Paragon and K-C and their respective successors and assigns, collectively. 1.38. "Person" means any individual, corporation, partnership, association, indenture trustee, organization, joint stock company, joint venture, estate, trust, governmental unit or any political subdivision thereof, the Creditors' Committee, holders of equity interests in and/or claims against Paragon or any other entity. 1.39. "Petition Date" means January 6, 1998. 1.40. "Plan" means a plan of reorganization for Paragon confirmed by the Bankruptcy Court pursuant to section 1129 of the Bankruptcy Code in the Chapter 11 Case, as the same may be amended or modified, relying upon and/or incorporating and, INTER ALIA, implementing the terms of this Settlement Agreement. -5- 1.41. "P&G" means The Procter & Gamble Company, an Ohio corporation. 1.42. "P&G Appeal" means that certain appeal taken by Paragon from the P&G Judgment and Rule 59 Denial, which appeal is evidenced by Paragon's Notice of Appeal, filed July 2, 1998, and Paragon's Amendment to Notice of Appeal, filed August 4, 1998, which appeal is docketed in the Federal Circuit Court as No. 98-1480. 1.43. "P&G Judgment" means, collectively, that certain (a) Opinion and Judgment, issued on December 30, 1997, and entered on the docket for the United States District Court for the District of Delaware on January 6, 1998, in favor of P&G and against Paragon; (b) Money Judgment entered on June 2, 1998; and (c) Permanent Injunction entered on June 2, 1998. 1.44. "P&G Judgment Amount" means one hundred seventy-eight million four hundred twenty-nine thousand five hundred thirty-six dollars ($178,429,536.00), plus accrued interest thereon, from the date of entry of the Money Judgment described in the preceding paragraph until the date that the Litigated Reduction or Consensual Reduction (as defined in Section 2.1(c) hereof) is approved by a Final Order, at the rate applicable to such Money Judgment. 1.45. "Rule 59 Denial" means that certain Opinion and Order, both entered August 4, 1998, denying Paragon's motion for relief from the P&G Judgment pursuant to Federal Rule of Civil Procedure 59. 1.46. "Settlement Effective Date" means the first Business Day after the Bankruptcy Court Approval Order is entered and is not subject to any stay. 1.47. "Texas District Court" means the United States District Court for the District of Texas, or, to the extent that such court ceases to exercise jurisdiction over the Action, such other court or adjunct thereof that exercises jurisdiction over the Action. 1.48. "Unimpaired" means not impaired within the meaning of section 1124 of the Bankruptcy Code. 1.49. "Withdrawal Motion" means that certain motion dated June 5, 1998, filed by K-C in the Georgia District Court, seeking withdrawal of the reference to the Bankruptcy Court with respect to all matters relating to the K-C Proof of Claim. 2. ALLOWED AMOUNT AND TREATMENT OF K-C CLAIMS. -6- 2.1. ALLOWED AMOUNT OF CLAIMS. K-C shall be granted three Allowed Claims in the Chapter 11 Case (and the K-C Proof of Claim shall be deemed amended accordingly): (a) an Allowed Administrative Expense Claim (the "K-C Allowed Administrative Claim") in an amount equal to the sum of five million dollars and zero cents ($5,000,000.00); (b) an Allowed Claim (the "K-C Fixed Allowed General Unsecured Claim") in an amount equal to the sum of (i) one hundred ten million dollars and zero cents ($110,000,000.00) plus (ii) interest on the principal amount of $110,000,000.00 from April 15, 1999 and through and including the Effective Date of the Plan; and (c) an Allowed Claim (the "K-C Conditionally Allowed Claim") in an amount equal to (i) forty percent (40%) of the amount by which the P&G Judgment Amount is reduced (the "Litigated Reduction") by a Final Order as a result of Paragon's prosecution (if Paragon so elects, in its sole and absolute discretion, to continue such prosecution) of the P&G Appeal, minus (ii) twenty million dollars and zero cents ($20,000,000.00). In the event that Paragon and P&G consensually resolve the P&G Appeal after a decision on the merits of the P&G Appeal by the Federal Circuit Court, the K-C Conditionally Allowed Claim shall equal (i) forty percent (40%) of the amount by which the agreed payment to P&G on account of the claims which are the subject of the P&G Judgment is less than the P&G Judgment Amount (the "Consensual Reduction"), minus (ii) twenty million dollars and zero cents ($20,000,000.00). In the event that Paragon and P&G consensually resolve the P&G Appeal prior to the issuance of any decision on the merits by the Federal Circuit Court, K-C shall not be entitled to receive the K-C Conditionally Allowed Claim and such Claim shall be deemed not to exist. For purposes of the preceding clause 2.1(b)(ii), to the extent the payment of same is permitted under applicable law, or either P&G or other holders of allowed prepetition, general unsecured claims receive payment of postpetition interest, interest shall accrue at six percent (6%) on a per annum 365 day year basis (the "Postpetition Interest Rate"). -7- 2.2. TREATMENT OF THE K-C ALLOWED ADMINISTRATIVE CLAIM. The K-C Allowed Administrative Claim shall be afforded treatment under the Plan as an Administrative Expense Claim in accordance with section 1129(a)(9)(A) of the Bankruptcy Code. 2.3. CLASSIFICATION AND TREATMENT OF THE K-C FIXED ALLOWED GENERAL UNSECURED CLAIM. Paragon shall classify and treat the K-C Fixed Allowed General Unsecured Claim as a prepetition, general unsecured claim in any Plan proposed by Paragon, and shall classify such claim in the same class as all other holders of prepetition, general unsecured Allowed Claims against Paragon in any such Plan; PROVIDED, HOWEVER, that Paragon may include a usual and customary "convenience," "small claims" or other similar class of prepetition, general unsecured Allowed Claims that does not include the K-C Fixed Allowed General Unsecured Claim in its Plan if Paragon determines it is necessary or appropriate. 2.4. CLASSIFICATION AND TREATMENT OF THE K-C CONDITIONALLY ALLOWED CLAIM. Paragon shall classify and treat the K-C Conditionally Allowed Claim, to the extent that the Litigated Reduction or the Consensual Reduction occurs, in the same manner under its Plan as the K-C Fixed Allowed General Unsecured Claim. In the event that the Confirmation Date of a Plan proposed by Paragon is before the date on which the K-C Conditionally Allowed Claim is determined, Paragon shall establish under such Plan an adequate reserve, as agreed to by the Parties and/or determined by the Bankruptcy Court, to provide for the treatment of the K-C Conditionally Allowed Claim provided for herein as and when the amount, if any, of such Allowed Claim is determined. The principal amount due to K-C with respect to the K-C Conditionally Allowed Claim shall, to the extent the payment of same is permitted under applicable law, or either P&G or other holders of allowed prepetition, general unsecured claims receive payment of postpetition interest, bear interest at the Postpetition Interest Rate from the date on which the Litigated Reduction or Consensual Reduction, as applicable, is approved by a Final Order or, in the event Bankruptcy Court approval is not required, otherwise becomes binding upon Paragon and K-C (the "Interest Commencement Date") until and through (a) the Effective Date, if the Interest Commencement Date occurs prior to the Effective Date, or (b) the date upon which Paragon effects its distribution to K-C on account of the K-C Conditionally Allowed Claim under the Plan, if the Interest Commencement Date occurs after the Effective Date. 2.5. CONVERSION OF CHAPTER 11 CASE. Notwithstanding anything to the contrary contained herein, in the event the Chapter 11 Case is converted to a case under chapter 7 of the Bankruptcy Code, each K-C Allowed -8- Claim shall (a) have all the rights of any other claim of equal priority against Paragon that shall have become an Allowed Claim prior to the date of such conversion, and (b) be treated as an Allowed Claim in any such chapter 7 case. 2.6. DISMISSAL OF CHAPTER 11 CASE. Notwithstanding anything to the contrary contained herein, in the event that the Chapter 11 Case is dismissed, the K-C Allowed Claims shall be deemed obligations of Paragon following dismissal of the Chapter 11 Case, and (a) in the case of the K-C Allowed Administrative Claim and the K-C Fixed Allowed General Unsecured Claim, such claims shall become due and payable on the date the Chapter 11 Case is dismissed, and (b) in the case of the K-C Conditionally Allowed Claim, such claim shall become due and payable on the first date that is on or after the date that both (i) the Chapter 11 Case is dismissed and (ii) the Litigated Reduction or the Consensual Reduction shall have been approved by a Final Order. 3. DISMISSAL OF THE ACTION, THE APPEAL AND THE WITHDRAWAL MOTION. 3.1. By Order of the Georgia District Court dated February 18, 1999, the Appeal, Paragon's motion to dismiss the Appeal, and the Withdrawal Motion were dismissed without costs and without prejudice to the right, of either Party within sixty (60) days, to re-open such proceedings if settlement of such proceedings is not consummated. If the Bankruptcy Court denies approval of this Settlement Agreement, the Parties shall cooperate with one another to take such steps as are necessary and appropriate to ensure that these proceedings are re-opened. 