1 U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended March 31, 1998 OR _ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from _____ to _____ Commission file number 0-26756 GEOGRAPHICS, INC. (Exact Name of Registrant as Specified in Its Charter) ________________ WYOMING 87-0305614 (State or Other Jurisdiction (I.R.S. Employer Incorporation or Organization) Identification No.) 1555 ODELL ROAD, P. O. BOX 1750, BLAINE, WASHINGTON 98231 (Address and Zip Code of Principal Executive Offices) Registrant's Telephone Number, Including Area Code (360) 332-6711 ________________ Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered under Section 12(g) of the Exchange Act: COMMON STOCK, NO PAR VALUE Indicate by checkmark 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 ___ No X --------------- Indicate by checkmark 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. The aggregate market value of the common stock held by nonaffiliates of the registrant as of May 21, 1999 was $3,696,470 based on a closing sales price of $0.375 per share on the NASDAQ OTC Bulletin Board on such date. The number of shares outstanding of the registrant's common stock, no par value, as of May 21, 1999 was 9,857,252. DOCUMENTS INCORPORATED BY REFERENCE. None. 2 TABLE OF CONTENTS PART I PAGE ITEM 1. BUSINESS 1 GENERAL 1 LATE-FILING; SUBSEQUENT EVENTS & FILINGS 1 FORWARD-LOOKING STATEMENTS 2 BACKGROUND 2 INDUSTRY 3 PRODUCTS 4 SALES BY PRODUCT CATEGORY 4 SALES/ASSETS BY GEOGRAPHIC LOCATION 5 BUSINESS CONCENTRATIONS 6 PURCHASING 6 DISTRIBUTION 7 COMPETITION 7 TRADEMARKS AND COPYRIGHTS 8 SEASONALITY 8 EMPLOYEES 8 EQUIPMENT INTEGRATION 9 INVESTIGATION OF FORMER MANAGEMENT 9 RISK FACTORS 11 ABILITY TO CONTINUE AS A GOING CONCERN; DEFAULTS UNDER CREDIT FACILITY; NEED FOR ADDITIONAL WORKING CAPITAL 11 COMPETITION 12 CUSTOMER CONCENTRATIONS 12 DEPENDENCE ON KEY VENDORS 13 TECHNOLOGY CHANGES AFFECTING PRODUCTS 13 UNCERTAIN PROTECTION OF INTELLECTUAL PROPERTY RIGHTS 13 DELISTING FROM NASDAQ SMALLCAP MARKET AND TORONTO STOCK EXCHANGE 14 APPLICABILITY OF RULES RELATING TO LOW-PRICED STOCK 14 EXISTENCE OF WARRANTS AND OPTIONS AND POSSIBLE DILUTION 14 FLUCTUATIONS OF QUARTERLY RESULTS; SEASONALITY 15 VOLATILITY OF STOCK PRICE 15 -i- 3 TABLE OF CONTENTS (continued) PAGE YEAR 2000 ISSUES 15 ITEM 2. DESCRIPTION OF PROPERTIES 16 ITEM 3. LEGAL PROCEEDINGS 16 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 17 PART II 17 ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS 17 PRICE RANGE OF COMMON STOCK 17 DIVIDENDS 18 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 20 RESULTS OF OPERATIONS 20 1998 COMPARED TO 1997 21 1997 COMPARED TO 1996 22 LIQUIDITY AND CAPITAL RESOURCES 23 ITEM 8. FINANCIAL STATEMENTS 24 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 25 PART III 25 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 25 BOARD AND COMMITTEE MEETINGS 26 BOARD INTERLOCKS AND INSIDER PARTICIPATION 26 SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE 26 ITEM 11. EXECUTIVE COMPENSATION 27 STOCK OPTION GRANTS AND EXERCISES 27 DIRECTOR COMPENSATION 27 EMPLOYMENT AGREEMENTS 27 ITEM 12. STOCK OWNERSHIP OF MANAGEMENT AND CERTAIN OTHER HOLDERS 28 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 28 PART IV 28 ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K 28 -ii- 4 TABLE OF CONTENTS (continued) PAGE SIGNATURES 30 -iii- 5 PART I ITEM 1. BUSINESS GENERAL Geographics, Inc. (the "Company" or "Geographics") was incorporated as a Wyoming corporation on September 20, 1974. The Company is engaged in the development, manufacture, marketing and distribution of specialty paper products, generally made using pre-printed designs, including stationery, business cards, brochures, memo pads and paper cubes. The Company's fiscal year end is March 31. The Company's executive offices and domestic operations are located at 1555 Odell Road, Blaine, Washington 98231, and its telephone number is (360) 332-6711. LATE-FILING; SUBSEQUENT EVENTS & FILINGS The Company has not timely filed all reports required to be filed by it by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, despite the fact that it has been subject to such filing requirements for the past 90 days. INFORMATION SET FORTH IN THIS FORM 10-K GENERALLY COVERS THE COMPANY'S FISCAL YEAR ENDED MARCH 31, 1998 AND MUST ONLY BE READ IN CONJUNCTION WITH THE COMPANY'S MOST RECENT REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. There has been a significant change in the composition of the Company's senior management and the Board of Directors in the past two years. As of March 31, 1997, the Board of Directors of the Company consisted of Mr. Ronald S. Deans, Mr. Mark G. Deans, Mr. R. Scott Deans, Mr. Luis Alberto Morato, Mr. Alan D. Tuck, Jr. and Mr. Robert S. Parker. During the year ended March 31, 1998, Messrs. Mark Deans, Scott Deans, Morato and Tuck resigned from the Board and were replaced by Mr. David P. McCleery and Mr. Raymond P. Maxon. In July 1998, Messrs. Ron Deans, McCleery and Maxon resigned from the Board and were replaced by Richard C. Gockelman, who became the sole director, President and Chief Executive Officer of the Company. In December 1998, Messrs. William T. Graham, C. Joseph Barnette, John F. Kuypers, William S. Hanneman and David C. Lentz were appointed as directors. On April 16, 1999, the Company held a special meeting of shareholders (the "Special Meeting") (the first shareholders' meeting in over two years). At the Special Meeting, the shareholders removed Messrs. Gockelman, Hanneman, Lentz and Kuypers, as Directors, re-elected Messrs. Graham and Barnette as Directors and elected Mr. James L. Dorman as Director. The newly appointed Board of Directors appointed Mr. Dorman as Chairman and Chief Executive Officer and placed Mr. Gockelman, the Company's President, on paid administrative leave. The Company's former directors and officers did not comply with the Company's obligations to timely file its reports under the Securities Exchange Act of 1934, as amended, including the filing of this Annual Report on Form 10-K. None of current directors served on the Board during the fiscal year ended March 31, 1998. Therefore, the information contained in this Annual Report on Form 10-K is based solely upon the Company's books and records and upon the audit report of Moss Adams LLP attached hereto. Although the current Board of Directors believes that the information contained in this Annual Report on Form 10-K is materially accurate, they are unable to independently verify such information. Potential investors should realize that material, subsequent developments with respect to the Company's business, operations and financial condition which have occurred from and after March 31, -1- 6 1998 are more fully described in each of the following reports filed by the Company on or before March 23, 1999: 1. Form 10-Q for the period ending December 31, 1998; 2. Form 10-Q for the period ending September 30, 1998; and 3. Form 10-Q for the period ending June 30, 1998. FORWARD-LOOKING STATEMENTS Statements herein concerning expectations for the future constitute forward-looking statements which are subject to a number of known and unknown risks, uncertainties and other factors which might cause actual results to differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements herein include, but are not limited to, those concerning anticipated growth in the preprint paper market; anticipated growth in the Company's sales; anticipated growth in sales of specialty paper products as a percentage of revenue; the Company's ability to increase its market share within the preprint industry; the ability of the Company to successfully implement price changes for the Company's products when and as needed; trends relating to the Company's profitability and gross profits margins; the ability of the Company to implement or modify its management information system, including its electronic data interchange system, adequate to meet operations requirements in the future and to improve its internal controls; the ability of the Company to refinance its existing revolving credit facility, to identify potential buyers for all or part of its business or to raise additional debt or equity financing sufficient to meet its working capital requirements; and the ability of the Company to continue operations as a going concern. Relevant risks and uncertainties include, but are not limited to, slower than anticipated growth of the preprint papers market; loss of certain key customers; insufficient consumer acceptance of the Company's specialty paper products; unanticipated actions, including price reductions, by the Company's competitors; unanticipated increases in the costs of raw materials used to produce the Company's products; loss of favorable trade credit, supply terms, reliable and immediately available raw material supply and other favorable terms with certain key vendors; greater than expected costs incurred in connection with the implementation of a management information system; failure to realize expected economic efficiencies of the Company's automated production system; the inability to hire and retain key personnel; unexpected increases in the overall costs of production as a result of collective bargaining arrangements; unfavorable determinations of pending lawsuits or disputes; and inability to secure additional working capital when and as needed. Additional risks and uncertainties include those described under "Risk Factors" below and those described from time to time in the Company's other filings with the Securities and Exchange Commission, press releases and other communications. BACKGROUND From its inception in 1974 until fiscal 1991, the Company was engaged exclusively in the manufacture and wholesale marketing of various rub-on and stick-on lettering, stencils, graphics arts products and other signage products. In 1991, the Company began the development of "pre-print" or "specialty" paper products consisting of paper on which photographs or other art images are printed and which is then cut to size. In 1992, the Company introduced its first specialty paper product under the Geopaper brand name. The Company now has several specialty paper products made using Geopaper designs, including stationery, business cards, brochures, memo pads, poster boards and paper cubes which, in North America, are sold primarily to office supply superstores, including Office Depot, and mass market retailers, such as Wal-Mart, and which are also distributed internationally through the -2- 7 Company's subsidiaries in Europe and Australia. The specialty papers group constitutes the Company's principal business, with approximately 78% of the Company's total sales in fiscal year 1998 attributable to sales of Geopaper products. On May 4, 1998, the Company sold substantially all of its assets related to its signage and lettering operating assets to Identity Group, Inc. for aggregate consideration of $16,820,000. Primarily as a result of sales generated by the specialty papers group, the Company experienced growth, with total sales increasing from $6,900,875 from fiscal year 1994 to $24,097,845 for fiscal year 1998, an increase of 246%. Primarily to develop its specialty papers group, the Company made substantial investments to expand facilities, purchase and install automated production equipment and an integrated management information system and enhance administrative and other infrastructure systems. The Company experienced delays and unanticipated additional expenses in the installation of the production equipment and its management information system. Unanticipated expenses relating to problems with the installment of the company's management information systems and operational inefficiencies, together with price reductions for the Company's products and cost increases for certain raw materials, had a negative impact on the Company's gross margins and contributed to a substantial net loss for fiscal year 1998. Since May 1997, the Company has been in default of several financial covenants under its revolving credit facility, the Company's primary source of working capital, and borrowings under the facility have exceeded permitted borrowing base limitations. The existence of these defaults constitutes a default under the Company's mortgage loans and equipment lease facilities. The report of the Company's auditors included in this Form 10-K states that the Company's fiscal year 1998 losses and non-compliance with covenants under its revolving credit facility raise and continue to raise substantial doubt about the Company's ability to continue as a going concern. The Company has been able to successfully negotiate a forbearance agreement with its revolving credit lender. However, a failure by the Company to obtain (a) an increase in borrowing availability under the revolving credit facility, (b) an extension to its forbearance agreement and (c) additional, alternative funds when and as needed to satisfy its working capital requirements may force the Company to curtail operations, seek extended payment terms from its vendors or seek protection under the federal bankruptcy law. See "Risk Factors--Ability to Continue as a Going Concern; Defaults under Credit Facility; Need for Additional Working Capital" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." INDUSTRY The market for preprinted papers ("preprints") includes preprinted cut sheet papers used for letterheads, brochures, flyers and bulletins. Suppliers within the preprint industry also offer combination sets made up of multiple products such as matching letterhead, envelopes and business cards, or software packages that improve ease of use of preprints by the consumer. New designs and a large variety of preprints and related specialty products have been important elements of success and growth for businesses in the preprint market. The preprint market is segmented among two major methods of distribution: retail and direct mail. Within the retail segment of the preprint market there are numerous sub-segments, including office supply superstores, mass market retailers, arts & crafts stores, party stores, specialty paper retailers, and office supply business-to-business retailers. The Company sells its specialty paper -3- 8 products exclusively in the retail segment of the preprint market, primarily to office supply superstores such as Office Depot and Office Max and mass market retailers such as Wal-Mart. Large retailers somewhat dominate the retail segment of the preprint industry, and as such, exert considerable influence over the operations of the relatively smaller suppliers, such as the Company, that service them in the preprint market. Of particular importance are factors such as pricing, monetary requirements for retailer's selling programs (including such expenses as volume rebates and advertising allowances), prompt order turnaround which in turn requires the maintenance of large inventories, and payment terms, including prompt pay discounts and extended and seasonal terms. See "Risk Factors--Competition", "--Maintenance of Large Inventory of Products" and "--Customer Concentrations." Compared to the preprint market, during fiscal year 1998, the market for the Company's lettering and signage products was smaller, more mature, slower-growing and more narrowly focused on the office supply and arts and crafts market. Though the total dollar volume of this market segment is unknown, the Company experienced little or no growth in its lettering and signage revenues over the past five years. PRODUCTS After the sale of its signage and lettering business on May 4, 1998, the Company's product line is specialty papers. SALES BY PRODUCT CATEGORY The percentage of the Company's approximate total sales attributable to each class of product offered by the Company for the last three years is set forth below. AS A PERCENTAGE OF SALES CLASS OF PRODUCT FISCAL YEAR - ---------------- ---------------- 1998 1997 1996 ---- ---- ---- Designer stationaries and specialty papers 75% 67% 71% Lettering, signage, stencil and graphic art products 25% 33% 29% STATED IN U.S. DOLLARS (ROUNDED) CLASS OF PRODUCT FISCAL YEAR - ---------------- -------------------------------------- 1998 1997 1996 ----------- ----------- ------------ Designer stationeries and specialty papers $19,976,920 $14,028,746 $16,075,000 Lettering, signage, stencil and graphic art products $ 6,599,000 $ 6,789,000 $ 6,500,000 -4- 9 SALES/ASSETS BY GEOGRAPHIC LOCATION Financial information relating to foreign and domestic operations and export sales (all foreign sales are export sales) is as follows: CLASS OF PRODUCT FISCAL YEAR - ---------------- ------------------------------------------------ 1998 1997 1996 ------------ ------------- -------------- Sales to Domestic and Foreign Customers United States $17,774,299 $11,637,497 $12,939,098 Canada(1) $ 4,082,664 $ 3,872,621 $ 2,854,935 Europe $ 1,197,192 $ 715,327 $ 281,330 Australia $ 1,043,690 $ 825,697 0 ----------- ------------ -------------- Total $24,097,845 $17,051,142 $16,075,363 =========== ============ ============== Operating profit or (loss): United States (7,261,961) (6,587,756) $ 944,157 Canada(1) (301,179) (473,296) $ 377,328 Europe (489,263) (727,467) $ 65,316 Australia $ 40,684 $ 189,715 0 ------------ -------------- Total (8,011,719) (7,598,804) $ 1,386,801 =========== ============ ============== Identifiable assets: United States $21,677,859 $27,464,715 $24,263,181 Canada(1) $ 1,122,452 $ 940,046 $ 410,060 Europe $ 1,321,662 $ 1,058,046 $ 64,800 Australia $ 1,222,992 $ 782,894 0 ----------- ------------ -------------- Total $25,344,965 $30,245,701 $24,738,041 =========== ============ ============== (1) Effective April 1, 1996, Geographics--Canada succeeded Martin Distribution, Inc. ("Martin Distribution") as the exclusive importer of Geographics products into Canada. Martin Distribution was at the time owned and controlled by one of the Company's then-acting directors. All export sales to Canada in fiscal year 1997 were to Geographics--Canada. All export sales to Canada in fiscal year 1996 and fiscal 1995 were to Martin Distribution. International sales accounted for approximately 20%, 32%, and 26% of the Company's total net sales in fiscal years 1996, 1997 and 1998, respectively. International sales were concentrated in Canada, Europe and Australia. As a result of such international sales, a significant portion of the Company's revenues will be subject to certain risks, including unexpected changes in regulatory requirements, exchange rates, tariffs and other barriers, political and economic instability and other risks. See "--Risk Factors-International Subsidiaries" and "--Risk Factors--Foreign Exchange and International