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, 1999
[ ] 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)
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Delaware 11-2230715
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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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 6,474,128 shares of Class A Common Stock
held by non-affiliates of the Company as of May 10, 1999 is $13,352,889.
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
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Class A Common Stock 6,724,880
par value $.01
Class B Common Stock 2,668,139
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, 1999.
PART I
Item 1. Business
General
Hirsch International Corp. ("Hirsch" or the "Company"), a Delaware
Corporation, was founded in 1970 and 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- and multi-head embroidery machines, proprietary application
software, a diverse line of embroidery supplies, accessories and proprietary
embroidery 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 wide-range of product offerings
together with its related value-added products and services place it in a
competitively advantageous position within its marketplace.
The application of new technologies has transformed the embroidery industry
from one which was labor-intensive, utilizing machinery with limited production
capabilities to an industry where investment in electronic, computer-controlled
machinery and related application software has increased labor efficiencies and
production capacities while expanding the flexibility and complexity of
embroidery designs. These developments have not only resulted in the expansion
of existing markets but have also led to the creation of new markets for
embroidery. Moreover, industry has benefited from the growth in consumer demand
for licensed products carrying the names, logos and designs of professional and
collegiate sports teams, entertainment companies and their characters, as well
as branded merchandise and related goods. Until recently, these trends and
others have contributed to the increase in demand for machinery, software and
services provided by Hirsch. However, during fiscal 1999, the Company and the
embroidery industry as a whole experienced a decrease in overall demand driven
by a shift in the sales mix of embroidery machines and the relocation offshore
of large multi-head equipment customers. As a result, the Company initiated a
restructuring program designed to address the market shifts in the industry,
including closing and consolidating certain divisions, reducing total employment
and disposing of facilities no longer required to support its new business
model. (See Management's Discussion and Analysis of Financial Condition and
Results of Operations).
The Company's customer base includes large operators who run numerous
machines as well as 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 "FX" models) machines in
the continental United States and Hawaii and large (six-head "DC" models through
thirty-head models) machines in 39 states. In the states of Arizona, Idaho,
Montana, Nevada, Oregon, Utah, Washington, Wyoming, and Hawaii, Hirsch has
semi-exclusive rights to distribute Tajima large machines.
The Company enjoys a solid relationship with Tajima, having spanned more
than 20 years. Hirsch is Tajima's largest distributor in the world and
collaborates with Tajima in the development of new embroidery equipment and
enhancements to existing equipment. Until recently, all Tajima equipment was
assembled in Japan. Last year, Hirsch announced the formation of a new
subsidiary, Tajima USA, Inc ("TUI"), which currently assembles two-four- and
six- head Tajima machines in the United States. In December 1997, Hirsch sold a
forty-five (45%) percent interest in TUI to Tokai Industrial Sewing Machine
Company, Ltd. ("Tokai"). The Company believes that the venture with Tokai, which
is Tajima's manufacturing arm, will act to further strengthen its relationship
with Tajima.
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 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, as well as
enabling the customization of designs and reduced production costs. The majority
of Pulse's proprietary application software programs are designed to operate in
the Microsoft(R) Windows(R) 95, Windows(R) 98 and Windows (R) NT environments,
which Hirsch believes will further simplify usage and enhance user flexibility.
The Company's leasing subsidiary, HAPL Leasing Co., Inc. ("HAPL Leasing"),
provides a wide range of financing options to customers wishing to finance their
purchases of embroidery equipment. Hirsch also sells a broad range of embroidery
supplies, accessories and proprietary embroidery products.
The Company's equipment and value-added products are marketed directly by
an employee sales force, whose efforts are augmented by trade journal
advertising, informational "open house" seminars and trade shows. Hirsch
believes its reputation, knowledge of the marketplace, 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 development of electronic computer-controlled embroidery machines has
led to new embroidery applications and markets, cost savings, higher profit
margins and production efficiencies and has transformed the embroidery industry
from being extremely labor-intensive to an industry characterized by rapid
growth and technological change. Recent innovations to embroidery machines offer
superior design flexibility and increased speed and provide the manufacturer
with the ability to embroider finished products, the ability to efficiently
embroider up to fifteen colors at a time, automatic thread trimming, and other
labor-saving improvements. The embroidery industry also benefited 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 other sources, 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
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 application and
integration of computers and specialized software.
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) assembles and sells a broad range of Tajima embroidery machines,
(ii) develops and supplies proprietary application software programs for
embroidery machines, (iii) provides leasing options to customers to finance
equipment purchases, (iv) sells a broad range of embroidery supplies,
accessories and proprietary products, (v) reconditions, remanufactures and sells
used embroidery equipment, and (vi) provides comprehensive customer training,
support and service for these embroidery machines. The Company believes that
this comprehensive approach positions it to become its customers' preferred
vendor for their embroidery equipment and related services 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 1-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 Microsystems Software. The Company's Pulse subsidiary offers a wide
range of proprietary application software which enhances and simplifies the
embroidery process. A majority of the Company's proprietary application software
products are designed to operate in the Microsoft(R) Windows(R) 95, Windows(R)
98 and Windows(R) NT environments which the Company believes will enhance
creativity, ease of use and user flexibility. It is the Company's established
practice to aggressively market its software with embroidery equipment and as an
upgrade to its installed base of approximately 14,000 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 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 bolstered
its software development team and will continue to work closely with Hirsch and
Tajima 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 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
parts, supplies and accessories division offers a broad range of embroidery
supplies, accessories and proprietary products, which is an integral part of the
Company's single source strategy. The Company has expanded the product line with
the introduction of proprietary products. Moreover, the expansion of the
Company's marketing efforts is directed toward telemarketing, trade publication,
advertising and trade show participation. The Company 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 which act to
simplify the embroidery process.
The Company's embroidery supplies and accessories business had previously
operated as the Embroidery Supply Warehouse ("ESW"), a division of Hirsch. At
the close of fiscal 1999, as part of its restructuring strategy, the Company
announced it was closing ESW as a separate division and consolidating its
operations with those of the Company. The Company believes that it will
experience substantial savings because of this consolidation due to the
elimination of duplicate operational systems and a corresponding reduction in
personnel.