3.2. Within five (5) Business Days after the Settlement Effective Date: (a) K-C shall dismiss with prejudice (i) the Action, (ii) the Appeal and (iii) the Withdrawal Motion; and (b) Paragon shall dismiss with prejudice its counterclaims in the Action. From and after the Settlement Effective Date, Paragon shall not contest any Valid Claim (as defined in the K-C License Agreement) held or asserted by K-C. 4. LICENSES. 4.1. Contemporaneously with the execution of this Settlement Agreement, K-C shall execute and deliver to Paragon the K-C License Agreement. 4.2. In consideration for the payments to K-C set forth in this Settlement Agreement, and subject to the truth of the representation and warranties of Paragon described on Exhibit G hereto, K-C, on behalf of itself and Kimberly-Clark Worldwide, Inc. (who K-C represents and warrants are -9- the only holders of patents issued as of March 1, 1999, including any reissues and reexaminations thereof, in the United States or Canada, including any territories thereof, as to which K-C or any of its current Affiliates has any right to assert or prosecute against an alleged infringer), covenants not to sue Paragon or its wholly-owned Canadian subsidiary for infringement of any of its current patents which have been issued as of March 1, 1999, including any reissues and reexaminations thereof, in the United States or Canada (collectively, including any territories of any of the foregoing, the "Approved Countries") with respect to the specific products attached hereto as Exhibits H-1 through H-12, including dual cuff versions of any of Exhibits H-1 through H-9 where the only product change is the replacement of the single leg cuff feature on such products with the dual leg cuff feature found on Exhibits H-10 through H-12 (the "Approved Products"). Notwithstanding the foregoing and subject to the K-C Release, (X) K-C covenants not to sue Paragon or its wholly-owned Canadian subsidiary for infringement of U.S. patent number 5,879,341 issued on March 9, 1999 in the name of Odorzynski, with respect to products of Paragon that are made, used or sold on or before June 7, 1999 (provided that such covenant not to sue shall not apply to products of Paragon that are made, used or sold after June 7, 1999, other than products made on or prior to June 7, 1999 but sold thereafter), and (Y) K-C shall be entitled to assert or prosecute against Paragon and/or its Affiliates: (a) claims under (i) U.S. patent number B1 5,147,343 issued on March 17, 1998 to Kellenberger, (ii) U.S. patent number 5,601,542 issued on February 11, 1997 to Melius, and (iii) U.S. patent number 5,843,056 issued on December 1, 1998 to Good, to the extent that Paragon's products do not remain within the respective "safe harbors" described in Exhibit I hereto; and (b) claims related to patents owned by K-C or as to which K-C has any right to assert or prosecute against an alleged infringer with respect to (i) products other than the Approved Products, (ii) process/method patents claims, (iii) patents issued under the laws of countries other than the Approved Countries, or (iv) U.S. patent number 5,176,671 issued on January 5, 1993 in the name of Roessler et al., with respect to products of Paragon (including the Approved Products attached hereto as Exhibits H-1, H-5 and H-11) that are made, used or sold on and after the date that is two years after the date of execution of this Settlement Agreement; and nothing in the covenant not to sue contained in this Section 4.2, which was issued in exchange for good and valuable consideration, shall be admissible against K-C in connection with any patent claim which it has preserved the right to bring under this Section. 4.3. Subject to the occurrence of the Settlement Effective Date, Paragon agrees that in any future dispute regarding a Valid Claim (as such term is defined in the K-C License Agreement), Paragon shall not contest the validity of the K-C -10- Licensed Patents and the validity of such patents shall be presumed. Subject to the occurrence of the Settlement Effective Date, the entry of the Bankruptcy Court Approval Order shall be deemed to be a judgment binding upon Paragon and K-C as to the provisions of this Settlement Agreement, including this Section 4.3. 4.4. Contemporaneously with the execution of this Settlement Agreement, Paragon shall execute and deliver to K-C the Paragon License Agreement. 4.5. On or before the date hereof, Paragon shall have changed the superabsorbent material in its products to fit within the Kellenberger/Melius "safe harbor" described in Exhibit I hereto. 5. RELEASES. 5.1. Contemporaneously with the execution of this Settlement Agreement, Paragon shall execute and hold in escrow the Paragon Release. Paragon shall release and deliver to K-C the Paragon Release within five (5) Business Days after the Settlement Effective Date. 5.2. Contemporaneously with the execution of this Settlement Agreement, K-C shall execute and hold in escrow the K-C Release. K-C shall release and deliver to Paragon the K-C Release within five (5) Business Days after the Settlement Effective Date. 6. REPRESENTATIONS OF THE PARTIES. 6.1. K-C represents and warrants that (a) it has not filed any proofs of claim in the Chapter 11 Case other than the K-C Proof of Claim, and (b) it has not acquired or transferred or entered into any agreement to acquire or transfer any proofs of claim, including the K-C Proof of Claim, filed against Paragon in the Chapter 11 Case. K-C represents, warrants and covenants that it (a) has not and will not amend, modify or supplement, or seek to amend, modify or supplement the K-C Proof of Claim and, (b) shall not acquire any claims asserted against Paragon by any Person in the Chapter 11 Case without Paragon's prior written consent. 6.2. Paragon represents and warrants that the statements contained in Exhibit G hereto are true and correct. 7. RESTRICTIONS ON TRANSFER OF K-C ALLOWED CLAIMS. Unless Paragon, in its sole and absolute discretion, otherwise agrees in writing, K-C shall not sell or otherwise transfer all or any portion of the K-C Allowed Claims for a period of ninety -11- (90) days following the date of execution of this Settlement Agreement. Following such ninety (90) day period, K-C shall not sell or otherwise transfer all or any portion of the K-C Allowed Claims to any Person or Persons unless such Person or Persons (i) agree(s) to be bound to the terms and conditions of this Settlement Agreement, and (ii) sign(s) an agreement that specifically provides that Paragon is an intended third party beneficiary of such Person(s)' agreement to be so bound to, and subject to the enforcement of, the terms and conditions of this Settlement Agreement. Notwithstanding any assignment or transfer by K-C of all or any portion of the K-C Allowed Claims in accordance with the terms hereof, K-C shall continue to remain bound by each of the provisions of this Settlement Agreement, including, but not limited to, K-C's obligations to execute, deliver and perform its obligations under each of the Ancillary Agreements. In the event that K-C sells or otherwise transfers all or any portion of the K-C Proof of Claim or the K-C Allowed Claims, and notwithstanding any provisions contained herein or in the K-C License Agreement to the contrary, the K-C License Agreement, if not previously terminated pursuant to its terms, shall remain in full force and effect notwithstanding (a) the lack, if any, of entry of the Bankruptcy Court Approval Order on or before July 31, 1999, or (b) the reversal or modification of such order on appeal. 8. EXCLUSIVITY AND PLAN CONFIRMATION. 8.1. If Paragon complies with its obligations under this Settlement Agreement, K-C shall not oppose any requests by Paragon for extensions of its exclusive periods to file a plan of reorganization and to solicit acceptances thereto (collectively, the "Exclusive Periods") under section 1121 of the Bankruptcy Code through and including May 31, 1999 and July 31, 1999, respectively, as long as it appears reasonably probable that the Effective Date can occur on or before July 31, 1999. 8.2. Notwithstanding the provisions of section 8.1 hereof, K-C shall have the right to object to (a) any motion filed by Paragon seeking an extension of the Exclusive Periods if Paragon is not diligently pursuing final approval of this Settlement Agreement (including its obligations under Section 19 below), or (b) confirmation of any Plan proposed in the Chapter 11 Case. 9. AMENDMENT. This Settlement Agreement may not be amended except by an instrument in writing signed by both Parties hereto after prior written notice to counsel to the Creditors' Committee and, if such amendment constitutes a material modification of this Settlement Agreement, approval of the Bankruptcy Court if the Effective Date has not yet occurred. 