On July 20, 2005, the Company entered into a definitive merger agreement with Sheridan Square Entertainment, Inc. (“Sheridan Square”), a privately held producer of recorded music, and SSE Acquisition Corp, our wholly-owned subsidiary. In connection with the merger agreement the Company purchased 40 shares of Series B Preferred Stock of Sheridan Square for $1,000,000. The Series B Preferred Stock was senior to all other equity securities of Sheridan in terms of dividends, distributions and liquidation preference. Dividends, whether or not declared, accrued at the rate of 8% per annum of the sum of the stated value of each share ($25,000) which commenced January 1, 2006, provided that in the event a “Disposition Transaction” (as defined in the Certificate of Designation of the Series B Preferred Stock) had not occurred by April 1, 2006, the dividend rate shall increase to 14% per annum and provided further that if a Disposition Transaction does not occur by July 1, 2006, the dividend rate shall increase to 18% per annum.
On July 12, 2006, the Company entered into a Stock Purchase Agreement with Sheridan Square pursuant to which Hirsch sold and Sheridan Square repurchased all of Hirsch’s right, title and interest in forty (40) shares of Series B Preferred Stock of Sheridan Square, together with all payment-in-kind dividends whether or not issued (the “Purchased Stock”) for an aggregate purchase price of $1,200,000 (the “Purchase Price”). The purchase price was due on October 31, 2006 and was not repaid on that date. As of December 31, 2006, the Company took a charge of $1,000,000 to other expense to fully reserve against the note receivable.
On March 5, 2007, the Company filed a Notice of Motion for Summary Judgement in Lieu of Complaint in New York State Supreme Court. In this Motion, the Company alleges that Sheridan Square failed to make payment for all of Hirsch’s right, title, and interest in and to forty (40) shares of the Series B Convertible Participating Stock of Sheridan Square, together with all payment-in-kind dividends, whether or not issued, in accordance with the terms of the Stock Purchase Agreement dated July12, 2006, between Hirsch and Sheridan Square. Hirsch has asked the court to enter judgment in its favor in the amount of $1,200,000, plus accrued interest.
The warranty reserve included in Accounts Payable and Accrued Expenses was $563,000 at March 31, 2007 and December 31, 2006, respectively. The Company recorded approximately $15,000 in warranty expense for the three months ended March 31, 2007 and $16,000 for the two months ended March 31, 2006.
On February 23, 2006, the Company agreed to terminate the lease on its corporate facility located in Hauppauge, New York and concurrently signed a new operating lease for a facility also located in Hauppauge, New York. During the quarter ended March 31, 2006, the Company wrote off
certain balance sheet items (approximately $1.2 million) related to the sales leaseback transaction that the Company had previously recorded and recognized $128,000 gain associated with the deferred termination. In connection with the lease termination, the Company incurred $500,000 in termination fees related to the lease termination agreement ($200,000 due on signing and $300,000 over 2 ½ years commencing July 1, 2006) and recognized approximately $128,000 in deferred gain.
ITEM 2: | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis contains forward-looking statements which involve risks and uncertainties. When used herein, the words “anticipate”, “believe”, “estimate” and “expect” and similar expressions as they relate to the Company or its management are intended to identify such forward-looking statements. The Company’s actual results, performance or achievements could differ materially from the results expressed in or implied by these forward-looking statements. Factors that could cause or contribute to such differences should be read in conjunction with, and is qualified in its entirety by, the Company’s Consolidated Financial Statements, including the Notes thereto. Historical results are not necessarily indicative of trends in operating results for any future period.
Three months ended March 31, 2007 as compared to the two months ended March 31, 2006.
Net sales. Net sales for the three months ended March 31, 2007 were $14.0 million, an increase of $5.4 million, or 62.8%, compared to $8.6 million for the two months ended March 31, 2006. The increase in sales for the three months ended March 31, 2007 is attributable to the inclusion of three months worth of sales during the quarter versus two months for the comparable period.
