UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended January 31, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File No.: 0-23434
HIRSCH INTERNATIONAL CORP.
(Exact name of registrant as specified in its charter)
Delaware 11-2230715
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 Wireless Boulevard, Hauppauge, New York 11788
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (516) 436-7100
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the 4,354,506 shares of Class A Common Stock
held by non-affiliates of the Company as of April 11, 1997 is $83,824,240.50.
Indicate the number of shares outstanding of each of the registrant's
classes of common equity, as of the latest practicable date:
Class of Number of
Common Equity Shares
Class A Common Stock 5,312,666
par value $.01
Class B Common Stock 2,732,249
par value $.01
The information required by Part III of this Form 10-K is incorporated by
reference from the Registrant's definitive proxy statement to be filed with the
Commission on or before May 30, 1997.
1
PART I
Item 1. Business
General
Founded in 1970, Hirsch International Corp. ("Hirsch" or the "Company") has
become a leading single source provider of electronic computer-controlled
embroidery machinery and related value-added products and services. The Company
offers a complete line of technologically advanced single-head and multi-head
embroidery machines, proprietary application software, a diverse line of
embroidery supplies, accessories and proprietary products, and a range of
equipment financing options. In addition, Hirsch provides a comprehensive
customer service program, user training and software support. The Company
believes its broad product offerings together with its related value-added
products and services place it in a strong competitive position within its
marketplace. From fiscal year 1993 to fiscal year 1997, the Company's net sales
increased at a 29.4% compound annual rate to $122.2 million, while net income
increased at a 47.5% compound annual rate to $8.8 million.
The Company's customers range from large operators who run numerous
machines to individuals who customize products on a single machine. Principal
customer groups include: (i) contract embroiderers, who serve manufacturers that
outsource their embroidery requirements; (ii) manufacturers, who use embroidery
to embellish their apparel, accessories, towels, linens and other products with
decorative appeal; and (iii) embroidery entrepreneurs, who produce customized
products for individuals, sports leagues, school systems, fraternal
organizations, promotional advertisers and other groups.
Hirsch has certain exclusive United States rights to sell new embroidery
machines manufactured by Tajima Industries Ltd. ("Tajima"). Tajima, located in
Nagoya, Japan, is one of the world's leading manufacturers of embroidery
machines, and is regarded as a technological innovator and producer of high
quality, reliable and durable embroidery equipment. The Company has exclusive
right to distribute Tajima small (one through six head) machines in the
continental United States and Hawaii and large (six and higher head) machines in
39 states. The exclusive rights to distribute large machines in the nine Western
states and Hawaii in which Hirsch does not have such distribution rights, is
held by an unrelated third party.
The Company and Tajima have had a 20-year relationship, and Hirsch believes
it is Tajima's largest distributor in the world. Hirsch collaborates with Tajima
in the development of new embroidery equipment and enhancements to existing
equipment. To date, all Tajima equipment has been assembled in Japan. Hirsch
recently announced the formation of a subsidiary, Tajima USA, Inc. ("Tajima
USA"), which initially will assemble Tajima machines with up to six heads in the
United States to provide additional manufacturing capacity. The Company
anticipates that this manufacturing capacity will enable it to reduce its
inventory carrying costs to its customers.
In addition to offering a complete line of technologically-advanced
embroidery machines and customer training, support and service, Hirsch provides
an array of value-added products and services to its customers. The Company's
software subsidiary, Pulse Microsystems Ltd. ("Pulse"), develops and supplies
application software programs which enhance and simplify the embroidery process,
enable customization of designs and reduce production costs. Pulse has designed
and delivered the majority of its proprietary application software programs to
operate in the Microsoft(R) Windows 95TM environment, which Hirsch believes will
further enhance and simplify ease of use and user flexibility. The Company's
leasing subsidiary, HAPL Leasing Co., Inc. ("HAPL Leasing"), provides a range of
equipment financing options to customers wishing to finance equipment purchases.
Hirsch also sells a broad range of embroidery supplies, accessories and
proprietary embroidery products through Company's Embroidery Supply Warehouse
division ("ESW").
The Company's equipment and value-added products are marketed and sold by
sales and marketing personnel, whose efforts are augmented by trade journal
advertising, informational "open house" seminars and trade
2
shows. Hirsch believes its reputation, knowledge of the marketplace,
exclusive Tajima distribution rights, industry expertise and innovation will
enable it to continue to increase the overall size of the embroidery equipment
market and its market share.
The Embroidery Industry
The embroidery industry has evolved from an industry characterized by
commercial embroiders using relatively simple labor intensive machinery with
limited production capabilities to an industry characterized by rapid growth and
technological change. The development of electronic computer-controlled
embroidery machines has led to new embroidery applications and markets, cost
savings, higher profit margins and production efficiencies. These machines offer
superior design flexibility, increased speed, the ability to embroider finished
products, the ability to efficiently embroider up to twelve colors at a time,
automatic thread trimming, and other labor-saving improvements. The embroidery
industry also benefitted from the sudden growth, beginning in the late 1980s, in
the use of licensed products by apparel and other manufacturers. Licensed names,
logos and designs provided by, among others, professional and collegiate sports
teams and the entertainment industry appear on caps, shirts, outerwear, luggage
and other softgoods for sale at affordable prices. In addition, the intricacy of
the designs capable of being embroidered and the availability of tandem
applications, those which include both embroidery and chenille, began to attract
broad fashion appeal and more recently commercial appeal for special event
promotional marketing. Embroidery equipment may contain single or multiple
sewing heads, each sewing head consisting of a group of needles which are fed by
spools of thread attached to the equipment. The design and production
capabilities of the sewing heads are enhanced through the integration of
computers and specialized software applications.
Business Strategy
The Company's objective is to establish and maintain long-term
relationships with its customers by providing them with a single source solution
for their embroidery equipment and related services and financing needs. To
achieve this goal, the Company has developed a comprehensive approach under
which it (i) sells a broad range of Tajima embroidery machines, (ii) develops
and supplies proprietary application software programs for embroidery machines,
(iii) sells a broad range of embroidery supplies, accessories and proprietary
products, (iv) provides leasing options to customers to finance equipment
purchases, (v) provides comprehensive customer training in the use of the
embroidery machines and related application software, and (vi) supports and
services the embroidery machines. The Company believes that this comprehensive
approach positions it to become its customers' preferred vendor for their
embroidery equipment and related services, supplies, and financing needs. To
complement its comprehensive approach effectively and efficiently, the Company's
business strategy includes the following:
Comprehensive Embroidery Machine Selection. The Company believes that
offering Tajima embroidery equipment provides it with a competitive advantage
because Tajima produces technologically advanced embroidery machines that are of
high quality, reliable and durable. The Company markets and distributes over 80
models of embroidery machines, ranging in size from one head per machine,
suitable for sampling and small production runs, to 30 heads per machine,
suitable for high production runs for embroidered patches and small piece goods
which become parts of garments of other soft goods.
Pulse Microsystem Software. The Company's Pulse subsidiary offers a wide
range of proprietary application software which enhances and simplifies the
embroidery process. The Company has designed and delivered a majority of its
proprietary application software products to operate in the Microsoft(R) Windows
95TM environment which the Company believes will enhance creativity, ease of use
and user flexibility. The Company intends to aggressively market its software
with embroidery equipment and as an upgrade to its installed base of
approximately 12,000 embroidery machines. The Company believes that these
products have broad appeal to purchasers of single-head and multi-head
embroidery machines and present opportunities for the Company to
3
increase sales of embroidery equipment and software as the Company
continues to emphasize marketing activities. Pulse intends to continue to
automate the process of creating embroidery applications in order to open new
markets, reduce costs and increase production efficiencies. Pulse has increased
the number of its software developers and will continue to develop software that
enhances new features in the embroidery machines being introduced.
Financing Options. The Company's HAPL Leasing subsidiary offers its
customers the option to lease rather than purchase embroidery equipment. The
Company believes that HAPL Leasing's programs increase opportunities to sell
equipment by reducing the initial capital commitment required of a potential
purchaser. HAPL Leasing's programs are attractive to purchasers who desire to
begin or expand embroidery operations while limiting their initial capital
investment.
Embroidery Supplies, Accessories and Proprietary Products. The Company's
ESW division offers a broad range of embroidery supplies, accessories and
proprietary products. ESW is an integral part of the Company's single source
strategy. The Company's expanding marketing efforts will be directed toward
telemarketing, trade publication, advertising, catalog mailers and trade show
participation. ESW offers proprietary products together with a full line of
consumable supplies, parts and materials utilized in the embroidery process and
continues to develop special purpose embroidery replacement parts and products
that are more durable and simplify the embroidery process.
Customer Support and Service. The Company provides comprehensive customer
training, support and service for the embroidery machines and software that it
sells. The Company's customer service department includes service technicians
operating out of its headquarters and 22 regional offices. After the Company
delivers an embroidery machine to a customer, its trained personnel assist in
the installation of the machine and with setup and operation. The Company has a
staff of service representatives who provide assistance to its customers by
telephone. Most customer problems or inquiries can be handled by telephone, but
when necessary the Company dispatches one of its service technicians to the
customer. In addition, the Company provides at its facilities introductory and
advanced training programs developed by the Company to assist customers in the
use and operation of the embroidery machines it sells.
Growth Strategy
The Company has developed a number of complementary growth strategies,
including the following:
Grow with Embroidery Equipment Customers. The continuing growth of the
embroidery industry and the increasing number of embroidery entrepreneurs who
sell customized products into specialized niche markets presents the Company
with the opportunity to grow with its customers. The Company believes that
purchasers of smaller embroidery machines are a significant source of future
business for larger multi-head machines as their operations expand. The
Company's customer support personnel work with customers to assist them in
expanding their operations. By establishing a relationship through the sale of a
smaller embroidery machine, the Company strives to establish itself as the
customers' preferred vendor for larger multi-head machines. New uses for
embroidery machines in the sewing of apparel also present the Company with an
opportunity to grow with its customers and sell to new customers.
Increase Penetration in Recently Acquired New Equipment Distribution
Markets. The Company believes that it has excellent opportunities for growth in
the distribution territories acquired in the acquisitions of Sewing Machine
Exchange, Inc. ("SMX") and Sedeco, Inc. ("Sedeco," and collectively referred to
as "Recent Acquisitions") and in the western states where the Company has the
exclusive right to distribute small Tajima machines. The Company anticipates
that the introduction of its approach to marketing and customer training,
support and service will allow it to further penetrate the potential customer
base in these markets.
4
Expand Sales of Value-Added Product and Services. Once a relationship with
a customer is established by the sale of a new or used embroidery machine, the
Company seeks to increase its sales by supplying software developed by Pulse and
a broad range of embroidery supplies and equipment through ESW. Offering the
customer leasing options through HAPL Leasing also presents the Company with an
opportunity to increase its revenues. In those regions of the United States into
which the Company has recently expanded through acquisitions and obtaining the
right to distribute small Tajima machines, the Company believes that it has a
particularly strong opportunity to expand sales of its value-added products and
services. Historically, the Company's sales of software products, leasing
activities and sales of ESW products have been concentrated in the states where
it has had the exclusive right to distribute embroidery machines. The Company
believes that expanding this area will allow it to better market its value-added
products and services. To facilitate this growth, the Company is establishing
ESW warehouses at the same locations as certain sales offices. In addition,
ESW's product line also is offered to all users of embroidery equipment in the
United States through trade publications, print advertising, catalogue mailers
and trade show participation.
In addition, HAPL Leasing has assembled a talented and aggressive staff of
regionalized sales and support personnel to blanket this expanded territory.
This regional sales approach is establishing HAPL Leasing's presence in the
midwest, southwest and on the west coast, and will increase their momentum in
sales and profitability. Pulse continues to set the software standard in the
embroidery industry with the release of Version 7 of its Signature(R) product
line. The user-friendly operating environment of Version 7 places the focus on
the creative end of designing which should revolutionize the art of digitizing.
In addition, the patented chenille software developed by Pulse has been
positively received by Tajima and has been displayed with their chenille
embroidery machines at international trade shows.
Establish Assembly Operations. The Company recently announced plans to
assemble Tajima embroidery machines in the United States through its subsidiary,
Tajima USA, initially in configurations of up to six heads. This assembly
facility will be located near the Company's headquarters. As a result, the
Company expects to be able to better manage its inventory. Presently, the
Company's current ordering cycle for these machines is approximately four to
five months prior to delivery to the Company. The Company also believes that
establishing this assembly facility will further strengthen its relationship
with Tajima.
Embroidery Equipment
Embroidery equipment may contain single or multiple sewing heads. The
Company markets and distributes over 80 models of embroidery machines, ranging
in size from one head per machine, suitable for sampling and small production
runs, to 30 heads per machine, suitable for high production runs for embroidered
patches and small piece goods which become part of garments or other soft goods.
The selling prices of these machines range from $20,000 to $180,000. Each sewing
head consists of a group of needles which are fed by spools of thread attached
to the equipment. The needles operate in conjunction with each other to
embroider the thread into the cloth or other surface in such configuration as to
produce the intended design. Thread flowing to each needle can be of the same or
varying colors. Each head creates a design and heads operating at the same time
create the same size and shape designs, although designs created at the same
time can differ in color. Thus, a 30 head machine with all heads operating
simultaneously creates an identical design on thirty surfaces. The design and
production capabilities are enhanced through the integration of computers and
specialized software applications.