10. NOTICES. Any notices or other communications hereunder or in connection herewith shall be in writing and shall -12- be deemed to have been duly given when delivered in person, by facsimile transmission or by registered or certified mail (postage prepaid, return receipt requested) addressed, as follows: If to Paragon, to: Paragon Trade Brands, Inc. 180 Technology Parkway Norcross, Georgia 30092 Telephone: 678-969-5000 Facsimile: 678-969-4959 Attention: Chairman of the Board Attention: General Counsel with a copy to: Willkie Farr & Gallagher 787 Seventh Avenue New York, New York 10019-6099 Telephone: 212-728-8000 Facsimile: 212-728-8111 Attention: Myron Trepper, Esq. Cravath Swaine & Moore Worldwide Plaza 825 Eighth Avenue New York, New York 10019 Telephone: 212-474-1000 Facsimile: 212-474-3700 Attention: Richard W. Clary, Esq. Alston & Bird LLP One Atlantic Center 1201 West Peachtree Street Atlanta, Georgia 30309 Telephone: 404-881-7000 Facsimile: 404-881-7777 Attention: Neal Batson, Esq. O'Melveny & Myers LLP Citicorp Center 153 East 53rd Street New York, New York 10022 Telephone: (212) 326-2000 Facsimile: (212) 326-2061 Attention: Joel B. Zweibel, Esq. If to K-C, to: Kimberly-Clark Corporation P.O. Box 619100 Dallas, Texas 75261-9100 -13- Telephone: (972) 281-1215 Facsimile: (972) 281-1492 Attention: General Counsel with a copy to: Sidley & Austin One First National Plaza Chicago, Illinois 60603 Telephone: (312) 853-7000 Facsimile: (312) 853-7036 Attention: Shalom L. Kohn, Esq. O'Melveny & Myers LLP Citicorp Center 153 East 53rd Street New York, New York 10022 Telephone: (212) 326-2000 Facsimile: (212) 326-2061 Attention: Joel B. Zweibel, Esq. or such other address as shall be furnished in writing pursuant to these notice provisions by any Party. A notice of change of address shall not be deemed to have been given until received by the addressee. 11. EFFECT ON LITIGATION. Neither this Settlement Agreement, the Ancillary Agreements, nor any of the terms hereof or thereof, nor any negotiations, documents, pleadings, proceedings or public reports in respect of any of the foregoing, shall constitute or be construed as or be deemed to be evidence of an admission on the part of either Paragon or K-C of any liability or wrong doing whatsoever, or of the truth or untruth of any of the claims made by either Paragon or K-C in their disputes or of the merit or lack of merit of any of the defenses thereto; nor shall this Settlement Agreement (including the Ancillary Agreements), or any of the terms hereof, or any negotiations, documents, pleadings, proceedings or public reports in respect of any of the foregoing, be offered or received in evidence or used or referred to in any such proceeding against either Paragon or K-C or used or referred to in any such proceeding for any purpose whatsoever except with respect to (i) effectuation and enforcement of this Settlement Agreement or the Ancillary Agreements and the discontinuance of the Action, the Appeal or the Withdrawal Motion, or (ii) with respect to proceedings in the Chapter 11 Case to authorize and approve this Settlement Agreement and the execution and delivery hereof, and to confirm the Plan. 12. EQUITABLE REMEDIES. The Parties hereto agree that irreparable damage would occur in the event that any of the provisions of this Settlement Agreement were not performed in accordance with its specific terms or otherwise were breached. It accordingly is agreed that the Parties shall be entitled to -14- specific enforcement of the terms and provisions hereof and to injunctive and other equitable relief in the Bankruptcy Court or any other court of the United States or any state thereof having jurisdiction in addition to any other remedy to which they are entitled to at law or in equity. To the extent such injunctive or other equitable relief requires the posting of a bond or other similar requirement, each Party expressly waives the satisfaction of such requirement by the other Party. 13. HEADINGS. The descriptive headings of the several sections of this Settlement Agreement are inserted for convenience of reference only and do not constitute a part of this Settlement Agreement, nor in any way affect the interpretation of any provisions hereof. 14. APPLICABLE LAW. This Settlement Agreement shall be governed in all respects, including validity, interpretation and effect, by the Bankruptcy Code and the laws of the State of New York, without giving effect to the principles of conflicts of law thereof. 15. COUNTERPARTS. This Settlement Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 16. ENTIRE SETTLEMENT. This Settlement Agreement (including the other documents referred to herein) (a) constitutes the entire settlement, and supersedes all other prior agreements and understandings, both written and oral, between the parties with respect to the subject matter hereof, and (b) except as otherwise expressly provided herein, is not intended to confer upon any other person any rights or remedies hereunder. 17. RULES OF CONSTRUCTION. 17.1. Any term used in this Settlement Agreement that is not defined herein, but that is used in the Bankruptcy Code or the Bankruptcy Rules, shall have the meaning assigned to that term in (and shall be construed in accordance with the rules of construction under) the Bankruptcy Code or the Bankruptcy Rules. Without limiting the foregoing, the rules of construction set forth in section 102 of the Bankruptcy Code shall apply to the Settlement Agreement, unless superseded herein. 17.2. The words "herein", hereof," "hereto," "hereunder" and others of similar import refer to the Settlement Agreement as a whole and not to any particular section, subsection or clause contained in this Settlement Agreement, unless the context requires otherwise. 17.3. Any reference in this Settlement Agreement to an existing document or -15- exhibit means such document or exhibit as it may be amended, modified or supplemented by the Parties. 17.4. Whenever from the context it is appropriate, each term stated in either the singular or the plural shall include both the singular and the plural, and each pronoun stated in the masculine, feminine or neuter includes the masculine, feminine and neuter. 17.5. In computing any period of time prescribed or allowed by this Settlement Agreement, the provisions of Bankruptcy Rule 9006(a) shall apply. 18. CONDITIONS. As an express condition precedent to the obligations of Paragon and K-C under this Settlement Agreement: 18.1. BANKRUPTCY COURT APPROVAL. An order shall have been entered approving this Settlement Agreement in all respects, which order shall not be subject to any stay. In the event that the Bankruptcy Court Approval Order is not entered, the terms of this Settlement Agreement and the Ancillary Agreements shall not be binding on any of the Parties hereto, except that (a) Sections 11 and 24 hereof shall remain binding, and (b) the License Agreements shall continue to be effective and terminable by the Parties in accordance with the terms thereof. 18.2. EXECUTION OF THE LICENSE AGREEMENTS. Contemporaneously with the execution hereof, Paragon and K-C shall execute and deliver each of the License Agreements. 19. AGREEMENT TO COOPERATE. As soon as reasonably practicable after the date of execution of this Settlement Agreement, Paragon shall take reasonable good faith steps to promptly obtain the entry of the Bankruptcy Court Approval Order through the filing of a motion pursuant to, INTER ALIA, Bankruptcy Rule 9019, and K-C shall take such steps as reasonably requested by Paragon in good faith to obtain entry of the Bankruptcy Court Approval Order. 20. REQUISITE AUTHORITY. Each of the undersigned Parties represents and warrants that, except as affected by the requirements of the Bankruptcy Code for the approval of, and subject to the terms of, this Settlement Agreement, (a) this Settlement Agreement and all other documents executed or to be executed by such Party in accordance with this Settlement Agreement are valid and enforceable in accordance with their terms, (b) such Party has taken all necessary corporate action required to authorize the execution, performance and delivery of this Settlement Agreement and the related documents, and (c) upon this Settlement Agreement being approved by an order of the Bankruptcy Court, it will perform this Settlement Agreement and consummate all of the transactions contemplated hereby. -16- 21. ANNOUNCEMENTS. All press releases by any Party regarding this Settlement Agreement shall be approved by both Paragon and K-C prior to the issuance thereof; provided that any Party may make any public disclosure it believes in good faith is required by law or regulation (in which case the disclosing Party shall advise the other Party prior to making such disclosure and provide such other Party an opportunity to review and comment on the proposed disclosure). Paragon's filing of a motion with the Bankruptcy Court seeking approval of this Settlement Agreement shall not be considered a public announcement requiring K-C's approval for purposes of this Section 21. 22. JURISDICTION. Unless and until the Chapter 11 Case is closed or dismissed, the Bankruptcy Court shall retain exclusive jurisdiction, and the Parties consent to such exclusive jurisdiction, to hear and determine any and all matters, claims or disputes arising from or relating to the interpretation and/or implementation of this Settlement Agreement; PROVIDED, HOWEVER, that the Bankruptcy Court shall not retain jurisdiction following the Effective Date to determine matters, claims and disputes concerning the interpretation and enforcement of the License Agreements. 