During fiscal 1999 the Company created its new "Building Blocks" division,
specializing in the creation and sale of stock embroidery designs and associated
software products into the retail market. The Company focused on developing the
"Building Blocks" product line and infrastructure during fiscal 1999, and
consequently, did not record any sales revenues for the Building Blocks division
during the fiscal year.
Retail Embroidery Services. During fiscal 1999, the Company together with
Jacobs Management Corporation formed Hometown Threads ("Hometown Threads") as a
joint venture for the purpose of providing retail embroidery services within
Wal-Mart establishments. The joint venture is currently test-marketing its
concept at a Wal-Mart location in Carrolton, Texas and, if successful,
anticipates expanding these operations to additional Wal-Mart retail
establishments through the United States.
Customer Support. 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 21 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 employs 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. During the last year, the
Company has undertaken a program to significantly upgrade its technical support
staff and operations on the West Coast due to increasing sales activity in this
area and resulting demand for technical support services. This will continue as
the Company has been granted semi-exclusive rights to distribute large Tajima
embroidery machines to the West Coast.
Growth Strategy
The Company has developed a number of complementary growth strategies,
including the following:
Grow with Embroidery Equipment Customers. 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 repeat 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
new distribution markets. The Company anticipates that its approach to
marketing, customer training, support and service will allow further penetration
of the potential customer base in these markets. In June and December 1996, the
Company consummated two acquisitions which expanded the territory in which the
Company distributes embroidery machines to 50 states. In January 1997, the
Company was granted the exclusive right to distribute Tajima one through
six-head "FX" model embroidery machines in nine western states and Hawaii. In
March 1998 Hirsch was granted semi-exclusive rights to distribute large Tajima
embroidery machines, six-head "DC" models through thirty-head models, to the
West Cost states of Arizona, Idaho, Montana, Nevada, Oregon, Utah, Washington,
Wyoming and Hawaii. The Company has continued to invest in the West Coast
infrastructure during fiscal 1999. This expansion included establishing
additional sales offices, hiring of technical service and support staff as well
as investment in demo equipment and inventory.
Expand Sales of Value-Added Product and Services. Because of the higher
profit margins realized through sales of Pulse, HAPL Leasing, and embroidery
parts, supplies and accessories as compared to new equipment sales, part of the
Company's growth strategy is to increase these sales. 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 parts, supplies and accessories through the
consolidated operations of what was formerly known as ESW. The leasing options
offered through HAPL leasing also present the Company with opportunities for
increased revenues not only for new embroidery equipment sales, but also of
value-added products and services. In those regions of the United States where
the Company has recently expanded through acquisitions and obtaining the right
to distribute small Tajima machines, the Company believes that it has an
additional opportunity to expand sales of its value-added products and services.
Historically, the Company's sales of software products, leasing activities and
sales of embroidery supplies and related products have been concentrated in the
states where it has had the exclusive right to distribute embroidery machines.
The Company believes that the expansion of this area will allow it to better
market its value-added products and services. To facilitate this growth, the
Company established warehouses for the storage of embroidery supplies and
related products at the same locations as certain sales offices. In addition,
the Company's embroidery supplies and accessories product line also is offered
to all users of embroidery equipment in the United States through trade
publications, print advertising and trade show participation.
Ability to Accept Used Equipment on a Trade-In Basis. As part of its sales
and marketing efforts, the Company may accept used embroidery equipment from a
customer to whom it is providing new machinery. As a result of this trend, the
industry as a whole has seen an increase in the number of used machines in the
market. The Company expects that the recent termination of the operations of
Hirsch Equipment Connection, Inc. ("HECI") and subsequent absorption of these
operations into the New York facility will provide better control and
profitability of this activity.
Assembly Operations. The Company's Tajima USA, Inc. ("TUI") subsidiary
maintains a facility located in Ronkonkoma, New York, near the Company's
headquarters which assembles Tajima machines of up to six heads. TUI's Net sales
during the fiscal year ended January 31, 1999 were approximately $23,026,000.
In early January 1998, Tokai Industries, which is Tajima's manufacturing
arm, purchased a forty-five (45%) percent interest in TUI for $900,000 in cash.
The Company's initial investment in TUI was $2,000,000 in June 1997. The
purchase price was initially paid to TUI and then subsequently remitted to the
Company to bring the Company's net contribution to $1,100,000 or fifty-five
(55%) percent. The Company believes this investment in TUI has further
solidified its relationship with Tajima and will become a vital component in the
Company's future success.
Embroidery Equipment
Embroidery equipment may contain single or multiple sewing heads. The
selling prices of these machines range from approximately $15,000 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) machines with faster operating
speeds and a wider variety of color selections; (ii) wide cap embroidery system,
which expands the small sewing field on finished caps to a 270 degree continuous
arc; (iii) the multi-color chenille embroidery machine, which enables
embroiderers to create more elaborate and colorful designs with chenille
stitches; (iv) single head chenille embroidery machine which enables the
embroidery entrepreneur the opportunity to enhance their products at an
affordable price; (v) the tandem chenille and embroidery machine, making it
possible to incorporate both chenille and embroidery into the same design; and
(vi) the Emblaser machine, which incorporates embroidery and laser technology
into one system, reduces production time and increases production efficiencies.
The Company believes that these machines will allow new applications for the use
of embroidery machines which will impact the sportswear market. Additionally,
Tajima develops customized applications to address specific customers needs.
Value Added Products
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. 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's computer-aided design software packages
target the different functions performed by embroiderers, and are contained 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 software provides users with the most technologically advanced
software solutions delivering improved productivity and quality for their
operations. In the near future, Pulse will be releasing a series of innovations
that will strengthen its position as the technological leader in the industry.
While continuing to invest in research in its core embroidery technologies,
Pulse has also created specialized and targeted applications that are addressing
the particular needs of growing segments of the embroidery market such as retail
operations, small entrepreneurs and uniform manufacturers. Pulse has also
designed, as part of their new Powertools suite of applications, products that
assist customers in creating an Internet presence for their embroidery
creations.