Recent Product Developments. The Company often collaborates with Tajima in
the development of embroidery products. Over the past few years, Tajima has
introduced the following embroidery products: (i) wide Cap embroidery system,
which expands the small sewing field on finished caps to a 270 degree continuous
arc; (ii) the multi-color chenille embroidery machine, which enables
embroiderers to create more elaborate and colorful designs with chenille
stitches; (iii) the tandem chenille and embroidery machine, making it possible
to incorporate both chenille and embroidery into the same design; and (iv) the
Emblaser machine, which incorporates embroidery and laser technology into one
system, reduces production time and increases production efficiencies. The
Company
5
believes that the greater variety of embroidered products that these
machines can produce will result in demand for these products presenting an
opportunity for growth for the Company.
Value Added Products
Software
All Tajima machines can be networked through Pulse software. The
computerization of the embroidery industry has led to a demand for more advanced
application software. Pulse, a strategic acquisition in 1994, is a developer and
supplier of a wide range of application software programs which enhance and
simplify the embroidery process. Pulse's computer-aided design software packages
are targeted at different functions performed by embroiderers, all in an
integrated product line. These products range from a basic lettering package
that permits the embroiderer to design names and letters for use on the product
to be embroidered to sophisticated packages that permit the creation and editing
of intricate designs, logos and insignias through the use of scanners and
computers.
Pulse also offers database products and business management tools to its
customers, including its Passport Embroidery Network which allows a single user
to network embroidery machines of any make or model. Additionally, it is a
production management system that provides users with the ability to monitor
production, diagnostic information and operator efficiency in real time.
In October 1995, Pulse introduced the Signature software product line which
enables designers to operate in the Microsoft(R) Windows 95TM environment. The
Signature software's TRUE TYPE functionality facilitates the creation of
embroidered lettering from any standard computer font. An On-Screen Digitizing
feature accommodates imported computer images and then, using many new artistic
features, easily digitizes them. This on-screen method is a quick and easy way
to create custom-embroidered designs with professional results.
In addition, Pulse has developed application software that uses bar codes
to recognize embroidery designs and embroidered lettering for the uniform
industry. Bar coding will facilitate the expedient and accurate retrieval of
designs from design databases. Pulse also developed application software to be
integrated with the new Tajima chenille and laser embroidery machines.
Leasing
In order to become a single source provider to the embroidery industry, the
Company formed HAPL Leasing in 1990. The Company believes that it is the only
embroidery equipment distributor with a captive leasing subsidiary providing the
Company with a unique competitive advantage.
Approximately 34.8% of the Company's revenues from sales were financed
through HAPL Leasing for the year ended January 31, 1997, compared to 35.3% for
the year ended January 31, 1996. HAPL Leasing minimizes its leasing risk by
selling substantially all of its sales-type leases to financial institutions on
a non-recourse basis. The selling price of the leases to financial institutions
generally will be a lump sum equal to the sales price of the embroidery
equipment leased, plus a portion of the finance charges paid by the lessee. In
addition, at the end of the lease term, the residual value of the embroidery
equipment may revert to HAPL Leasing or HAPL Leasing sells the equipment to the
lessee at terms agreed upon in the original lease agreement. Each lease
generally has a term of three to five years. As of January 31, 1997, HAPL
Leasing had sold approximately 90% of its leases on a non-recourse basis.
In some cases, third party funding sources condition their purchase of
leases on the establishment of a payment history. HAPL Leasing also retains
selected leases for which it has not obtained a purchase commitment from its
funding sources. In each case where a lease is retained, HAPL Leasing applies
its policies and procedures and knowledge of the industry to determine whether
to enter into the lease, including an evaluation of the
6
purchaser's business prospects and the creditworthiness of the principals.
HAPL Leasing sells these leases if financing becomes available at a later date.
HAPL Leasing is continuing to increase the number of funding sources and
works with its funding sources to develop new lease programs attractive to the
embroidery industry.
Embroidery Supply Warehouse
ESW offers a broad range of embroidery supplies including threads, needles,
thread cone winders, embroidery hoops, embroidery backings and embroiderable
products such as caps, t-shirts, jackets, sweat suits, sweatshirts and canvas
bags. In addition, ESW develops embroidery products based on the recommendations
of embroiderers. ESW also distributes the Universal Hooper, a manual hooping
device, a machine thread rack upgrade called "Quick Thread" and specially sized
embroidering hoops for unusual applications.
ESW also recently introduced "Hoopless Air Clamps," a proprietary product
that allows manufacturers to apply embroidery to unfinished flat pieces without
the need for a hoop. The Company anticipates that this product will benefit
clothing manufacturers by reducing labor costs and production time.
Other products recently introduced by, ESW include: "Power Hoops;" Tajima
Hoops; 3-D Embroidery Foam, which allows embroiderers to add new multi-media,
multi-dimensional embroidery to a design using existing equipment; steamers,
which remove wrinkles and hoop marks; cleaning guns, which remove stains that
occur during the embroidery process; and Peggy's Stitch Eraser, an electric
stitch remover that allows embroiderers to quickly and efficiently remove bobbin
thread from sewn garments.
Marketing and Customer Support
The Company has been selling embroidery equipment since 1976 and believes
it is the leading distributor of Tajima equipment in the world. The Company
reinforces recognition of its name through trade journal advertising and
participation in seminars and over 25 trade shows annually. The Company's
growing sales staff is headed by Paul Levine, Executive Vice President and Chief
Operating Officer of the Company, and currently consists of salespeople who
maintain frequent contact with customers in order to understand each customer's
needs. Through its reputation, knowledge of the marketplace, investment in
infrastructure and experience in the industry, the Company believes it is
increasing its market share.
The Company believes that a key element in its success has been focus on
customer service, and investment in sales support and training, infrastructure
and technology to support operations. The Company provides at its facilities
extensive two to five day training programs developed by the Company to assist
customers in the use and operation of the embroidery machines it sells.
Customers are trained in the operation of embroidery machines as well as in
embroidery techniques and the embroidery industry in general. The Company
provides proprietary videotapes and manuals as training tools. Company personnel
also provide technical and software support by telephone, field maintenance
services and quality control testing, as well as advice with respect to matters
generally affecting embroidery operations.
The Company also has developed an internal training center for its
employees at its Cleveland training center. The program educates employees about
the embroidery industry, the history of embroidery and the Company, embroidery
techniques and the operation of embroidery machines. Service technicians receive
an intensive training program in addition to the aforementioned program. Senior
service technicians also receive formal training from Japan for several weeks
and receive technical updates from Tajima throughout the year. The Company will
continue to dedicate resources to education and training as the foundation for
providing the highest level of customer service.
7
In addition, the Company collaborates with its customers and Tajima in
connection with the development of new embroidery equipment and applications to
meet the specialized needs of the Company's customers. Current projects include
the development of embroidery applications for a major automobile manufacturer,
collaborations with high end designer clothing manufacturers to reduce
production costs and increase efficiency and further development of Pulse
software to be integrated with the Tajima chenille and laser machines.
The Company provides the customer with a one-year warranty against
malfunctions from defects in material or workmanship on the Tajima machines it
distributes. The warranty covers parts and labor. Tajima provides the Company
with a one-year warranty that covers substantially all of the Company's warranty
costs.
Supplier Relationships with Tajima
Three separate distributorship agreements govern the Company's right to
distribute Tajima embroidery equipment in the United States.
The Company has two separate distributorship agreements with Tajima which,
collectively, provide the Company the exclusive right to distribute Tajima's
complete line of standard embroidery, chenille embroidery and certain specialty
embroidery machines in 39 States. The main agreement (the "East Coast/Midwest
Agreement") which covers 33 States, became effective on February 21, 1991, has a
term of 20 years and contains a renewal provision which permits successive five
year renewals upon mutual agreement of the parties. The East Coast/Midwest
Agreement is terminable by Tajima and/or the Company on not less than two years'
prior notice except that Tajima cannot terminate the East Coast/Midwest
Agreement prior to February 20, 1998. The second agreement (the "Southwest
Agreement") covers six states, became effective on February 21, 1997 and has a
term of five years. Under the third distributorship agreement, which covers nine
western states and Hawaii, the Company is the exclusive distributor of Tajima's
single, two, four and six head machines as well as chenille or chenille/standard
embroidery machines with less than four heads or two stations, respectively (the
"West Coast Agreement"). The West Coast Agreement has a term of five years
initially terminates on February 20, 2002, and contains a renewal provision
which permits successive five year renewals upon mutual agreement of the
parties.
Each of the agreements may be terminated if the Company fails to achieve
certain minimum sales quotas. Furthermore, the East Coast/Midwest Agreement may
be terminated if Henry Arnberg and Paul Levine (or in certain circumstances,
their spouses and children) fail to own a sufficient number of shares of voting
stock to elect a majority of the Company's Board of Directors. The Southwest
Agreement may be terminated if the Company fails to remain the sole shareholder
of its subsidiary that is the party to the Southwest Agreement. The West Coast
Agreement may be terminated should any material change occur in the current
Class B shareholders, directors or officers of the Company.
Although there can be no assurance, management of the Company believes that
the likelihood of the loss of Tajima as a source of supply is remote because:
(i) the Company has a 20 year relationship with Tajima and is Tajima's largest
distributor; (ii) Tajima's success in the United States is, in large part,
attributable to the Company's knowledge of the marketplace as well as the
Company's reputation for customer support; and (iii) the Company and Pulse
support Tajima's development activities and the Pulse software enhances the
Tajima product line.
Other Supplier Relationships
The Company purchases personal computers which are integrated with the
embroidery machines it distributes. ESW obtains its supplies from many different
sources. The Company believes that alternate sources of supply are readily
available.
8
Customers
The Company's customers range from large operators who run numerous
machines to individuals who customize products on a single machine. Principal
customer groups include: (i) contract embroiderers, who serve manufacturers that
outsource their embroidery requirements; (ii) manufacturers, who use embroidery
to embellish their apparel, accessories, towels, linens and other products with
decorative appeal; and (iii) embroidery entrepreneurs, who produce customized
products for individuals, sports leagues, school systems, fraternal
organizations, promotional advertisers and other groups. The Company's customers
include: Fruit of the Loom, Russell Licensed Products, Logo 7, Healthtex, Five
B's, Osh Kosh B'Gosh, Avanti Lines and William Carter Company.
Competition
The Company competes with distributors, such as Macpherson, Inc., a
distributor of Barudan multi-head embroidery machines and Meistergram
single-head embroidery machines, as well as with smaller distributors. The
Company also competes with original equipment manufacturers, such as Brother
International and Melco Embroidery Systems ("Melco"), which distribute products
directly into the Company's markets. The Company believes it competes against
these distributors on the basis of knowledge, experience, name recognition,
customer service and the quality of the embroidery equipment it distributes.
Further, the Company's customers are subject to competition from importers
of embroidered products, which could affect the Company's operations.
The Company's success is dependent, in part, on the ability of Tajima to
continue producing products which are technologically superior and price
competitive with those of other manufacturers.
Pulse's software products compete against products developed by several
companies from around the world. The primary competitors are Wilcom Pty., an
Australian corporation, Gunold & Stickma GmbH, a German corporation and Melco.
The Company believes that Pulse competes on the basis of ease of use,
functionality and the range of software applications it markets.
HAPL Leasing competes principally with equipment leasing brokers
specializing in the embroidery industry and other financing sources such as
banks and other financial institutions. The Company believes that it competes on
the basis of HAPL Leasing's favorable pricing and because the Company is a
single source provider of embroidery equipment, customer service and support and
value added products.
ESW competes with a division of Melco and other vendors of embroidery
supplies. The Company believes that the market for embroidery supplies is
fragmented and that ESW will benefit from the breadth of its product line,
development of proprietary products and the fact that the Company is a single
source provider.
Patents and Copyrights
The Pulse software has copyright protection under Canadian law and the
Berne Convention which also affords it protection in the United States. Certain
of the Pulse software has also been granted United States copyright
registrations. The following patents have been granted in the United States:
"Method For Modifying Embroidery Design Programs", "Embroidery Design System",
"Method For Creating Self-Generating Embroidery Pattern" and "Method for
Automatically Generating Chain Stitches," and two patents entitled "Method for
Automatically Generating A Chenille-Filled Embroidery Stitch Pattern." Pulse
also has several other patents pending in the United States Patent and Trademark
Office. Pulse also has the following patent pending in the European Patent
Offices: "Method for Modifying Embroidery Design Programs," and the following
patents pending in the Japanese Patent office: "Method for Modifying Embroidery
Design Programs," "Method for Automatically Generating Chain Stitches" and
"Method For Automatically Generating A Chenille-Filled Embroidery Stitch
9
Pattern." Pulse believes these protections are sufficient to prevent
unauthorized third party uses of such property rights. Neither Pulse nor the
Company is aware of any patents or other intellectual property rights of third
parties which would prevent the use of Pulse's intellectual property. The
Company continues to seek intellectual property protection for Pulse products.
Employees
As of March 31, 1997, the Company employed approximately 325 persons
engaged in sales for the Company, ESW, HAPL Leasing and Pulse, customer service
and supplies, product development, and finance administration and management.
None of the Company's employees is represented by unions. The Company believes
its relationship with employees is good.
Item 2. Properties
The Company's corporate headquarters is in Hauppauge, New York in a 50,000
square foot facility. This property houses the Company's executive offices, the
Northeast sales office, customer service, software support and warehouse space.