23. CONFIDENTIALITY. Nothing contained in this Settlement Agreement modifies, or is intended to modify, the obligations of K-C and/or its employees, advisors and agents under any confidentiality agreements that such Entities have executed with Paragon. (REST OF PAGE INTENTIONALLY LEFT BLANK) -17- IN WITNESS WHEREOF, each of the Parties hereto has caused this Settlement Agreement to be executed on its behalf by its officers thereunto duly authorized, all as of the day and year first above written. PARAGON TRADE BRANDS, INC. Debtor and Debtor in Possession By: /S/ B.V. ABRAHAM -------------------------------- Title: Chairman and CEO KIMBERLY-CLARK CORPORATION By: /S/ O. GEORGE EVERBACH -------------------------------- Title: Senior Vice President - Law and Government Affairs -18- EX-10.34 9 U.S. LICENSE AGREEMENT (ENLOE) LICENSE AGREEMENT BETWEEN KIMBERLY-CLARK CORPORATION AND PARAGON TRADE BRANDS, INC. LICENSE AGREEMENT This License Agreement is made and entered into as of this 15th day of March, 1999, between Kimberly-Clark Corporation, a Delaware corporation having offices at 351 Phelps Drive, Irving, Texas 75038 ("LICENSOR") and Paragon Trade Brands, Inc., a Delaware Corporation having a principal place of business at 180 Technology Parkway, Norcross, Georgia 30092 (including any entity which it controls or as to which it is under common control, "LICENSEE"). WITNESSETH WHEREAS, LICENSEE has requested a license from LICENSOR under certain patents in order to manufacture disposable absorbent products with containment flaps; and WHEREAS, the parties desire to enter into this License Agreement under the terms and conditions hereinafter recited. NOW THEREFORE, it is agreed as follows: ARTICLE I DEFINITIONS As used throughout this Agreement, each term shall have the meaning set forth in this Article I: 1.01 "ABSORBENT PANT(S)" shall mean absorbent articles which are intended to be pulled on to fit about the waist of the wearer, whether infant or child, and includes training pants. 1.02 "CALENDAR YEAR" shall mean the twelve (12) month period commencing on the Effective Date and ending on the last day of the twelfth month thereafter, and each subsequent twelve (12) month period thereafter. 1.03. "CONVERSION DATE" shall mean the earlier of (a) August 1, 1999, if the Effective Date has not yet occurred; or (b) 90 days after the Court Order has been stayed or modified in any manner not approved by LICENSOR in writing, unless the Court Order has been reinstated or modified in a manner approved by LICENSOR in writing prior to the expiration of such 90 day period. In further clarification of the foregoing, no Conversion Date shall occur if the Court Order has been entered prior to August 1, 1999 and remains in full force and effect. 1.04 "COURT ORDER" shall mean an order of the Bankruptcy Court in Bankruptcy Case No. 98-60390 (U.S. Bankruptcy Court, Northern District of Georgia, Atlanta Division) approving the Settlement Agreement between the LICENSEE and the LICENSOR. 1.05 "DALLAS LITIGATION" shall mean the action captioned KIMBERLY-CLARK CORPORATION V. PARAGON TRADE BRANDS, INC., pending before the U.S. District Court, Northern District of Texas, Dallas Division (Civil Action 3:95-CV-2574-T). 1.06 "EFFECTIVE DATE" shall mean the first day of the month following the entry of the Court Order. 1.07 "ENLOE PATENTS" shall mean U.S. Patent 4,704,116, U.S. Patent 4,846,823, U.S. Patent 5,413,570, U.S. Patent 5,415,644 and U.S. Patent 5,599,338 and/or any U.S. continuations, continuations-in-part, divisions, extensions, reissues and reexaminations thereof; and any U.S. patent issued pursuant to U.S. Patent Application Serial No. 437,358 dated 05/09/1995, and/or any U.S. continuations, divisions, continuations in-part, extensions, reissues, and reexaminations of the Serial No. 437,358 application; and any counterpart patent applications and patents issued in Canada. 1.08 "INFANT DISPOSABLE DIAPER(S)" shall mean absorbent articles which are intended to be manually fastened about an infant or a child and are not intended to be pulled on to fit about the waist of the wearer. 1.09 "NET SALES" shall mean the gross amount of sales invoiced to independent third parties by LICENSEE, less Reductions in Sales, for Infant Disposable Diapers or Absorbent Pants which (a) are made, used, or sold by LICENSEE and (b), but for this license, would infringe a Valid Claim in the place where such products are made, used or sold by LICENSEE. For the purpose of this Agreement, products which have been accused of infringement in the Dallas Litigation shall be deemed to infringe a Valid Claim. Net Sales for the purpose of calculating royalties hereunder shall reflect a selling price which results from a bona fide, arm's length 2 transaction between LICENSEE and an independent, unrelated third party customer. If the selling price is reduced in light of other consideration from the buyer, or is a sale to a related third party, such selling price shall not be deemed a selling price derived from a bona fide, arm's length transaction, and a selling price for the same product resulting from a bona fide, arm's length transaction between LICENSEE and an independent, unrelated third party customer shall be substituted for purposes of calculating "Net Sales" under this Agreement, or, at LICENSOR's option, in the event the sale by LICENSEE is not to an independent third party, Net Sales shall be measured on the basis of the highest price in any of the succession of sales or other transfers of the applicable products until such products come into an independent third party's hands. "Net Sales" shall not include bulk sales of defective product not sold or resold for use as Infant Disposable Diapers or Absorbent Pants. 1.10 "REDUCTIONS IN SALES" shall mean, (a) transportation charges or allowances actually paid or granted; (b) credits or allowances actually given or made on account of rejects, returns, or retroactive price reductions; (c) any tax or other governmental charge directly on sale, transportation, use or delivery of products included in the invoice, paid by LICENSEE and not recovered from the purchaser; and (d) rebates, discounts and broker commissions. "Reductions in Sales" do not include (a) slotting fees or other payments made to a retailer to induce it to stock a manufacturer's product(s), or (b) any reimbursement, credit or payment for retailer advertising or retailer promotion expenses; and no deduction of such fees, payments, reimbursements or credits shall be made in calculating Net Sales. 1.11 "Safe Harbor Absorbent Pants" shall mean Absorbent Pants that: (a) employ no superabsorbent material having an Absorbency Under Load value of 27 grams per gram or greater as described in and determined by the teachings of U.S. Patent B1 5,147, 343 issued March 17, 1998 to Kellenberger ("Kellenberger Patent"); and (b) employ no superabsorbent material having a Pressure Absorbency Index of 100 or greater as described in and determined by the teachings of U.S. Patent 5, 601,542, issued February 11, 1997 to Melius ("Melius Patent"); and 3 (c) employ a liquid impermeable, vapor permeable film which has a basis weight of not less than 22 grams per square meter in any backsheet that employs a substantially liquid impermeable, vapor permeable film as a component of the backsheet; and (d) employ a containment means ("ULG") as illustrated in the drawing attached hereto as Exhibit A and as described (substituting "training pant" for "diaper"), both as to physical structure and as to performance, in the letter attached hereto as Exhibit B; and (e) which are otherwise of the same construction, configuration and formed from the same materials as the training pant attached hereto as Exhibit C. 1.12 "Safe Harbor Infant Disposable Diapers" shall mean Infant Disposable Diapers that: (a) employ no superabsorbent material having an Absorbency Under Load value of 27 grams per gram or greater as described in and determined by the teachings of U.S. Patent B1 5,147, 343 issued March 17, 1998 to Kellenberger; and (b) employ no superabsorbent material having a Pressure Absorbency Index of 100 or greater as described in and determined by the teachings of U.S. Patent 5, 601,542, issued February 11, 1997 to Melius; and (c) employ a liquid impermeable, vapor permeable film which has a basis weight of not less than 22 grams per square meter in any backsheet that employs a substantially liquid impermeable, vapor permeable film as a component of the backsheet; and (d) employ a containment means ("ULG") as illustrated in the drawing attached hereto as Exhibit A and as described, both as to physical structure and as to performance, in the letter attached hereto as Exhibit B; and (e) which are otherwise of the same construction, configuration and formed from the same materials as the Infant Disposable Diaper attached hereto as Exhibit D. 1.13 "SETTLEMENT AGREEMENT" shall mean the settlement agreement between LICENSEE and LICENSOR settling LICENSOR'S claims as defined therein. 