Trade." -5- 10 BUSINESS CONCENTRATIONS Historically, a substantial portion of the Company's sales have been to a limited number of customers. Concentration of sales to the Company's five largest customers is detailed below: CUSTOMER FISCAL YEAR ENDED MARCH 31, - -------- ------------------------------- 1998 1997 1996 --------- --------- --------- Office Depot Inc 31% 31% 40% Office Max Inc 15% 26% 24% Business Depot, Inc(1) 11% 10% 13% United Stationers Inc 3% 0% 0% Wal-Mart Stores, Inc 6% 0% 0% -------- -------- -------- 66% 67% 77% ======== ======== ======== (1) Business Depot, Inc. (Staples of Canada) sales were included in sales of Martin Distribution for 1996 and 1995. The Company expects that sales to relatively few customers will continue to account for a high percentage of its net sales in the foreseeable future and believes that its financial results will continue to depend in significant part upon the success of these few customers. See "Risk Factors--Customer Concentrations." PURCHASING The Company's principal purchases are materials for use in the manufacture of specialty paper. In particular, the Company routinely purchases sheets, rolls and reams of commodity paper, as well as other direct materials involved in the printing and packaging of its Geopaper product lines, such as inks, packaging film, labels, shipping boxes and other materials. Certain of the products used in the manufacture of the Company's products are considered commodities, and as such can vary significantly in cost from time to time. Though prices may vary, the Company has not experienced and does not currently anticipate any market shortages of supply of the specific raw materials that it purchases and uses in the manufacture of its products. The Company's success depends in large part on reliable and uninterrupted supply of raw materials from its major vendors. Although the Company purchases goods from approximately 700 vendors, it historically has practiced a "sole source" approach to vendor selection in that it typically relied on a single vendor for all purchases on its various categories of production materials, and other major categories of purchased goods and services. One key vendor of commodity paper and related products is Unisource Corporation, a broker/vendor from whom a significant portion of the Company's total purchases during the fiscal years 1998 and 1997. Unisource has provided the Company an immediately available and uninterrupted supply of paper. In addition, Unisource and other key vendors have granted the Company significant amounts of trade credit, along with favorable pricing and payment terms. Although the Company may be able to find -6- 11 other sources of supply for commodity paper and other major raw material categories, there can be no assurance that potential new vendors, once sourced, would provide an uninterrupted supply of raw materials or adequate levels of trade credit, competitive prices or acceptable payment terms. See "Risk Factors-Dependence on Key Vendors." DISTRIBUTION The Company sells its products on a wholesale basis primarily to retailers, including office supply superstores, mass market retailers, arts & crafts stores, party stores, specialty paper retailers, and office supply business-to-business catalog retailers. The Company also markets its products to office supply distributors in the U.S. and to distributors in those countries where the Company does not service retailers directly. Historically, the Company has sold a substantial portion of its products to a limited number of retail customers, and the Company believes that this trend can be expected to continue in the future. See "--Business Concentrations" and "Risk Factors-Customer Concentrations." The Company conducts its export operations through three subsidiaries: o Geographics Marketing Canada, Inc. ("Geographics--Canada") was incorporated as a British Columbia, Canada corporation on July 31, 1995, and was established to import the Company's products into Canada and market them to wholesale and retail distribution channels. o Geographics (Europe) Limited ("Geographics--Europe") was incorporated in England on December 12, 1995. The offices of Geographics--Europe are located at 4 Iceni Court, Letchworth, Herts SG6 1TN, England, and its telephone number is 01462-487100. Geographics--Europe was established to import, warehouse, market and distribute the Company's products throughout Europe. o Geographics Australia Pty. Ltd. ("Geographics--Australia") was incorporated in Brisbane, Australia on June 28, 1996. The offices of Geographics--Australia are located at 3/32 Lillian Fowler Place, Marrickville NSW 2204, Australia and its telephone number is 61-2-9519-4488. Geographics--Australia was organized to import, warehouse, market and distribute the Company's products throughout Australia. COMPETITION The Company operates in a highly competitive environment. The Company's designer stationery products compete in most of the Company's markets with Domtar Papers, Great Papers, Action Communications, Inc., Avery Dennison Office Products, First Base, Paper Direct, Inc., American Pad and Paper, Inc., Z-International, Inc., and REDIFORM, Inc. (a division Moore Corp Ltd.). The Company's designer stationery products compete for limited shelf space in the office products superstores, office product stores, mass market stores, contract stationers, wholesalers, office product catalogs and mail order catalogs. The Company believes that its product designs, product quality, merchandising programs, distribution channels, customer service and competitive pricing distinguishes the Company from its competitors. However, many of the Company's competitors are larger, better capitalized and have substantially greater financial, marketing and human resources. In order to remain competitive, the Company may be required to continue to make significant expenditures for capital equipment, sales, service, training and support capabilities, investments in systems, procedures and controls, expansions of operations and research and development, among many other items. Additional financing might be required to fund the Company's investments in those areas. There can be no assurance that additional -7- 12 financing will be available on terms acceptable to the Company, or at all. See "--Risk Factors--Competition" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation--Liquidity and Capital Resources." TRADEMARKS AND COPYRIGHTS The Company maintains twelve registered trademarks in the United States, Canada and Australia and has applied for two additional marks. The Company's trademarks have various expiration dates from 2002 to 2006 in the U.S., expiration dates in 2005 in Canada, and expiration dates in 2011 in Australia. The Company considers consumer awareness of its products and brand names an important factor in creating demand for its products among office supply stores and other existing or prospective customers. Part of the Company's strategy for increasing consumer awareness is to establish consistent brand identity across all of its major product lines. The Company believes that its trademarks and copyrights play an important role in this effort While the Company has made reasonable efforts to protect its intellectual property, including registering them as trademarks and copyrights in the countries where the product lines are marketed, to the extent that such protections are inadequate, the Company could lose all or a part of these rights which, in turn, could result in the diminution of the Company's overall brand identity or individual product line identities. Either the loss of intellectual property rights or the diminution of the Company's brand identities could have a material adverse effect on the Company. See "Risk Factors--Uncertain Protection of Intellectual Property Rights". BACKLOG The Company's backlog of orders as of September 8, 1998 was $2,180,117. The Company expects to fill substantially all of these orders during the second quarter of 1998. The Company includes in backlog the value of all purchase orders received from customers for product not yet shipped and invoiced. Because the Company only recently implemented internal controls necessary to determine backlog, the Company is unable to determine backlog at March 31, 1998 or at the end of any prior period. The Company's backlog is subject is subject to fluctuations as a result of seasonality in the Company's business and other factors and is, therefore, not necessarily indicative of future sales. There can be no assurance that current backlog will necessarily lead to sales in any future period. The Company's inability to ship product with respect to a purchase order could result in cancellation of such purchase order and reduction of backlog and could have a material adverse effect on the Company's business, financial condition and results of operations. SEASONALITY A significant portion of the Company's customer orders are placed between August and October of each year for shipment during the Company's third fiscal quarter, which includes the Christmas season, with the largest levels of sales historically occurring in the second half of the calendar year. As a result, the Company has experienced, and expects to continue experiencing, seasonal fluctuations in its operating results based upon past purchasing patterns. EMPLOYEES At March 31, 1999, the Company had approximately 112 employees, 99 of whom were employed at its headquarters in Blaine, Washington, 6 of whom were employed at the Company's facilities in the -8- 13 United Kingdom, and 7 of whom were employed at the Company's facilities in Australia. As of the date of this Report, none of the Company's employees were subject to a collective bargaining agreement. EQUIPMENT INTEGRATION In 1996 and 1997, the Company purchased an integrated printing line combining a high speed press with a slitter and packaging line. As the system consisted of major components from different manufacturers, an outside firm was retained to perform system integration services. Management does not believe that the system is capable of producing the full scope of product for which its design was intended at this time. Alternative manufacturing techniques have been developed which are currently in place. In addition, an integrated packaging line was also installed in 1996. This line has experienced similar issues with respect to its ability to perform as envisioned, and consequently alternate manufacturing techniques have been employed. Significant resources may be required for modification of these systems in order to achieve the manufacturing efficiencies and cost targets originally envisioned. INVESTIGATION OF FORMER MANAGEMENT In January 1998, the Company's board of directors appointed a special committee to conduct an examination of the performance and conduct of the Company's management (the "Special Committee"). The Special Committee engaged independent counsel to assist with this examination. The focus of the examination has been on the adequacy of documentation related to a number of expenses incurred by Mr. Ronald L. Deans, the Company's former President and Chief Executive Officer, and other members of management which were paid or reimbursed by the Company, whether such expenses were business or personal in nature, the tax reporting and accounting for certain stock option exercises by Mr. Deans and his sons in January 1996, the basis for compliance with the registration requirements of applicable securities laws in connection with three separate issuances of common stock by the Company in 1996 and 1997 and certain other securities-secured mattes. In March 1998, based on the findings of the Special Committee to that point in time, the Special Committee requested that Mr. Deans undertake certain corrective measures and implement certain policies and procedures. Certain of the findings and recommendations of the Special Committee are summarized below. Expenses Based on a review by the accountants hired by independent counsel for the Special Committee of Company records of expenses reimbursed or paid by the Company in 1997, it appears that a substantial portion of the approximately $125,000 of expenses reimbursed or paid by the Company in 1997 for Mr. Deans lacked adequate documentation for tax purposes and/or appeared to be primarily personal in nature. Based on a limited review of Mr. Deans' expense accounts for 1996 by independent counsel, it appears that most of the approximately $150,000 in reimbursed expenses for Mr. Deans in that year also lacked adequate documentation for tax purposes or appeared to be personal expenses. Pending further review of Company records and possible explanation by Mr. Deans, the Special Committee requested that Mr. Deans reimburse the Company $100,000 with respect to 1997 and 1996 and agree to provide further reimbursement to the Company if and to the extent that expenses paid or reimbursed by the Company for him in excess of that amount are later determined not to be deductible for tax purposes. Mr. Deans reviewed certain of his expense records and agreed that certain expenses may not have been properly substantiated and, pending his further review of the remainder of his expense records, he has offered to reimburse the Company $32,000 with respect to 1997 and 1996 by reducing a note payable by the Company to a company affiliated with Mr. Deans. As of the date of this report, the Board of Directors and Mr. Deans have not reached agreement on either the amount to be paid by Mr. Deans or Mr. Deans' -9- 14 proposed method of payment. In addition, to the extent that it is determined that additional expenses were not properly substantiated, Mr. Deans has agreed to reimburse the Company for such additional amounts. The accountants engaged by independent counsel also found that the documentation related to a substantial portion of reimbursed expenses of several other corporate officers is inadequate, and the Special Committee has directed that those employees also reimburse the Company for those expenses that are personal or lack adequate documentation. The new Board of Directors has implemented policies that will insure proper expense reporting in the future. To the extent it is determined that expenses paid or reimbursed by the Company for the benefit of Mr. Deans or any other officer were personal in nature or not adequately documented, such expenses may not be deductible for tax purposes and the Company may owe additional tax, together possibly with interest and penalties, for prior periods in which it otherwise did not incur a loss for tax purposes. In addition, the net income reported by the Company for periods in which the expenses were deducted may have been overstated to the extent of the tax savings realized from the deduction of expenses which are later determined to be nondeductible, if any. Also, unless these expenses are repaid, the amount of income for such individuals reported in prior Securities and Exchange Commission reports may have been understated to the extent such expenses were personal in nature. Due to the volume of transactions and the complexity of the questions involved, it is not possible at this time to quantify such amounts. Stock Option Exercises In January 1996, Mr. Deans, his sons, Scott and Mark Deans, and other Company personnel exercised certain non-qualified stock options to purchase shares of the Company's common stock. The difference between the exercise prices of the options exercised by the Deans the market value of the shares of the Company's common stock issued upon exercise of such options yielded a gain of $1,089,049 in the aggregate as of the date of exercise. Although this gain likely should have been reported for tax purposes as income by the Deans in 1996 and recorded as an expense by the Company in that year, it was not. With respect to these option exercises, the Special Committee has (i) directed Mr. Deans to cause the Company to issue amended 1996 Form W-2s to himself, Mark and Scott Deans to include previously unreported income associated with such exercises and to instruct the Company's tax preparer to seek a deduction for the Company in that amount, and (ii) asked Mr. Deans, Mark Deans and Scott Deans each to include such amounts on amended tax returns for the tax year 1996. Mr. Deans has agreed to instruct the Controller to issue an amended Form W-2 to himself and his sons, and to instruct the Company's accountants to seek the appropriate deduction. Mr. Deans also agreed to include the appropriate income on his tax return and request Mark and Scott Deans to do the same. The deemed gain associated with these options exercises should have been, but was not, reported in the Company's annual report on Form 10-K for the fiscal year ended March 31, 1996. Issuance Of Common Stock In July 1996, October 1997 and November 1997, Mr. Deans caused the Company to issue shares of common stock in three separate transactions. It appears that the Company may not have complied with the registration requirements of federal and state securities laws in connection with such transactions. The Company initially made certain disclosures regarding the 1996 transaction in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1997. If it is determined that these issuances of stock did not comply with an exemption from the registration requirements of applicable securities laws, the Company may be subject to penalties or liability for damages. It is not possible to determine at this time whether the issuance of stock will subject the Company to liability. The Company's management believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's business, financial condition or results of operations. -10- 15 RISK FACTORS PROSPECTIVE INVESTORS ARE STRONGLY CAUTIONED THAT AN INVESTMENT IN THE COMPANY INVOLVES A VERY HIGH DEGREE OF RISK. PROSPECTIVE INVESTORS SHOULD NOT DISMISS, AS "BOILERPLATE" OR "CUSTOMARY," DISCLOSURE OF THE RISK FACTORS SET FORTH BELOW. THE CONTINGENCIES AND OTHER RISKS DISCUSSED BELOW COULD AFFECT THE COMPANY IN WAYS NOT PRESENTLY ANTICIPATED BY ITS MANAGEMENT AND THEREBY HAVE A MATERIAL ADVERSE EFFECT ON THE VALUE OF ITS COMMON STOCK. A CAREFUL REVIEW AND UNDERSTANDING OF EACH OF THE RISK FACTORS SET FORTH BELOW, AS WELL AS THE OTHER INFORMATION CONTAINED IN THIS REPORT IS ESSENTIAL FOR AN INVESTOR SEEKING TO MAKE AN INFORMED DECISION WITH RESPECT TO THE COMPANY. ABILITY TO CONTINUE AS A GOING CONCERN; DEFAULTS UNDER CREDIT FACILITY; NEED FOR ADDITIONAL WORKING CAPITAL As a result of the rapid growth of the Company's specialty papers group, capital expenditures relating to the purchase and installation of an automated production system and a management