Pulse has recently expanded its distribution network by establishing
relationships in several Asian territories such as China, Hong Kong, Japan and
India. While the Company expects that it will take some time before achieving
significant financial results from these territories, the Company is confident
that these new relationships will strengthen Pulse's position as the global
leader in embroidery software.
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 50.7% of the Company's new machine sales were financed
through HAPL Leasing for the year ended January 31, 1999, compared to 36.9% for
the year ended January 31, 1998. Historically, HAPL Leasing has minimized its
leasing risk by selling substantially all of its sales-type leases to financial
institutions on a non-recourse basis. This trend continued in fiscal 1999.
Additionally, during the third quarter of fiscal 1998, HAPL entered into an
Ultimate Net Loss ("UNL") Limited Liability Recourse Agreement with a
third-party financial institution. The maximum exposure is limited to 10% of the
minimum lease payments receivable, for which the Company records a reserve. 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 5 years. As of
January 31, 1999, HAPL Leasing had sold approximately 90.9% of its leases.
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 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 continues to work both internally and with its funding sources
to develop new lease programs attractive to the embroidery industry.
Used Embroidery Machinery
The Company accepts used embroidery machines from customers as a condition
to the sale of a new machine on a case by case basis. The Company's ability to
accept used machines is an important sales tool and necessary element in the
Company's sales strategy. The Company believes that the market for reconditioned
and remanufactured embroidery machines is steadily growing and will be a steady
source of revenue in the future.
Embroidery Supplies and Accessories
The Company 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, the Company develops embroidery products based on
the recommendations of embroiderers. The Company 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.
The Company markets "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.
In addition, the Company's distribution of embroidery supplies and
accessories includes the following products: "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.
Following the Company's machine sales expansion to the West Coast, the
Company expanded the hours of its telemarketing operations, making it easier for
customers across the United States to place an order. The Company believes that
the elimination of ESW as a separate division, and the consolidation of ESW's
operations into the Company will enhance the Company's competitiveness in the
market for embroidery supplies and accessories as well as help the Company to
realize increased efficiencies.
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 sales
staff is headed by Paul Levine, President 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 for both machinery and
value-added products and services.
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 maintains an internal training center for its employees at its
Cleveland training center primarily for the training of service technicians.
Senior service technicians also receive formal training from Tajima in addition
to technical updates 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. The Company has taken steps to close the Cleveland
facility during fiscal 2000 and to consolidate its operations at an existing but
undetermined location.
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 its customers 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 six month warranty. As a consequence, the Company absorbs a portion of
the cost of providing warranty service on Tajima products.
Supplier Relationships with Tajima
The Company has three 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 and has a term of 20 years. The East Coast/Midwest Agreement is
terminable by Tajima and/or the Company on not less than two years' prior
notice. 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 "FX" model 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, which 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 maintained a relationship with Tajima for over 20 years 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; (iii) the Company and
Pulse support Tajima's development activities and the Pulse software enhances
the Tajima product line; and (iv) the acquisition by Tokai of a forty-five (45%)
percent interest in the TUI venture.
Other Supplier Relationships
The Company purchases personal computers which are integrated with the
embroidery machines it distributes. The Company obtains its inventory for its
embroidery supplies and accessories business from many different sources. The
Company believes that alternate sources of supply are readily available.
Customers
The Company's customers range from large operators utilizing 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 Athletic, 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
subsidiary of Willcox & Gibbs, Inc., a distributor of Barudan multi-head
embroidery machines and Meistergram single-head embroidery machines, as well as
with smaller distributors. On April 20, 1999, Willcox & Gibbs, Inc. filed a
joint plan of reorganization under Chapter 11 of the U.S. Bankruptcy Code in the
U.S. Bankruptcy Court for the District of Delaware. 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. The Company also competes with original equipment manufacturers,
such as Brother International and Melco Industries, which distribute products
directly into the Company's markets.
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, Melco Industries, Inc., a United States-based subsidiary
of Sauer Textile Machinery Group, a Swiss corporation and Compucon S.A., of
Greece. 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. 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.
The Company's embroidery supplies and accessories business competes with a
division of Melco Industries and other vendors of embroidery supplies. The
Company believes that the market for embroidery supplies is fragmented and that
the Company 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 Systems",
"Method For Creating Self-Generating Embroidery Pattern," two patents entitled
"Method for Automatically Generating Chain Stitches" and three 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 has been granted the following patent in the
European Patent Office: "Method for Modifying Embroidery Design Programs." Pulse
also has 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 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, 1999, the Company employed approximately 365 persons
engaged in sales, customer service and supplies, product development, finance
administration and management for the Company, Pulse, TUI and HAPL Leasing. None
of the Company's employees is represented by unions. The Company believes its
relationship with employees is good.
Risk Factors
Dependence on Tajima
For the fiscal year ending January 31, 1999, approximately 93.0% of the
Company's revenues resulted from the sale or lease of embroidery equipment
supplied by Tajima and substantially all of the Company's machine sales were to
users of Tajima embroidery equipment. Three separate distributorship agreements
(collectively, the "Tajima Agreements") govern the Company's rights to
distribute Tajima embroidery equipment in the United States. Two of the
distributorship agreements with Tajima collectively provide the Company with the
exclusive rights 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 now covers 33 states,
first 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. The second
agreement (the "Southwest Agreement") which covers six states, became effective
on February 21, 1997, and has a term of five years. Under the third
distributorship agreement, (the "West Coast Agreement") which covers nine
western states and Hawaii, the Company is the exclusive distributor of Tajima's
small machines, as well as chenille and tandem chenille/standard embroidery
machines with less than four heads or two stations, respectively. The West Coast
Agreement, which has a term of five years, became effective on February 21,
1997, and contains a renewal provision which permits successive five year
renewals upon mutual agreement of the parties. Each of the Tajima 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 or in the event of the death, physical or mental
disability of a duration of six months or longer, or incapacity of both Henry
Arnberg and Paul Levine. 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 or should there occur any change in control of the
Company. The termination of the Tajima Agreements would have a material adverse
effect on the Company's business, financial condition and results of operations.