1.14 "TERRITORY" shall mean the United States of America, its territories and possessions and Canada, its territories and possessions. 1.15 "VALID CLAIM" shall mean a claim of an unexpired Enloe Patent which has not been found invalid or unenforceable by a U.S. or Canadian governmental tribunal or a U.S. or 4 Canadian court of competent jurisdiction in a decision from which no appeal has or may be taken. ARTICLE II LICENSE 2.01 LICENSE GRANT: LICENSOR grants to LICENSEE, subject to the terms and conditions of this Agreement, a non-exclusive right and license under the Enloe Patents to make, have made, use and sell Infant Disposable Diapers and Absorbent Pants in the Territory. LICENSEE has no right to grant sublicenses under the Enloe Patents. The term for the license grant under this Section 2.01 shall commence on January 1, 1999 and, unless terminated in accordance with any other provision hereof, shall remain in full force and effect until the expiration of the last to expire of the Enloe Patents. No implied license is granted to LICENSEE other than under the Enloe Patents. 2.02 COVENANT NOT TO SUE: (a) So long as LICENSEE is in compliance with the material terms of this Agreement, LICENSOR covenants not to sue LICENSEE for infringement, if any, of the Enloe Patents arising from the manufacture, use or sale of Infant Disposable Diapers or Absorbent Pants by LICENSEE occurring on or after January 1, 1999. (b) So long as LICENSEE is in compliance with the material terms of this Agreement, LICENSOR covenants not to sue LICENSEE for infringement, if any, of the Kellenberger Patent (as defined in Section 1.11(a)), the Melius Patent (as defined in Section 1.11(b)) or U.S. Patent 5,843,056 issued December 1, 1998 to Good ("Good Patent") or any counterpart patent issued in Canada to the Kellenberger Patent, Melius Patent or Good Patent, arising from the manufacture, use or sale by LICENSEE on or after January 1, 1999, of Infant Disposable Diapers which conform with Section 1.12(a), (b) and (c) or of Absorbent Pants which conform with Section 1.11(a), (b) and (c). 2.03 CONVERSION DATE: The license and covenant not to sue set forth in Sections 2.01 and 2.02, respectively, shall, except with respect to products manufactured prior to the Conversion Date and sold pursuant to Article III and Section 4.05, terminate and be of no further force and effect on and after the Conversion Date. 5 ARTICLE III CONVERSION DATE On or before the Conversion Date, LICENSEE shall cease manufacture of any Infant Disposable Diapers and any Absorbent Pants which infringe a Valid Claim. LICENSOR may continue to sell Infant Disposable Diapers and Absorbent Pants manufactured prior to the Conversion Date subject to payment of the royalties set forth in Section 4.05. ARTICLE IV ROYALTIES 4.01 ROYALTIES: Royalties shall be payable at different rates for different products. (a) INFANT DISPOSABLE DIAPERS From the Effective Date through the term of this Agreement, LICENSEE shall pay LICENSOR a royalty of two and one-half percent (2.5%) for the first two hundred million dollars of Net Sales of Infant Disposable Diapers in each Calendar Year and shall pay LICENSOR a royalty of one and one-half percent (1.5%) of Net Sales of Infant Disposable Diapers in excess of two hundred million dollars in each Calendar Year if such royalties are paid voluntarily by LICENSEE provided, however, that for the term of this Agreement, royalties shall be payable at the higher rate of two and one-half percent (2.5%) as to any product design as to which LICENSOR is required to enforce its rights hereunder through litigation or arbitration; and provided further, however, that no percentage royalty under the Enloe Patents shall be due on Safe Harbor Infant Disposable Diapers. (b) ABSORBENT PANTS: From the Effective Date through the term of this Agreement, LICENSEE shall pay LICENSOR a royalty of 5.0 percent (5.0%) of Net Sales of Absorbent Pants; provided, however, that no percentage royalty under the Enloe Patents shall be due on Safe Harbor Absorbent Pants. 4.02 MINIMUM ANNUAL ROYALTY: In each Calendar Year during which this Agreement is in effect, LICENSEE shall pay to LICENSOR a minimum annual royalty for Infant Disposable Diapers of five million dollars ($5,000,000.00). Royalties on Infant Disposable Diapers paid pursuant to Section 4.01(a) shall count towards the minimum annual royalty. 6 4.03 ONE ROYALTY: Royalties shall be payable only once on each unit of product and shall accrue upon sale by LICENSEE. 4.04 ROYALTY BEFORE EFFECTIVE DATE. Commencing as of January 1, 1999 and until the Effective Date, LICENSEE shall pay LICENSOR a royalty of two and one-half percent (2.5%) of Net Sales of Infant Disposable Diapers and a royalty of 5.0 percent (5.0%) of Net Sales of Absorbent Pants; provided, however, that no percentage royalty under the Enloe Patents shall be due on Safe Harbor Infant Disposable Diapers or Safe Harbor Absorbent Pants; and provided further that anything to the foregoing notwithstanding, the minimum payment to LICENSOR under this Section 4.04 with respect to the month of January, 1999 shall be $250,000, and with respect to any month thereafter shall not be less than $500,000. 4.05 ROYALTY AFTER CONVERSION DATE. Sales of product manufactured before the Conversion Date but sold after the Conversion Date will be subject to a royalty at the same rates as set forth in Section 4.04, which shall be calculated by applying such royalty rates to LICENSEE's inventory on hand as of the Conversion Date, except that the royalty payable under this Section 4.05 with respect to such inventory shall not be less than $500,000. ARTICLE V PAYMENT AND ACCOUNTING 5.01 MINIMUM PAYMENTS: Except as otherwise provided in Section 5.02, the minimum annual royalty for Infant Disposable Diapers set forth in Section 4.02 shall be paid by LICENSEE to LICENSOR in quarterly installments of one million two hundred-fifty thousand dollars ($1,250,000.00) on the last day of each quarter of the Calendar Year until such time as the minimum annual royalty for Infant Disposable Diapers for that Calendar Year has been paid to LICENSOR. The minimum payment of $500,000 per month under Sections 4.04 and 4.05 shall be paid on the 15th of each month, and any additional percentage royalties shall be paid on or before the 30th of the following month. The royalty payment under Section 4.05 shall be paid 15 days after the Conversion Date. 5.02 ONGOING ROYALTIES AND ACCOUNTINGS: Within sixty (60) days after the close of each quarter of the Calendar Year during the term of this Agreement, and within thirty (30) days after each month during the time prior to the Effective Date, LICENSEE shall render an accounting to 7 LICENSOR with respect to all royalty payments due under the provisions of Article IV. Such accounting shall be accompanied by payment from LICENSEE of the amounts by which the cumulative royalties due to the end of the period which is the subject of the accounting for Infant Disposable Diapers and Absorbent Pants, respectively, exceed the amount of royalties as to such products theretofore paid for such period. Such accounting shall indicate, for such period, the monetary amount of Net Sales with respect to which royalty payments are due. LICENSEE shall keep accurate records in sufficient detail to enable royalties to be determined and shall maintain such records at its principal place of business in the United States. Each such accounting shall be treated as confidential and proprietary information of Paragon to the extent the information therein is not substantially available elsewhere, and shall only be used for the purposes set forth herein, PROVIDED, HOWEVER, that the dollar amount of the royalties paid or payable to LICENSOR hereunder shall not be deemed confidential. LICENSOR's in-house patent counsel shall maintain the confidentiality of each such accounting and the information contained therein, and shall only share such accounting and the information contained therein with such persons at LICENSOR or its outside counsel or auditors who need to know such information for purposes of verifying such accounting. 5.03 ROYALTIES UPON TERMINATION: Within sixty (60) days of the Conversion Date or of termination of this Agreement according to the provisions of Article VII or Article VIII, LICENSEE shall render an accounting to LICENSOR with respect to all royalty payments which it is obligated to pay under the provisions of Article IV and shall pay such royalties to LICENSEE. Such accounting shall be subject to the confidentiality treatment set forth in Section 5.02. 5.04 AUDIT: At LICENSOR's request and expense, LICENSEE shall permit an independent certified public accountant selected by LICENSOR, except one to whom there shall be some reasonable objection by LICENSEE, to have access, once in each Calendar Year during regular business hours and upon reasonable notice to LICENSEE, to such of the records of LICENSEE as may be necessary to verify the accuracy of the reports and payments made under this Agreement, but said accountant shall not disclose to LICENSOR any information except that which relates to the information which should properly have been contained in such reports as provided for in Sections 5.02 and 5.03. The right to review LICENSEE's records as to any given time period shall terminate two (2) years after LICENSOR's receipt of royalties in respect to such time periods. 