Cost of sales. For the three months ended March 31, 2007, cost of sales increased $3.1 million to $8.7 million from $5.6 million for the two months ended March 31, 2006. The increase is directly related to higher sales volume recorded during the longer (three months) reporting period versus the two months ended March 31, 2006. The Company’s gross margin increased to 38.1% for the three months ended March 31, 2007 as compared to 35.5% for the two months ended March 31, 2006. The fluctuation of the dollar against the yen, which is the currency the Company’s embroidery machines are priced in, has affected and is likely to continue to affect the Company’s machine sales pricing competitiveness.
Operating Expenses. For the three months ended March 31, 2007 operating expenses were $4.5 million or 32.1% of net sales as compared to $ 2.8 million or 32.5% for the two months ended March 31, 2006. Included in operating expenses for the two months ended March 31, 2006 is the recognition of $128,000 in deferred gain associated with the termination of the lease on the corporate headquarters. (See Note 6 to the Consolidated Financial Statements).
Interest Expense. Interest expense for the three months ended March 31, 2007 decreased to $3,000 from $25,000 for the two months ended March 31, 2006. Interest expense was primarily associated with the sale/leaseback transaction of the corporate headquarters (See Note 6 to the Consolidated Financial Statements).
Other Income. Other income for the three months ended March 31, 2007 increased by $3,000 to $60,000, from $57,000 for the two months ended March 31, 2006 primarily associated with an increase in interest income.
Income tax expense. The income tax expense of $51,000 recorded for the three months ended March 31, 2007 represents the effective tax rate of 5.9% on year end income for various state and local income taxes, for which the net operating loss carry-forwards from prior years do not apply.
Net Income. Net income for the three months ended March 31, 2007 was $817,000 an increase of $525,000 over the net income of $292,000 for the two months ended March 31, 2006, primarily from an increase in operating income.
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Liquidity and Capital Resources
Operating Activities and Cash Flows
The Company’s working capital was $16.8 million at March 31, 2007, increasing $1.1 million, or 7.0%, from $15.7 million at December 31, 2006.
During the three months ended March 31, 2007, the Company’s cash and cash equivalents remained relatively constant at $13.2 million. Net cash of $1.2 million was used by the Company’s operating activities primarily used to decrease Accounts Payable and Accrued Liabilities. Cash of $76,000 was provided by financing activities resulting from the exercise of stock options. During the two months ended March 31, 2006, the Company’s cash and cash equivalents remained relatively constant at $13.2 million. Net cash of $427,000 was used by the Company’s operating activities primarily used to increase inventory. Cash of $500,000 was provided by financing activities resulting from the unrestricting of cash related to the termination of the capital lease on the corporate facility in Hauppauge, New York.
Inventory purchase commitments are covered by current purchases of foreign currency. As of March 31, 2007, the Company did not own any foreign currency futures contracts.
Revolving Credit Facility and Borrowings
The Company had a Loan and Security Agreement (“the Congress Agreement”) with Congress Financial Corporation (“Congress”) for an initial term of three years which expired on November 26, 2005. On February 23, 2006, the Company terminated its lease for its facility in Hauppauge, New York. As of February 28, 2006, the Company signed a Termination Agreement with Wachovia Bank, National Association (successor by merger to Congress Financial Corporation). In conjunction with this transaction, the standby letter of credit of approximately $500,000 was terminated. The Company, at this time, does not intend to enter into a new bank agreement.
Critical Accounting Policies and Estimates
There have been no material changes in our critical accounting policies and estimates from those disclosed in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2006.
Future Capital Requirements
The Company believes that its existing cash and funds generated from operations, will be sufficient to meet its working capital and capital expenditure requirements.
Backlog and Inventory
The ability of the Company to fill orders quickly is an important part of its customer service strategy. The embroidery machines held in inventory by the Company are generally shipped within a week from the date the customer’s orders are received, and as a result, backlog is not meaningful as an indicator of future sales.