Importing Tajima's equipment from Japan subjects the Company to risks of
engaging in business overseas, including international political and economic
conditions, tariffs, foreign regulation of trade with the United States, and
work stoppages. The interruption of supply or a significant increase in the cost
of Tajima equipment for any reason could have a material adverse effect on the
Company's business, financial condition and results of operation. In addition,
Tajima manufactures its embroidery machines in one location in Japan. The
Company could be adversely affected should this facility be seriously damaged as
a result of a natural disaster or otherwise. Further, the Company could be
adversely affected by adverse business or financial developments at Tajima.
Embroidery machines produced by Tajima are subject to technological
advances and new product introductions. Current competitors or new market
entrants could introduce products with features that render products sold by the
Company and products developed by Tajima less marketable. The Company relies on
Tajima's embroidery equipment to be high quality and state of the art. The
Company's future success will depend, to a certain extent, on the ability of
Tajima to adapt to technological change and address market needs. There can be
no assurance that Tajima will be able to keep pace with technological change in
the embroidery industry or the current demands of the marketplace.
Embroidery Industry
The Company's growth in past years has resulted in part from the increase
in demand for embroidered products and the growth of the embroidery industry as
a whole. The embroidery industry has recently experienced a decline in demand
for large embroidery machines, which has had an adverse effect on the operations
of the Company and its business. A decrease in consumer preferences for
embroidered products, a general economic downturn or other events having an
adverse effect on the embroidery industry would also have an adverse effect on
the Company.
In addition, the embroidery industry has seen a shift of manufacturing
operations toward Mexico, the Caribbean basin and Latin America due to lower
labor and operating costs in these locations. These areas are currently outside
of the Company's distribution territory for Tajima embroidery machines. The
continued shifting of embroidery operations by U.S. embroiderers to Mexico, the
Caribbean basin and Latin America may weaken demand in the U.S. for new
embroidery machines and could have a material adverse effect on the business and
operations of the Company.
Foreign Currency Risks
The Company pays for its Tajima embroidery machinery in Japanese Yen. Any
devaluation of the U.S. Dollar compared to the Japanese Yen increases the cost
to the Company of its embroidery machine inventory. The Company has generally
been able to recover these increased costs through price increases to its
customers or, in limited circumstances, price reductions from Tajima. However
there can be no assurance that the Company will be able to recover such
increased costs in the future.
Assembly Facility
The Company assembles Tajima embroidery machines in the United States
through its subsidiary TUI, initially in configurations of up to six heads per
machine. Tajima provides the Company with technical assistance and support.
While TUI operations were profitable in fiscal 1999, the throughput of the
facility is dependent on continued demand for embroidery machines generated by
the Hirsch sales organization.
Expansion
Since June 1996, the Company has acquired four (4) companies (the
"Acquisitions"). These acquisitions (i) increased the area in which the Company
is the exclusive distributor of the complete line of Tajima embroidery equipment
from 26 states to 39 states; and (ii) increased the Company's ability to offer a
customer value for its used embroidery equipment. 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. In March
1998, the Company was granted certain rights to distribute large Tajima
embroidery machines, six-head "DC" models through thirty-head models throughout
certain West Coast states, and the Company has invested substantial assets to
support the West Coast expansion. There can be no assurance that the Company
will be able to profitably sell equipment or the Company's value-added products
in the new territories.
During the fiscal year, the Company announced the establishment of its new
Building Blocks division for the purpose of creating and distributing stock
embroidery designs and associated software products to the retail market. As of
the end of fiscal 1999, Building Blocks had not commenced operations, nor was
the Company's investment in Building Blocks material. The Company anticipates
the commencement of operations during fiscal 2000 at which time it may
experience additional start-up costs. Although the Company believes it will be
able to access the substantial home and retail embroidery market, there is no
guaranty that it will be able to do so on a profitable basis.
In addition, the Company announced during the fiscal year the creation of a
joint venture with Jacobs Management Corporation called "Hometown Threads".
Hometown Threads was created for the purpose of establishing retail embroidery
service centers within Wal-Mart retail locations. As of the end of fiscal 1999,
Hometown Threads had commenced operations on a test-market basis at the Wal-Mart
center located in Carrollton, Texas. As of the end of fiscal 1999, the Company's
investment in Hometown Threads was not material. Although the Company believes
it will be able to access the market for retail embroidery services, there is no
guaranty that it will be able to do so on a profitable basis.
The past growth and current diversification of the Company's business have
resulted in new and increased responsibilities for management and have placed
increased demands upon the Company's operating, financial and technical
resources. The Company's ability to successfully manage its expansion will
require continued enhancement of its management and operational, financial and
technical resources. The Company will also need to attract and retain qualified
personnel to support the expansion of its operations. The Company's failure to
manage successfully its diversification or attract and retain qualified
personnel could have a material adverse effect on the Company's business,
financial condition and results of operations.
Leasing Operations
HAPL Leasing provides a range of equipment financing options to customers
wishing to finance equipment purchases. HAPL Leasing retains selected leases for
which it has not obtained a purchase commitment from its funding sources.
Although HAPL Leasing has sold approximately 90.9% of the leases it has written
to date, there can be no assurance that it will continue to be able to sell its
leases to third party funding sources. Unfunded leases create the risk of
nonpayment by lessees, including the risk that foreclosure could be hampered by
bankruptcy or other legal proceedings, and the risk that foreclosed equipment
cannot be released or sold due to market conditions or the physical condition of
the equipment. The operations of HAPL Leasing are interest rate sensitive. If
interest rates rise, there can be no assurances that profit margins can be
maintained, and, consequently, the operations of HAPL Leasing could be adversely
affected.