information system, operating losses and other factors, the Company has required, and continues to require, substantial external working capital. Moreover, subsequent to the end of fiscal year 1998, the Company experienced working capital short-falls which required the Company to delay payments to certain vendors, delay purchases, institute internal cost reduction measures and take other steps to conserve operating capital. At the end of fiscal year 1998, the Company's only available source of working capital consisted of borrowings available under its revolving credit facility. See "Management's Discussion and Analysis of Financial Condition and Results of Operation,--Liquidity and Capital Resources." Since May 1997, the Company has failed to comply with the net worth, debt-to-equity ratios and cash flow coverage ratios under the revolving credit facility, and borrowings under the facility exceeded the permitted borrowing base limitations. The Company's lender has also provided the Company with several mortgage loans and equipment loans, and the existence of the defaults under the revolving credit facility constitutes a default under these other loans. The report of the Company's auditors included in this Report states that the Company's fiscal year 1998 losses and non-compliance with covenants under its revolving credit facility raise substantial doubt about the Company's ability to continue as a going concern. The Company entered into a forbearance agreement with its lender, effective August 31, 1997, pursuant to which the lender agreed to extend the expiration date of the revolving credit facility to October 31, 1997, to increase the $12.0 million commitment by a $300,000 stand-by letter of credit, to permit borrowings of up to $2.25 million in excess of the applicable borrowing base limitation (not to exceed the $12.0 million revolving credit facility commitment) and to forbear from asserting its rights with respect to the Company's non-compliance with the financial covenants as well as the defaults under the Company's mortgage loans and equipment loans. However, on September 12, 1997, the Company was required to request borrowings in excess of the amended borrowing limits in order to meet payroll and other expenses. Although the Company's lender permitted the requested borrowings, it did not formally waive this additional default. The Company is continuing to seek extended payment terms from its vendors, delayed purchases of raw materials, internal cost reduction measures and other steps to conserve operating capital. As a result, the Company's vendors may place the Company on credit hold or take other actions against the Company, including the termination of their relationship with the Company or the initiation of collection proceedings. See "--Dependence on Key Vendors." In addition, the Company will continue to actively pursue additional sources of working capital, which could include the issuance of debt or equity securities or the sale of some or all of the Company's assets. However, at the -11- 16 end of fiscal year 1998, the Company had received no firm commitments with respect to any such transactions and there can be no assurance that any such transaction will be identified. Further, there can be no assurance that the Company will be able to obtain more sources of additional working capital when and as needed or that the terms of any such funding will be acceptable to the Company or in the best long-term interests of the Company's shareholders. The failure to obtain an increase in borrowing availability under, and to extend the expiration date of, the Company's revolving credit facility, or to otherwise obtain sufficient funds when and as needed to satisfy the Company's working capital requirements could force the Company to curtail operations, seek extended payment terms from its vendors or seek protection under the federal bankruptcy laws. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." COMPETITION The Company believes that its product designs, product quality, merchandising programs, distribution channels, customer service and competitive pricing distinguishes the Company from its competitors. However, many of the Company's competitors, particularly in the designer stationery industry, are larger, better capitalized, more established and have substantially greater financial, marketing and human resources. Moreover, the development and manufacture of new designer stationeries and specialty papers are highly capital intensive. In order to remain competitive, the Company may be required to continue to make significant expenditures for capital equipment, sales, service, training and support capabilities, investments in systems, procedures and controls, expansions of operations and research and development, among many other items. Additional financing might be required to fund the Company's investments in those areas. There can be no assurance that additional financing will be available on terms acceptable to the Company, or at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operation--Liquidity and Capital Resources." CUSTOMER CONCENTRATIONS The Company's three largest customers, Office Depot Inc., Office Max, Inc. and Business Depot, Inc., in the aggregate accounted for approximately 55% and 67% of the Company's total sales for fiscal year 1998 and fiscal year 1997, respectively. The Company expects that sales to relatively few customers will continue to account for a high percentage of its net sales in the foreseeable future and believes that its financial results depend in significant part upon the success of a limited number of customers. See "Business Concentrations." Although the composition of the group comprising the Company's largest customers may vary from period to period, the loss of a significant customer or any reduction in orders by any significant customer, including reductions due to market, economic or competitive conditions in the designer stationery or specialty papers industry, would have a material adverse effect on the Company's business, financial condition and results of operations. As a result of the concentration occurring in the office supply industry in which the major office megastores are accounting for a greater percentage of industry-wide sales, it is anticipated that an increasing number of the smaller outlets and retail stores will discontinue operations in the years ahead. While the Company anticipates that certain of such sales will be transferred to the larger megastores to which the Company currently supplies its products, there can be no assurance that any loss of sales to smaller outlets and retail stores will be replaced in this manner. -12- 17 DEPENDENCE ON KEY VENDORS The Company's success depends in large part on reliable and uninterrupted supply of raw materials from its major vendors. Although the Company purchases goods from approximately 700 vendors, it historically practiced a "sole source" approach to vendor selection in that it typically relied on a single vendor for all purchases on its various categories of production materials, and other major categories of purchased goods and services. One key vendor of commodity paper and related products is Unisource, a broker/vendor from whom significant portions of the Company's total purchases during the fiscal years 1998 and 1997. Unisource has provided the Company an immediately available and uninterrupted supply of paper. In addition, Unisource and other key vendors have granted the Company significant amounts of trade credit, along with favorable pricing and payment terms. Although the Company may be able to find other sources of supply for commodity paper and other major raw material categories, there can be no assurance that potential new vendors, once sourced, would provide an uninterrupted supply of raw materials or adequate levels of trade credit, competitive prices or acceptable payment terms. TECHNOLOGY CHANGES AFFECTING PRODUCTS The design and manufacture of production equipment used in the designer stationery and specialties paper industries has undergone and continues to undergo rapid and significant technological change. In particular, developments in the software industry may afford customers and consumers with the ability to produce paper products which offer quality characteristics comparable with that provided by the Company. Any such developments may, therefore, have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company's business is, to a significant degree, dependent on the enhancement of its current products and development of new products. Product development and enhancement involve substantial expenditures and a high degree of risks, and there is no assurance that product development efforts of the Company will be successful, will have sufficient utility or will be superior to efforts by others, including current customers and consumers of the Company's products. There can be no assurances that future technological developments will not render existing or proposed products of the Company uneconomical or obsolete, or that the Company will not be adversely affected by the future development of commercially viable products by others. The development of superior products by others could have a material adverse effect on the Company's business, financial condition or results of operations. UNCERTAIN PROTECTION OF INTELLECTUAL PROPERTY RIGHTS The Company owns a number of trademarks and copyrights, and certain of the Company's proprietary manufacturing processes are protected by trade secrets. There can be no assurance that the Company's trade secrets, trademarks, copyrights or other proprietary rights will be effective in discouraging competition or held valid if subsequently challenged, or that others will not assert rights in, or ownership of, any of such proprietary rights. In addition, there can be no assurance that the actions taken by the Company to protect its proprietary rights will be adequate to prevent imitation of its products, that the Company's proprietary information will not become known to competitors or that others will not independently develop products substantially equivalent or superior to the Company's products without infringing on the Company's proprietary rights. There can be no assurance that any pending trademark application will result in the issuance or a registered trademark. In addition, the laws of certain foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. While the Company has made reasonable efforts to protect all of its trade secrets, trademarks, copyrights and other proprietary rights, to the extent such protections are inadequate, the -13- 18 Company could lose a part or all of these rights which, in turn, could have a material adverse effect on the Company's business, financial condition or results of operations. DELISTING FROM NASDAQ SMALLCAP MARKET AND TORONTO STOCK EXCHANGE The Company's securities were delisted from the NASDAQ National Market and subsequently the NASDAQ Smallcap Market during fiscal 1998. Trading of the Company's securities has continued on the NASDAQ OTC Electronic Bulletin Board. However, the delistings may restrict marketability of the Company's common stock. Further, the Securities and Exchange Commission has adopted regulations which generally define a "penny stock" to be any equity security that has a market price (as defined) of less than $5 per share, subject to certain exceptions. As the Common Stock is not listed on the Nasdaq National Market or the Nasdaq SmallCap Market, it may be deemed to be "penny stock" and thus may be subject to rules that impose additional sales practice requirements on broker/dealers who sell such securities to persons other than established customers and accredited investors. These rules could adversely effect the ability and willingness of broker-dealers to sell the Common Stock, which could reduce the liquidity of the Common Stock and have a material adverse effect on the trading market and the market price for the Common Stock. In addition, the common shares of the company were suspended from trading on The Toronto Stock Exchange on June 11, 1998 due to the failure of the Company to provide the required financial information and filings. Securities suspended from trading on the Toronto Exchange which have not been approved for reinstatement will be automatically delisted after a period of one year. To obtain approval for reinstatement, suspended companies are required to fulfill original listing requirements for new listings. During the term of the suspension, the original listing requirements of The Toronto Stock Exchange were revised and increased. Under these requirements, companies suspended from trading are required to fulfil listing requirements made of new listings. The Company does not currently meet the minimum net worth requirement of Cdn. $7,500,000. However, management expects the Company to be able to meet this requirement following its anticipated private placement of a combination of debt and/or equity in the amount of $3,000,000 to $5,000,000. See "Liquidity and Capital Resources." Consequently, management expects to move forward with a new listing application following completion of the recapitalization efforts referenced above. APPLICABILITY OF RULES RELATING TO LOW-PRICED STOCK The Securities and Exchange Commission has adopted regulations which generally define a "penny stock" to be any equity security that has a market price (as defined) of less than $5 per share, subject to certain exceptions. Unless the Common Stock is listed on the Nasdaq National Market or the Nasdaq SmallCap Market, it will be deemed to be "penny stock" and will continue to be subject to rules that impose additional sales practice requirements on broker/dealers who sell such securities to persons other than established customers and accredited investors. These rules adversely effect the ability and willingness of broker-dealers to sell the Common Stock, which could reduce the liquidity of the Common Stock and have a material adverse effect on the trading market and the market price for the Common Stock. EXISTENCE OF WARRANTS AND OPTIONS AND POSSIBLE DILUTION As of March 31, 1998, there were outstanding warrants for the purchase of an aggregate of 1,342,293 shares of Common Stock at an exercise price of $.77 to $6.50 per share. In addition, as of March 31, 1998, there were outstanding options granted under the Company's stock option plan to purchase up to 173,500 shares of Common Stock at exercise prices ranging from Cdn. $1.00 to Cdn. $4.15 per share. In the event that the outstanding warrants and options are exercised, the holders will be -14- 19 given the opportunity to profit from a rise in the market price of the underlying shares. This may have certain dilutive effects on, and a materially depressive effect on, the market price for the Common Stock. The terms on which the Company could obtain additional capital during the life of such warrants and options may be adversely affected because the holders may be expected to exercise them at a time when the Company might otherwise be able to obtain comparable additional capital in a new offering of securities at a price per share greater than the exercise price of such options and warrants. As a result, the existence and possible exercise of such options or warrants could have a material adverse effect on the Company's ability to raise capital through the sale of its equity securities. FLUCTUATIONS OF QUARTERLY RESULTS; SEASONALITY Management continues to expect that the Company's financial results may vary materially from period to period. Most of the Company's customers order products for immediate delivery. As a result, a substantial amount of the Company's net sales in each quarter results from orders received in that quarter. The Company's net sales and operating results may, therefore, vary significantly as a result of, among other things, volume and timing of orders received during the quarter, variations and sales mix, and delays in production schedules. Accordingly, the Company's historical financial performance is not necessarily a meaningful indicator of future results. Moreover, a significant portion of the Company's customer orders are placed between August and October of each year in anticipation for shipment during the Company's third fiscal quarter (i.e., the Christmas period). As a result, the Company has experienced and is expected to continue to experience seasonal fluctuations in its operating results based on such purchasing patterns. See "--Seasonality." These fluctuations in quarterly operating results could have a material adverse effect on, among other things, the market price for the Company's Common Stock. VOLATILITY OF STOCK PRICE The market price of the Common Stock has been, and is likely to continue to be, volatile. See Market for Registrant's Common Equity and Related Stockholder Matters." The market price of the Common Stock could fluctuate, perhaps substantially, in response to a number of factors, such as actual or anticipated variations in the Company's quarterly operating results, announcements of technological innovations or new products or enhancements by the Company or its competitors, developments in the Company's relationships with its customers or suppliers, changes in the general condition of, or trends in, the designer stationery and specialty paper industry, paper prices, changes in governmental regulations, or changes in securities analysts' estimates of the Company's or its competitors' or industry's, future performance. In addition, in recent years the stock market in general, and the market for shares of small capitalization stocks in particular, including the Company's, have experienced extreme price and volume volatility, which has had a substantial effect on the market prices of securities of many smaller public companies for reasons frequently unrelated to the operating performance of such companies. These broad market fluctuations may have a material adverse effect on the market price of the Common Stock. YEAR 2000 ISSUES The Company uses three principal software packages at its North American production, warehousing and administrative facilities. These include an operating system, an electronic data interchange software and an integrated operations and accounting application package. Of particular importance, the Company's operations and accounting applications were determined to not be Year 2000 ready. Accordingly, the Company is in negotiations to secure a new operating and accounting software package with installation to be scheduled as soon as practicable. The Company estimates that the costs of acquiring and installing this new software package