Additionally, both HAPL Leasing and ESW operate out of this facility. On October
27, 1994, the Company entered into a ten year, $2,295,000 Mortgage agreement
with a bank for its new corporate headquarters. The Mortgage bears interest at a
fixed rate of 8.8% and is payable in equal monthly principal installments of
$19,125. The Company's obligations under the Mortgage are secured by a lien on
the premises and the related improvements thereon.
In March 1997, the Company entered into a five year lease for a 25,000
square foot factory facility in Bohemia, New York where its subsidiary, Tajima
USA, Inc., will operate a machine assembly facility. The lease provides for
lease payments of approximately $132,000 per annum.
In addition to the Company's headquarters, the Company owns one satellite
office and leases 22 regional satellite offices. These offices consist of
regional sales offices, training centers, repair centers and warehouse and
showroom space.
Item 3. Legal Proceedings
There are no material legal proceedings pending against the Company.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of Security holders during
the fourth quarter of its most recent fiscal year.
10
PART II
Item 5. Market For Common Equity and Related Stockholder Matters
(a) The Company's outstanding Common Stock consists of two classes, Class A
Common Stock and Class B Common Stock. The Class A Common Stock, par value $.01
per share, trades on the NASDAQ Stock Market under the symbol HRSH. The
following table sets forth for each period indicated the high and low sale
prices for the Class A Common Stock as reported on the NASDAQ National Market.
Trading began in the Class A Common Stock on February 17, 1994.
Fiscal 1996 High Low
First Quarter ended April 30, 1995........................$ 8.48 $ 6.23
Second Quarter ended July 31, 1995........................$10.40 $ 6.88
Third Quarter ended October 31, 1995......................$12.20 $ 8.80
Fourth Quarter ended January 31, 1995.....................$12.00 $ 8.80
Fiscal 1997
First Quarter ended April 30, 1996........................$13.20 $10.20
Second Quarter ended July 31, 1996........................$17.60 $12.60
Third Quarter ended October 31, 1996......................$19.25 $15.25
Fourth Quarter ended January 31, 1997.....................$23.00 $17.25
The sale prices have been adjusted to reflect two 5-for-4 stock splits paid
in the form of a 25% stock divided effected July 25, 1995 and July 22, 1996.
(b) As of April 21, 1997, the Company believes that there were
approximately 3,395 beneficial owners of its Class A Common Stock.
(c) The Company intends to retain earnings for use in operations and
expansion of its business and therefore does not anticipate paying cash
dividends on the Class A Common Stock or the Class B Common Stock in the
foreseeable future. The future payment of dividends is within the discretion of
the Board of Directors and will be dependent, among other things, upon earnings,
capital requirements, financing agreement covenants, the financial condition of
the Company and applicable law. The Class A Common Stock and Class B Common
Stock share ratably in any dividends declared by the Company on its Common
Stock. Any stock dividends on the Class A Common Stock and the Class B Common
Stock will be paid in shares of Class A Common Stock.
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and the Notes thereto
included elsewhere herein. The consolidated financial statement data as of
January 31, 1997 and 1996 and for the fiscal years ended January 31, 1997, 1996
and 1995 are derived from, and are qualified by reference to, the audited
Consolidated Financial Statements included elsewhere herein and should be read
in conjunction with those Consolidated Financial Statements and the Notes
thereto. The consolidated financial statement data as of January 31, 1995, 1994
and 1993 and for the fiscal years ended January 31, 1994 and 1993 are derived
from audited Consolidated Financial Statements not included herein.
11
Year Ended January 31,
(in thousands)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Statement of Operations Data:
Net Sales........................... $122,195 $87,974 $70,709 $49,959 $43,584
Interest income related to sales-type 3,243 3,022 1,617 571 37
leases..............................
Cost of goods sold.................. 80,820 58,836 47,881 35,452 30,628
Selling, general and administrative 29,070 20,638 16,155 10,520 9,614
expenses............................
Income before income taxes.......... 15,170 11,402 8,159 4,272 3,078
Income taxes........................ 6,402 4,837 3,335 1,663(1) 1,226
Net income (5)...................... 8,768 6,565 4,823 2,609(1) 1,853
Income per share.................... $ 1.10 $ 0.87 $ 0.66 $ 0.49(1) $ 0.35
======= ======= ======= ========== =======
Shares used in the calculation of net
income per share (5)................ 7,972 7,512 7,335 5,332 5,332
January 31,
(in thousands of dollars)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Balance Sheet Data:
Working capital..................... $22,959 $16,847(3) $10,363(2) $ 1,674 $ 5,351
Total assets........................ 83,696 47,872(3) 37,504(2) 21,349 15,149
Long-term debt, less current 13,194(4) 1,779 2,696 776 935
maturities..........................
Stockholders' equity................ 41,682 29,134(3) 20,636(2) 7,830 6,287
(1) Income taxes, net income and income per share for the fiscal year ended
January 31, 1994 reflect, on a pro forma basis, the federal and regular state
income taxes which would have been incurred if the Company had been taxed as a C
Corporation under the Code and applicable state statutes during such period.
(2) In February 1994, in connection with its initial public offering (the
"IPO"), the Company received net proceeds of $7,353,000, after deducting
expenses of the IPO.
(3) In January 1996, in connection with a second public offering of its
Class A Common Stock (the Second Offering"), the Company received net proceeds
of $1,906,000, after deducting expenses of the Second Offering.
(4) Included in long-term debt, less current maturities at January 31, 1997
is $11,645,000 of debt relating to the Company's Recent Acquisitions.
12
(5) Income per share figures and shares used in calculation of net income
per share have been retroactively adjusted to refle ct a 5% stock dividend paid
in August 1994 and two 5-for-4 stock splits paid in the form of a 25% stock
dividend effected July 1995 and July 1996.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis contains forward-looking statements
which involve risks and uncertainties. When used herein, the words "anticipate,"
"believe," "estimate" and "expect" and similar expressions as they relate to the
Company or its management are intended to identify such forward-looking
statements. The Company's actual results, performance or achievements could
differ materially from the results expressed in or implied by these
forward-looking statements. As used herein, "fiscal year" refers to the fiscal
year ending January 31 of the identified calendar year.
General
Hirsch is a leading single source supplier of electronic
computer-controlled embroidery machinery and related value-added products and
services to the embroidery industry. The Company offers a complete line of
technologically advanced single-head and multi-head embroidery machines,
proprietary application software and a diverse line of embroidery supplies,
accessories and proprietary products. Hirsch believes its comprehensive customer
service, user training, software support and broad product offerings combine to
place the Company in a superior competitive position within its marketplace. The
Company sells embroidery machines manufactured by Tajima.
The Company's focus during the past several years has been on growth and
expansion. The acquisitions of Sewing Machine Exchange, Inc. ("SMX") and Sedeco,
Inc. ("Sedeco") increased the area in which the Company is the exclusive
distributor of Tajima embroidery equipment from 26 states to 39 states. These
acquisitions (the "Recent Acquisitions") were accounted for as Purchases in
accordance with Accounting Principles Board Opinion on No. 16, "Business
Combination." See Note 3 of Notes to Consolidated Financial Statements. In
January 1997, Tajima granted the Company the exclusive right to distribute small
(one through six head) Tajima embroidery machines in nine western states and
Hawaii. With this expansion of the Company's small machine territory to the West
Coast, Hirsch now has the exclusive right to distribute Tajima small machines in
the continental United States and Hawaii. Hirsch also announced the formation of
its newest subsidiary, Tajima USA which has been created for the sole purpose of
assembling Tajima embroidery machines in the United States. Production at Tajima
USA will consist of models in configurations of up to six heads per machine.
With the full assistance and support of Tajima, Hirsch expects the facility to
be in operation by June 1997.
The Company's growth has also resulted from rapid technological change in
embroidery equipment and related application software, the continued strong
demand for embroidered products, the creation of new embroidery applications and
the continued strength of "embroidery entrepreneur," who produce customized
products for individuals, sports leagues, school systems, fraternal
organizations, promotional advertisers and other groups, as a growing segment of
the marketplace. The Company believes that the purchasers of smaller embroidery
machines are a significant source of future business for the sale of multi-head
embroidery machines as the entrepreneurs' operations expand.
The Company's revenues have increased at a compound annual growth rate of
31.7% from $72,326,000 in fiscal year 1995 to $125,439,000 in fiscal year 1997.
Revenue growth from fiscal year 1995 to fiscal year 1997 has benefitted from an
increase in revenue from the sale of embroidery machinery of approximately
$40,958,000 from $60,753,000 in fiscal year 1995 to $101,711,000 in fiscal year
1997. Revenue for fiscal year 1997 also benefitted from $14,500,000 in revenues
from the newly acquired distribution territories. The revenue contribution from
value-added products divisions has increased from approximately 7.5% of total
revenues in fiscal year 1995
13
to approximately 9% of total revenue in fiscal year 1997 which has also
contributed significantly to the Company's growth during this period.
Earnings per share have increased at a compound annual growth rate of 29.1%
from $.66 per share for fiscal year 1995 to $1.10 per share for fiscal year 1997
and, net income has increased at a compound annual growth rate of 35% from
$4,823,000 for fiscal year 1995 to $8,768,000 for fiscal year 1997. Growth in
earnings per share and net income is the result of consistent margins on the
sale of embroidery machinery and the growth in the sale of higher margin
value-added products. The net income contribution from the Company's value-added
products has increased from approximately 24% in fiscal year 1995 to
approximately 34% in fiscal year 1997. After consideration of amortization
expense for the excess of cost over net assets acquired and interest expense for
the incurred debt, the net income contributions from the Recent Acquisitions
were nominal in fiscal year 1997.
Results of Operations
The following table presents certain income statement items expressed as a
percentage of total revenue for the fiscal years ended January 31, 1995, 1996
and 1997.
Year Ended January 31,
1997 1996 1995
---- ---- ----
Net sales....................................................... 97.4% 96.7% 97.8%
Interest income related to sales-type leases.................... 2.6% 3.3% 2.2%
------ ------ --------
Total revenue................................................... 100.0% 100.0% 100.0%
Costs of goods sold............................................. 64.4% 64.7% 66.2%
Selling, general and administrative expenses.................... 23.2% 22.7% 22.3%
Interest expense, net........................................... 0.7% 0.4% 0.5%
Other income, net............................................... (0.3%) (0.3%) (0.3%)
------ ------ --------
Income before income taxes...................................... 12.0% 12.5% 11.3%
Provision for income taxes...................................... 5.0% 5.3% 4.6%
------ ------ --------
Net income...................................................... 7.0% 7.2% 6.7%
====== ====== ========
Fiscal Year 1997 as Compared to Fiscal Year 1996
Net Sales. Net sales for fiscal year 197 were $122,195,000, an
increase of $34,221,000, or 38.9%, compared to $87,974,000 for fiscal year 1996.
Approximately $25,347,000, or 74.1%, of this increase was due to the sale of
embroidery machinery for fiscal year 1997. The sale of embroidery machines
represented approximately $101,710,000 or 83.2%, and $76,363,000 or 86.8%, of
net sales for fiscal years 1997 and 1996, respectively. The Company believes
that this increase is the result of the continued strong demand for embroidered
products, the creation of new embroidery applications and markets and the
continued strength of "embroidery entrepreneurs" as a growing segment of the
marketplace. Additionally, technological advances and innovations in embroidery
equipment have opened up new marketing opportunities.
The expansion of the Company's distribution territory through the
Recent Acquisitions also resulted in increased reenues for fiscal year 1997.
Approximately $12,500,000 of sales were attributable to the acquisition of SMX
for the period from June 7, 1996 through January 31, 1997, and approximately
$2,000,000 of sales were attributable to the acquisition of Sedeco for the
period from December 20, 1996 through January 31, 1997 (See Note 3 of Notes to
Consolidated Financial Statements).
The Company's revenues have also grown in lrge part as a result in the
growth in sales of the single-head embroidery machine. Single-head embroidery
machines and multi-head embroidery machines represented 45.6% and 54.4%,
respectively, of the number of embroidery machines sold during fiscal year 1997
as compared to 39.8% and 60.2% for fiscal year 1996, respectively.
14
The Company previously sold embroidery machines manufactured by Brother
Industries Ltd. ("Brother") and, through the acquisition of SMX, Melco
Embroidery Systems ("Melco"). However, effective October 16, 1996, the Company
discontinued the distribution of Brother embroidery machines. In addition, the
Company came to a mutual agreement with Melco effective December 31, 1996 in
which the Company discontinued the distribution of Melco embroidery equipment
through SMX.
Revenue from the sale of the Company's proprietary application software,
embroidery supplies, accessories and proprietary products for fiscal year 1997
aggregated approximately $20,485,000, as compared to $11,611,000, which
represents an increase of approximately 76.4% for fiscal year 1996. This
increase is primarily attributable to the increase in revenues from the sale of
embroidery machines.
Interest income related to sales-type leases. HAPL Leasing's interest
income increased 7.3% to $3,243,000 for fiscal year 1997 from $3,022,000 for the
comparable period of the prior year. This increase is a result of the continued
expansion of HAPL Leasing's operations and staff. In order to increase market
share, HAPL Leasing reduced its rates in certain instances, which resulted in
growth that was not proportionate to the growth in revenues from the sale of
embroidery machines.