HAPL Leasing's strategy is to enter into leases that qualify as sales-type
leases for which revenue is recognized immediately in an amount equal to the
present value of minimum lease payments. However, high interest rates, weakness
of the U.S. dollar, poor general economic conditions, market conditions, or
other factors could result in HAPL Leasing having to enter into operating leases
resulting in deferral of revenue recognition. Unlike sales-type leases, revenue
relating to operating leases is recognized over the term of the lease, resulting
in a deferral in the recognition of revenue. The embroidery industry as a whole
has been experiencing a leveling off of overall demand for embroidery machines,
which if prolonged, could have an adverse effect on the operations of HAPL.
Inventory
The Company's ordering cycle is approximately four to five months prior to
delivery to the Company. Since the Company generally delivers new Tajima
embroidery machines to its customers within one week of receiving orders, it
orders inventory based on experience and forecasted demand. Due to lower than
forecasted demand, the Company has recently experienced an increase in inventory
levels beyond the desired supply which has caused the Company to experience
higher then projected inventory costs. Any failure in the future to property
manage inventory levels could have an adverse effect on the Company's business,
financial condition and results of operations.
Competition
The Company competes with distributors of embroidery machines produced by
manufacturers other than Tajima and with manufacturers who distribute their
embroidery machines directly as well as with other providers of embroidery
products and services. The Company believes that competition in the embroidery
industry is based on technological capability and quality of embroidery
machines, price and service. The Company has been able to compete effectively in
part because of the relatively advanced technological capabilities and excellent
quality of Tajima embroidery machines. However, if other manufacturers develop
more technologically advanced embroidery machines or the quality of Tajima
embroidery machines diminishes, the Company would not be able to compete as
effectively which could have a material adverse effect on its business,
financial condition and results of operations. The Company also faces
competition in selling software, embroidery supplies, accessories and
proprietary products as well as providing leasing and customer training, support
and services. The Company's failure to compete effectively in these areas could
have an adverse affect on its business, financial condition and results of
operations.
The Company also faces competition in its sales of software, embroidery
supplies, accessories and proprietary products as well as in providing leasing
and customer training, support and services. The Company's failure to compete
effectively in these areas could have an adverse effect on its business,
financial condition and results of operation.
Software
The software industry is characterized by the rapid development of new
programs with increased capabilities. Other producers of software for embroidery
machines could produce new software programs that would make the software
developed by Pulse less marketable or obsolete. The failure by Pulse to continue
to develop and upgrade its software products could have a material adverse
effect on its business, financial condition and results of operations.
Pulse's software products, like software programs generally, may contain
undetected errors when introduced or when new versions are released. To date,
Pulse has not experienced significant adverse financial or operational problems
due to post release software errors, although there can be no assurance that
this will not occur in the future, particularly if these software programs
continue to become more complex and sophisticated. Defective software could
result in loss of or delay in market acceptance of the Company's software
products, warranty liability or product recalls.
The Company has been granted patent and copyright protection for Pulse's
software products. Although the Company does not believe that the ownership of
such patents or copyrights is a significant factor in Pulse's business or that
its success is materially dependent upon the ownership, validity or
enforceability of such patents or copyrights, existing intellectual property
laws afford limited protection of patents and copyrights and unauthorized
parties may obtain and use information that the Company regards as proprietary.
The Company intends to enforce its intellectual property rights in Pulse's
products, but there can be no assurance that it will be successful in doing so.
Dependence on Existing Management
The Company's continued success will depend to a significant extent upon
the abilities and continued efforts of Henry Arnberg, Chairman of the Board and
Chief Executive Officer of the Company; Paul Levine, President, and a Director
of the Company; Ronald Krasnitz, Chief Operating Officer, Secretary and a
Director of the Company; and Richard Richer, who joined the Company during the
fourth quarter of fiscal 1999 as its Vice President-Finance and Chief Financial
Officer. Pulse's continued success will depend to a significant extent upon the
abilities and continued efforts of Tas Tsonis, Vice President and a Director of
the Company and President of Pulse; Brian Goldberg, Vice President of the
Company and Executive Vice President of Pulse. The Company has entered into five
year employment agreements with Messrs. Arnberg and Levine which expired as of
February 20, 1999 with their employment by the Company continuing on an at-will
basis on roughly the same terms and conditions contained in their expired
employment agreements. Effective as of February 24, 1999, Messrs. Tsonis and
Goldberg elected to renew their respective employment agreements for an
additional three (3) year term. Mr. Richer is currently in the third year of a
five year employment agreement. Mr. Richer does not currently have a written
employment agreement with the Company. The loss of the services of Messrs.
Arnberg, Levine, Tsonis, Goldberg and Richer or the services of other key
management personnel could have a material adverse effect upon the Company's
business, financial condition and results of operations.
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. Effective April 30, 1999, in conjunction with a waiver and amendment
obtained by the Company relating to the violation of a covenant contained in its
Mortgage at January 31, 1999 and subsequent amendment thereof, the interest rate
on the Mortgage increased from 8.8% to 9.3% 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 Tajima USA, Inc.,
operates 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 leases 21 regional
satellite offices, as well as a location in Mississauga, Ontario, Canada for the
Pulse headquarters. These offices consist of regional sales offices, training
centers, repair centers and warehouse and showroom space. As part of the
Company's efforts at restructuring and cost reduction, it is anticipated that as
yet an undetermined number of the regional satellite offices will be closed
during fiscal 2000.
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.
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 closing
bid 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 1999 High Low
First Quarter ended April 30, 1998........................$22 3/4 8 3/32
Second Quarter ended July 31, 1998........................$11 1/4 4 1/2
Third Quarter ended October 31, 1998......................$5 5/8 2
Fourth Quarter ended January 31, 1999.....................$5 1/2 2 3/4
Fiscal 1998
First Quarter ended April 30, 1997........................$22 3/4 $16 1/2
Second Quarter ended July 31, 1997........................$24 3/4 $16 1/2
Third Quarter ended October 31, 1997......................$26 1/4 $17 1/4
Fourth Quarter ended January 31, 1998.....................$22 $17
The foregoing over-the-counter market quotations represent inter-dealer
prices, without retail mark-up, mark-down or commission and may not represent
actual transactions.
(b) As of March 29, 1999, the Company believes that there were
approximately 3,769 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.