will range between $125,000 and $150,000. -15- 20 The Company continues to evaluate its remaining principle software packages and believes that existing available upgrades will mitigate the risk of significant operational problems. However, the Company has not completed an assessment of its hardware and other systems, including those of vendors, customers and other third parties. Until a complete assessment is completed, the Company is unable to estimate the total expense of assuring that all of its software and hardware are Year 2000 compliant. The Company plans to complete these assessments no later than June 1999. ITEM 2. DESCRIPTION OF PROPERTIES The Company considers its properties to be suitable and adequate for their intended uses for the foreseeable future. These properties consist of the following: Executive Offices And Domestic Facilities The Company's headquarters and manufacturing facility in Blaine, Washington has approximately 96,500 square feet of office, warehouse and manufacturing space located on ten and one-half acres of Company-owned land. The Company's Blaine, Washington facility was increased from 34,000 sq. ft to 49,000 sq. ft in December 1994. The facility was increased to its current size during fiscal year 1996. Other Whatcom County Facilities During 1998 and 1997, the Company also leased 4 additional 10,000 sq. ft. buildings at a business park facility near Ferndale, Washington, each facility on a renewable six month lease of $15,000 per month, triple net. European Facilities In connection with the distribution of the Company's products in Europe, Geographics--Europe leases 6,700 square feet of warehouse space near London, England. The lease requires quarterly lease payments of approximately $13,600, triple net, and expires on February 14, 2006. Australian Facilities In connection with the distribution of the Company's products in Australia, Geographics--Australia leases 5,000 square feet of warehouse space near Brisbane, Australia. The lease requires lease payments of $3,400 per month, triple net (with annual review of the rental rate beginning in August 1997), and expires on August 31, 1999. ITEM 3. LEGAL PROCEEDINGS In its Form 10-Q filed with the Securities and Exchange Commission on April 29, 1998 for the period ending December 31, 1997, the Company reported that in July 1997, three related class actions were filed against it, its then Chairman of the Board, Ronald S. Deans, and its then chief financial officer, Terry A. Fife. These suits alleged that the defendants violated Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. In August 1998, the Company, its insurance carrier and the plaintiffs reached an agreement to settle the lawsuits, which had previously been consolidated as one lawsuit (the "Settlement"). On October 30, 1998, the judge presiding over this lawsuit approved the Settlement. Under the terms of the Settlement, the plaintiffs received a cash payment of $1.6 million without any admission of liability or wrongdoing by the defendants. In light of the defendants' insurance carrier's proposed substantial contribution to any final settlement amount, the Company does -16- 21 not believe that the funding of the settlement will have a material impact on its financial condition or operations. In addition to the litigation matter described above, the Company is subject to additional claims and actions incident to the operation of its business. It is the opinion of management that the ultimate resolution of these matters and any future unidentified claims will not have a material adverse effect on the Company's business, 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 quarter ended March 31, 1998. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF COMMON STOCK The Company's Common Stock began trading on the Nasdaq National Market under the symbol "GGIT" on March 8, 1996. From May 5, 1995 to March 7, 1996 the Company's Common Stock traded on the OTC Bulletin Board under the symbol "GGIT". The following table sets forth the high and low closing bid prices or closing sales prices, as the case may be, of the Common Stock, as reported on the OTC Bulletin Board or the Nasdaq National Market System, as the case may be, for each fiscal quarter beginning with the first fiscal quarter of the fiscal year ended March 31, 1997. 1997 HIGH LOW - ---- ---- --- First Quarter (June 30, 1996) $6.94 $4.75 Second Quarter (September 30, 1996) $5.96 $2.88 Third Quarter (December 31, 1996) $5.38 $2.75 Fourth Quarter (March 31, 1997) $5.25 $3.25 1998 HIGH LOW - ---- ---- --- First Quarter (June 30, 1997) $3.48 $0.88 Second Quarter (September 30, 1997) $1.16 $0.44 Third Quarter (December 31, 1997) $1.00 $0.33 Fourth Quarter (March 31, 1998) $0.63 $0.27 -17- 22 The foregoing quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. As of March 31, 1998, there were approximately 272 holders of record of the Company's Common Stock. DIVIDENDS The Company has not paid dividends at any time during the two fiscal year period ending on March 31, 1998. The Company anticipates that any future earnings will be retained for investment in its business. Any payment of cash dividends in the future will be at the discretion of the Company's Board of Directors and will depend upon, among other things, the Company's earnings, financial condition, capital requirements, extent of indebtedness and contractual restrictions with respect to the payment of dividends. Specifically, the Company's current bank facilities restrict its ability to pay dividends. On April 29, 1999, the Company issued an aggregate of $100,000 in convertible subordinated notes (the "Notes") pursuant to exemption under Section 4(2) of the Securities Act of 1933, as amended. One $50,000 Note was issued to Mr. James L. Dorman, the Company's Chairman of the Board and Chief Executive Officer, and one $50,000 Note was issued to William T. Graham, a Director of the Company. The Notes bear interest at a rate equal to the prime rate (as determined by U.S. Bank National Association ("U.S. Bank")) plus two percent (2%) per annum. The Notes are subordinated to the Company's senior indebtedness to U.S. Bank and are convertible into shares of the Company's common stock at $0.3927 per share. Proceeds from the sale of the Notes were used to fund the Company's operations when the Company had reached its borrowing limit under its credit facilities with U.S. Bank and had no other sources of working capital. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data are derived from the Company's Consolidated Financial Statements for the periods indicated. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's 1998 Consolidated Financial Statements and notes thereto contained elsewhere in this Report. -18- 23 STATEMENT OF OPERATIONS DATA 1994 1995 1996 1997 1998 ------------ ------------ ------------ ------------ ------------ Sales $ 6,901,845 $10,186,136 $16,075,363 $17,051,142 $24,097,845 Cost of sales 4,488,176 5,881,649 10,343,463 16,522,236 21,035,139 Gross margin 2,413,669 4,304,487 5,731,900 528,906 3,062,706 Selling, general and administrative 2,981.861 2,873,476 4,185,331 8,127,710 11,074,425 Amortization of goodwill 479,300 639,067 159,768 -- -- ----------- ----------- ----------- ----------- ----------- Income (loss) from operations (1,047,492) 791,944 1,386,801 (7,598,804) (8,011,719) Other income (expense) 209,521 15,398 130,684 24,907 (38,365) Gain (loss) on sales of property and equipment (12,687) (13,468) (594) (86,048) (159,406) Reserve for impairment on EDP installation-in-progress -- -- (620,759) -- Interest expense (356,060) (457,499) (539,394) (805,079) (1,413,219) ----------- ----------- ----------- ----------- ----------- Income (loss) before provision for income taxes (1,206,718) 336,375 977,497 (9,085,783) (9,622,709) Income tax provision (benefit) 34,800 (411,367) 332,350 (55,972) -- ----------- ----------- ----------- ----------- ----------- Income (loss) From Continuing Operations 1,241,518 747,742 645,147 (9,029,811) (9,622,709) =========== =========== =========== =========== =========== Income (loss) from continuing operations per average common share outstanding $ (0.28) $ 0.16 $ 0.10 $ (0.97) $ (1.00) =========== =========== =========== =========== =========== Income from discontinued operations per average common share outstanding -- -- $ 0.09 $ 0.12 $ 0.10 =========== =========== =========== =========== =========== Income From Discontinued Operations net of income taxes in 1996 of $302,329* 586,877 1,079,510 973,091 Net Income (loss) $(1,241,518) $ 747,742 $ 1,232,024 $(7,950,301) $(8,649,618) Net income (loss) per average common share outstanding $ (0.28) $ 0.16 $ 0.19 $ (0.85) $ (0.90) Weighted average shares outstanding used in computing per share data 4,424,535 4,549,101 6,606,499 9,322,278 9,626,335 * Substantially all sales in years 1995, 1994 were from Lettering Signage. -19- 24 BALANCE SHEET DATA: For the year ended: 1994 1995 1996(1) 1997(1) 1998 ---------- ----------- ----------- ----------- ------------ Working capital $ 869,651 $ 1,836,436 $ 5,886,703 $ 401,550 ($8,795,125) Total assets 6,788,067 10,614,673 24,738,041 30,245,701 25,344,965 Long-term obligations, less current portion 2,484,634 3,319,948 3,690,360 4,322,371 4,853,254 Stockholders' equity 1,471,514 2,803,341 9,989,852 7,917,023 (427,218) (1) Certain amounts for the fiscal year ended March 31, 1996 and 1997 have been reclassified to conform to the current year presentation of the fiscal year ended March 31, 1998 amounts. Such reclassifications had no effect on previously reported earnings or financial position. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated financial statements of the Company and the Notes thereto appearing elsewhere on this Report. RESULTS OF OPERATIONS The following table sets forth the percentages which the items in the Company's consolidated statements of income bear to net sales for the periods indicated: 1998 1997 1996 ------ ------ ------ Net sales 100.0% 100.0% 100.0% Cost of sales 87.3 96.9 64.3 Gross margin 12.7 3.1 35.7 Selling, general and Administrative expenses 45.9 47.7 26.0 Amortization of goodwill -- -- 0.9 Income from operations (33.2) (44.6) 8.6 Other income -- .1 .8 Interest expense (5.9) (4.7) (3.4) Total other income (expense) (6.7) (8.7) (2.5) Income before provision for Income taxes (39.9) (53.3) 6.1 Income tax provision (benefit) -- (.3) 2.1 Income From Discontinued Operations 4.0 6.3 3.6 Net income (35.9) (46.6) 7.7 -20- 25 1998 COMPARED TO 1997 NET SALES. Net sales increased 41.3% to $24,097,845 in fiscal year 1998 from $17,051,142 in fiscal year 1997. This increase was primarily attributable to the continued growth of the Geopaper product line, which offset certain factors in the third and fourth quarters that negatively impacted fiscal year 1998 sales. Revenue growth with respect to the Geopaper product line slowed compared to the two prior years. Geopaper sales increases in 1998 were due primarily to sales for new store openings by Office Depot, and initial shipments of Geopaper products to new customers, including Wal-Mart, Target and Kmart. In addition, Geopaper sales increased due to the introduction of the Geoposterboard product line in over 900 Wal-Mart stores, 500 Office Depot stores in the United States and Canada, and 80 Staples/Business Depot stores in Canada. The shift in the Company's sales mix toward Geopaper and related products continued in fiscal year 1998. In 1998, the percentage of total Company sales represented by Geopaper increased to 78%, compared to 71% of total sales in fiscal year 1997, while signage and lettering sales declined to 22% of total sales. In fiscal year 1997, the sales mix of signage and lettering was 29% of sales. Sales for signage and lettering products are not presented with net sales in the Statement of Operations, but are included in discontinued operations, which is discussed later in this section. GROSS MARGIN. Cost of sales includes product manufacturing costs, occupancy and distribution costs. Gross profit as a percentage of sales increased to 12.7% in fiscal year 1998, from 3.1% in fiscal year 1997. The higher gross margin is primarily attributable to an increase in selling prices for the Company's paper products coupled with modest cost decreases and a continuing shift in mix of sales to higher margin products SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses ("SG&A") are those expenses that are incurred to support the Company's selling, marketing and manufacturing efforts. SG&A expenses increased to $11,074,425 (45.9% of sales) in fiscal year 1998 from $8,127,710 (47.7% of sales) in fiscal year 1997. The SG&A expense for fiscal year 1998 was attributable to an increase in advertising rebates and other rebates and promotions to customers, and increases in salaries and wages of administrative, and sales & marketing personnel and an increase in legal expenses incurred by the Company. INCOME/LOSS FROM OPERATIONS. The Company incurred a loss from operations in fiscal year 1998 of $8,011,719 compared to an operating loss of $7,598,804 during fiscal year 1997. The operating loss was the result of higher gross margins more than offset by significantly higher sales, general and administrative expenses. OTHER INCOME (EXPENSE). There was no other income in fiscal year 1998 compared to $24,907 in fiscal year 1997. In previous years, this category included such items such as management fees, foreign exchange gains, gains on disposition of fixed assets, and other miscellaneous items. INTEREST EXPENSE. Interest expense increased to $1,413,219 (5.9% of sales) during fiscal year 1998, compared to $805,079 (4.7% of sales) during fiscal year 1997. The higher interest costs were caused by increased average borrowings to support the Company's operating losses, and the acquisition of equipment used in the manufacture of Geopaper in 1998 and 1997. INCOME/LOSS BEFORE PROVISION FOR INCOME TAXES. The loss before provision for income taxes was $9,622,709 (39.9% of sales) in fiscal year 1998 compared to the loss before provision for -21- 26 income taxes of $9,085,783 (53.3% of sales) in fiscal year 1997. The 1998 loss before provision for income taxes was primarily the result of the Company's operating losses and increased interest expense. The Company did not recognize a tax benefit resulting from its loss from continuing operations in 1998 because of uncertainty concerning the use of this loss to reduce future taxes. A portion of the loss was used to reduce taxes that would have been attributable to income from discontinued operations. The amount of taxes eliminated on discontinued operations was estimated to be approximately $330,000. As of March 31, 1998, the total deferred tax assets estimated to be available to the Company were $5,801,000 which had been reduced in their entirety by a valuation allowance. DISCONTINUED OPERATIONS. On May 4, 1998, the Company sold substantially all of its signage and lettering operating assets, licenses, inventory and other rights to a corporation for total consideration of $6,820,000. Signage and lettering net sales for fiscal year 1998 decreased 3% to approximately $6,598,000 from $6,789,000 in fiscal year 1997. The decline in the sales of the signage and lettering product lines was attributable to a general decline in the demand for products of this type and increased management attention on the development of the specialty papers group. Management believes that sales of signage and lettering products will continue to decline in the future as the computerization of homes and offices will allow the efficient production of lettering and signage products by current end-users. NET INCOME/LOSS. Net loss of $8,649,618 in fiscal year 1998, or 35.9% of sales, compares to net income of $7,950,301 in fiscal year 1997, 46.6% of sales. 1997 COMPARED TO 1996 NET SALES. Net sales increased 6.1% to $17,051,142 in fiscal year 1997 from $16,075,363 in fiscal year 1996. This increase was primarily attributable to the acceptance of the Geopaper product line. Geopaper experienced a sales increase of 665% in fiscal year 1996 to $16,075,363 compared to $2,100,000 for fiscal 1995. Geopaper sales increases in fiscal year 1996 were due to shipments of Geopaper products to all Office Depot Inc. and OfficeMax stores in North America, as well as shipments of Geopaper products to 248 Wal-Mart stores in March 1996. Signage and lettering sales for fiscal year 1997 increased 4% to $6,789,364 from $6,538,272 in fiscal year 1996. The majority of the increase in signage and lettering sales was due to increased sales to OfficeMax. The sales mix of Geopaper products remained unchanged in fiscal year 1997 and 1996. Lettering and signage sales also remained unchanged for the same periods. GROSS MARGIN. Gross margin as a percentage of sales decreased to 3.1% in fiscal year 1997, from 35.7% in fiscal year 1996. The decrease in the gross margin was the result of a change in sales mix to products with lower gross margins. Geopaper represented 71% of sales while lettering and signage represented 29% of sales in 1997, compared to 71% and 29% of sales in 1996, respectively. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses increased in fiscal year 1997 to $8,127,710 (47.7% of sales) from $4,185,331 (26.0% of sales) in fiscal year 1996. AMORTIZATION OF GOODWILL. Goodwill amortization declined to $0 from $159,768 (.98% of sales) for fiscal years 1997 and 1996 respectively. The decrease was due to the completion of the amortization of the goodwill related to the 1993 purchase of the lettering division of E-Z Industries. -22- 27 INCOME FROM OPERATIONS. Income from operations decreased to $(7,598,804) (44.6% of sales) during fiscal year 1997, a decrease from $1,386,801 (8.6% of sales) in fiscal year 1996. OTHER INCOME. Other income was $24,907 (0.14% of sales) in fiscal year 1997, compared to $130,684 (0.8% of sales) during fiscal year 1996. INTEREST EXPENSE. Interest expense increased to $805,079 (4.7% of sales) during fiscal year 1997, compared to $539,394 (3.4% of sales) for fiscal year 1996. The acquisition of equipment used in the manufacture of Geopaper, in addition to higher bank debt related to facilities expansion and working capital requirements resulted in higher interest costs during fiscal year 1997. INCOME BEFORE PROVISION FOR INCOME TAXES. Income before provision for income taxes declined to $(9,085,783) (53.2% of sales) in fiscal year 1997 compared to $977,497 (6.1% of sales) in fiscal year 1996. INCOME TAX PROVISION/BENEFIT. There is no ITP in fiscal year 1998. In fiscal year 1997, the Company recorded a current income tax benefit of $55,972, which represents the amount of income tax recoverable from net operating loss carry-backs. The total potential income tax benefit for fiscal year 1997, and corresponding increase in the Company's deferred tax asset as of March 31, 1997, was an estimated $3,162,000. The total potential deferred tax asset (before valuation allowance) as of March 31, 1997 was $3,774,000. Based on the Company's current operating income and available projections for operating income, the Company determined that future operating and taxable income may not be sufficient to fully or partially recognize the deferred tax asset of $3,774,000 at March 31, 1997. As a result, the Company decided to provide a valuation allowance on all of its deferred tax assets at March 31, 1997. This valuation analysis was recorded in the fourth quarter and totaled $3,774,000. The income tax provision in fiscal year 1996 was 2.1% of sales in fiscal year 1996. This provision was 34% of pre-tax net income. NET INCOME. Net income of $(7,950,301) in fiscal year 1997 (46.6% of sales) compares to net income of $1,232,024 in fiscal year 1996 (7.7% of sales). LIQUIDITY AND CAPITAL RESOURCES As a result of the rapid growth of the Company's specialty papers group, capital expenditures relating to the purchase and installation of an automated production system and a management information system, operating losses and other factors, the Company has required, and continues to require, substantial external working capital. The Company has experienced working capital shortfalls, which have required the Company to delay payments to certain vendors, institute internal cost reduction measures and take other steps to conserve operating capital. During fiscal 1999, operating losses totaled $3,347,175, and the Company experienced positive operating cash flows of $8,297,015. At the date of this Report, the Company's only available source of working capital consisted of borrowings available under its revolving credit facility. The revolving credit facility permits borrowings of up to $5.5 million subject to a borrowing base limitation of 70% of the value of the Company's eligible accounts and 55% of the value of its inventory, net of certain reserves. Borrowings under the facility bear interest at the prime rate and are secured by substantially all of the Company's assets. Under the terms of the facility, the Company is required to comply with a number of financial covenants relating to, among other things, the maintenance of minimum net worth, debt-to-equity ratios and cash flow coverage ratios. Since May 1997, borrowings under the Company's revolving credit facility exceeded the permitted borrowing limitations. In addition, the Company has failed to comply with the net worth, debt- -23- 28 to-equity ratios and cash flow coverage ratios under the revolving credit facility. The Company's lender has also provided the Company with several mortgage loans and equipment loans, and the existence of the defaults under the revolving credit facility constitutes default under these other loans. The report of the Company's auditors included in this Report states that the Company's fiscal 1999 and 1998 losses and non-compliance with covenants under its revolving credit facility raise substantial doubt about the Company's ability to continue as a going concern. In May of 1999, the Company secured agreement from its principal lender, U.S. Bank, to extend the fifth forbearance agreement until June 30, 1999. Further, an extension of credit over and above the borrowing base in the amount of $750,000 has been granted. Discussions with alternate lenders are currently under way. It is management's intention to restructure all debt to terms that are consistent with the Company's cash flow, and to raise $3,000,000 to $5,000,000 of debt, equity, or a combination of both via private placement offering for recapitalization of the Company. The failure to obtain an increase in borrowing availability under, and to extend the expiration date of, the revolving credit facility, or to otherwise obtain sufficient funds when and as needed to satisfy its working capital requirements could force the Company to curtail operations, seek extended payment terms from its vendors or seek protection under the federal bankruptcy laws. See "Item 1. Business--Risk Factors--Ability to Continue as a Going Concern; Defaults under Credit Facility; Need for Additional Working Capital." ITEM 8. FINANCIAL STATEMENTS The following consolidated financial statements of Geographics, Inc. are incorporated into this Item 8 by reference to another section of this Report as follows: (a) Report of Moss Adams LLP regarding Financial Statements F-1 (b) Consolidated Balance Sheets as of March 31, 1998 and 1997 F-2 (c) Consolidated Statements of Income for the years ended March 31, 1998, 1997 and 1996 F-3 (d) Consolidated Statements of Stockholders' Equity for the years ended March 31, 1998, 1997 and 1996 F-4 (e) Consolidated Statements of Cash Flows for the years ended March 31, 1998, 1997 and 1996 F-5 (f) Notes to Consolidated Financial Statements F-8 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. -24- 29 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets for the names, ages and positions with the Company of the executive officers and directors of the Company as of May 24, 1999. None of the current directors were directors during the year ended March 31, 1998. Directors are elected for one year terms or until their successors are elected and qualified. Officers are elected by the Board and their terms of office are at the discretion of the Board. NAME AGE POSITION - ---- --- ------------------------------------------------------- James L. Dorman 66 Chairman of the Board of Directors and Chief Executive Officer William T. Graham 74 Director C. Joseph Barnette 57 Director James L. Dorman is the Chairman and Chief Executive Officer Chairman of the Board of Intercontinental Trading, Ltd., a position he has held President and Chief Executive Officer since 1984. Intercontinental Trading specializes in assisting smaller companies with importing and exporting issues. In addition, Mr. Dorman is the Chairman and Chief Executive Officer of Amalga Composites, Inc., a position he has held since 1989. Amalga designs, engineers and manufacturers composite components parts. Mr. Dorman is also a stockholder, director and officer of Panint Electric Ltd. of Hong Kong, a developer and manufacturer of consumer home products. William T. Graham was a shareholder, officer and director and co-founder of Uniek, Inc. from 1987 until July 1998. Uniek is engaged in the business of crafts, photo frames and photo albums which are distributed to the mass market and office superstores. Mr. Graham sold his interest in Uniek in July, 1998. In 1949, Mr. Graham founded W.T. Rogers, Inc. ("W.T. Rogers"). Under Mr. Graham's leadership, W.T. Rogers became a leading manufacturer and supplier of office products to mass market retailers and office superstores. In 1990, the year before W.T. Rogers was merged with a wholly-owned subsidiary of Newell, Inc., its sales had reached $45,000,000 annually. C. Joseph Barnette is the co-founder and President of Kent Adhesive Products Company ("KAPCO"), a privately held adhesive products company, a position he has held since KAPCO's beginning in 1972. BOARD AND COMMITTEE MEETINGS During the fiscal year ended March 31, 1998, there were two meetings of the Board. Each of the incumbent directors attended at least 75% of the meetings of the Board. As of the end of the fiscal year ended March 31, 1998, the Company had established two standing committees of the Board: an Audit Committee and a Compensation Committee. The Audit Committee's function is to make recommendations concerning the effectiveness of the Company's internal auditing methods and procedures, to determine through discussions with independent auditors whether any limitations or restrictions have been placed upon them connection with either the scope of the audit or its implementation, review the Company's financial statements and related notes with the auditors to ensure that the statements and notes fully disclose all material facts of the Company, and to recommend approval or non-approval of such financial statements and related notes. The Audit -25- 30 Committee met one time during the fiscal year ended March 31, 1998, with all members attending such meeting. The Compensation Committee's function is to monitor and make recommendations with respect to compensation of senior officers, as well as the granting of stock options and stock awards. The Compensation Committee met one time during the fiscal year ended 1998, with all members attending such meeting. No Compensation Committee report is included since the members of the Compensation Committee during the year ended March 31, 1998 are no longer directors of the Company. BOARD INTERLOCKS AND INSIDER PARTICIPATION During the year ended March 31, 1998, Ronald S. Deans served as a member of the Compensation Committee. During that fiscal year, Mr. Deans was the President, Chief Executive Officer, Chief Financial Officer and Secretary of the Company and the Chairman of the Company's Board of Directors. Mr. Deans is also the father of Mark G. Deans and R. Scott Deans, former Executive Vice President--Sales and Marketing and Executive Vice President--Operations, respectively, of the Company. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires the Company's directors, certain officers and persons who own more than ten percent (10%) of the Company's outstanding Common Stock ("Reporting Persons") to file with the Securities and Exchange Commission (the "Commission") initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Reporting Persons are required by Commission regulations to furnish the Company with copies of all Section 16(a) reports. To the Company's knowledge, based solely on its review of copies of all Section 16(a) reports furnished to the Company and written representations that no other reports were required, all Section 16(a) filing requirements applicable to the Company's directors and officers were complied with during the fiscal year ended March 31, 1998. ITEM 11. EXECUTIVE COMPENSATION The following table shows compensation paid by the Company for services rendered during its fiscal years ended March 31, 1996, 1997 and 1998 to (a) the Company's Chief Executive Officer and (b) the two most highly compensated individuals (other than the Chief Executive Officer) who were serving as executive officers of the Company at March 31, 1998 and whose total annual salary and bonus for the fiscal year ended March 31, 1998 exceeded $100,000 (collectively, the "Named Executive Officers"). None of the current directors or executive officer was an executive officer during these periods. -26- 31 SUMMARY COMPENSATION TABLE ANNUAL COMPENSATION LONG-TERM -------------------------- COMPENSATIONS AWARDS SECURITIES NAME AND PRINCIPAL UNDERLYING ALL OTHER POSITION YEAR SALARY BONUS OPTIONS(#) COMPENSATION(1) - -------------------- ---- ---------- -------------- -------------------- --------------- Ronald S. Deans, 1998 $264,018 $ 0 0 $5,559 Chairman, President 1997 $275,000 86,379 0 -- & CEO 1996 $234,000 87,629 30,0000 -- Mark G. Deans Executive Vice 1998 $130,738 $ 0 0 $ 674 President-Sales and 1997 $149,903 $29,531 0 -- Marketing 1996 $111,694 $28,184 32,000 -- R. Scott Deans 1998 $124,969 $ 0 0 $ 674 Executive Vice 1997 $149,221 $29,531 0 -- President-Operations 1996 $111,694 $28,184 32,000 -- (1) The amount reported for Ronald S. Deans includes $4,680 life insurance premium paid by the Company on Mr. Deans' behalf. All other amounts reflected in the column reflect 401(k) matching amounts paid by the Company. The Company matches employee 401(k) contributions with Common Stock. STOCK OPTION GRANTS AND EXERCISES The Company did not grant any stock options during the fiscal year ended March 31, 1998. In addition, none of the Named Executive Officers exercised any stock options held by any of them during the fiscal year ended March 31, 1998. DIRECTOR COMPENSATION The Company pays each director a fee of $500 per month plus $750 for each meeting of the Company's Board of Directors attended. Directors are entitled to reimbursement for reasonable travel and other out-of-pocket expenses incurred in connection with attendance of meetings of the Company's Board of Directors. EMPLOYMENT AGREEMENTS The Company had no written employment agreements with any of its directors or officers as of March 31, 1998. ITEM 12. STOCK OWNERSHIP OF MANAGEMENT AND CERTAIN OTHER HOLDERS The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as May 21, 1999 with respect to (i) each shareholder known by the Company to be the beneficial owner of more than five percent (5%) of the outstanding Common Stock; (ii) each -27- 32 director of the Company; (iii) each of the Named Executive Officers; and (iv) all current directors and executive officers as a group. Unless otherwise noted, the Company believes that the beneficial owners of the Common Stock listed below have sole investment and voting power with respect to such shares, subject to community property laws where applicable. This table is based upon information supplied to the Company by directors, officers, and principal shareholders. NUMBER OF SHARES PERCENT NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED OWNED - ------------------------------------------------- ------------------ ------- Dean Family Limited Partnership (1) 8373 Semiahmoo Drive Blaine, WA 98230 1,225,537 12.5% Fidel Garcia Carrancedo (2) c/o Geographics, Inc. 1555 Odell Road Blaine, WA 98231 1,001,968 10.2% Wellington Management Company LLP (3) 75 State Street Boston, MA 02109 780,000 7.9% William T. Graham (4) 4918 Femrite Drive Madison, WI 53716 446,678 4.5% James L. Dorman (5) c/o Geographics, Inc. 1555 Odell Road Blaine, WA 98231 510,011 4.9% C. Joseph Barnette 1000 Cherry St. Kent, OH 44240-7520 0 * Total Executive Officers and Directors as a Group (3 persons) (6) 956,689 9.1% 1) The Deans Family Limited Partnership has not filed a Schedule 13D or Schedule 13G with respect to its holdings. The share ownership of The Deans Family Limited Partnership is based solely upon information previously provided to the Company, and the Company is unable to independently verify such information. The Company had been previously informed that these shares are held for the benefit of Ronald S. Deans, Mark G. Deans and R. Scott Deans. Ronald Deans was the Company's former Chief Executive Officer. Mark Deans and Scott Deans are former officers of the Company. (2) Fidel Garcia Carrancedo has not filed a recent Schedule 13D or Schedule 13G with respect to his holdings. The share ownership of Fidel Garcia Carrancedo is based solely upon information previously provided to the Company, and the Company is unable to independently verify this information. -28- 33 (3) This information is based on a report on Schedule 13G dated February 9, 1999 (the "Schedule 13G") filed by Wellington Management Company LLP. Based on the Schedule 13G, these shares are held of record by clients of Wellington Management LLP. Such clients have the power to receive, or the power to direct the receipt of, dividends from, or the proceeds from the sale of, such shares. Based upon the Schedule 13G, no client of Wellington Management Company LLP is known to have such right or power with respect to more than 5% of the shares. (4) Includes 126,678 shares of Common Stock issuable upon conversion of the $50,000 Convertible Subordinated Note. See "Certain Relationships and Related Transactions." (5) Consists of currently exercisable options to purchase 327,778 shares of Common Stock, options that become exercisable within 60 days to purchase 55,555 shares of Common Stock and 126,678 shares of Common Stock issuable upon conversion of the $50,000 Convertible Subordinated Note. See "Certain Relationships and Related Transactions." (6) Includes currently exerciable options to purchase 327,778 shares of Common Stock options that became exercisable within 60 days to purchase 55,555 shares of Common Stock and 253,356 shares of Common Stock issuable upon conversion of the two $50,000 Convertible Subordinated Notes. See "Certain Relationships and Related Transactions." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K A. List of documents are filed as part of this Report: 1. FINANCIAL STATEMENTS (a) Report of Moss Adams LLP regarding Financial Statements (b) Consolidated Balance Sheets as of March 31, 1998 and 1997 (c) Consolidated Statements of Operations for the years ended March 31, 1998, 1997 and 1996 (d) Consolidated Statements of Stockholders' Equity for the years ended March 31, 1998, 1997 and 1996 (e) Consolidated Statements of Cash Flows for the years ended March 31, 1998, 1997 and 1996 (f) Notes to Consolidated Financial Statements All other schedules have been omitted because the required information is included in the financial statements or the notes thereto, or is not applicable or required. -29- 34 2. EXHIBITS FILED AS PART OF THIS REPORT EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - -------------- ----------------------- 3.1 Restated Articles of Incorporation of Geographics, Inc. (incorporated by reference to Exhibit 3.1 to the Registration Statement on Form 10, as amended, filed on September 12, 1995). 3.2 Restated Bylaws of Geographics, Inc. (incorporated by reference to Exhibit 3.2 to the Registration Statement on Form 10, as amended, filed on September 12, 1995). 10.1 Business Loan Agreement, dated as of February 13, 1996 (the "Loan Agreement"), between Geographics, Inc. and U.S. Bank of Washington, N.A. (incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.2 Promissory Note, dated February 13, 1996, made by Geographics, Inc. payable to U.S. Bank of Washington, N.A., pursuant to the Loan Agreement (incorporated by reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.3 Loan and Security Agreement, dated as of July 10, 1992, between Geographics, Inc. and U.S. Bank of Washington, N.A. (incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.4 Master Equipment Lease Agreement, dated as of May 22, 1996 (the "Master Lease"), between Geographics, Inc. and KeyCorp Leasing Ltd. (incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.5 Subordination Agreement, dated as of May 22, 1996, among U.S. Bank of Washington, N.A., c/o U.S. Bancorp Mortgage Company and KeyCorp Leasing Ltd. (incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.6 Equipment Schedule No. 4 to the Master Lease, dated as of December 4, 1996, between Geographics, Inc. and KeyCorp Leasing Ltd. (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.7 Equipment Schedule No. 4 to the Master Lease, dated as of May 23, 1997, between Geographics, Inc. and KeyCorp Leasing Ltd. (incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). -30- 35 10.8 Agreement for Sale of Business, dated November 26, 1996, between Geographics, Inc. and Graham's Graphics Pty. Ltd. (incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.9 Form of Stock Option Agreement relating to options granted by Geographics, Inc. prior to the adoption of the Geographics, Inc. 1996 Stock Option Plan (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.10 Geographics, Inc. 1996 Stock Option Plan (incorporated by reference to Exhibit 4(a) to the Company's Registration Statement on Form S-8 filed on November 26, 1996). 