Inflation
The Company does not believe that inflation has had, or will have in the foreseeable future, a material impact upon the Company’s operating results.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The Company is exposed to various market risks, including changes in foreign currency exchange rates and interest rates. Market risk is the potential loss arising from adverse changes in market rates and
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prices, such as foreign currency exchange and interest rates. The recent fluctuation of the dollar against the yen, which is the currency the company’s embroidery machines are priced in, has affected and is likely to continue to affect the Company’s machine sales pricing competitiveness. Embroidery machinery prices have changed in US dollars due to these exchange rate fluctuations. Some but not all of the Company’s competitors face similar circumstances. The Company has a formal policy that prohibits the use of currency derivatives or other financial instruments for trading or speculative purposes. The policy permits the use of financial instruments to manage and reduce the impact of changes in foreign currency exchange rates that may arise in the normal course of the Company’s business. Currently, the Company does not use interest rate derivatives.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, the Company carried out an evaluation of the effectiveness of the design and operation of the disclosure controls and procedures, as defined in Rules 13a-15e and 15d-15e of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, as of the end of the period covered by this Report, in ensuring that material information relating to the Company required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rule and forms, including ensuring that such material information is accumulated and communicated to the Company’s Management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in the Company’s internal controls over financial reporting that occurred during the quarter ended March 31, 2007 that have materially affected, or are reasonably likely to affect, the Company’s internal controls over financial reporting.
PART II-OTHER INFORMATION
We are from time to time a party to various legal actions arising in the normal course of business. However, management believes that as a result of legal defenses and insurance arrangements with parties believed to be financially capable, there are no proceedings, threatened or pending against us that, if determined adversely, would have a material adverse effect on our business or financial position.
There were no material changes from the risk factors previously disclosed in our Report of Form 10-K for the 11 months ended December 31, 2006. For a full description of these risk factors, please refer to Item 1A (Risk Factors) in the Company’s Report on Form 10-K for the 11 months ended December 31, 2006.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
Item 3. | Defaults Upon Senior Securities |
None.
Item 4. | Submission of Matters to a Vote of Security Holders |
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The Company’s 2006 Annual Meeting of Stockholders was held January 25, 2007. At the meeting, the Company’s stockholders voted upon (1) the election of directors and (2) the approval of BDO Seidman, LLP as the Company’s independent registered public accounting firm for the year ended December 31, 2007.
The following is a tabulation of the votes:
(1) Election of Directors | | | |
| For | Against | |
Marvin Broitman (Class A) | 7,112,588 | 64,870 | |
Mary Ann Domuracki (Class A) | 7,089,202 | 88,256 | |
Henry Arnberg (Class B) | 400,018 | -0- | |
Paul Gallagher (Class B) | 400,018 | -0- | |
Christopher J. Davino (Class B) | 400,018 | -0- | |
| | | |
(2) Approval of BDO Seidman, LLP as the Company’s Independent Registered Public Accounting Firm |
| | | |
For | Against | Abstain | |
7,557,949 | 7,474 | 12,052 | |
*3.1 | | Restated Certificate of Incorporation of the Registrant |
| | |
**3.2 | | Amended and Restated By-laws of the Registrant |
| | |
***4.1 | | Specimen of Class A Common Stock Certificate |
| | |
***4.2 | | Specimen of Class B Common Stock Certificate |
| | |
31.1 | | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d – 14(a). |
| | |
31.2 | | Certification of Chief Financial Officer to Section Rule 13a-14(a) or Rule 15d – 14(a). |
| | |
32.1 | | Certification of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |
| | |
32.2 | | Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002 |
*Incorporated by reference from the Registrant’s Form 10-Q filed for the quarter ended July 31, 1997.
**Incorporated by reference from the Registrant’s Form 10-Q filed for the quarter ended October 31, 1997.
***Incorporated by reference from the Registrant’s Registration Statement on Form S-1, Registration Number 33-72618
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SIGNATURES
Pursuant to the requirements 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.
| HIRSCH INTERNATIONAL CORP.
Registrant |
| | |
| By: | /s/ Paul Gallagher |
| | Paul Gallagher |
| | President and Chief Executive Officer |
| | |
| | |
| By: | /s/ Beverly Eichel |
| | Beverly Eichel |
| | Executive Vice President, Finance, Chief Financial
Officer and Secretary |
| | |
Dated: May 3, 2007 | | |
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