8 5.05 INCOME TAX: Any income or other tax that LICENSEE is required to withhold and pay on behalf of LICENSOR with respect to the royalties payable to LICENSOR under the Agreement shall be deducted from said royalties prior to remittance to LICENSOR; provided, however, that in regard to any tax so deducted, LICENSEE shall give or cause to be given to LICENSOR such assistance as may reasonably be necessary to enable LICENSOR to claim exemption therefrom or credit therefor, and in each case shall furnish LICENSOR proper evidence of the taxes paid on its behalf. Notwithstanding the foregoing, LICENSEE shall not withhold any income or other tax, if LICENSOR provides its tax number to LICENSEE, unless a change in law requires withholding notwithstanding the furnishing of such number. ARTICLE VI ARBITRATION Any dispute between LICENSOR and LICENSEE as to whether or not a given Infant Disposable Diaper or Absorbent Pant is subject to payment of a percentage royalty under the terms of this Agreement or the amount of any royalty hereunder shall be subject to mandatory binding arbitration by a panel of three arbitrators, one of which will be selected by each of LICENSOR and LICENSEE and the third of which shall be selected by the other two arbitrators. Any party which fails to select an arbitrator within 45 days of a written demand for arbitration hereunder shall be deemed to have waived its right to designate an arbitrator, and such arbitrator may be selected by such office of JAMS/Endispute or the American Arbitration Association as the other party shall designate. Any such arbitration shall be limited in scope to the question of whether or not a given Infant Disposable Diaper or Absorbent Pant is subject to payment of a percentage royalty under the terms of this Agreement (including the proper construction of the Valid Claim(s) of the Enloe Patent asserted to be infringed) or the required amount of such payment and shall not address any aspect or issue concerning the validity of any of the Enloe Patents, which validity shall be presumed. The party losing any such arbitration shall bear the costs of the three arbitrators, and, in the event the arbitrators conclude that the losing party was acting in bad faith, the winner's reasonable attorneys' fees, as determined by the arbitrators. The arbitration shall be conducted pursuant to such rules and proceedings as the parties shall agree at that time; in the event of any disagreement between the parties about the terms, conditions or timing of the arbitration, the arbitrators shall have the authority to resolve the dispute. The arbitration and any decision rendered shall be confidential to the parties and shall not be 9 disclosed to third parties except to the extent required by law, by rules governing litigation, or by court order. ARTICLE VII EFFECTIVE DATE AND TERM Except as otherwise provided herein, this Agreement will become effective on the day first written above, and, unless previously terminated in accordance with any of the provisions hereof, shall remain in effect until the last of the Enloe Patents to expire, except that the provisions of Section 2.02(b) shall remain in effect until the last of the Kellenberger Patent, Melius Patent and Good Patent and any counterpart patents issued in Canada has expired. ARTICLE VIII TERMINATION 8.01 BREACH: Failure by LICENSEE or LICENSOR to comply with any of its obligations and covenants contained in this Agreement shall entitle the other party to give to the party in default a written notice requiring it to cure such default(s). If a default is not cured within thirty (30) days after receipt of notice, the notifying party shall be entitled, without prejudice to any other rights conferred by this Agreement or by law, to terminate this Agreement by giving written notice to take effect immediately. The right of each party to terminate this Agreement shall not be affected by waiver of, or failure to terminate for any previous default. 8.02 INSOLVENCY: LICENSOR may, at its election, terminate this Agreement upon the bankruptcy or insolvency of LICENSEE. In such event, termination shall be deemed effective as of the date of LICENSEE's insolvency but in no event later than a time prior to LICENSEE's filing of a petition in bankruptcy. This Section 8.02 shall not apply to LICENSEE'S Chapter 11 Bankruptcy Case No. 98-60390 (United States Bankruptcy Court, Northern District of Georgia, Atlanta Division). 8.03 SURVIVAL: Termination of this Agreement under Section 8.01 or Section 8.02 shall not terminate the parties' obligations to one another for the period prior to termination. Without limiting the generality of the foregoing, the provisions of Article VI shall survive termination of this Agreement under Section 8.01 or Section 8.02, but the arbitration described in such Article shall 10 be limited to Infant Disposable Diapers and Absorbent Pants manufactured, used or sold by LICENSEE prior to the date of termination. ARTICLE IX ASSIGNMENT 9.01 GENERAL: Subject to the provisions of this Article IX, this Agreement shall be binding upon and inure to the benefit of the successors and assigns of all or substantially all of LICENSEE'S Infant Disposable Diaper business and the successors and assigns of all or substantially all of LICENSEE'S Absorbent Pants business; provided, however, that a successor or assign of only one of such Infant Disposable Diaper business or Absorbent Pants business shall have the benefit and burdens of this Agreement only with respect to such line of business. This Agreement shall not create a license for or otherwise apply to the activities of successors or assigns prior to the date of any such succession or assignment. 9.02 EXISTING DIAPER ENTITIES: Notwithstanding Section 9.01 hereof, in the event of assignment hereunder to or any combination of LICENSEE and an existing business which sells Infant Disposable Diapers, then (a) the phrase "two hundred million dollars" in Section 4.01(a) shall be increased by an amount equal to the sales by such existing business of Infant Disposable Diapers for the twelve months preceding the date of such assignment or combination ("Existing Business Diaper Sales"); (b) the figure $5,000,000 in Section 4.02 shall be increased by an amount equal to two and one half percent (2.5%) of Existing Business Diaper Sales; (c) the figure $1,250,000 in Section 5.01 shall be increased by an amount equal to five-eighths of one percent (0.625%) of Existing Business Diaper Sales; and (d) the royalty rate under Section 4.01(a) shall be two and one-half percent (2.5%) with respect to such amount of all annual sales by LICENSEE, in excess of the sum ("Combined Twelve Month Diaper Sales") of Existing Business Diaper Sales and the sales of Infant Disposable Diapers by LICENSEE in the twelve months preceding the date of such assignment or combination ("Prior LICENSEE Diaper Sales"), as shall equal the ratio (i) Existing Business Diaper Sales to (ii) Combined Twelve Month Diaper Sales (the amount of incremental sales so determined under this subsection 9.02(d), "Existing Business Attributable Diaper Increase"). 9.03 SUCCESSIVE COMBINATIONS: In the event of more than one assignment or combination of LICENSEE and an existing business which sells Infant Disposable Diapers, then the 11 provisions of Section 9.02 shall continue be applied to each such successive assignment and thereafter, except that (a) "Existing Business Diaper Sales" shall equal the sum of (i) all Existing Business Diaper Sales as previously determined under Section 9.02 (without regard to this Section 9.03), (ii) the Existing Business Attributable Diaper Increase for the twelve months preceding such successive assignment or combination (the sum of (i) and (ii), "Old Existing Business Diaper Sales"); and (iii) the sales of Infant Disposable Diapers by the existing business which is the subject of such successive assignment or combination for the twelve months preceding such successive assignment or combination; and (b) "Prior LICENSEE Diaper Sales" shall equal the sales by LICENSEE for the twelve months preceding such successive assignment or combination, less Old Existing Business Diaper Sales. 9.04 CONSENT TO ASSIGNMENT: The license grant hereunder shall be personal to Paragon and shall be nontransferable and nonassignable to third parties without the prior written consent of K-C, which consent K-C shall not unreasonably withhold or unreasonably delay. It shall not be unreasonable for K-C to withhold or delay its consent if the effect of the proposed transfer or assignment would be to allow a transferee or assignee to obtain the prospective right to make, import, use, offer for sale or sell Infant Disposable Diapers or Absorbent Pants in the Territory without entering into a mutually agreeable settlement agreement with K-C for any past infringing activity by the transferee or assignee with respect to the K-C patents identified in this License Agreement. In addition, the license grant hereunder shall not apply to the manufacture, import, use or sale of Infant Disposable Diapers or Absorbent Pants by any other business entity acquired by Paragon, by which Paragon is acquired, merged with Paragon, consolidated with Paragon, partnered with Paragon or in any other business arrangement with Paragon after the effective date of this Settlement Agreement without the prior written consent of K-C, which consent K-C shall not unreasonably withhold or unreasonably delay. It shall not be unreasonable for K-C to withhold or delay its consent if the effect of the proposed transaction would be to allow an acquiring, merging or consolidating entity or partner to obtain the prospective right to make, import, use, offer for sale or sell Infant Disposable Diapers or Absorbent Pants in the Territory without entering into a mutually agreeable settlement agreement with K-C for any past infringing activity by the acquiring, merging or consolidating entity or partner with respect to the K-C patents identified in this License Agreement. 