10.11 Form of Stock Option Agreements issued pursuant to the Geographics, Inc. 1996 Stock Option Plan (incorporated by reference to Exhibit 4(b) to the Company's Registration Statement on Form S-8 filed on November 26, 1996). 10.12 Form of Subscription Agreement (the "Subscription Agreement") between Geographics, Inc. and each of the persons participating in a private placement of units consisting of common stock and warrants completed in May 1996 (the "Private Placement") (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.13 Warrant Indenture, dated as of February 4, 1997 (the "Warrant Agreement") between Geographics, Inc. and Montreal Trust Company of Canada relating to the warrants issued in the Private Placement (incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.14 Form of Warrant to Purchase Common Stock issued in the Private Placement pursuant to the Warrant Agreement (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.15 Form of Registration Rights Agreement between Geographics, Inc. and each purchaser of units sold in the Private Placement (incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended March 31, 1997). 10.16 Financial Advisory Agreement, dated August 6, 1997, between Geographics, Inc. and Cruttenden Roth, Incorporated (incorporated by reference to Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997). -31- 36 10.17 Subscription Agreement, dated October 9, 1997, between Geographics, Inc. and First Prudential Investment Fund, Inc. (incorporated by reference to Exhibit 10.17 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997). 10.18 Amended and Restated Asset Purchase Agreement by and among Geographics, Inc., Identity Group, Inc., and U.S. Bank National Association, dated May 4, 1998 (incorporated by reference to Exhibit 10.18 to the Company's Report on Form 8-K filed on June 29, 1998). 10.19 Escrow Agreement by and among Geographics, Inc., Identity Group, Inc., U.S. Bank National Association and Lawyers Title Insurance Corporation, dated May 4, 1998 (incorporated by reference to Exhibit 10.19 to the Company's Report on Form 8-K filed on June 29, 1998). 10.20 Third Forbearance Agreement, between U.S. Bank, N.A. and Geographics, Inc., dated May 1, 1998 (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998). 10.21 Fourth Forbearance Agreement, between U.S. Bank, N.A. and Geographics, Inc., dated November 1, 1998 (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1998). 10.22 Convertible Subordinated Note between Geographics, Inc. and James L. Dorman, dated April 29, 1999, filed herewith. 10.23 Convertible Subordinated Note between Geographics, Inc. and William T. Graham, dated April 29, 1999, filed herewith. 11.1 Statement regarding computation of per share earnings. 21.1 List of the subsidiaries of Geographics, Inc. 23.1 Consent of Moss Adams LLP. 27.1 Financial Data Schedule. B. No Current Reports on Form 8-K were filed during the quarter ended March 31, 1999. -32- 37 SIGNATURES 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 the date indicated. 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 9th day of June, 1999. GEOGRAPHICS, INC. By: /s/ James L. Dorman ------------------- James L. Dorman 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 the date indicated. /s/ James L. Dorman -------------------- James L. Dorman Chief Executive Officer and Chairman of the Board /s/ William T. Graham -------------------- William T. Graham Director /s/ C. Joseph Barnette -------------------- C. Joseph Barnette Director -33- 38 GEOGRAPHICS, INC. TABLE OF CONTENTS MARCH 31, 1998, 1997 AND 1996 PAGE ---- INDEPENDENT AUDITOR'S REPORT. . . . . . . . . . . . . . . . . F-1 CONSOLIDATED FINANCIAL STATEMENTS Balance Sheet . . . . . . . . . . . . . . . . . . . . . . F-2 Statement of Operations . . . . . . . . . . . . . . . . . F-3 Statement of Stockholders' Equity (Deficit) . . . . . . . F-4 Statement of Cash Flows . . . . . . . . . . . . . . . . . F-5 Notes to Financial Statements. . . . . . . . . . . . . . . F- 39 INDEPENDENT AUDITOR'S REPORT To the Stockholders Geographics, Inc. We have audited the accompanying consolidated balance sheets of Geographics, Inc. as of March 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the years ended March 31, 1998, 1997 and 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 consolidated financial statements referred to above, present fairly in all material respects, the consolidated financial position of Geographics, Inc. as of March 31, 1998 and 1997 and the consolidated results of its operations and its cash flows for each of the years ended March 31, 1998, 1997 and 1996 in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 15 to the financial statements, the Company has incurred substantial losses in 1998 and 1997 and is out of compliance with its borrowing agreements, which raise substantial doubt about its ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Bellingham, Washington September 22, 1998 F-1 40 GEOGRAPHICS, INC. CONSOLIDATED BALANCE SHEET MARCH 31, 1998 AND 1997 ASSETS 1998 1997 ----------- ----------- CURRENT ASSETS Cash $316,078 $408,757 Accounts receivable Trade receivables, net of allowance for doubtful accounts, sales returns and cash discounts of $930,958 in 1998 and $814,841 in 1997 4,164,861 6,654,500 Other receivables 148,050 993,243 Inventory, net of allowance for obsolete inventory of $586,000 in 1998 and $1,290,000 in 1997 6,763,508 9,457,874 Prepaid expenses, deposits, and other current assets 731,307 893,483 ----------- ----------- Total current assets 12,123,804 18,407,857 PROPERTY, PLANT AND EQUIPMENT, net 12,881,118 10,832,231 OTHER ASSETS 340,043 1,005,613 ----------- ----------- TOTAL ASSETS $25,344,965 $30,245,701 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES Bank overdrafts $301,716 $467,446 Note payable to bank 11,300,808 8,649,390 Accounts payable 3,285,467 2,421,768 Accrued liabilities 2,680,594 2,145,030 Note payable to officer/director - 850,000 Current portion of long-term debt 3,350,344 3,472,674 ---------- ---------- Total current liabilities 20,918,929 18,006,307 LONG-TERM DEBT 4,853,254 4,322,371 ---------- ---------- Total liabilities 25,772,183 22,328,678 ---------- ---------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY (DEFICIT) No par common stock - 100,000,000 authorized, 9,857,252 and 9,467,877 issued and outstanding in 1998 and 1997, respectively 15,769,018 15,574,018 Foreign currency translation adjustment 33,899 (76,478) Accumulated deficit (16,230,135) (7,580,517) ----------- ----------- Total stockholders' equity (deficit) (427,218) 7,917,023 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $25,344,965 $30,245,701 =========== =========== F-2 41 GEOGRAPHICS, INC. CONSOLIDATED STATEMENT OF OPERATIONS YEARS ENDED MARCH 31, 1998, 1997 AND 1996 1998 1997 1996 ----------- ----------- -------------- SALES Wholesale sales $24,097,845 $17,051,142 $13,220,428 Related party sales - - 2,854,935 ------------ ------------ ------------- Total sales 24,097,845 17,051,142 16,075,363 COST OF SALES 21,035,139 16,522,236 10,343,463 ------------ ------------ ------------- Gross margin 3,062,706 528,906 5,731,900 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 11,074,425 8,127,710 4,185,331 AMORTIZATION OF GOODWILL - - 159,768 ------------ ------------ ------------- Income (loss) from operations (8,011,719) (7,598,804) 1,386,801 ------------ ------------ ------------- OTHER INCOME (EXPENSE) Other income - 24,907 130,684 Miscellaneous expense (38,365) - - Loss on sales of property and equipment (159,406) (86,048) (594) Reserve for impairment on EDP installation-in-progress - (620,759) - Interest expense (1,413,219) (805,079) (539,394) ------------ ------------ ------------- Total other income (expense) (1,610,990) (1,486,979) (409,304) ------------ ------------ ------------- INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (9,622,709) (9,085,783) 977,497 INCOME TAX PROVISION (BENEFIT) - (55,972) 332,350 ------------ ------------ ------------- NET INCOME (LOSS) FROM CONTINUING OPERATIONS (9,622,709) (9,029,811) 645,147 INCOME FROM DISCONTINUED OPERATIONS, net of income taxes in 1996 of $302,329 973,091 1,079,510 586,877 ------------ ------------ ------------- NET INCOME (LOSS) $(8,649,618) $(7,950,301) $ 1,232,024 ============ ============ ============= BASIC EARNINGS PER SHARE Income (loss) from continuing operations $(1.00) $(0.97) $ 0.10 ============ ============ ============= Discontinued operations $0.10 $0.12 $ 0.09 ============ ============ ============= Net income (loss) $(0.90) $(0.85) $ 0.19 ============ ============ ============= DILUTED EARNINGS PER SHARE Income (loss) from continuing operations $(1.00) $(0.97) $ 0.09 ============ ============ ============= Discontinued operations $0.10 $0.12 $ 0.08 ============ ============ ============= Net income (loss) $(0.90) $(0.85) $ 0.17 ============ ============ ============= SHARES USED IN COMPUTING EARNINGS PER SHARE Basic 9,626,335 9,322,278 6,606,499 ============ ============ ============= Diluted 9,626,335 9,322,278 7,204,220 ============ ============ ============= F-3 42 GEOGRAPHICS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) YEARS ENDED MARCH 31, 1998, 1997 AND 1996 Foreign Currency Retained Common Stock Translation Earnings ------------ Shares Amount Adjustment (Deficit) Total ------ ------ ---------- --------- ----- BALANCE, March 31, 1995 5,176,213 $ 3,665,581 $ - $ (862,240) $ 2,803,341 Proceeds from issuance of common stock 520,000 1,986,100 - - 1,986,100 Notes payable, debentures and other liabilities converted to common stock 1,540,371 2,169,233 - - 2,169,233 Common stock issued for cash on exercise of stock options and warrants, including income tax benefit 768,000 1,799,154 - - 1,799,154 Net income - - - 1,232,024 1,232,024 - - - ------------ ----------- BALANCE, March 31, 1996 8,004,584 9,620,068 - 369,784 9,989,852 Proceeds from issuance of common stock 1,269,293 6,114,062 - - 6,114,062 Notes payable, converted to common stock 30,000 52,005 - - 52,005 Common stock issued for acquisition of subsidiary 50,000 200,000 - - 200,000 Common stock issued for cash on exercise of stock options and warrants 114,000 345,883 - - 345,883 Revision of estimate of income tax benefit from exercise of stock options and warrants - (758,000) - - (758,000) Foreign currency translation adjustment - - (76,478) - (76,478) Net loss - - - (7,950,301) (7,950,301) - - - ------------ ----------- BALANCE, March 31, 1997 9,467,877 15,574,018 (76,478) (7,580,517) 7,917,023 Proceeds from issuance of common stock 389,375 195,000 - - 195,000 Foreign currency translation adjustment - - 110,377 - 110,377 Net loss - - - (8,649,618) (8,649,618) --------- ----------- -------- ------------ ----------- BALANCE, March 31, 1998 9,857,252 $15,769,018 $ 33,899 $(16,230,135) $ (427,218) ========= =========== ======== ============= =========== F-4 43 GEOGRAPHICS, INC. CONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED MARCH 31, 1998, 1997 AND 1996 Increase (Decrease) in Cash 1998 1997 1996 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $(8,649,618) $(7,950,301) $ 1,232,024 Adjustments to reconcile net income to net cash flows from operating activities Depreciation and amortization 1,849,706 1,372,292 1,124,999 Deferred income taxes - 404,000 125,000 Loss on sales of property and equipment 159,406 86,048 594 Reserve for impairment on EDP installation-in-progress - 620,759 - Services rendered in exchange for common stock 195,000 - - Changes in noncash operating assets and liabilities Trade receivables 2,489,639 (1,500,098) (2,561,832) Related party receivables - 899,422 (560,447) Other receivables 845,193 (930,671) (3,357) Inventory 2,694,366 (121,153) (6,238,118) Prepaid expenses, deposits and other current assets 162,176 (44,402) (517,278) Accounts payable 863,699 (212,830) 1,315,997 Accrued liabilities 535,564 920,286 814,756 Income tax payable - (145,278) 336,645 ----------- ----------- ----------- Net cash flows from operating activities 1,145,131 (6,601,926) (4,931,017) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Increase in (repayment of) bank overdrafts (165,729) 467,445 - Net borrowings on note payable to bank 2,651,418 3,326,451 3,139,463 Proceeds from long-term debt borrowings - 2,333,526 1,003,029 Repayment of long-term debt (1,790,535) (875,134) (467,986) Proceeds from notes payable to officers and directors - - 2,452,573 Repayments of notes payable to officer/directors (850,000) (362,706) (398,629) Proceeds from issuance of common stock - 6,459,945 2,827,254 Foreign currency translation 110,377 (76,478) - ----------- ----------- ----------- Net cash flows from financing activities (44,469) 11,273,049 8,555,704 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of plant and equipment (1,933,911) (4,159,500) (3,296,165) Proceeds from sales of equipment 75,000 50,887 16,741 Net advances from (repayments to) partnerships - (34,484) (56,786) (Increase) decrease in other assets 665,570 (169,297) (253,797) ----------- ----------- ----------- Net cash flows from investing activities (1,193,341) (4,312,394) (3,590,007) ----------- ----------- ----------- NET CHANGE IN CASH (92,679) 358,729 34,680 CASH, beginning of year 408,757 50,028 15,348 ----------- ----------- ----------- CASH, end of year $ 316,078 $ 408,757 $ 50,028 =========== =========== =========== NONCASH INVESTING AND FINANCING ACTIVITIES Financing obtained in acquisition of equipment $ 2,199,088 $ 1,989,895 $ 1,110,242 =========== =========== =========== F-5 44 Issuance of common stock in exchange for $195,000 $ - $ - ======== ========= ========== services rendered Issuance of common stock on conversion of notes payable, debentures and other liabilities $ - $ 52,005 $2,169,233 ======== ========= ========== Issuance of common stock for acquisition of $ - $ 200,000 $ - ======== ========= ========== subsidiary Income tax benefit (expense) related to exercise of stock options and warrants $ - $(758,000) $ 958,000 ======== ========= ========== 45 NOTE 1 - DESCRIPTION OF OPERATIONS Geographics, Inc. (the "Company") is a Wyoming corporation with its offices and main manufacturing facilities located in Blaine, Washington. The Company also has warehouse/distribution facilities near London, England, and Sydney, Australia and a warehouse/distribution facility in Bellingham, Washington. The Company is a manufacturer of designer stationeries, value-added papers, lettering, signage and graphic art products (see Note 16 regarding the sale of certain business operations). NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Geographics (Europe) Limited, Geographics Pty. Limited and Geographics Marketing Canada Inc. Significant intercompany transactions have been eliminated in consolidation. On July 1, 1996, a merger between the Company and Grahams Graphics Pty. Ltd., an Australian distributor, was completed. In connection with this transaction, the Company issued 50,000 shares of common stock, valued at approximately $200,000 (approximate market value), assumed liabilities of approximately $150,000 and paid cash of $40,000. This merger was accounted for as a purchase, with no goodwill recognized on the transaction. CASH AND EQUIVALENTS - For purposes of the statement of cash flows, cash and equivalents include cash on deposit with banks and other highly liquid investments with original maturities of ninety days or less. CASH AND OVERDRAFT BALANCES - The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The nature and content of bank overdrafts include disbursements from the payroll checking account which are covered via transfers of funds from the general operating cash account as payroll checks are presented for payment. The Company also has an account for which the bank funds disbursements as they are presented for payment via an overnight investment sweep account. ACCOUNTS RECEIVABLE - The Company typically offers credit terms to its customers, which generally require payment within sixty days. Management considers all accounts receivable in excess of the allowance for doubtful accounts to be fully collectible. Accounts receivable are not collateralized. INVENTORY - Inventory is valued at the lower of cost on a first-in, first-out (FIFO) basis or market. PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment is stated at historical cost. Depreciation is provided based on useful lives of three to forty years, using primarily the straight-line method. Betterments, renewals and repairs that extend the life of assets are capitalized. Repairs and maintenance items are expensed when incurred. Depreciation expense was $1,729,706, $1,280,801 and $894,570 during the years ended March 31, 1998, 1997 and 1996, respectively. FEDERAL INCOME TAXES - The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities represent the estimated tax effects of future deductible or taxable amounts attributed to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. This method also allows recognition of income tax benefits for loss carryforwards, credit carryforwards and certain temporary differences for which tax benefits See accompanying notes to these consolidated statements. F-6 46 have not previously been recorded. The tax benefits recognized as assets must be reduced by a valuation allowance where it is more likely than not the benefits may not be realized. FOREIGN CURRENCY TRANSLATION - The financial statements of the Company's non-U.S. subsidiaries whose "functional" currencies are other than U.S. dollars are translated at current rates of exchange. Income and expense items are translated at the average exchange rate for the year. The resulting translation adjustments are recorded directly into a separate component of stockholders' equity, if significant. Certain other translation adjustments and transaction gains and losses are reported in net income in the period they are realized. USE OF ESTIMATES - The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following significant estimates are included in the financial statements. o DEPRECIATION - Depreciation represents an expense allocation matching asset costs to revenue