Cost of Goods Sold. For fiscal year 1997, cost of goods sold increased
$21,984,000, or 37.4%, to $80,820,000 from $58,836,000 for fiscal year 1996. The
increase was in direct proportion to the Company's increased sales volume. The
fluctuation of the dollar against the yen had a minimal effect on Tajima
equipment gross margins since currency fluctuations generally have been
reflected in pricing adjustments in order to maintain consistent gross margins
on machine revenues. Gross margins for the Company's value-added products are
generally higher than gross margins on the sale of embroidery machinery.
Selling, General and Administrative ("SG&A") Expenses. For fiscal year 1997
SG&A expenses increased $8,432,000, or 40.9%, to $29,070,000 from $20,638,000
for fiscal year 1996. SG&A expenses increased as a percentage of revenues to
23.2% from 22.7%. This increase in SG&A expenses as a percentage of revenues is
primarily attributable to the following factors:
o The Company made a significant investment in its infrastructure as it
relates to its growth strategy and the West Coast Expansion. Additional sales,
marketing, training, administrative and technical support personnel were hired
to support this growth. The Company also entered into leases for several new
sales offices and incurred start up costs related to these offices. The Company
also increased expenditures for advertising and for participation in trade
shows.
o Expenses incurred in connection with the Recent Acquisitions.
Interest Expense. Interest expense for fiscal year 1997 increased $435,000,
or 109.7%, from $397,000 in fiscal year 1996 to $832,000 in fiscal year 1997.
This increase is directly attributable to the increased interest costs related
to the additional debt incurred in connection with the Recent Acquisitions.
Provision for Income Taxes. The provision for income taxes reflected an
effective tax rate of approximately 42.2% for fiscal year 1997 as compared to
42.4% for fiscal year 1996. Differences from the federal statutory rate
consisted primarily of provisions for state income taxes net of Federal tax
benefit. The principal components of the deferred income tax assets result from
allowances and accruals which are not currently deductible for tax purposes and
differences in amortization periods between book and tax bases. There was no
effect on deferred taxes as a result of the SMX acquisition, which was accounted
for as an asset purchase for tax purposes. The goodwill related to the SMX
acquisition is being amortized over 15 years for both book and tax purposes. The
goodwill related to the Sedeco acquisition, which was accounted for as a stock
purchase for tax purposes, resulted in a permanent difference since it is not
deductible for tax purposes. The Company has not established any
15
valuation allowances against these deferred tax assets because management
believes it is more likely than not that the Company will realize these assets
in the future based upon the historical profitable operations of the Company.
Net Income. Net Income for fiscal year 1997 increased $2,203,000, or 33.6%,
to $8,768,000 from $6,565,000 for fiscal year 1996. This increase was due to the
continued growth in machine sales in addition to the contribution to net income
from the sale of the Company's value added products. The net margin decreased to
6.99% in fiscal year 1997 from 7.21% in fiscal year 1996. This decrease is
attributable to the increase in SG&A expenses.
Fiscal Year 1996 as Compared to Fiscal Year 1995
Net Sales. Net sales for the fiscal year 1996 were $87,974,000, an increase
of $17,265,000, or 24.4%, compared to $70,709,000 for the fiscal year 1995.
Approximately $15,609,000 of this increase was the result of increased sales of
embroidery machinery. The sale of embroidery machines represented approximately
$76,363,000 or 86.8% and approximately $80,753,000 or 85.9% of net sales for
fiscal years 1996 and 1995, respectively. The Company believes that this
increase resulted from the continued strong demand for traditional embroidered
products, the expanding number of new embroidery applications and markets and
the emergence of embroidery entrepreneurs as a growing segment of the
marketplace.
The increase in single-head machine sales has attributed to the overall
increase in net sales. Single-head and multi-head embroidery machines
represented 39.8% and 60.2%, respectively, of the number of embroidery machines
sold during fiscal year 1996 as compared to 38.0% and 62.0%, respectively, for
fiscal year 1995.
Revenues from the sale of the Company's proprietary application software,
embroidery supplies, accessories, proprietary embroidery products and used
machines for fiscal year 1996 aggregated approximately $11,611,000 as compared
to $9,956,000 for fiscal year 1995, which represents an increase of
approximately 16.6% for fiscal year 1995. This increase is primarily
attributable to the increase in revenue from the sale of embroidery machines.
Interest Income Related to Sales-Type Leases. HAPL Leasing had interest
income of $3,022,000 for fiscal year 1996 compared to $1,617,000 for fiscal year
1995. This increase was a result of the continued expansion of HAPL Leasing's
operations.
Cost of Goods Sold. For fiscal year 1996, cost of goods sold increased
$10,954,000, or 22.9%, to $58,836,000 from $47,881,000 for fiscal year 1995.
This increase was in direct proportion to the Company's increased sales volume.
The devaluation of the dollar against the yen had a minimal effect on Tajima
equipment gross margins since all currency fluctuations were generally reflected
in pricing adjustments. Profit margins were consistent throughout the Tajima and
Brother product lines.
Selling, General and Administrative ("SG&A") Expenses. For fiscal year
1996, SG&A expenses increased $4,483,000, or 27.8%, to $20,638,000 from
$16,155,000 for fiscal year 1995. SG&A expenses increased as a percentage of
revenues to 22.7% from 22.3%. This increase was primarily attributable to the
Company's investment in its infrastructure. In order to implement its growth
strategy, the Company hired additional sales and marketing personnel dedicated
to small machine sales, opened or expanded eight sales offices, hired additional
software programmers and support staff and expanded the embroidery supplies,
sales and marketing staff. The Company also increased expenditures for
advertising and participation at trade shows and seminars.
Interest Expense. Interest expense for fiscal year 1996 increased $40,000,
or 11.3%, to $397,000 from $357,000 fiscal year 1995. This increase was a result
of the mortgage on the Company's new corporate headquarters.
16
Provision for Income Taxes. The provision for income taxes reflected an
effective tax rate of approximately 42.4% for fiscal year 1996 as compared to
40.9% for fiscal year 1995. Differences from the Federal statutory rate
consisted primarily of provisions for state income taxes net of Federal tax
benefits. The increase in the tax rate for fiscal year 1996 was principally the
result of changes in the sales mix which resulted in increased sales to states
with higher effective tax rates and increased sales of software which are taxed
in a jurisdiction with a higher effective tax rate. The principal components of
the deferred income tax assets resulted from allowances and accruals which were
not deductible for tax purposes and differences in amortization periods between
book and tax bases. The Company has not established any valuation allowances
against these deferred tax assets because management believes it is more likely
than not that the Company will realize these assets in the future based upon the
historical profitable operations of the Company.
Net Income. Net income for fiscal year 1996 increased $1,742,000, or 36.1%,
to $6,565,000 from $4,823,000 for fiscal year 1995. The Company's net margin
increased from 6.7% in fiscal year 1995 to 7.2% in fiscal year 1996. These
increases were primarily due to the continued growth in the sale of embroidery
equipment and increased sales of the Company's value-added products.
Liquidity and Capital Resources
Operating Activities and Cash Flows
The Company's working capital was $22,959,000 at January 31, 1997,
increasing $6,112,000, or 36.3%, from $16,847,000 at January 31, 1996. The
Company has financed its operations principally through cash generated from
operations, long-term financing of certain capital expenditures and the proceeds
from the Secondary Offering completed in January 1996. The acquisition of SMX
was financed through a term loan agreement with a bank. The acquisition of
Sedeco was financed through borrowings against the $30 million Revolving Credit
Facility described below (See Note 8 of Notes to Consolidated Financial
Statements).
During fiscal year 1997, the Company's cash and cash equivalents and
short-term investments available-forsale increased by $1,609,000 to $10,460,000.
Net cash of $3,422,000 was provided by the Company's operating activities
principally as a result of the Company's earnings of $8,768,000. Changes to
working capital components resulted in a use of cash of approximately
$7,598,000. Cash provided by increases in the balance of trade acceptances
payable, income taxes payable and customer deposits aggregating approximately
$5,889,000 was offset by cash used to increase inventory, accounts receivable,
net investment in sales-type leases and other assets aggregating $10,885,000 and
a decrease in accounts payable and accrued expenses of approximately $2,602,000.
These changes resulted from expansion of the Company's business and the
acquisitions during the year.
The Company purchases foreign currency futures contracts to hedge specific
purchase commitments. Substantially all foreign currency purchases commitments
are matched with specific foreign currency futures contracts. Consequently, the
Company believes that no material foreign currency exchange risk exists relating
to outstanding trade acceptances payable. The cost of such contracts are
included in the cost of inventory. See Note 11(B) of Notes to Consolidated
Financial Statements.
Revolving Credit Facility and Borrowings
In January 1997, The Company entered into a $30,000,000 Revolving Credit
Facility with two banks (the "Revolving Credit Facility"). The Revolving Credit
Facility is to be used for working capital loans, letters of credit and deferred
payment letters of credit and bear interest as defined in the Revolving Credit
Facility. The terms of the Revolving Credit Facility restrict additional
borrowings by the Company and require the Company to maintain certain minimum
tangible net worth, quick asset ratio and fixed charge coverage levels as
defined. The Revolving Credit Facility also provides a $15,000,000 sub-Facility
to finance acquisitions (as defined therein), under which approximately
$4,446,000 was outstanding at January 31, 1997 to finance the Sedeco acquisition
and repay its
17
outstanding credit facilities (see Notes 3 and 8 (C) of Notes to
Consolidated Financial Statements). The Revolving Credit Facility had also been
used for letters of credit and deferred payment letters of credit aggregating
approximately $13,332,000 at January 31, 1997. There were no working capital
loans outstanding at January 31, 1997.
On June 10, 1996, the Company entered into a term loan agreement with a
bank (the "Term Loan Agreement") pursuant to which the bank lent $7,500,000 to
the Company to fund the acquisition of SMX and to repay SMX's credit facilities
under which approximately $6,750,000 was outstanding on January 31, 1997. The
loan is repayable in twenty equal quarterly installments of principal and
interest (as defined in the Term Loan Agreement) commencing September 30, 1996.
The loan has been guaranteed by Hirsch, Pulse and SMX and requires the Company
to maintain, among others, certain minimum tangible net worth, quick asset ratio
and fixed charge coverage ratio levels, as defined.
HAPL Leasing sells substantially all of its leases to financial
institutions on a non-recourse basis several months after the commencement of
the lease term thereby reducing its financing requirements. HAPL Leasing, which
was fully activated in May 1993, has closed $93,953,000 in lease agreements as
of January 31, 1997. As of February 28, 1997, approximately $84,782,000, or
90.2%, of the leases have been sold to third party financial institutions on a
non-recourse basis.
Future Capital Requirements
The Company believes its existing cash and funds generated from operations,
together with amounts available under the Revolving Credit Facility, will be
sufficient to meet its working capital and capital expenditure requirements and
to finance planned growth.
Backlog and Inventory
The ability of the Company to fill orders quickly is an important part of
its customer service strategy. The embroidery machines held in inventory by the
Company are generally shipped within a week from the date the customer's orders
are received, and as a result, backlog is not meaningful as an indicator of
future sales.
Inventory at January 31, 1997 of new Tajima embroidery machines was
$9,151,000 representing approximately one month's sales which is comparable to
historical inventory levels. Inventory of approximately $3,094,000 consisted of
computer software, used machines and other equipment, supplies and accessories.
Inflation
The Company does not believe that inflation has had, or will have in the
foreseeable future, a material impact upon the Company's operating results.
Recent Pronouncements of the Financial Accounting Standards Board
Earnings Per Share and Capital Structure. Recent pronouncements of the
Financial Accounting Standards Board ("FASB"), which are not required to be
adopted at this date, include Statement of Financial Accounting Standards
("SFAS") No. 129, "Disclosure of Information about Capital Structure" ("SFAS No.
129") and SFAS No. 128, "Earnings Per Share" ("SFAS No. 128"). SFAS No. 129 and
128 specify guidelines as to the method of computation as well as presentation
and disclosure requirements for earnings per share ("EPS"). The objective of
these statements is to simplify the calculation and to make the U.S. standard
for computing EPS more compatible with the EPS standards of other countries and
with that of the International Accounting Standards Committee. These statements
are effective for fiscal years ending after December 15, 1997 and earlier
application is not permitted.
18
SFAS 129 and 128 will have an impact on the Company's EPS calculation and
disclosure requirements but management cannot predict the outcome at this time.
Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Debt. SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities" ("SFAS No. 125") is
effective for transactions occurring after December 15, 1996, although many
provisions have been effectively deferred by the issuance of SFAS No. 127,
"Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125"
until after December 15, 1997 for certain transactions. Adoption of these
pronouncements are not expected to have a material impact on the Company's
consolidated financial statements.
Stock-Based Compensation. The Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123") for fiscal year 1997. As discussed in
Note 2 of Notes to Consolidated Financial Statements, the Company continues to
account for its stock-based awards using the intrinsic value method in
accordance with APB No, 25, "Accounting for Stock Issued to Employees" and its
related interpretations. Accordingly, no compensation expense has been
recognized in the consolidated financial statements for employee stock
arrangements. SFAS No. 123 requires disclosure of pro forma net income and
earnings per share had the Company adopted the fair value method as of the
beginning of fiscal year 1996. The Company's calculations were made using the
Black-Scholes option pricing model. If the computed fair values of the 1997
awards had been amortized to expense over the vesting period of the awards, pro
forma net income for fiscal year 1997 would have been approximately $8,494,000
($1.07 per share). The impact of SFAS No. 123 on pro forma net income for fiscal
year 1996 was zero. However, the impact of outstanding non-vested stock options
has been excluded from the pro forma calculation; accordingly, the pro forma
adjustments for fiscal years 1997 and 1996 are not indicative of future period
pro forma adjustments, when the calculation will apply to all applicable stock
options.