12 ARTICLE X GOVERNING LAW This Agreement shall be construed and all questions relating hereto shall be determined in accordance with the laws of the State of Delaware. ARTICLE XI REPRESENTATIONS AND WARRANTIES; LIMITATIONS 11.01 REPRESENTATIONS AND WARRANTIES OF LICENSOR: LICENSOR hereby represents and warrants the following: (a) LICENSOR has the full right, power and authority to enter into this Agreement and perform in accordance with its terms. (b) LICENSOR has good and complete title in and to (or beneficial interest to) the Enloe Patents and has the right to license them to LICENSEE in accordance with the terms of this Agreement. (c) LICENSOR has good and complete title in and to (or beneficial interest to) the Kellenberger Patent, Melius Patent and Good Patent (including any Canadian counterpart patents) and has the right to grant a covenant not to sue LICENSEE in accordance with the terms of Section 2.02(b) of this Agreement. 11.02 REPRESENTATION AND WARRANTIES OF LICENSEE: (a) LICENSEE has the full right, power and authority to enter into this Agreement and perform in accordance with its terms. (b) LICENSEE has no knowledge of any existing or contingent impediment, including the effect of its pending bankruptcy proceeding or any lack of liquidity, to its performing in accordance with the terms of this Agreement. 11.03 LIMITATIONS: (a) Except as set forth above, neither party has made, or intends to make, any express or implied warranty to the other. In particular, LICENSOR has made no express or implied warranty in this Agreement that LICENSEE's making, using, or selling of products will not infringe another patent held by LICENSOR or held by a third party. 13 (b) Nothing in this Agreement shall be construed as granting by implication, estoppel, or otherwise, any licenses or rights under patents of LICENSOR other than the Enloe Patents. ARTICLE XII NOTICES Any notice required or permitted to be given under this Agreement by one of the parties to the other shall be in writing and shall be deemed to have been sufficiently given for all purposes hereunder if personally delivered or mailed by registered or certified mail, postage prepaid, addressed to such party at its address below or as from time to time may be directed otherwise by such party by notice to the other party. Any such mailed notice shall be deemed to have been given three (3) business days after mailing. All notices to LICENSOR shall be addressed as follows: Kimberly-Clark Corporation 351 Phelps Drive Irving, Texas 75038 Attention: Senior Vice President, Law and Government Affairs All notices to LICENSEE shall be addressed as follows: Paragon Trade Brands, Inc. 180 Technology Parkway Norcross, Georgia 30092 Attention: General Counsel ARTICLE XIII PATENT MARKING LICENSEE shall mark each package containing Infant Disposable Diapers or Absorbent Pants (as the case may be) which, but for this license, would infringe a Valid Claim with a statement substantially equivalent to "The products are made under one or more of the following U.S. Patents: 4,704,116, 4,846,823, 5,413,570, 5,415,644 and 5,599,338." 14 LICENSEE shall modify such statement upon request of LICENSOR to add a reference to Enloe Patents which cover LICENSEE's product and that issue after the date of this Agreement. LICENSEE shall commence the marking program upon exhaustion of LICENSEE's current supply of packaging materials. ARTICLE XIV WAIVER The waiver by either of the parties to this Agreement of any breach of any provision hereof by the other party shall not be construed to be a waiver of any succeeding breach of such provision or a waiver of the provision itself. ARTICLE XV ENFORCEABILITY If and to the extent that any court or governmental tribunal of competent jurisdiction holds any of the terms, provisions or conditions or part thereof of this Agreement, or the application hereof to any circumstances, to be invalid or unenforceable in a final nonappealable order, the remainder of this Agreement and the application of such term, provision or condition or part thereof to circumstances other than those as to which it is held invalid or enforceable shall not be affected thereby and each of the other terms, provisions and conditions of this Agreement shall be valid and enforceable to the extent it is consonant with the intention of the parties upon entering into this Agreement. ARTICLE XVI HEADINGS The headings appearing herein have been inserted solely for the convenience of the parties hereto and shall not affect the construction, meaning or interpretation of this Agreement. 15 ARTICLE XVII ENTIRE AGREEMENT This Agreement is entered into as part of a Settlement Agreement. The terms and provisions contained in this Agreement and the Settlement Agreement (including its attachments) attached hereto as Exhibit E constitute the entire agreement and understanding between the parties to this Agreement. Neither party has relied or will rely on any representation or agreement of the other except to the extent set forth herein or in the Settlement Agreement (including its attachments), and neither party shall be bound by or charged with any oral, written or implied agreements, representations, warranties, understandings, commitments or obligations not specifically set forth herein or in the Settlement Agreement (including its attachments). These Agreements may not be released, discharged, abandoned, changed or modified in any manner except by an instrument in writing signed by a duly authorized officer of each of the parties hereto. Each of the parties hereto has caused this instrument to be executed by its respective duly authorized representative as of the day and year first above written. KIMBERLY-CLARK CORPORATION PARAGON TRADE BRANDS, INC. BY: /s/ O. George Everbach BY: /s/ B. V. Abraham -------------------------- ------------------------ O. George Everbach B. V. Abraham -------------------------- ------------------------ (print) (print) TITLE: Senior Vice President - TITLE: Chairman and CEO Law and Government Affairs -------------------------- ------------------------ (print) (print) 16 EX-10.35 10 U.S. LICENSE AGREEMENT (SMITH, SUZUKI) LICENSE AGREEMENT BETWEEN PARAGON TRADE BRANDS, INC. AND KIMBERLY-CLARK CORPORATION. LICENSE AGREEMENT This License Agreement is made and entered into as of this 15th day of March, 1999, between Paragon Trade Brands, Inc., a Delaware Corporation having a principal place of business at 180 Technology Parkway, Norcross, Georgia 30092 ("LICENSOR"), and Kimberly-Clark Corporation, a Delaware corporation having offices at 351 Phelps Drive, Irving, Texas 75038 ("LICENSEE"). WITNESSETH WHEREAS, LICENSEE has requested a license from LICENSOR under certain patents in order to manufacture disposable products; and WHEREAS, the parties desire to enter into this License Agreement under the terms and conditions hereinafter recited. NOW THEREFORE, it is agreed as follows: ARTICLE I DEFINITIONS As used throughout this Agreement, each term shall have the meaning set forth in this Article I: 1.01 "LICENSED PATENTS" shall mean U.S. Patent 4,977,011 issued December 11, 1990 to Smith; U.S. Patent 5,209,801 issued May 11, 1993 to Smith; and U.S. Patent, 4,687,477 issued August 18, 1987 to Suzuki; and/or any U.S. continuations, divisions, continuations in-part, reissues, and reexaminations thereof. 1.02 "TERRITORY" shall mean the United States of America, its territories and possessions. 1.03 "VALID CLAIM" shall mean a claim of the Licensed Patents which has not been found invalid or unenforceable by a U.S. government tribunal or a U.S. court of competent jurisdiction in a decision from which no appeal has or may be taken. ARTICLE II LICENSE 2.01 LICENSE GRANT: LICENSOR grants to LICENSEE, subject to the terms and conditions of this Agreement, a fully-paid, non-exclusive, right and license under the Licensed Patents to practice the methods and to make, have made, use and sell the products therein described and claimed in the Territory. LICENSEE has no right to grant sublicenses under the Licensed Patents. The term for the license grant under this Section 2.01 shall commence on January 1, 1999 and, unless terminated in accordance with Section 2.03, shall remain in full force and effect until the expiration of the last to expire of the Licensed Patents. No implied license is granted to LICENSEE other than under the Licensed Patents. 