earned over the estimated lives of assets owned by the Company. Periodically, the Company re-evaluates the lives and methods of depreciation applied to its property and equipment and considers such things as general condition and utility, technological status and economic viability. Such evaluations may result in the Company's revision and adjustment of asset carrying values in relatively short-term time periods. o PROPERTY, PLANT AND EQUIPMENT - It is the Company's policy to record property, plant and equipment and other long-lived assets at historical cost and depreciate these assets over their expected useful life. The Company has sustained significant losses as shown in the accompanying consolidated financial statements and described in Note 15, and may be unable to continue as a going concern. It is reasonably possible that the Company's estimate that it will recover the carrying amount of long-lived assets from future operations will change in the near term. o INCOME TAXES - The Company operates in a number of taxing jurisdictions and endeavors to comply with all tax laws as applicable, consistent with minimizing taxes paid by the Company where possible. To comply with these laws the Company must allocate and prorate certain items of revenue and expense in addition to establishing appropriate transfer pricing policies. These allocations and policies are subject to scrutiny and audit which may result in the Company's need to adjust its tax accruals and provisions as a result of its interactions with taxing authorities. o SALES RETURNS AND ALLOWANCES - The Company currently estimates an allowance for sales returns as a percentage of sales, based on historical information. Changes in market conditions and demand for the Company's products could result in customers returning products in an amount greater than that currently allowed for. Depending upon the volume of sales returns, such amounts could impact future gross margins. o INVENTORY - The Company makes provisions for obsolete inventory by reviewing recent sales information, inventory turnover rates and volumes on hand. The Company will often offer substantial dealer discounts and may enter into agreements with discount distributors to sell slower moving product lines. The provision for obsolete inventory attempts to account for reduced margins expected on slower moving products, however, it is possible that additional 2 47 discounts or incentives may be necessary to liquidate slow-moving inventory and the provisions for obsolete inventory will need to be increased. ADVERTISING COSTS - Advertising costs are charged to expense in the period in which they occur except for direct response advertising which is capitalized and amortized over its expected period of future benefits. Direct response advertising consists primarily of advertisements placed with industry related catalogs and are amortized over the period following the mailing date at a rate approximating the rate and timing of customer response. Unamortized advertising costs of $149,609 and $40,950 are included in other assets at March 31, 1998 and 1997, respectively. The Company also participates with its customers in cooperative advertising and other promotional programs, in which the Company reimburses the customers for a portion of their advertising costs. Advertising expense amounted to $1,393,001, $1,924,442 and $867,198 in 1998, 1997 and 1996, respectively. EARNINGS PER SHARE - During fiscal 1998 the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share. This Statement superseded Accounting Principles Board (APB) No. 15 Earnings Per Share and establishes standards for computing and presenting earnings per share. All prior years presented have been restated to conform with the new requirements. Basic earnings per share amounts are computed based on the weighted average number of shares outstanding during the period after giving retroactive effect to stock dividends and stock splits. Diluted earnings per share amounts are computed by determining the number of additional shares that are deemed outstanding due to stock options and warrants under the treasury stock method. FAIR VALUE OF FINANCIAL INSTRUMENTS - Statement of Financial Accounting Standard ("SFAS") No. 107, Disclosure About Fair Value Of Financial Instruments, requires disclosure of the fair value of financial instruments, both assets and liabilities, recognized and not recognized, in the consolidated balance sheet of the Company for which it is practicable to estimate fair value. The estimated fair values of financial instruments which are presented herein have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of amounts the Company could realize in a current market exchange. The following methods and assumptions were used to estimate fair value: CASH, RECEIVABLES, ACCOUNTS PAYABLE AND ACCRUED LIABILITIES - The carrying amounts of cash, receivables, accounts payable and accrued liabilities approximate fair value due to their short-term nature. NOTES PAYABLE AND LONG-TERM DEBT - Discounted cash flows using current interest rates for financial instruments with similar characteristics and maturity were used to determine the fair value of notes payable and long-term debt. There were no significant differences as of March 31, 1998 and 1997 in the carrying value and fair value of financial instruments. NEW ACCOUNTING STANDARDS - In June 1997, the FASB issued SFAS No. 130, Comprehensive Income and SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. 3 48 SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components. SFAS No. 131 establishes standards for reporting about operating segments, products and services, geographic areas, and major customers. The standards become effective for fiscal years beginning after December 15, 1997. Management plans to adopt these standards in the year ending March 31, 1999. Management believes that adoption of these standards will result in some changes in the presentation of its financial information but will not have a material impact on its reported financial condition or results of operation. RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to current year presentation. Such reclassifications had no effect on previously reported earnings or financial position. NOTE 3 - INVENTORY 1998 1997 ---- ---- Raw materials $ 609,183 $ 672,635 Work-in-progress 1,483,308 3,396,754 Finished goods 5,257,515 6,678,485 ---------- ----------- 7,350,006 10,747,874 Less allowance for obsolete inventory 586,498 1,290,000 ---------- ----------- $6,763,508 $ 9,457,874 ========== =========== NOTE 4 - PROPERTY, PLANT AND EQUIPMENT Accumulated Depreciation and Net Book Value -------------- Cost Amortization 1998 1997 ---- ------------ ---- ---- Land $ 114,563 $ - $114,563 $ 114,563 Buildings 3,874,478 852,823 3,021,655 3,070,234 Machinery and equipment 3,706,786 1,656,507 2,050,279 1,635,018 Machinery and equipment under capital lease 7,107,475 1,274,937 5,832,538 4,281,155 Display racks 3,287,340 1,659,652 1,627,688 1,155,824 Computers and software 499,615 330,461 169,154 224,229 Automobiles 187,615 140,139 47,476 258,340 Leasehold improvements 32,415 14,650 17,765 26,790 EDP installation-in-progress - - - 66,078 ----------- ---------- ----------- ----------- $18,810,287 $5,929,169 $12,881,118 $10,832,231 =========== ========== =========== =========== NOTE 5 - OTHER ASSETS 1998 1997 ---- ---- Other $205,808 $236,168 Trademarks 134,235 109,480 Equipment deposits - 556,390 Setup costs - 103,575 -------- ---------- $340,043 $1,005,613 ======== ========== NOTE 6 - FINANCING ARRANGEMENTS 4 49 1998 1997 ---- ---- Installment notes payable to a bank, fixed interest rates ranging from 8.825% to 10%, payable in monthly installments through November 2010, collateralized by real estate. $2,200,029 $2,408,948 Capital lease obligations collateralized by certain equipment and fixtures. 5,877,633 5,133,327 Installment notes payable to banks, interest rates ranging from fixed at 9.75% to variable rates from prime plus 1% to prime plus 1.5%, payable in monthly installments through October 2000, collateralized by certain equipment. 125,936 252,770 ---------- ---------- 8,203,598 7,795,045 Less current portion 3,350,344 3,472,674 ---------- ---------- $4,853,254 $4,322,371 ========== ========== The prime rate was 8.5% at March 31, 1998 and 1997. The Company has a revolving credit agreement with a bank for up to $12,000,000, subject to borrowing base limitations of 80% of eligible accounts receivable and 55% of inventories, net of reserves. Interest on outstanding advances is payable monthly at the bank's prime rate, with a stated due date of April 15, 1998. Total outstanding advances under the revolving credit agreement were $11,300,808 and $8,649,390 at March 31, 1998 and 1997, respectively. The revolving credit agreement and installment notes are collateralized by substantially all of the assets of the Company. The revolving credit agreement and term debt (included in installment notes payable above) with the same bank are subject to the "Second Forbearance Agreement" with the bank which acknowledges the Company's default with respect to the original terms of the debt obligations, but allows continued borrowing pursuant to the terms of the forbearance agreement which expires April 15, 1998. On May 1, 1998 the Company and the bank entered into the "Third Forbearance Agreement" which required the Company to sell its signage and lettering, intangible and operating assets (the "Core Business" - see note 16) to a corporation for total consideration of approximately $6.8 million, the net proceeds of which were to be applied to the revolving credit obligation. The Third Forbearance Agreement expires November 1, 1998 and reduces the maximum borrowings under the revolving agreement to $5.5 million during May through July 1998 and $6.0 million during August through October of 1998. The advance rate against eligible accounts receivable was reduced to 70%, and the maximum advance rate against eligible inventory was reduced to $3.5 million. All outstanding obligations with this bank have been shown as currently due, pursuant to the terms of the forbearance agreements. At March 31, 1998, the terms of the agreements provide principal payments on long-term debt and capital lease obligations as follows: 5 50 1998 $3,350,344 1999 1,124,757 2000 1,175,066 2001 957,129 2002 705,189 Thereafter 891,113 ---------- $8,203,598 ========== Future minimum lease payments under capital leases together with the present value of minimum lease payments as of March 31, 1998 are as follows: 1999 $1,586,211 2000 1,557,436 2001 1,483,659 2002 1,122,109 2003 829,847 Thereafter 825,919 ---------- Total minimum lease payments 7,405,181 Less amount representing imputed interest 1,527,548 ---------- Present value of minimum lease payments $5,877,633 ========== NOTE 7 - FEDERAL INCOME TAXES The provision (benefit) for income taxes consists of the following: 1998 1997 1996 ---- ---- ---- Current provision (benefit) $ - $(459,972) $509,679 Deferred provision (benefit) - 404,000 125,000 ---- --------- -------- Total income tax provision (benefit) $ - $ (55,972) $634,679 ==== ========= ======== Income taxes are allocated between continuing and discontinued operation as follows: 1998 1997 1996 ---- ---- ---- Total income tax provision (benefit) $ - $(55,972) $634,679 Amounts applicable to discontinued operations - - 302,329 ---- -------- -------- Taxes allocated to continuing operations $ - $(55,972) $332,350 ==== ======== ======== The total tax provision differs from the amount computed using the statutory federal income tax rate as follows: 6 51 1998 1997 1996 ---- ---- ---- Amount % Amount % Amount % ------ - ------ - ------ - Tax expense (benefit) at statutory rate on continuing operations $(3,272,000) (34.0)% $(3,089,000) (34.0)% $332,350 34.0% Exercise of stock options and warrants 367,000 3.8 (758,000) (8.2) - - Other differences, net 548,000 5.6 (350,972) (3.4) - - Change in valuation allowance for deferred tax assets 2,027,000 21.1 3,774,000 41.5 - - Benefit absorbed by income from discontinued operations 330,000 3.5 368,000 4.0 - - ------------ ------- -------------- ------ -------- ----- Total income tax provision (benefit) $ - - % $(55,972) (.1)% $332,350 34.0% ============ ======= ============= ====== ======== ===== The significant components of deferred income tax expense (benefit) are as follows: 1998 1997 1996 ---- ---- ---- Change in valuation allowance for deferred tax assets $ 2,027,000 $ 3,774,000 $ - Depreciation of plant and equipment 302,000 244,000 88,000 Change in tax credit carryforward - 34,000 105,000 Amortization of goodwill and intangibles 17,000 31,000 (31,000) Other differences, net (13,000) (4,000) (20,000) Change in allowance for doubtful accounts (259,000) (8,000) (38,000) Increase in cash surrender value of life insurance (2,000) (35,000) - Accruals for financial reporting purposes 3,000 (50,000) - Inventory differences 239,000 (416,000) (10,000) Effect of net operating loss carryforwards (2,214,000) (3,162,000) - ----------- ----------- -------- Total deferred income tax expense (benefit) $ - $ 404,000 $125,000 =========== =========== ======== The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows: 1998 1997 ---- ---- Deferred Tax Assets Net operating losses $5,476,000 $3,162,000 Inventory, principally due to additional cost inventoried for tax purposes and financial statement allowances 236,000 475,000 Goodwill and intangible assets, principally due to amortization differences 332,000 349,000 Accruals for financial reporting purposes 68,000 71,000 Alternative minimum tax credit carryforwards 70,000 70,000 Accounts receivable, due to allowance for doubtful accounts 317,000 58,000 Cash surrender value of life insurance 37,000 35,000 Other differences, net 25,000 12,000 ---------- ---------- 7 52 Net deferred tax assets 6,561,000 4,232,000 Deferred Tax Liabilities Plant and equipment, principally due to depreciation differences 760,000 458,000 ---------- ---------- Net deferred tax assets before valuation allowance 5,801,000 3,774,000 Valuation allowance (5,801,000) (3,774,000) ---------- ---------- Net deferred tax assets $ - $ - ========== ========== Based on the Company's current operating income and expectations for the future, management determined that future operating and taxable income may not be sufficient to fully recognize all deferred tax assets existing at March 31, 1998 and 1997. As a result, the carrying value of net deferred tax assets was reduced to $-0- at March 31, 1998 and 1997 by increasing the valuation against deferred tax assets. Net operating loss carryforwards approximating $14,200,000 are available to offset future taxable income through 2013. In addition, net operating losses on foreign operations of approximately $1,800,000 are available to the Company subject to foreign tax rules. NOTE 8 - STOCKHOLDERS' EQUITY STOCK OPTION AND INCENTIVE PLANS - As of March 31, 1998, the Company had reserved 1,000,000 shares of common stock for issuance to key employees, officers and directors pursuant to the 1996 Stock Option Plan. Options granted under the Plan qualify as incentive stock options and will generally not be taxable to the holder until the share subject to the option is ultimately sold by the holder of the option. There were no shares granted pursuant to this Plan as of March 31, 1998. Options to purchase the Company's common stock are granted at a price equal to or greater than the market price of the stock at the date of grant, and are exercisable pursuant to the terms of the grant. All options expire no more than ten years after the date of grant. Prior to the formation of the 1996 Stock Option Plan, the Company granted nonqualified stock options on a case-by-case basis as deemed appropriate by the Board of Directors. Pro forma information regarding net income and earnings per share is required by Statement of Financial Accounting Standards No. 123 Accounting for Stock-Based Compensation. The pro forma information recognizes, as compensation, the value of stock options granted using an option valuation model. Pro forma earnings per share amounts also reflect an adjustment for an assumed purchase of stock from proceeds deemed obtained from the issuance of stock options. The fair value for options issued in 1996 is estimated at $181,000, net of tax. There were no options issued in 1998 or 1997 and therefore no presentation is required for 1998 or 1997. The following assumptions were used to estimate the fair value of the options: 1996 ---- Risk-free interest rate 6.26% Dividend yield rate -% Price volatility .6787 Weighted average expected life of options 1.60 yr. 8 53 Management believes that the assumptions used in the option pricing model are highly subjective and represent only one estimate of possible value, as there is no active market for the options granted. The fair value of the options granted in 1996 are recognized in the period issued because they are immediately exercisable. Pro forma disclosures: 1996 ---- Net income as reported $1,232,024 Additional compensation for fair value of stock options $ 181,000 Pro forma net income $1,051,024 Pro forma earnings per share Basic $ .16 Diluted $ .15 The changes in stock options outstanding are as follows: Nonqualified Common Stock Option Price Options Per Share ------- --------- BALANCE, March 31, 1995 452,000 Granted 496,000 $1.47 to 3.57 Exercised (628,000) $.73 to 2.56 -------------- BALANCE, March 31, 1996 320,000 Granted - Exercised (144,000) $.73 to 2.56 Expired (2,500) $3.04 -------------- BALANCE, March 31, 1997 173,500 Granted - Exercised - Expired - --------------- BALANCE, March 31, 1998 173,500 =============== Options Outstanding Options Exercisable ------------------------------------ --------------------------- Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price - ------- ----------- ----------- ---------- ----------- --------- Up to $2 86,000 2.07 years $1.46 86,000 $1.46 $2 to 4 87,500 2.55 years 2.93 87,500 2.93 9 54 In addition, warrants to purchase 1,342,293 and 24,000 shares of common stock at prices ranging from $.77 to $6.50, and $.75 to $4.77, were outstanding as of March 31, 1997 and 1996, respectively. These warrants are exercisable upon issuance and expire from April 15, 1998 to December 1, 2001. The exercise price of the warrants was equal to the market price of the stock at the date the warrants were issued. During the year ended March 31, 1997, the Company's shareholders and its Board of Directors approved a resolution to increase the Company's authorized shares from ten million to one hundred million. The Company filed the Articles of Amendment during the current year end. NOTE 9 - EARNINGS PER SHARE The numerators and denominators of basic and diluted earnings per share are as follows: 1998 1997 1996 ------------ ------------ ---------- Net income (loss) (numerator) $(8,649,618) $(7,950,301) $1,232,024 ============ ============ ========== Shares used in the calculation (denominator) Weighted average shares outstanding 9,626,335 9,322,278 6,604,499 Effect of dilutive stock options - - 599,721 ------------ ------------ ---------- Diluted shares 9,626,335 9,322,278 7,204,220 ============ ============ ========== As described in Note 8, the Company has granted stock options and warrants to purchase up to 1,515,793 shares. The potential dilutive effects of these potential shares outstanding were disregarded in 1998 and 1997 because the Company reported losses in those years and the effects of the instruments would have been anti-dilutive to the reported per share losses. In future periods, these instruments may reduce the reported net income per share once profitable operations are attained. NOTE 10 - RELATED PARTY TRANSACTIONS On September 15, 1995, officers and directors converted debentures in an aggregate face amount of $200,000 into 219,178 common shares. The debentures were convertible at the holder's option into common shares of the Company at Cdn. $1.25 per share, to a maximum of 219,178 common shares. There is no remaining balance of debentures outstanding at March 31, 1997. The Company issued $996,000 of convertible debentures payable to officers and directors on September 26, 1995. The debentures were convertible at the holder's option into common shares of the Company at Cdn. $4.45 per share, to a maximum 274,233 common shares. On December 22, 1995, these debentures were converted into 274,233 common shares, and are no longer outstanding. At March 31, 1996, a certain officer and directors had advanced the Company $1,264,711 in the form of uncollateralized notes payable. The notes are payable on demand and are classified as current liabilities. Interest on these notes are payable monthly at the rate of prime plus 1%. As of March 31, 1997, the balance remaining on these notes payable to a certain officer totaled $850,000, which was paid in full subsequent to year end. Total interest costs associated with these notes and debentures was approximately $11,200 and $92,000 for the years ended March 31, 1998 and 1997, respectively, and $60,000 during the year ended March 31, 1996. 