PART III
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, 1999 and 1998 and for the fiscal years ended January 31, 1999, 1998
and 1997 are derived from, and 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, 1997, 1996,
and 1995 and for the fiscal years ended January 31, 1996 and 1995 are derived
from audited Consolidated Financial Statements not included herein.
Year Ended January 31, 1999
(in thousands of dollars, except per share amounts)
Hirsch International Corp. and Subsidiaries 1999 1998 1997 1996 1995
- ------------------------- ------------------------ ---- ---- ---- ---- ----
Statement of Operations Data:
Net sales............................................................... $127,546 $147,045 $122,195 $87,974 $70,709
Interest income related to sales-type leases............................ 5,348 5,432 3,243 3,022 1,617
Cost of sales........................................................... 85,054 96,099 80,820 58,836 47,881
Selling, general and administrative expenses............................ 44,381 41,055 29,070 20,638 16,155
(Loss) income before income tax (benefit) provision..................... (6,066) 14,255 15,170 11,402 8,159
Income tax (benefit) provision.......................................... (1,848) 6,059 6,402 4,837 3,355
Net (loss) income....................................................... (4,608) 8,196 8,768 6,565 4,823
Basic net (loss) income per share (1), (2).............................. $ ( 0.49) $ 0.92 $ 1.13 $ 1.10 $ 0.66
Diluted net (loss) income per share (1), (2)............................ $ ( 0.49) $ 0.89 $ 1.10 $ 1.09 $ 0.66
Shares used in the calculation of basic
net (loss) income per share (1), (2).................................. 9,413 8,953 7,782 5,960 7,332
Shares used in the calculation of diluted
net (loss) income per share (1), (2).................................. 9,436 9,236 7,967 6,002 7,335
(1) Basic and diluted net income per share figures and shares used in the
calculation of diluted net income per share have been retroactively adjusted to
reflect 25% stock dividends which were paid in July 1996 and 1995, respectively
and a 5% stock dividend which was paid in August 1994.
(2) Basic and diluted net income per share figures and shares used in the
calculation of diluted net income per share for Fiscal years 1995 through 1997
have been retroactively adjusted to reflect the adoption of SFAB No. 128,
"Earnings per Share".
January 31, 1999
(in thousands of dollars)
Hirsch International Corp. and Subsidiaries 1999 1998 1997 1996 1995
- ------------------------- ------------------------
Balance Sheet Data:
Working capital......................................................... $ 51,939 $40,169(6) $22,004 $16,847(4) $10,363(3)
Total assets............................................................ 106,935 114,832(6) 83,696 47,872(4) 37,504(3)
Long-term debt, less current maturities................................. 15,640 1,421 13,194(5) 1,779 2,696
Stockholders' equity.................................................... 70,207 75,623(6) 41,682 29,134(4) 20,636(3)
(3) In February, 1994, in connection with its Initial Public Offering (the
"IPO"), the Company received net proceeds of approximately $7,373,000 (after
deducting expenses of the IPO).
(4) In January 1996, in connection with its Secondary Offering (the "Second
Offering"), the Company received net proceeds of $1,906,000 (after deducting
expenses of the Second Offering).
(5) Included in long-term debt, less current maturities at January 31, 1997
is $11,645,000 of debt relating to the acquisitions of SMX and Sedeco.
(6) In June 1997, in connection with a Secondary Offering (the "Secondary
Offering"), the Company received net proceeds of approximately $24,300,000
(after deducting expenses of the Secondary Offering).
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. Factors that could cause or contribute to such
differences should be read in conjunction with, and is qualified in its entirety
by, the Company's Consolidated Financial Statements, including the Notes
thereto. Historical results are not necessarily indicative of trends in
operating results for any future period. As used herein, "fiscal year" and
"fiscal" refers to the applicable fiscal year ending January 31 of the
applicable calendar year.
General
Hirsch International Corp. ("Hirsch" or the "Company") 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- and
multi-head embroidery machines, proprietary application software and a diverse
line of embroidery supplies and accessories. 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
Industries Ltd. ("Tajima") and Tajima USA, Inc. ("TUI"), a subsidiary formed in
fiscal 1999, as well as a wide variety of embroidery supplies, microcomputers
manufactured by Dell Computer Corporation and software manufactured by the
Hirsch subsidiary, Pulse.
The Company's focus during the past several years has been on growth and
expansion. The acquisitions of SMX and Sedeco increased the area in which the
Company is the exclusive distributor of Tajima embroidery equipment from 26
states to 39 states. In January 1997, Tajima granted the Company the exclusive
right to distribute small (one through six-head "FX" models) 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 right to
distribute Tajima machines throughout the continental United States and Hawaii.
In fiscal 1998 Hirsch formed TUI for the purpose of assembling Tajima embroidery
machines in the United States. Production at TUI consists of models in
configurations of up to six heads per machine. In January 1998 Tokai Industries
(Tajima's manufacturing arm) purchased a 45 percent interest in TUI. This
investment reflects their continuing confidence in this endeavor and will be a
contributing factor in the long range growth of TUI.
The Company grew rapidly from the time of its initial public offering
through fiscal 1998. Growth was fueled by rapid technological advances in
software and hardware, the continued strong demand for embroidered products, the
creation of new embroidery applications and the continued strength of the
"embroidery entrepreneur" as a growing segment of the marketplace. The Company
believes that the purchasers of smaller embroidery machines are a significant
source of repeat business for the sale of multi-head embroidery machines as the
entrepreneurs' operations expand.
Fiscal 1999 was a year of retrenchment for the industry, driven by a shift
in the sales mix of embroidery machines and relocation offshore of large
multi-head equipment customers. It was further compounded by dramatic swings in
the US dollar / Yen exchange rate. All industry competitors faced difficulty in
meeting these new market demands. The Company initiated a restructuring program
to address the market shifts in the industry, including closing and
consolidating certain divisions, reducing total employment, and disposing of
facilities no longer required to support its new business model (See Note 7 of
Notes to Consolidated Financial Statements). The Company believes the
implementation of the restructuring program will position it to return to
profitable operations at revenue levels reflecting today's market realities.