2.02 COVENANT NOT TO SUE: So long as LICENSEE is in compliance with this Agreement, LICENSOR covenants not to sue LICENSEE for infringement, if any, of the Licensed Patents arising from the manufacture, use or sale of products by LICENSEE occurring on or after January 1, 1999. 2.03 TERMINATION: LICENSEE and LICENSOR have entered into a license agreement dated March 15, 1999, relating to the Enloe Patents (as those patents are defined in that license agreement) ("Enloe License Agreement"). In the event that the Enloe License Agreement is terminated and is of no further force and effect pursuant to Section 2.03 of the Enloe License Agreement, then the license and covenant not to sue set forth in Section 2.01 and 2.02, respectively, of this Agreement shall, except with respect to products manufactured prior to the date of that termination, terminate and be of no further force and effect on and after the termination date. ARTICLE III EFFECTIVE DATE AND TERM This Agreement will become effective on the day first written above and, unless previously terminated in accordance with Section 2.03, shall remain in effect for the term of the last of the Licensed Patents to expire. 2 ARTICLE IV ASSIGNMENT 4.01 ASSIGNMENT: This Agreement shall be binding upon and inure to the benefit of the successors and assigns of all or substantially all of one or more of LICENSEE's disposable products businesses. This Agreement shall not create a license for or otherwise apply to the activities of successors or assigns prior to the date of any such succession or assignment. 4.02 CONSENT TO ASSIGNMENT: The license grant hereunder shall be personal to LICENSEE and shall be nontransferable and nonassignable to third parties without the prior written consent of LICENSOR, which consent LICENSOR shall not unreasonably withhold or unreasonably delay. It shall not be unreasonable for LICENSOR to withhold or delay its consent if the effect of the proposed transfer or assignment would be to allow a transferee or assignee to obtain the prospective right to make, import, use, offer for sale or sell disposable products in the United States without entering into a mutually agreeable settlement agreement with LICENSOR for any past infringing activity by the transferee or assignee with respect to the Licensed Patents. ARTICLE V GOVERNING LAW This Agreement shall be construed, and all questions relating hereto shall be determined, in accordance with the laws of the State of TEXAS. ARTICLE VI REPRESENTATIONS AND WARRANTIES; LIMITATIONS 6.01 REPRESENTATIONS AND WARRANTIES OF LICENSOR: LICENSOR hereby represents and warrants the following: (a) LICENSOR has the full right, power and authority to enter into this Agreement and perform in accordance with its terms. (b) LICENSOR has good and complete title in and to (or beneficial interest to) the Licensed Patents and has the right to license them to LICENSEE in accordance with the term of this Agreement. 3 6.02 REPRESENTATION AND WARRANTIES OF LICENSEE: (a) LICENSEE has the full right, power and authority to enter into this Agreement and perform in accordance with its terms. (b) LICENSEE has no knowledge of any existing or contingent impediment to its performing in accordance with the terms of this Agreement. 6.03 LIMITATIONS: (a) Except as set forth above, neither party has made, or intends to make, any express or implied warranty to the other. In particular, LICENSOR has made no express or implied warranty that LICENSEE's making, using, or selling of products will not infringe another patent held by LICENSOR or held by a third party. (b) Nothing in this Agreement shall be construed as granting by implication, estoppel, or otherwise, any licenses or rights under patents of LICENSOR other than the Licensed Patents. ARTICLE VII NOTICES Any notice required or permitted to be given under this Agreement by one of the parties to the other shall be in writing and shall be deemed to have been sufficiently given for all purposes hereunder if personally delivered or mailed by registered or certified mail, postage prepaid, addressed to such party at its address below or as from time to time may be directed otherwise by such party by notice to the other party. Any such mailed notice shall be deemed to have been given three (3) business days after mailing. All notices to LICENSEE shall be addressed as follows: Kimberly-Clark Corporation 351 Phelps Drive Irving, Texas 75038 Attention: Senior Vice President, Law and Government Affairs All notices to LICENSOR shall be addressed as follows: Paragon Trade Brands, Inc. 180 Technology Parkway Norcross, Georgia 30092 Attention: General Counsel ARTICLE VIII PATENT MARKING 4 LICENSEE shall mark each package containing products which, but for this license, would infringe a Valid Claim with a statement substantially equivalent to one of the following: "The products are made under one or more of the following U.S. Patents: 4,687,477" "The products are made under one or more of the following U.S. Patents: 4,977,011 and 5,209,801." LICENSEE shall modify such statement upon request of LICENSOR to add a reference to Licensed Patents which cover LICENSEE's product and that issue after the date of this Agreement. LICENSEE shall commence the marking program upon exhaustion of LICENSEE's current supply of packaging materials provided, however, such marking of all packages shall commence no later than June 1, 1999. ARTICLE IX WAIVER The waiver by either of the parties to this Agreement of any breach of any provision hereof by the other party shall not be construed to be a waiver of any succeeding breach of such provision or a waiver of the provision itself. ARTICLE X ENFORCEABILITY If and to the extent that any court or governmental tribunal of competent jurisdiction holds any of the terms, provisions or conditions or part thereof of this Agreement, or the application hereof to any circumstances, to be invalid or unenforceable in a final nonappealable order, the remainder of this Agreement and the application of such term, provision or condition or part thereof to circumstances other than those as to which it is held invalid or enforceable shall not be affected thereby, and each of the other terms, provisions and conditions of this Agreement shall 5 be valid and enforceable to the extent it is consonant with the intention of the parties upon entering into this Agreement. ARTICLE XI HEADINGS The headings appearing herein have been inserted solely for the convenience of the parties hereto and shall not affect the construction, meaning or interpretation of this Agreement. ARTICLE XII ENTIRE AGREEMENT This Agreement is entered into as part of a Settlement Agreement. The terms and provisions contained in this Agreement and the Settlement Agreement (including its attachments) attached hereto as Exhibit A constitute the entire agreement and understanding between the parties to this Agreement. Neither party has relied, or will rely, on any representation or agreement of the other except to the extent set forth herein or in the Settlement Agreement (including its attachments), and neither party shall be bound by or charged with any oral, written or implied agreements, representations, warranties, understandings, commitments or obligations not specifically set forth herein or in the Settlement Agreement (including its attachments). These Agreements may not be released, discharged, abandoned, changed or modified in any manner except by an instrument in writing signed by a duly authorized officer of each of the parties hereto. Each of the parties hereto has caused this instrument to be executed by its respective duly authorized representative as of the day and year first above written. KIMBERLY-CLARK CORPORATION PARAGON TRADE BRANDS, INC. BY: /s/ O. George Everbach BY: /s/ B. V. Abraham -------------------------- ------------------------ O. George Everbach B. V. Abraham -------------------------- ------------------------ (print) (print) TITLE: Senior Vice President - TITLE: Chairman and CEO Law and Government Affairs -------------------------- ------------------------ (print) (print) 6 EX-21.1 11 SUBSIDIARIES OF THE COMPANY PARAGON TRADE BRANDS, INC. Subsidiaries of the Company
SUBSIDIARY JURISDICTION OF INCORPORATION ---------- ----------------------------- Paragon Trade Brands (Canada) Inc. Canada Paragon Trade Brands FSC, Inc. U.S. Virgin Islands PTB International, Inc. State of Delaware PTB Acquisition Sub, Inc. State of Delaware PTB Holdings, Inc. State of Ohio Paragon-Mabesa International, S.A. de C.V. (49%) Mexico
EX-23.1 12 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K into Paragon Trade Brands, Inc.'s previously filed Registration Statements on Form S-8, File Nos. 33-73726, 33-61802, 33-95344 and 33-34626. Arthur Andersen LLP Atlanta, Georgia April 9, 1999 EX-27 13 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10K FOR THE YEAR ENDED DECEMBER 27, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 DEC-29-1997 YEAR DEC-27-1998 DEC-27-1998 22,625 0 87,856 8,700 53,282 163,646 271,298 (165,098) 429,287 78,495 0 0 0 124 (61,964) 429,287 535,207 535,207 428,572 428,572 0 0 450 (57,292) 8,091 (65,383) 0 0 0 (65,383) (5.48) (5.48)
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