10 55 On January 23, 1996, the Company completed a private placement of 500,000 common shares to officers and directors at a price of Cdn. $5.75. Total cash received, net of issuance costs, totaled $1,986,100. Effective April 1, 1996, the Company transferred to Geographics Marketing Canada, Inc., a wholly-owned subsidiary, the exclusive rights to market and distribute the Company's products in Canada. These marketing and distribution rights were previously maintained by Martin Distribution, Inc. ("Martin"), a company related through common directorship. As such, the financial results of Geographics Marketing Canada, Inc. have been included in the consolidated results of Geographics, Inc. for the fiscal years ended March 31, 1998 and 1997, with all material intercompany transactions eliminated. Sales to Martin amounted to $2,854,935 during the year ended March 31, 1996. No sales to Martin were made during the years ended March 31, 1998 and 1997, and there were no amounts due from Martin as of those dates. International Geographics of Ontario recorded purchases from Martin in the aggregate amount of $118,659 during the year ended March 31, 1996. No purchases were made from Martin during the years ended March 31, 1998 and 1997. The Company has approximately $32,800 and $210,000 due to Guildmark, Inc., a company related through common ownership, included in accounts payable at March 31, 1998 and 1997. NOTE 11 - EMPLOYEE BENEFIT PLANS On April 1, 1995, the Board of Directors approved a retirement savings plan, which permits eligible employees to make contributions to the plan on a pretax salary reduction basis in accordance with the provisions of Section 401(k) of the Internal Revenue Code. The Company makes a matching stock contribution of 10% of the employee's pretax contribution. Eligible employees may contribute up to 18% of their pretax compensation. Total expense related to this plan was $11,471 and $36,296 during the year ended March 31, 1998 and 1997, respectively. NOTE 12 - COMMITMENTS AND CONTINGENCIES Leases - The Company conducts certain operations in a leased facility, under a lease that is classified as an operating lease for financial statement purposes. The lease requires the Company to pay real estate taxes, common area maintenance, and certain other expenses. Lease terms, excluding renewal option periods exercisable by the Company at escalated rents, expire in 1999. The total minimum lease commitment is $64,770 in 1999. Rental expense under all operating leases were $320,000, $257,000 and 100,000 in 1998, 1997 and 1996, respectively. Litigation - In July 1997, three related class action suits were filed in the United States District Court for the Western District of Washington against the Company, its former President, Chief Executive Officer and Chairman of its Board of Directors, and the Company's Vice President of Finance and Chief Financial Officer. In August 1998, the Company, its insurance company and the plaintiffs reached an agreement to settle the suits. The settlement is subject to review by the court prior to being ratified, which is expected to occur in October 1998. The Company has recorded its portion of the settlement to be paid, representing the deductible on its insurance policy. The total settlement was $1.6 million. 11 56 Special Committee Investigation - In the Company's 10 Q filed for the third quarter ending December 31, 1997, the Company announced that a special committee of its audit committee was appointed to examine the performance and conduct of the Company's management. As a result of their examination, issues were raised concerning the adequacy of documentation for certain travel and entertainment expenses submitted to the Company for payment in prior periods, the propriety of certain issuances of common stock, and appropriate treatment and reporting of taxable income associated with stock options. The Company is continuing to evaluate these matters and believes they will be resolved in a manner that will not result in a material impact to the Company's financial position or results of operations. However, the ultimate outcome of these matters is uncertain. There are various additional claims, lawsuits, and pending actions against the Company incident to the operations of its business. It is the opinion of management that the ultimate resolution of these matters and any future unidentified claims will not have a material effect on the Company's financial position, results of operations or liquidity. Contingency For Year 2000 Issues - The Company uses three principal software packages at its North American production, warehousing and administrative facilities. These include an operating system, an electronic data interchange software and an integrated operations and accounting application package. Of particular importance, the Company's operations and accounting applications were determined to not be Year 2000 ready. Accordingly, the Company is in negotiations to secure a new operating and accounting software package with installation to be scheduled as soon as practicable. The Company estimates that the costs of acquiring and installing this new software package will range between $125,000 and $150,000. The Company continues to evaluate its remaining principle software packages and believes that existing available upgrades will mitigate the risk of significant operational problems. However, the Company has not completed an assessment of its hardware and other systems, including those of vendors, customers and other third parties. Until a complete assessment is completed, the Company is unable to estimate the total expense of assuring that all of its software and hardware are Year 2000 compliant. The Company plans to complete these assessments no later than March 1999. NOTE 13 - INFORMATION ABOUT CREDIT RISK AND BUSINESS CONCENTRATIONS Assets for which the Company has credit risk include trade accounts receivable, which amounted to $4,164,861 and $6,654,500 at March 31, 1998 and 1997, respectively. The Company's trade customers are concentrated in the retail office products industry and mass market retail stores. Sales to four major customers approximated 72%, 74% and 80% of total sales for the years ended March 31, 1998, 1997 and 1996, respectively. Amounts due from three customers approximated 74% and 89% of the total accounts receivable at March 31, 1998 and 1997, respectively. Historically, a substantial portion of the Company's sales have been to a limited number of customers. Concentration of sales to the Company's five largest customers is detailed below: 12 57 Fiscal Year ----------- Customer 1998 1997 1996 ---- ----------- ---- Office Depot Inc. 31% 31% 40% Office Max, Inc. 15 26 24 Business Depot, Inc. 11 10 0 Wal-Mart Stores 6 0 0 United Stationers Inc. 3 0 0 Martin Distribution, Inc. 0 0 13 ---- ----------- ---- 66% 67% 77% ==== =========== ==== Effective April 1, 1996, Geographics-Canada succeeded Martin Distribution as the exclusive Importer of Geographics products into Canada. Business Depot, Inc. (Staples of Canada) sales were included in sales of Martin Distribution for 1996. The Company expects that sales to relatively few customers will continue to account for a high percentage of its net sales in the foreseeable future and believes that its financial results depend in significant part upon the success of these few customers. Although the composition of the group comprising the Company's largest customers may vary from period to period, the loss of a significant customer or any reduction in orders by any significant customers, including reductions due to market, economic or competitive conditions in the designer stationary or specialty papers industry, may have a material adverse effect on the Company's business, financial condition and results of operations. The following table represents approximate sales and trade accounts receivable related to the geographic regions in which the Company operates. 1998 ---- Total United States Canada Other ----- ------------- ------ ----- Sales 100% 79% 13% 8% ==== ==== ==== === Accounts receivable 100% 73% 18% 9% ==== ==== ==== === 1997 ---- Total United States Canada Other ----- ------------- ------ ----- Sales 100% 78% 16% 6% ==== ==== ==== === Accounts receivable 100% 86% 9% 5% ==== ==== ==== === 1996 ---- Total United States Canada Other ----- ------------- ------ ----- Sales 100% 86% 13% 1% ==== ==== ==== === Accounts receivable 100% 83% 15% 2% ==== ==== ==== === The Company purchases goods from approximately 700 vendors. One vendor accounted for a significant portion of the Company's total merchandise purchases during the years ended March 31, 1998, 1997 and 1996. The Company purchases commodity paper and other related products from this broker/vendor that could be supplied by other sources. There can be no assurances that the 13 58 relationship between the Company and this vendor will continue and the loss of the purchasing power the Company has established with this company would likely have a material adverse effect on the Company. The Company does not consider itself dependent on any single source for materials to manufacture its products. Financial information relating to foreign and domestic operations and export sales (all foreign sales are export sales) is as follows: Fiscal Year ------------ Sales to Domestic and Foreign Customers 1998 1997 1996 ------------ ------------ ----------- United States $17,774,299 $11,637,497 $12,939,098 Canada 4,082,664 3,872,621 2,854,935 Europe 1,197,192 715,327 281,330 Australia 1,043,690 825,697 - ------------ ------------ ----------- Total $24,097,845 $17,051,142 $16,075,363 ============ ============ =========== Operating profit or (loss): United States $(7,261,961) $(6,587,756) $944,157 Canada (301,179) (473,296) 377,328 Europe (489,263) (727,467) 65,316 Australia 40,684 189,715 - ------------ ------------ ----------- Total $(8,011,719) $(7,598,804) $1,386,801 ============ ============ =========== Identifiable assets: United States $21,677,859 $27,464,715 $24,263,181 Canada 1,122,452 940,046 410,060 Europe 1,321,662 1,058,046 64,800 Australia 1,222,992 782,894 - ------------ ------------ ----------- Total $25,344,965 $30,245,701 $24,738,041 ============ ============ =========== Effective April 1, 1996, Geographics - Canada succeeded Martin Distribution, Inc. ("Martin Distribution") as the exclusive importer of Geographics products into Canada. Martin Distribution was at the time owned and controlled by one of the Company's then-acting directors. All export sales to Canada in fiscal 1997 were to Geographics - Canada. All export sales to Canada in fiscal 1996 and fiscal 1995 were to Martin Distribution. International sales accounted for approximately 20%, 32%, and 26% of the Company's total net sales in fiscal years 1996, 1997, and 1998, respectively. International sales were concentrated in Canada, Europe and Australia. As a result of such international sales, a significant portion of the Company's revenues will be subject to certain risks, including unexpected changes in regulatory requirements, exchange rates, tariffs and other barriers, political and economic instability and other risks. See "-Risk Factors-International Subsidiaries" and "-Risk Factors-Foreign Exchange and International Trade." NOTE 14 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION 1998 1997 1996 ---- ---- ---- Cash paid during the year for interest $1,659,150 $995,691 $812,416 =========== ======== ======== Net cash paid (refund) during the year for income taxes $ (371,528) $304,303 $173,034 =========== ======== ======== 14 59 Interest expense of approximately $250,000, $258,000 and $248,000 was included in income from discontinued operations during 1998, 1997 and 1996, respectively. NOTE 15 - LIQUIDITY AND OPERATIONS As shown in the accompanying financial statements, the Company incurred a net loss of $8,649,618 and $7,950,301 for the years ended March 31, 1998 and 1997, respectively. As a result of these losses, a decline in gross profit margins, the Company's failure to comply with certain covenants under its line of credit and other factors, the report of the Company's auditors states that there is substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements have been prepared assuming the Company will continue as a going concern and does not include any adjustments to reflect the possible future effects on the recoverability and classification of assets and liabilities that may result from this uncertainty. As described in Note 16, in July 1998 the Company appointed a new President and CEO who was planning to take steps necessary to enable the Company to continue as a going-concern. This includes the development of a detailed business plan that will enable the Company to identify and focus on profitable products and the profitability of its current market share positions, thereby reducing the demand for Company resources on unprofitable business. In addition, the Company will take steps to identify and reduce unnecessary selling, general and administrative expenses, continue to improve the operating efficiency of its manufacturing processes and reduce its raw material costs, in order to return the Company to profitability. Management anticipates that these steps will enable the Company to better estimate the correct levels of working capital required and supporting debt and equity financing necessary to stabilize the Company and position it for profitable and controlled growth. The Company then plans to cost effectively refinance its equity and debt funding in amounts necessary to meet its objectives. The successful development and execution of this plan is dependent upon the Company's ability to achieve adequate gross margins on sales, maintain its liquidity through its current borrowing arrangements, maintain adequate working relationships with its vendors, customers and employees, and the successful management of contingencies and uncertainties affecting the viability of the Company. The outcome of these matters is uncertain. NOTE 16 - SUBSEQUENT EVENTS Subsequent to year end, the Company sold substantially all of its signage and lettering operating assets, licenses, inventory and other rights (collectively the, "Core Business") to a corporation for total consideration of $6,820,000. Total assets sold, which are included in the year end balance sheet, were approximately $1.0 million. The signage and lettering operations which have been discontinued accounted for approximately 22% of consolidated total revenues during the year ended March 31, 1998. The remaining 78% of total consolidated revenues are generated from the Company's ongoing paper product operations. The gain of approximately $5.5 million from the sale of the Core Business will be included in the Company's 1999 statement of operations. The available net proceeds from the sale were used to reduce the outstanding balance on the Company's revolving line of credit. Summarized results of operations for the Core Business for fiscal years 1998, 1997 and 1996 are as follows: 15 60 1998 1997 1996 ---- ---- ---- Net sales $6,598,881 $6,789,364 $6,538,272 ========== ========== ========== Operating income $1,222,688 $1,337,506 $1,137,660 ========== ========== ========== Income from discontinued operations before provision for income taxes $ 973,091 $1,079,510 $ 889,206 ========== ========== ========== In July 1998, the Company's Board of Directors appointed a new President and CEO who also became the sole director of the Company. The terms for employment were established pursuant to a board resolution which provides for a three-year employment contract at a specified salary, reimbursement for out-of-pocket costs incurred in relocation and 500,000 stock options at a strike price of $.43 per share. The resolution also provides for the creation of an incentive compensation arrangement to be ratified by a newly established board of directors to be recruited for the Company. NOTE 17 - STOCK EXCHANGE LISTING REQUIREMENTS The Company's securities were delisted from the Nasdaq National Market and subsequently the Nasdaq SmallCap Market during fiscal 1998. Trading of the Company's securities has continued on the Nasdaq's OTC Electronic Bulletin Board. However, the delistings may restrict marketability of the Company's common stock. 16