Item 8. Financial Statements And Supplementary Data
The information contained in pages F-1 through F-23 hereof.
Item 9. Changes In And Disagreement With Accountants On Accounting and
Financial Disclosure
None
19
PART IV
Item 10. Exhibits, Financial Statement Schedules And Reports On Form 8-K
(a)(1) CONSOLIDATED FINANCIAL STATEMENTS PAGE(S)
Index to Consolidated Financial Statements F-1
Independent Auditor's Reports F-2
Consolidated Balance Sheets as of January 31, 1997 and 1996 F-3
Consolidated Statements of Income for the years ended January 31, F-5
1997, 1996 and 1995
Consolidated Statements of Stockholder's Equity for the years ended F-6
January 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years ended January F-7
31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements F-9 - F-23
(a)(2) FINANCIAL STATEMENT SCHEDULES
None
(a)(3) EXHIBITS
Exhibit Description
Number
*3.1 Amended and Restated Certificate of Incorporation of the Registrant
*3.2 By-Laws of the Company
*4.1 Specimen of Class A Common Stock Certificate
*4.2 Specimen of Class B Common Stock Certificate
***10.1 $7,500,000 Term Loan Agreement, Dated as of June 10, 1996,
among Hirsch International Corp., HAPL Leasing Co., Inc., Sewing Machine
Exchange, Inc., Pulse Microsystems, Ltd. and The Bank of New York
10.2 $30,000,000 Revolving Credit Facility Dated as of January 7, 1997 among Hirsch
International Corp., HAPL Leasing Co., Inc., Sewing Machine Exchange, Inc.,
Pulse Microsystems, Ltd., Sedeco, Inc., The Bank of New York and Fleet Bank,
N.A.
**10.3 $2,295,000 Mortgage Note from Hirsch International Corp. to Chemical
Bank
**10.4 Mortgage between Hirsch International Corp. and Chemical Bank
**10.5 Guaranty of Payment of HAPL Leasing Col, Inc. and Pulse Microsystems Ltd. to
Chemical Bank
****10.6 Stock Purchase Agreement, dated June 7, 1996, by and
among Hirsch International Corp. and Ronald H. Krasnitz and Martin Krasnitz
*****10.7 Stock Purchase Agreement, Dated December 20, 1996 by and between
Hirsch International Corp. and Jimmy L. Yates
20
*10.8 Employment Agreement between Henry Arnberg and the Registrant
*10.9 Employment Agreement between Paul Levine and the Registrant
*10.10 Employment Agreement between Kenneth Shifrin and the Registrant
*10.11 Employment Agreement between Tas Tsonis and the Registrant
*10.12 Employment Agreement between Brian Goldberg and Pulse Microsystems Ltd.
***10.13 Employment Agreement between Ronald H. Krasnitz and Sewing Machine Exchange,
Inc.
***10.14 Employment Agreement between Martin Krasnitz and Sewing Machine Exchange, Inc.
10.15 Employment Agreement between Jimmy L. Yates and Sedeco, Inc.
*10.16 Distributorship Agreement Dated February 21, 1991 together with Supplements and
Amendments Thereto, among Tajima Industries Ltd., Nomura Trading Co. Ltd.,
Nomura (America) Corp. and Hirsch International Corp. ("Hirsch Distributorship
Agreement")
10.17 Amendment Number Two to Hirsch Distributorship Agreement, Dated June 7, 1996
10.18 Distributorship Agreement, Dated February 21, 1991, together with Supplement Dated
February 21, 1996, among Tajima Industries Ltd., Nomura Trading Co. Ltd., Nomura
(America) Corp., and Sedeco, Inc.
10.19 West Coast Distributorship Agreement, Dated February 21, 1997, among Tajima
Industries Ltd., Nomura Trading Co. Ltd. and Nomura (America) Corp., and Hirsch
International Corp.
***10.20 Stock Option Plan, as Amended
#10.21 1994 Non-Employee Director Stock Option Plan
10.22 Registration Rights Agreement, Dated December 20, 1996, between Hirsch
International Corp. and Jimmy L. Yates
10.23 Non-Qualified Stock Option Agreement between Hirsch International Corp. and Jimmy
L. Yates, Dated December 6, 1996
10.24 Non-Qualified Stock Option Agreement between Hirsch International Corp. and
Ronald H. Krasnitz, Dated June 7, 1996
10.25 Non-Qualified Stock Option Agreement between Hirsch International Corp. and Martin
Krasnitz, Dated June 7, 1996
21.1 List of Subsidiaries of the Registrant
- ----------------
*Incorporated by reference from the Registrant's Registration Statement on
Forms S-1, Registration Number 33- 72618
**Incorporated by reference from the Registrant's Form 10-K filed for the
fiscal year ended January 31, 1995.
#Incorporated by reference from the Registrant's Registration Statement on
Form S-1, Registration No. 33-80563.
***Incorporated by reference from the Registrant's Form 10-Q filed for the
quarter ended July 31, 1996.
****Incorporated by reference from Registrant's Form 8-K filed with the
Commission on June 19, 1996.
*****Incorporated by reference from Registrant's Form 8-K filed with the
Commission on January 3, 1997.
(b)(1) REPORTS ON FORM 8-K
A report on Form 8-K was filed by the Company on January 3, 1997, with
respect to the Company's acquisition of all the outstanding capital stock of
Sedeco, Inc. for $6.6 million on December 20, 1996.
21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HIRSCH INTERNATIONAL CORP.
--------------------------
By: \s\Henry Arnberg
---------------------------
Henry Arnberg, President
Dated: May 1, 1997
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 dates indicated.
Signature Title Date
--------- ----- ----
\s\Henry Arnberg Chairman of the Board of Directors, President May 1, 1997
- ---------------------- and Chief Executive Officer (Principal Executive
Henry Arnberg Officer)
\s\Paul Levine Executive Vice President, Chief Operating May 1, 1997
- ---------------------- Officer and Secretary (Principal Operating
Paul Levine Officer)
\s\Tas Tsonis Vice President and Director May 1, 1997
- ----------------------
Tas Tsonis
\s\Kenneth Shifrin Vice President-Finance and Chief Financial May 1, 1997
- ---------------------- Officer (Principal Accounting and Financial
Kenneth Shifrin Officer)
\s\Ronald Krasnitz Vice President and Director May 1, 1997
- ----------------------
Ronald Krasnitz
\s\Herbert M. Gardner Director May 1, 1997
- ----------------------
Herbert M. Gardner
\s\Marvin Broitman Director May 1, 1997
- ----------------------
Marvin Broitman
\s\Douglas Schenendorf Director May 1, 1997
- ----------------------
Douglas Schenendorf
TABLE OF CONTENTS TO CONSOLIDATED FINANCIAL STATEMENTS
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES PAGE
Independent Auditors' Report F-2
Consolidated Balance Sheets as of January 31, 1997 and 1996 F-3
Consolidated Statements of Income for the years ended
January 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Stockholders' Equity for the years
ended January 31, 1997, 1996 and 1995 F-6
Consolidated Statements of Cash Flows for the years ended
January 31, 1997, 1996 and 1995 F-7
Notes to Consolidated Financial Statements F-9
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors
Hirsch International Corp.
Hauppauge, New York
We have audited the accompanying consolidated balance sheets of Hirsch
International Corp. and Subsidiaries as of January 31, 1997 and 1996, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended January 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
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, such consolidated financial statements present fairly, in
all material respects, the consolidated financial position of Hirsch
International Corp. and Subsidiaries as of January 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended January 31, 1997 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
Jericho, New York
March 11, 1997
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
January 31,
1997 1996
ASSETS
Current Assets:
Cash and cash equivalents $ 7,864,662 $ 6,564,628
Short-term investments available-for-sale 2,595,601 2,286,194
Accounts receivable, net of an allowance for
doubtful accounts of approximately $2,578,000
and $1,041,000, respectively 21,761,001 13,707,328
Net investment in sales-type leases-
current portion (Note 5) 1,715,164 1,592,733
Inventories, net (Notes 4 and 11) 15,768,865 7,969,203
Deferred income taxes (Note 9) 1,298,250 1,055,473
Other current assets 774,968 630,295
---------------- ---------------
Total Current Assets 51,778,511 33,805,854
---------------- ---------------
Net investment in sales-type leases - non-current
portion (Note 5) 9,179,421 7,052,091
Excess of cost over net assets acquired, net of
accumulated amortization of approximately
$383,000 and $0, respectively (Note 3) 14,043,331 -
Purchased technologies, net of accumulated
amortization of approximately $558,000 and
$367,000, respectively 781,196 972,508
Property, plant and equipment, net of accumulated
depreciation and amortization (Notes 6 and 8) 6,242,137 4,840,530
Other assets (Notes 3 and 9) 1,671,208 1,201,143
---------------- ---------------
Total Assets $ 83,695,804 $ 47,872,126
================ ===============
See notes to consolidated financial statements.
F-3
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
January 31,
1997 1996
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Trade acceptances payable (Note 11) $ 13,331,834 $ 8,656,094
Accounts payable and accrued expenses (Note 7) 10,159,556 6,774,178
Current maturities of long-term debt (Note 8) 2,429,500 242,760
Income taxes payable (Note 9) 1,541,561 733,009
Customer deposits payable 1,357,063 552,981
---------------- ---------------
Total Current Liabilities 28,819,514 16,959,022
Long-term debt, less current maturities (Note 8) 13,194,034 1,778,626
---------------- ---------------
Total Liabilities 42,013,548 18,737,648
---------------- ---------------
Commitments and Contingencies (Notes 8 and 11)
Stockholders' Equity (Notes 1 and 10): Preferred stock, $.01 par value;
authorized:
1,000,000 shares; issued: none - -
Class A common stock, $.01 par value;
authorized: 20,000,000 shares, outstanding,
5,312,666 and 3,288,200 shares, respectively 53,127 32,882
Class B common stock, $.01 par value;
authorized: 3,000,000 shares, outstanding:
2,732,249 and 2,868,606 shares, respectively 27,322 28,686
Additional paid-in capital 15,626,059 11,885,627
Unrealized holding gain (loss) on short-term
investments available-for-sale 20,827 (15,105)
Retained earnings 25,954,921 17,202,388
---------------- ---------------
Total Stockholders' Equity 41,682,256 29,134,478
---------------- ---------------
Total Liabilities and Stockholders' Equity $ 83,695,804 $ 47,872,126
================ ===============
See notes to consolidated financial statements.
F-4
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended January 31,
1997 1996 1995
Net sales $ 122,195,444 $ 87,974,185 $ 70,708,874
Interest income related to sales-type leases 3,243,340 3,022,239 1,617,292
--------------- ------------- -------------
Total revenue 125,438,784 90,996,424 72,326,166
--------------- ------------- -------------
Cost of goods sold (Note 11) 80,819,751 58,835,780 47,881,483
Selling, general and administrative
expenses 29,070,201 20,638,144 16,154,880
Interest expense (Note 8) 832,337 396,976 356,595
Other income, net (453,774) (276,702) (225,465)
--------------- ------------- -------------
Total expenses 110,268,515 79,594,198 64,167,493
--------------- ------------- -------------
Income before income taxes 15,170,269 11,402,226 8,158,673
Provision for income taxes (Note 9) 6,402,320 4,837,294 3,335,355
--------------- ------------- -------------
Net income $ 8,767,949 $ 6,564,932 $ 4,823,318
=============== ============= =============
Net income per share $1.10 $0.87 $0.66
===== ===== =====
Weighted average number of shares used in
the calculation of net income per share (Note 10D) 7,971,630 7,511,694 7,335,080
=============== ============= ==============
See notes to consolidated financial statements.
F-5
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Class A Class B
Common Stock Common Stock Additional
(Note 10) (Note 10) Paid-In Unrealized Retained Holding Gain
Shares Amount Shares Amount Capital (Loss) Total
Earnings
Balance, February 1, 1994 250,000 $2,500 3,000,000 $ 30,000 $ 227,442 $ - $ 7,570,151 $ 7,830,093
Proceeds from initial public offering
of common stock, net (Note 1) 1,187,500 11,875 (56,250) (562) 7,341,276 - - 7,352,589
Issuance of shares in connection with
acquisition (Note 1) 156,250 1,562 - - 660,939 - - 662,501
Transfer of Class B stock to Class A
stockholder 10,000 100 (10,000) (100) - - - -
Stock dividend (5%) 226,879 2,269 - - 1,741,833 - (1,744,102) -
Unrealized holding loss (Note 2C) - - - - - (32,880) - (32,880)
Net income - - - - - - 4,823,318 4,823,318
--------- ------- --------- -------- ------------ --------- ------------ ------------
Balance, January 31, 1995 1,830,629 18,306 2,933,750 29,338 9,971,490 (32,880) 10,649,367 20,635,621
Proceeds from public offering of
common stock, net (Note 1) 265,144 2,652 (65,144) (652) 1,906,160 - - 1,908,160
Stock dividend (25%) (Note 10D) 1,191,115 11,911 - - - - (11,911) -
Exercise of stock options 1,312 13 - - 7,977 - - 7,990
Unrealized holding gain (Note 2C) - - - - - 17,775 - 17,775
Net income - - - - - - 6,564,932 6,564,932
--------- ------- ---------- -------- ------------ --------- ------------ ------------
Balance, January 31, 1996 3,288,200 32,882 2,868,606 28,686 11,885,627 (15,105) 17,202,388 29,134,478
Issuance of shares in connection
with acquisitions (Note 3) 143,668 1,437 - - 2,636,407 - - 2,637,844
Transfer of Class B to Class A
stockholder 136,357 1,364 (136,357) (1,364) - - - -
Stock dividend (25%) (Note 10D) 1,541,580 15,416 - - - - (15,416) -
Exercise of stock options and warrants 202,861 2,028 - - 1,104,025 - - 1,106,053
Unrealized holding gain (Note 2C) - - - - - 35,932 - 35,932
F-6
Net income - - - - - - 8,767,949 8,767,949
--------- ------- ---------- -------- ------------ --------- ------------ ----------
Balance, January 31, 1997 5,312,666 $53,127 2,732,249 $ 27,322 $15,626,059 $ 20,827 $25,954,921 $41,682,256
========= ======= ========== ======== ============ ========= ============ ==========
See notes to consolidated financial statements.