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, 1999, 1998
and 1997.
1999 1998 1997
---- ---- ----
Net sales 95.8% 96.4% 97.4%
Interest income related to sale-type leases 4.2% 3.6% 2.6%
----- ----- -----
Total revenue 100.0% 100.0% 100.0%
Cost of sales 66.7% 63.0% 64.4%
Operating expenses 36.7% 26.9% 23.2%
Interest expense, net 1.2% 0.6% 0.7%
Other expense (income), net 0.2% 0.1% (0.4%)
----- ----- ------
(Loss) income before income
taxes and minority interest -4.8% 9.4% 12.1%
Income tax (benefit) provision -1.5% 4.0% 5.1%
Minority interest 0.3% 0.0% 0.0%
----- ----- -----
Net (loss) income -3.6% 5.4% 7.0%
===== ===== =====
Fiscal Year 1999 as Compared to Fiscal Year 1998
Net sales. Net sales for fiscal year 1999 were $122,198,000, a decrease of
$24,847,000, or 16.9%, compared to $147,045,000 for fiscal year 1998. The
Company believes that the reduction in the sales level for the fiscal year ended
January 31, 1999 is attributable to a softening of demand for new large
(six-head "DC" models through thirty-head models) machines. In addition, the
reduction in sales revenue during fiscal year 1999 is also attributable to lower
average machine selling prices as compared to fiscal year 1998. This reduction
in average selling price was mainly the result of the strong dollar/yen exchange
rate.
The sale of new embroidery machinery represented approximately $96,491,000,
or 79.0% and $120,560,000, or 82.0%, of net sales for the fiscal years 1999 and
1998, respectively. Small embroidery machines (one through six-head "FX" models)
and large embroidery machines (six-head "DC" models through thirty-head models)
represented approximately $49,281,000, or 51.1%, and $47,210,000, or 48.9% of
total new embroidery machine sales during fiscal year 1999 as compared to
approximately $51,376,000, or 42.6%, and $69,184,000, or 57.4%, respectively for
fiscal year 1998.
Revenue from the sale of the Company's used machines, computer hardware and
software, parts, service, application software and embroidery supplies for
fiscal year 1999 was approximately $25,707,000, as compared to $26,485,000 for
fiscal year 1998.
Interest income related to sales-type leases. HAPL's interest income
decreased 1.6% to $5,348,000 for fiscal year 1999 from $5,432,000 for the
comparable period of the prior year. This small decrease in HAPL's interest
income as compared to the decrease in new embroidery machine sales is a result
of the continued expansion of HAPL's operations. Their diversified leasing
programs have resulted in a 37.4% increase in the number of new equipment sales
which are leased to 50.7% of total new equipment sales for fiscal year 1999 from
36.9% for fiscal year 1998. This is primarily attributable to HAPL's continued
penetration into the small machine market, which represented 51.1% of new
machine sales in fiscal 1999 as compared to 42.6% of new machine sales in fiscal
1998.
Cost of sales. For fiscal year 1999, cost of sales decreased $11,045,000,
or 11.5%, to $85,054,000 from $96,099,000 for fiscal year 1998. The decrease was
a result of the related decrease in net sales for fiscal 1999 as compared to
fiscal 1998, offset by the inventory write-down of $3,450,000 recorded in fiscal
1999. The inventory write-down relates to the Company's restructuring plan and
includes the write-down of used machine and ESW inventories (See Note 7 of Notes
to Consolidated Financial Statements). The fluctuation of the dollar against the
yen has historically had a minimal effect on Tajima equipment gross margins
since currency fluctuations are generally reflected in pricing adjustments in
order to maintain consistent gross margins on machine revenues. Exclusive of the
inventory write-down recorded in fiscal 1999, there was a small decrease in the
Company's gross margin for fiscal year 1999 to 36.0% as compared to 37.0% for
fiscal year 1998. This is primarily attributable to an increase in sales of used
embroidery machines, which typically yields lower gross margins than those
obtained in the sale of new embroidery machines.
Selling, general and administrative ("SG&A") expenses. For fiscal year 1999
SG&A increased $3,326,000, or 8.1%, to $44,381,000 from $41,055,000 for fiscal
year 1998. SG&A expenses increased as a percentage of revenues to 34.8% from
26.9%. The increase in SG&A as a percentage of revenues for fiscal year 1999 as
compared to fiscal 1998 is primarily attributable to the Company's investment in
its infrastructure to support anticipated sales levels. In addition,
approximately $300,000 of SG&A expenses were incurred in fiscal 1999 in
connection with the formation of the Hometown Threads joint venture with Jacobs
Management Corporation and the Company's creation of its new Building Blocks
division. Based upon the decrease in net sales in fiscal 1999 as compared to
fiscal 1998, the Company has developed and implemented a cost reduction plan.
The purpose of the plan is to reduce costs through the consolidation of our
support and back office infrastructure and reduction of our overhead. This will
bring the Company's expenses in line with revised sales projections.
Interest expense. Interest expense for fiscal year 1999 increased $633,000,
or 67.8%, from $934,000 in fiscal year 1998 to $1,567,000 in fiscal year 1999.
This increase in interest expense is the result of increased working capital
borrowings outstanding against the Company's Revolving Credit Facility during
fiscal year 1999 as compared to fiscal year 1998.
Income tax (benefit) provision. The income tax benefit reflected an
effective benefit rate of approximately 30.5% for fiscal year 1999 as compared
to an income tax provision reflecting an effective tax rate of 42.5% for fiscal
year 1998. 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
that are not currently 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 as 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 (loss) income. The net loss for fiscal year 1999 was $4,608,000, a
decrease in income of $12,804,000, or 156.2%, as compared to net income of
$8,196,000 for fiscal year 1998. The net margin decreased to -3.6% in fiscal
year 1999 from 5.4% in fiscal year 1998. These decreases are primarily
attributable to the restructuring costs and inventory write-down recorded in
connection with the Company's restructuring plan (See Note 7 of Notes to
Consolidated Financial Statements), as well as an increase in SG&A expenses.