F-7
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended January 31,
1997 1996 1995
Cash flows from operating activities:
Net income $ 8,767,949 $ 6,564,932 $4,823,318
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,763,464 1,142,018 896,860
Provision for bad debts 433,225 578,402 435,798
Provision for slow-moving inventories 230,000 419,667 92,627
Loss on disposal of assets 18,303 61,615 12,513
Deferred income taxes (192,885) (288,428) (330,775)
Changes in operating assets and liabilities:
Accounts receivable (5,011,589) (5,592,861) (4,157,208)
Net investment in sales-type leases (2,287,261) (1,899,759)
(859,699)
Inventories (2,777,864) (1,244,337)
(1,125,485)
Other current assets (61,033) (113,933)
(330,884)
Other assets (746,954) (403,271)
(222,567)
Trade acceptances payable 4,675,740 1,346,590
1,939,775
Accounts payable and accrued expenses (2,602,069) 1,351,833
1,914,887
Income taxes payable 408,552 15,809 551,196
Customer deposits payable 804,082 (245,386) 56,886
------------- ------------- -------------
Net cash provided by operating activities 3,421,660 1,692,891 3,697,242
------------- ------------- -------------
Cash flows from investing activities:
Capital expenditures (1,446,437) (1,123,125)
(4,505,712)
Acquisition of Pulse Microsystems Ltd. - -
(750,000)
Acquisition of Sewing Machine Exchange, Inc. (4,973,222) - -
Acquisition of Sedeco, Inc. (4,153,038) - -
Short-term investments:
(Purchases) proceeds (392,116) 1,226,854
------------- ------------
Net cash (used in) provided by
investing activities (10,964,813) 103,729 (8,926,513)
------------- ------------- -------------
F-8
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended January 31,
1997 1996 1995
Cash flows from financing activities:
Proceeds from public offering $ - $ 2,325,000 $8,251,000
Repayment of short-term notes payable - - (2,436,967)
Proceeds of long-term debt 11,946,305 - 2,295,000
Repayments of long-term debt (4,209,171) (311,647) (139,709)
Dividends paid - - (750,000)
Proceeds from exercise of stock options and warrants 1,106,053 7,990 -
------------- ------------- ----------
Net cash provided by
financing activities 8,843,187 2,021,343
------------- -------------
7,219,324
Increase in cash and cash equivalents 1,300,034 3,817,963
1,990,053
Cash and cash equivalents, beginning of period 6,564,628 2,746,665 756,612
------------- ------------- ----------
Cash and cash equivalents, end of period $ 7,864,662 $ 6,564,62
============= =============
Supplemental disclosure of cash flow information:
Interest paid $ 796,419 $ 387,431 $339,127
============= ============= ==========
339,127
Income taxes paid $ 5,788,038 $ 4,842,640 $3,125,648
============= ============= ===========
Non-cash investing and financing activities:
Property and equipment returned in
satisfaction of capital lease $ - $ (622,295) $ -
============= ============= ==========
Satisfaction of capital lease obligation $ - $ 691,052 $ -
============= ============= ==========
The Company purchased all of the capital stock of SMX and Sedeco (see Note
3) for $8,690,000 and $6,565,000, respectively. In connection with the
acquisitions the following activity was recorded:
F-9
SMX Sedeco
Fair value of assets acquired $ 6,360,000 $4,359,000
Fair value of liabilities assumed (7,711,000) (1,378,000)
----------- ------------
Net assets acquired $1,351,000 2,981,000
============ ============
Cash paid (gross) for net assets $ 5,000,000 $4,165,000
Promissory notes issued for net assets 3,500,000 -
Class A common stock issued for net assets 238,000 2,400,000
Acquisition costs 755,000 548,000
------------- -------------
Total consideration 9,493,000 7,113,000
Less net assets acquired 1,351,000 (2,981,000)
Less accumulated amortization (361,000) (22,000)
Less offset of promissory notes (550,000) -
------------- -------------
Excess of cost over net assets acquired $ 9,933,000 $ 4,110,000
============= =============
See notes to consolidated financial statements.
F-10
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JANUARY 31, 1997, 1996 and 1995
NOTE 1 - BUSINESS ORGANIZATION AND BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Hirsch International Corp. ("Hirsch"), HAPL Leasing Co., Inc. ( "HAPL" or "HAPL
Leasing"), Pulse Microsystems Ltd. ("Pulse"), Sewing Machine Exchange, Inc.
("SMX") and Sedeco, Inc. ("Sedeco") (collectively, the "Company"). The
operations of SMX and Sedeco are included in consolidated operations since their
acquisitions on June 7, 1996 and December 20, 1996, respectively (see Note 3).
The Company is a single source provider of sophisticated equipment and
valued added products and services to the embroidery industry. The embroidery
equipment and value added products sold by the Company are widely used by
contract embroiderers, large and small manufacturers of apparel and fashion
accessories, retail stores and embroidery entrepreneurs servicing specialized
niche markets. HAPL Leasing provides leasing services to customers of the
Company.
During fiscal 1995, the Company consummated an initial public offering (the
"IPO") of Class A common stock. The Company sold 1,000,000 shares at $8.00 per
share. Net proceeds of $7,353,000, after offering expenses of approximately
$898,000, were received by the Company.
Concurrent with the IPO, the Company acquired all of the outstanding
capital stock of Pulse. The acquisition of Pulse has been accounted for as a
purchase and accordingly, the acquired assets have been recorded at their
estimated fair market values at the date of acquisition. The cost in excess of
fair value of Pulse has been recorded as purchased technologies and is being
amortized over a period of seven years.
On January 24, 1996, the Company consummated a secondary public offering of
Class A common stock (the "Second Offering"). The Company sold 200,000 shares at
$12.375 per share. Another 800,000 shares were sold by certain of the Company's
officers. Net proceeds of approximately $1,906,000, after offering expenses of
approximately $417,000, were received by the Company. On February 15, 1996, the
underwriters exercised their over-allotment option to purchase an additional
150,000 shares from certain of the Company's officers.
Amounts of shares and per share amounts in this note have not been adjusted
to reflect stock dividends or stock splits (see Note 10D).
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) Principles of Consolidation - The consolidated financial statements
include the accounts of
F-11
the Company and its wholly-owned subsidiaries. All intercompany balances
and transactions have been eliminated in consolidation.
F-12
(B) Revenue Recognition - The Company distributes embroidery equipment
which it offers for ------------------- sale or lease. Revenue related to the
sale of equipment is recorded at the time of shipment. Lease contracts which
meet the criteria of Statement of Financial Accounting Standards No. 13,
"Accounting For Leases" are accounted for as sales-type leases. Under this
method, revenue is recognized as a sale at the later of the time of shipment or
acceptance by the lessee in an amount equal to the present value of the rental
payments under the lease term (usually 36-60 months). The difference between the
total lease payments and the present value is amortized over the term of the
lease so as to produce a constant periodic rate of return on the net investment
in the lease. To date, all leases issued by the Company and HAPL Leasing have
been sales-type leases. The operating method of accounting for leases would be
followed for lease contracts not meeting the above criteria. Under this method
of accounting, aggregate rental revenue would be recognized over the term of the
lease.
Service revenues and costs are recognized when services are provided. Sales
of computer hardware and software are recognized when shipped provided that no
significant vendor and post-contract and support obligations remain and
collection is probable.
(C) Cash Equivalents and Short-Term Investments Available-For-Sale - Cash
equivalents consist of money market accounts with initial maturities of three
months or less. Short-term investments consist primarily of tax-exempt bonds. In
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities", the Company has stated
short-term investments available-for-sale at market value.
(D) Allowance for Doubtful Accounts - The Company provides an allowance for
doubtful accounts determined by a specific identification of individual accounts
and a general reserve to cover other accounts based on historical experience.
The Company writes off receivables upon determination that no further
collections are probable.
(E) Inventories - Inventories consisting of machines and parts are stated
at the lower of cost or market. Cost for machinery is determined by specific
identification and for all other items on a first-in, first-out basis. Reserves
are established to record provisions for slow moving inventories in the period
in which it becomes reasonably evident that the product is not salable or the
market value is less than cost.
(F) Foreign Operations - Assets and liabilities of the Company's foreign
subsidiary are translated at year-end exchange rates. Results of operations are
translated using the average exchange rate prevailing throughout the year. Gains
and losses from foreign currency transactions are included in net income and are
not significant.
The Company makes only limited use of derivative financial instruments and
does not use them for trading purposes. Trade acceptances payable are
denominated in Japanese yen and are related to the purchase of equipment from
the Company's major supplier. The Company purchases foreign currency forward
contracts (which are usually approximately six months in duration) to hedge the
risk associated with fluctuations in foreign currency exchange rates (see Note
11B). The cost of such contracts are included in the cost of the related
machinery in inventory.
F-13
(G) Property, Plant and Equipment - Property, plant and equipment are
stated at cost less accumulated depreciation and amortization. Capitalized
values of property under leases are amortized over the life of the lease or the
estimated life of the asset, whichever is less. Depreciation and amortization
are provided on the straight-line or declining balance methods over the
following estimated useful lives:
Asset Category Lives in Years
---------------- --------------
Building 39
Furniture and fixtures 5-7
Machinery and equipment 5-7
Automobiles 3-5
Leasehold improvements 5-20
(H) Software Development Costs - The development of new software products
and enhancements to existing products are expensed as incurred until
technological feasibility has been established. After technological feasibility
is established, any additional costs would be capitalized in accordance with
Statement of Financial Accounting Standards No. 86 "Accounting for the Costs of
Computer Software to Be Sold, Leased, or Otherwise Marketed". Capitalized
software costs are amortized on a straight-line basis over the estimated useful
product lives (normally three years) commencing in the month following product
release. During the years ended January 31, 1997 and 1996, the Company
capitalized approximately $364,000 and $252,000 of software development costs,
respectively. Such costs are included in other assets on the accompanying
consolidated balance sheets. Amortization expense for the years ended January
31, 1997 and 1996 was approximately $84,000 and $21,000, respectively. No
software development costs were capitalized in fiscal 1995.
(I) Impairment of Long-Lived Assets - In accordance with Statement of
Financial Accounting Standards No. 121, "Accounting For the Impairment of
Long-Lived Assets and For Long- Lived Assets To Be Disposed Of" ("SFAS 121"),
the Company reviews its long-lived assets, including property, plant and
equipment, identifiable intangibles and purchased technologies, for impairment
whenever events or changes in circumstances indicate that the carrying amount of
the assets may not be fully recoverable. To determine recoverability of its
long- lived assets, the Company evaluates the probability that future
undiscounted net cash flows, without interest charges, will be less than the
carrying amount of the assets. Impairment is measured at fair value. SFAS 121
had no effect on the Company's consolidated financial statements.
(J) Leases - Leases (in which the Company is lessee) which transfer
substantially all of the risks and benefits of ownership are classified as
capital leases, and assets and liabilities are recorded at amounts equal to the
lesser of the present value of the minimum lease payments or the fair value of
the leased properties at the beginning of the respective lease terms. Interest
expense relating to the lease liabilities is recorded to effect constant rates
of interest over the terms of the leases. Leases which do not meet such criteria
are classified as operating leases and the related rentals are charged to
expense as incurred.
(K) Income Taxes - The Company accounts for income taxes pursuant to
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("SFAS No. 109"). SFAS No. 109 requires recognition of deferred tax
assets and liabilities for the expected future tax
F-14
consequences of events that have been included in the Company's
consolidated financial statements or tax returns. Under this method, deferred
tax assets and liabilities are determined based on the differences between the
financial accounting and tax bases of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
(L) Net Income Per Share - Net income per share is based on the weighted
average number of common shares outstanding during the period after giving
retroactive effect to stock dividends and splits (see Note 10D). Stock options
are considered to be common stock equivalents and, accordingly, have been
included in the computation of earnings per share for the years ended January
31, 1997, 1996 and 1995, respectively, using the Treasury Stock Method.
(M) Stock-based Compensation - The Company accounts for stock-based awards
to employees using the intrinsic value method in accordance with APB No. 25,
"Accounting for Stock Issued to Employees" ("APB 25").
(N) Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
(O) Fair Value of Financial Instruments - Financial instruments consist
primarily of investments in cash, short-term investments, trade account
receivables, accounts payable and debt obligations. At January 31, 1997 and
1996, the fair value of the Company's financial instruments approximated the
carrying value (see Note 2C).
NOTE 3 - ACQUISITIONS
(A) Acquisition of Sewing Machine Exchange - On June 7, 1996 the Company
acquired all of the outstanding capital stock of SMX. The acquisition was
accounted for as a purchase in accordance with Accounting Principles Board
Opinion No. 16 "Business Combinations" ("APB 16") and accordingly, the acquired
assets and assumed liabilities have been recorded at their estimated fair market
values at the date of acquisition. The cost in excess of fair value of SMX is
being amortized over a 15-year period.
The purchase price was $8,690,000, paid in the form of a promissory note in
the principal amount of $4,250,000 to each of the two former shareholders of SMX
and by delivery of an aggregate of 9,375 shares of the Company's Class A Common
Stock. Pursuant to the terms of the promissory notes, the Company was required
to make a principal payment on each note in the amount of $2,500,000 on June 13,
1996 with the balance of each note ($1,750,000) payable in 60 equal monthly
installments of principal and interest beginning July 7, 1996 (see Note 8B).
These notes were subsequently reduced by $550,000 related to certain guarantees
in the stock purchase agreement regarding inventory and accounts receivable.
Concurrent with the acquisition, the Company entered into five-year employment
contracts with SMX's former shareholders pursuant to which they received 331,250
options to purchase shares of Hirsch Class A common stock (see Note 10B). The
options were issued at fair market value at the date of acquisition and vest in
four annual installments of 25
F-15
percent each on the first, second, third, and fourth anniversary of the
date of grant and expire five years from the date thereof.
F-16
(B) Acquisition of Sedeco - On December 20, 1996 the Company acquired all
of the outstanding capital stock of Sedeco. The acquisition was accounted for as
a purchase in accordance with APB 16 and accordingly, the acquired assets and
assumed liabilities have been recorded at their estimated fair market value
(pending final purchase price allocation) at the date of acquisition. The costs
in excess of fair value of Sedeco is being amortized over a 15-year period.
The purchase price was $6,565,000, paid in the form of $4,165,000 in cash
and $2,400,000 in the Company's Class A common stock. Concurrent with the
acquisition, the Company entered into a five-year employment contract with
Sedeco's former shareholder pursuant to which 60,300 options to purchase shares
of Hirsch Class A common stock (see Note 10B) were issued. The options were
issued at fair market value at the date of acquisition and vest in four annual
installments of 25 percent each on the first, second, third, and fourth
anniversary of the date of grant and expire five years from the date of grant.
On the basis of a pro forma consolidation of the results of operations as
if the acquisitions of SMX and Sedeco had taken place at the beginning of fiscal
1996, management believes that the acquisitions would not have had a material
effect on the reported amounts for fiscal 1997 and 1996. Such pro forma amounts
are not necessarily indicative of what the actual consolidated results might
have been if the acquisitions had been effective at the beginning of fiscal
1996.
NOTE 4 - INVENTORIES
January 31,
1997 1996
---- ----
Machines $ 12,244,563 $6,158,040
Parts and accessories 5,527,352 2,837,165
Less: Reserve for slow moving inventory (2,003,050) (1,026,002)
--------------- --------------
Total $15,768,865 $ 7,969,203
=============== ==============
NOTE 5 - NET INVESTMENT IN SALES-TYPE LEASES
January 31,
1997 1996
---- ----
Total minimum lease payments receivable $ 11,141,379 $ 9,595,952
Estimated residual value of leased
property (unguaranteed) 3,058,948 1,832,088
Reserve for estimated uncollectible
lease payments (337,500) (300,000)
Less: Unearned income (2,968,242 ) (2,483,216)
--------------- --------------
Net investment 10,894,585 8,644,824
Less: Current portion 1,715,164 1,592,733
--------------- --------------
Non-current portion $ 9,179,421 $ 7,052,091
=============== ==============
F-17
At January 31, 1997 future annual lease payments receivable (including
estimated residual values) under sales-type leases are as follows:
Fiscal Year Ending January 31,
1998 $ 2,808,430
1999 2,693,405
2000 2,567,790
2001 2,373,487
2002 2,093,999
Thereafter 1,663,216
---------------
$ 14,200,327
===============
NOTE 6 - PROPERTY, PLANT AND EQUIPMENT
January 31,
1997 1996
---- ----
Land and building $ 3,288,137 $ 2,767,355
Machinery and equipment 3,039,794 1,996,191
Furniture and fixtures 1,373,929 880,773
Automobiles 670,056 275,421
Leasehold improvements 1,368,845 658,875
-------------- -----------
Total at cost 9,740,761 6,578,615
Less: Accumulated depreciation and amortization (3,238,242) (1,738,085)
Reserve for assets held for sale (260,382) -
--------------- ----------
Property, plant and equipment, net $ 6,242,137 $4,840,530
============== ===========
NOTE 7 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
January 31,
1997 1996
---- ----
Accounts payable $ 4,640,688 $ 2,863,371
Accrued commissions payable 818,969 845,746
Accrued payroll costs 832,529 685,435
Accrued warranty costs 625,635 365,635
Other accrued expenses 3,241,735 2,013,991
--------------- -------------
Total accounts payable and accrued expenses $ 10,159,556 $ 6,774,178
=============== =============
NOTE 8 - LONG-TERM DEBT
January 31,
1997 1996
---- ----
Term Note (A) $ 6,750,000 $ -
Promissory Notes (B) 2,541,662 -
Sedeco acquisition (C) 4,446,305 -
Mortgage (D) 1,778,625 2,008,126
Other 106,942 13,260
------------- ------------
Total (E) 15,623,534 2,021,386
Less: Current maturities 2,429,500 242,760
-------------- ------------
Long-term maturities $ 13,194,034 $ 1,778,626
============== ============
F-18
(A) On June 10, 1996, the Company entered into a term loan agreement with a
bank (the "Term Loan Agreement") pursuant to which the bank lent $7,500,000 to
the Company to fund the acquisition of SMX and to repay SMX's credit facilities.
The loan is repayable in 20 equal quarterly installments of principal and
interest (as defined in the Term Loan Agreement) beginning September 30, 1996.
The loan has been guaranteed by Hirsch, Pulse and SMX, and requires the Company
to maintain, among others, certain minimum tangible net worth, quick asset ratio
and fixed charge coverage ratio levels, as defined.
(B) In connection with the acquisition of SMX, the Company issued
promissory notes in the principal amount of $4,250,000 to each of the two former
shareholders of SMX. Pursuant to the terms of the promissory notes, the Company
was required to make a principal payment on June 13, 1996 with the balance of
each note ($1,750,000) payable in 60 equal monthly installments of principal and
interest beginning July 7, 1996. The notes bear interest at the rate (the
"Hirsch Rate") defined in the Hirsch Term Agreement plus two percent through
June 1999 and from July 1999 through maturity at the Hirsch Rate. Pursuant to
the terms of the Stock Purchase Agreement, the former shareholders of SMX made
certain guarantees with respect to collectibility of accounts receivable and
salability of inventory among other things. In the fourth quarter, these notes
were reduced by approximately $550,000 (See Note 3).
(C) In connection with the purchase of Sedeco, the Company borrowed
approximately $4,446,000 to fund the acquisition and repay Sedeco's credit
facilities. The amounts were borrowed under the provisions of the Revolving
Credit Facility (see E) and bear interest as defined therein. The Revolver
matures three years from the closing date at which point, any amounts used to
fund acquisitions thereunder will convert to a term loan facility and be paid in
12 equal quarterly installments over a three-year period. At January 31, 1997,
all amounts outstanding thereunder were classified in Long-Term Debt on the
Balance Sheets.
(D) On October 27, 1994, Hirsch entered into a ten year, $2,295,000
mortgage agreement with a bank (the "Mortgage") for its new corporate
headquarters. The Mortgage bears interest at a fixed rate of 8.8 percent and is
payable in equal monthly principal installments of $19,125. The terms of the
Mortgage, among other things, restrict additional borrowings by the Company, and
require the Company to maintain certain debt service coverage ratio levels, as
defined in the Mortgage. The obligation under the Mortgage is secured by a lien
on the premises and the related improvements thereon.
(E) The Company has a $30,000,000 Revolving Credit Facility with two banks
(the "Facility"). The Facility is for working capital loans, letters of credit,
and deferred payment letters of credit and bear interest as defined in the
Facility. The terms of the Facility, among other things, restrict additional
borrowings by the Company and require the Company to maintain, among other
things, certain minimum tangible net worth, quick asset ratio and fixed charge
coverage levels, as defined. The Facility also provides a $15,000,000 sub-limit
to finance acquisitions (as defined therein), under which approximately
$4,446,000 was outstanding at January 31,1997 for the Sedeco acquisition(see
Notes 3 and 8C). This Facility has also been used for letters of credit and
deferred payment letters of credit aggregating approximately $13,332,000 at
January 31, 1997. There were no working capital loans outstanding against this
Facility at January 31, 1997.
F-19
The Company had an unsecured Line of Credit Agreement with a bank in the
prior year, to finance working capital loans, lines of credit and deferred
payment letters of credit. This line had been used for letters of credit and
deferred payment letters of credit aggregating approximately $8,656,000 at
January 31, 1996.
Long-term debt (including capitalized lease obligations) of the Company at
January 31, 1997 matures as follows:
Fiscal Year Ending January 31,
1998 $ 2,429,500
1999 2,479,259
2000 6,911,201
2001 2,194,297
2002 979,500
Thereafter 629,777
--------------
$ 15,623,534
NOTE 9 - INCOME TAXES
The provision for income taxes for each of the periods presented herein is
as follows:
January 31,
1997 1996 1995
------- ------ ------
Current:
Federal $ 4,841,997 $3,855,262 $2,831,498
State 1,753,208 1,270,460 834,632
------------- ----------- ---------
Total current 6,595,205 5,125,722 3,666,130
------------- ------------- ---------
Deferred:
Federal (100,052) (223,811) (252,960)
State (92,833) (64,617) (77,815)
-------------- ------------- ----------
Total deferred (192,885) (288,428) (330,775)
-------------- ------------- ----------
Total provision for income taxes $ 6,402,320 $ 4,837,294 $3,335,355
============= ============= ==========
The tax effects of temporary differences that give rise to deferred income
tax assets at January 31, 1997 and 1996 are as follows:
January 31, 1997 January 31, 1996
------------------------------- -----------------------
Net Net Net Net
Current Long-Term Current Long-Term
Deferred Deferred Deferred Deferred
Tax Assets Tax Assets Tax Assets Tax Assets
---------- ---------- ---------- -----------
Accounts receivable $ 589,178 $ - $ 413,946 $ -
Inventories 487,142 - 450,239 -
Accrued warranty costs 152,068 - 147,241 -
Other accrued expenses 69,862 - 44,047 -
Purchased technologies - 131,492 - 92,365
Net investments in sales-type leases
(allowance for doubtful accounts) - 140,470 - 120,810
Capitalized software development
costs - (201,139) - (92,460)
------------- ----------- ------------ -------------
Total $ 1,298,250 $ 70,823 $ 1,055,473 $ 120,715
============= =========== ============ =============
F-20
Valuation allowances for such deferred tax assets have not been established
as it is more likely than not that the Company will realize these assets in the
future based upon the historical profitable operations of the Company.
Net long-term deferred tax assets are included in other assets on the
accompanying consolidated balance sheets.
A reconciliation of the differences between the federal statutory tax rate
of 34 percent and the Company's effective income tax rate is as follows:
Year Ended January 31,
1997 1996 1995
Federal statutory income tax rate 34.0% 34.0% 34.0%
State income taxes, net of Federal benefit 8.4 7.5 6.1
Permanent differences (0.2) 0.9 0.8
----------------------- --------
Effective income tax rate 42.2% 42.4% 40.9%
========== ====== ======
NOTE 10 - STOCKHOLDERS' EQUITY
(A) Common Stock - The Class A Common Stock and Class B Common Stock has
authorizations of 20,000,000 and 3,000,000 shares, respectively. The Class A
Common Stock and Class B Common Stock are substantially identical in all
respects, except that the holders of Class B Common Stock elect two-thirds of
the Company's Board of Directors (as long as the number of shares of Class B
Common Stock outstanding equals or exceeds 400,000), while the holders of Class
A Common Stock elect one-third of the Company's Board of Directors. Each share
of Class B Common Stock automatically converts into one share of Class A Common
Stock upon transfer to a non-Class B common stockholder. At the same time, the
Board approved the authorization of 1,000,000 shares of preferred stock to be
issued from time to time, in such series and with such designations, rights and
preferences as the Board may subsequently determine. The stock splits and the
changes in authorized capital have been retroactively reflected for all periods
presented herein.
(B) Stock Option Plans - The Company maintains two stock options plans
pursuant to which an aggregate of 984,375 shares of Common Stock may be granted.
The 1993 Stock Option Plan was adopted by the Board of Directors in
December 1993 and was approved by the stockholders of the Company on July 28,
1994 (the "1993 Plan").
The 1993 Plan has 750,000 shares of Common Stock reserved for issuance upon
the exercise of options designated as either (i) incentive stock options
("ISOs") under the Internal Revenue Code of 1986, as amended (the "Code"), or
(ii) non-qualified options. ISOs may be granted under the Stock Option Plan to
employees and officers of the Company. Nonqualified options may be granted to
consultants, directors (whether or not they are employees), employees or
officers of the Company.
F-21
Stock option transactions during the years ended January 31, 1997, 1996 and
1995 for the 1993 Plan are summarized below:
Weighted
Shares Price Range Average Price
Options granted 53,467 $4.88 - $5.89 $ 5.43
--------- ------------- ------------
Options outstanding - January 31, 1995 53,467 $4.88 - $5.89 $ 5.43
Options granted 11,720 $9.12 - $10.04 $ 9.73
Options exercised (1,640) $4.88 $ 4.88
--------- ------------------ ------------
Options outstanding - January 31, 1996 63,547 $4.88 - $10.04 $ 6.21
Options granted 255,625 $10.20 - $17.05 $ 14.94
Options exercised (4,602) $4.88 $ 4.88
Options canceled (5,625) $14.50 $ 14.50
---------- ----------------- -----------
Options outstanding - January 31, 1997 308,945 $4.88 - $17.05 $ 13.23
========== ================= ===========
Options exercisable at January 31, 1997 51,127 $4.88 - $10.04 $ 5.76
========== ================= ============
Options Outstanding Options Exercisable
Weighted Avg. Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life (yrs) Price Exercisable Price
$ 4.88 - $ 5.89 47,225 2.5 $ 5.43 47,225 $5.43
$ 9.12 - $10.20 11,720 3.5 $ 9.83 3,902 $9.73
$14.50 - $17.05 250,000 4.5 $15.00 - -
----------- ----------
308,945 51,127
=========== ==========
All options granted for the fiscal year ended January 31, 1995 are
exercisable one year from the date of grant and expire five years from the date
of grant. All options issued subsequent to the fiscal year ended January 31,
1995 vest in three annual installments of 33-1/3 percent each on the first,
second, and third anniversary of the date of grant. There are 435,188 shares
available for future grants under the 1993 Plan. Approximately 5,625 options
have been canceled under this plan.
The 1994 Non-Employee Director Stock Option Plan (the "Directors Plan") was
adopted by the Board of Directors in September 1994, and was approved by the
Stockholders of the Company in June 1995. The Directors Plan has 234,375 shares
of Common Stock reserved for issuance. Pursuant to the terms of the Directors
Plan, each independent unaffiliated Director shall automatically be granted,
subject to availability, without any further action by the Board of Directors or
the Stock Option Committee: (i) a non-qualified option to purchase 7,500 shares
of Common Stock upon their election to the Board of Directors; and (ii) a non-
F-22
qualified option to purchase 2,500 shares of Common Stock on the date of
each annual meeting of stockholders following their election to the Board of
Directors. The exercise price under each option is the fair market value of the
Company's Common Stock on the date of grant. Each option has a five-year term
and vests in three annual installments of 33-1/3 percent each on the first,
second, and third anniversary of the date of grant. Options granted under the
Directors Plan are generally not transferable during an optionee's lifetime but
are transferable at death by will or by the laws of descent and distribution. In
the event an optionee ceases to be a member of the Board of Directors (other
than by reason of death or disability), then the non-vested portion of the
option immediately terminates and becomes void and any vested but unexercised
portion of the option may be exercised for a period of 180 days from the date
the optionee ceased to be a member of the Board of Directors. In the event of
death or permanent disability of an optionee, all options accelerate and become
immediately exercisable until the scheduled expiration date of the option.
Stock option transactions during the years ended January 31, 1997, 1996 and
1995 for the Directors Plan are summarized below:
Weighted
Shares Price Range
====== ===========
Average Price
-------------
Options granted 35,157 $ 5.36 $ 5.36
-------- -------- -----------
Options outstanding - January 31, 1995 35,157 $ 5.36 $ 5.36
Options granted 11,718 $ 9.12 $ 9.12
--------- ----------------- -----------
Options outstanding - January 31, 1996 46,875 $5.36 - $9.12 $ 6.30
Options granted 9,375 $15.50 $ 15.50
--------- ----------------- -----------
Options outstanding - January 31, 1997 56,250 $5.36 - $15.50 $ 7.83
========= ================= ===========
Options exercisable at January 31, 1997 27,344 $5.36 - $9.12 5.90
========= ================= ===========
Options Outstanding Options Exercisable
Weighted Avg. Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life (yrs) Price Exercisable Price
$ 5.36 35,157 2.5 $ 5.36 23,438 $5.36
$ 9.12 11,718 3.5 $ 9.12 3,906 $9.12
$ 15.50 9,375 4.5 $15.50 - -
----------- ----------
56,250 27,344
=========== ==========
There are 178,125 shares available for future grants under the Directors
Plan. No options have been exercised or canceled under this plan.
In connection with the acquisitions of Sedeco, SMX, and Pulse,
approximately 427,000 nonplan options have been issued as follows:
F-23
Weighted
Shares Price Range Average Price
------- ----------- -------------
Options granted - Pulse acquisition 35,892 $ 4.88 $ 4.88
---------- ---------------- ---------
Options outstanding -
January 31, 1995 and 1996 35,892 $ 4.88 $ 4.88
Options granted - SMX and Sedeco
acquisitions 391,550 $16.20 - $18.25 $ 16.52
---------- --------------- ----------
Options outstanding -
January 31, 1997 427,442 $ 4.88 - $18.25 $ 15.54
========== ================ ==========
Options exercisable at January 31, 1997 35,892 $ 4.88 $ 4.88
========== ================ ===========
F-24
Options Outstanding Options Exercisable
Weighted Avg. Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life (yrs) Price Exercisable Price
------------------- ----------- ----------------- ------------ ----------- --------
$ 4.88 35,892 2.5 $ 4.88 35,892 $4.88
$ 16.20 331,250 4.5 $16.20 - -
$ 18.25 60,300 4.75 $18.25 - -
----------- ----------
427,422 35,892
=========== ==========
The options issued in connection with the Pulse acquisition are exercisable
and have a life of five years. The options issued in connection with the SMX and
Sedeco acquisitions vest in four annual installments of 25 percent each in the
first, second, third, and fourth anniversary of the date of grant and expire
five years from the date of grant. No options have been exercised or canceled.
In addition, pursuant to the IPO, the underwriters received warrants to
purchase from the Company 205,080 shares of Class A Common Stock. The warrants
are exercisable for a period of four years commencing one year after the date of
the IPO at exercise prices ranging from 107 percent to 128 percent of the
initial public offering price. During the fiscal year ended January 31, 1997,
198,300 warrants were exercised at a price of $5.56 per share. Approximately
6,780 are exercisable at a price of $5.90 per share.
(C) Additional Stock Plan Information - As discussed in Note 2, the Company
continues to account for its stock-based awards using the intrinsic value method
in accordance with APB 25 and its related interpretations. Accordingly, no
compensation expense has been recognized in the financial statements for
employee stock arrangements.
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation", ("SFAS 123") requires the disclosure of pro forma net
income and earnings per share had the Company adopted the fair value method as
of the beginning of fiscal 1996. Under SFAS 123, the fair value of stock-based
awards to employees is calculated through the use of option pricing models, even
though such models were developed to estimate the fair value of freely tradable,
fully transferable options without vesting restrictions, which significantly
differ from the Company's stock option awards. These models also require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect the calculated values. The Company's
calculations were made using the Black-Scholes option pricing model with the
following weighted average assumptions for 1997 and 1996: expected life, five
years following vesting; stock volatility, 28 percent, risk free interest rate
of 6.0 percent and no dividends during the expected term. The Company's
calculations are based on a multiple option valuation approach and forfeitures
are recognized as they occur. If the computed fair values of the 1997 awards had
been amortized to expense over the vesting period of the awards, pro forma net
income would have been approximately $8,494,000 ($1.07 per share). The impact of
SFAS 123 on pro forma net income for 1996 was zero. However, the impact of
outstanding non-vested stock options granted prior to February 1, 1995 has been
excluded from the pro forma calculation; accordingly, the 1997 and 1996 pro
forma adjustments are not indicative of future period pro forma adjustments,
when the calculation will apply to all applicable stock options.
F-25
(D) Stock Dividend - On June 25, 1996 and June 23, 1995, the Company
declared five-for-four stock splits effected in the form of 25 percent stock
dividends which were paid on July 22, 1996 and July 24, 1995 to stockholders of
record on July 8, 1996 and July 10, 1995, respectively. The par value of the
shares remains unchanged at $.01 per share.
Unless otherwise noted, all numbers of shares, per share amounts and per
share prices in the consolidated financial statements and notes thereto have
been adjusted to reflect the stock dividends and splits.
(E) Profit Sharing Plan - The Company has a voluntary contribution profit
sharing plan (the "Plan"), which complies with Section 401(k) of the Internal
Revenue Code. Employees who have attained the age of 21 and have one year of
continuous service are eligible to participate in the Plan. The Plan permits
employees to make a voluntary contribution of pre-tax dollars to a pension
trust, with a matching contribution by the Company up to a maximum of two
percent of an eligible employee's annual compensation. The Company contributed
approximately $78,000, $59,000 and $54,000, for the years ended January 31,
1997, 1996 and 1995, respectively. The Company funds all amounts when due.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
(A) Minimum Operating Lease Commitments - The Company has operating leases
for various automobiles and sales and service locations. The annual aggregate
rental commitments required under these leases, except for those providing for
month-to-month tenancy, are as follows:
Fiscal Year Ending January 31,
1998 $ 531,548
1999 360,117
2000 186,720
2001 109,680
2002 88,567
Thereafter 38,260
-------------
Total $ 1,314,892
=============
Rent expense was approximately $617,000, $264,000 and $235,000 for the
years ended January 31, 1997, 1996 and 1995, respectively.
(B) Foreign Currency Contracts - In connection with the purchase of
equipment from its major supplier, the Company purchases foreign currency
forward contracts (which usually approximate six months in duration) to hedge
the risk associated with fluctuations in foreign currency exchange rates
relating to all trade acceptances payable and certain firm purchase commitments.
The costs of such contracts are included in the cost of the related machinery in
inventory.
At January 31, 1997, the Company held foreign currency contracts for the
purchase of Japanese yen amounting to approximately $58,000,000.
F-26
(C) Litigation - The Company is a defendant in various litigation matters,
all arising in the normal course of business. Based upon discussion with Company
counsel, management does not expect that these matters will have a material
adverse effect on the Company's consolidated financial position or results of
operations.
(D) Employment Agreements - The Company has five-year employment agreements
with the Company's senior executives. These employment agreements provided that
each executive receive minimum annual compensation of $350,000 for the remainder
of the term of the employment agreement. In addition, each employment agreement
provides for an annual bonus equal to five percent of pre-tax profits of the
Company. The Company also entered into a five-year employment agreement with
another officer of the Company, who will receive annual compensation of $100,000
with a bonus equal to two percent of pre-tax profits of the Company. The Company
also has five-year employment agreements with the former shareholders of Pulse,
providing each with an annual base salary of $300,000 and an annual bonus based
on annual pre-tax profits of Pulse.
(E) Dependency Upon Major Supplier - During the fiscal years ended January
31, 1997, 1996 and 1995, the Company made purchases of approximately
$69,000,000, $47,000,000 and $40,000,000, respectively, from Tajima Industries
Ltd. ("Tajima"), the manufacturer of the embroidery machines the Company sells.
This amounted to approximately 83, 80 and 82 percent of the Company's total
purchases for the years ended January 31, 1997, 1996 and 1995, respectively.
The Company has two separate distributorship agreements with Tajima which,
collectively, provide the Company the exclusive right to distribute Tajima's
complete line of embroidery machines in 39 states. The main agreement (the "East
Coast / Midwest Agreement") which covers 33 states, including the original
Hirsch territory and the additional states acquired in the SMX territory, became
effective on February 21, 1991, has a term of 20 years and contains a renewal
provision which permits successive five year renewals upon mutual agreement of
the parties. The East Coast / Midwest Agreement is terminable by Tajima and/or
the Company on not less than two years' prior notice except that Tajima cannot
terminate the East Coast / Midwest Agreement prior to February 20, 1998. The
second agreement (the "Southwest Agreement") covers the six states acquired in
the Sedeco territory, became effective on February 21, 1997 and has a term of
five years.
In the states of Arizona, California, Hawaii, Idaho, Montana, Nevada,
Oregon, Utah, Washington and Wyoming, the Company is the exclusive distributor
of Tajima's single, two, four, and six-head machines as well as chenille or
chenille/standard embroidery machines with less than four heads or two stations,
respectively (the "West Coast Agreement"). The West Coast Agreement has a term
of five years and contains a renewal provision which permits successive
five-year renewals upon mutual agreement of the parties. Tajima may terminate
the West Coast Agreement or its exclusivity on 30 days written notice or upon a
material change in the current Class B shareholders in which case, the West
Coast Agreement can be terminated earlier.
The minimum purchase of embroidery machines for 1996 was met. The minimum
quantity to be sold in 1997 is 1,503 machines in various designations as
defined.
F-27
There are several manufacturers of multihead embroidery equipment. Although
management of the Company believes that the likelihood of the loss of Tajima as
a supply source is remote, if Tajima terminated the current distributor
relationship with the Company, management believes that it could establish a
similar arrangement with another manufacturer of embroidery equipment.
* * * * * *
F-28