Fiscal Year 1998 as Compared to Fiscal Year 1997
Net sales. Net sales for fiscal year 1998 were $147,045,000, an increase of
$24,850,000, or 20.3%, compared to $122,195,000 for fiscal year 1997.
Approximately $18,850,000 of such increase was due to the sale of embroidery
machinery for fiscal year 1998. The sale of embroidery machinery represented
approximately $120,560,000 or 82.0%, and $101,710,000, or 83.2%, of net sales
for fiscal years 1998 and 1997, respectively. The Company believes that this
increase is the result of the continued strong demand for embroidered products,
the growth in unit sales of the single-head embroidery machine, the expansion
into new territories acquired through acquisitions (See Note 3 of Notes to
Consolidated Financial Statements), 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.
Revenue from the sale of the Company's computer hardware and software,
parts, service, used machines, application software and embroidery supplies for
fiscal year 1998 aggregated approximately $26,485,000, as compared to
$20,485,000 for fiscal year 1997, which represents an increase of approximately
29.3%. This increase is directly attributable to the increase in machine
revenues.
Small embroidery machines (one through six-head "FX" models) and large
embroidery machines (six-head "DC" models through thirty-head models)
represented approximately $51,376,000 and $69,184,000, respectively of total
embroidery machine sales during fiscal year 1998 as compared to approximately
$33,749,000 and $67,961,000 for fiscal year 1997, respectively.
Interest income related to sales-type leases. HAPL's interest income
increased 67.5% to $5,432,000 for fiscal year 1998 from $3,243,000 for the
comparable period of the prior year. This increase is a result of the continued
expansion of HAPL's operations and HAPL's consummation of a limited liability
recourse agreement with a third party funding source. This limited liability
recourse agreement provides HAPL with more favorable terms than the non-recourse
agreements.
Cost of sales. For fiscal year 1998, cost of sales increased $15,279,000,
or 18.9%, to $96,099,000 from $80,820,000 for fiscal year 1997. The increase was
in direct proportion to the Company's increased sales volume. The fluctuation of
the dollar against the yen has a minimal effect on Tajima equipment gross
margins since currency fluctuations are generally reflected in pricing
adjustments in order to maintain consistent gross margins on machine revenues.
The increase in Company's gross margin for fiscal 1998 as compared to fiscal
1997 is attributable to increases in sales of the Company's value added
products. Gross margins for the Company's value-added products (i.e., ESW,
Pulse, and HAPL) are generally higher than gross margins on the sale of
embroidery machinery. For fiscal year 1998, the revenue contribution of the
Company's value-added products was approximately 12.5% of total revenue, an
increase of 45.4% as compared to 8.56% for fiscal 1997.
Selling, general and administrative ("SG&A") expenses. For fiscal year 1998
SG&A increased $11,985,000, or 41.2%, to $41,055,000 from $29,070,000 for fiscal
year 1997. SG&A expenses increased as a percentage of revenues to 26.9% from
23.2%. This increase in SG&A as a percentage of revenues is attributable to the
Company's investment in its infrastructure to support expanding operations as
well as start-up costs incurred in connection with the commencement of the
assembly operation at TUI.
Interest expense. Interest expense for fiscal year 1998 increased $102,000,
or 12.3%, from $832,000 in fiscal year 1997 to $934,000 in fiscal year 1998.
This increase is directly attributable to the increased interest costs related
to the additional debt assumed for the SMX, Sedeco and ECI acquisitions.
Income tax provision. The income tax provision reflected an effective tax
rate of approximately 42.5% for fiscal year 1998 as compared to 42.2% for fiscal
year 1997. Differences from the federal statutory rate consisted primarily of
provisions for state income taxes net of Federal tax benefit. The increase in
the tax rate for fiscal year 1998 is attributable to changes in the sales mix
which resulted in increased sales to states and other taxing jurisdictions with
higher effective tax rates. Additionally, 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 principle components of the deferred income tax assets resulted 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
Company has not established any valuation allowances against these deferred tax
assets as 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 1998 decreased $572,000, or 6.5%, to
$8,196,000 from $8,768,000 for fiscal year 1997. The net margin decreased to
5.4% in fiscal year 1998 from 7.0% in fiscal year 1997. These decreases are
attributable to the increase in SG&A expenses.
Liquidity and Capital Resources
Operating Activities and Cash Flows
The Company's working capital was $51,939,000 at January 31, 1999,
increasing $11,770,000, or 29.3%, from $40,169,000 at January 31, 1998. The
Company has financed its operations principally through long-term financing of
certain capital expenditures, the proceeds from Secondary Offerings completed in
June 1997 (See Note 1 of Notes to Consolidated Financial Statements) and working
capital borrowings under its Revolving Line of Credit Agreement. The acquisition
of ECI was financed through borrowings against the Company's Revolving Credit
Facility (See Note 3 of Notes to Consolidated Financial Statements) although
this borrowing was repaid in June 1997 with the proceeds of the June 1997
Secondary Offering.
During fiscal year 1999, the Company's cash and cash equivalents increased
by $122,000 to $3,078,000. Net cash of $11,996,000 was used in the Company's
operating activities. Cash provided by decreases in the balance of accounts
receivable, net investment in sales-type leases and other assets aggregating
approximately $11,425,000 was offset by cash used to increase inventory and
prepaid taxes aggregating approximately $5,253,000 and a decrease in trade
acceptances payable, accounts payable and accrued expenses and income taxes
payable aggregating approximately $17,232,000.
Cash generated from operations was partially used for the purchase of
approximately 90,000 shares of the Company's stock in the open market during
fiscal year 1999, at an average cost of approximately $9.20 per share.
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 11b of Notes to Consolidated
Financial Statements).
Revolving Credit Facility and Borrowings
In February 1999 the Company amended its existing Revolving Credit Facility
(the "Facility") to, among other things, reduce the total commitment from
$60,000,000 to $40,000,000 for Hirsch and from $10,000,000 to $6,500,000 for
HAPL and to provide a security interest in substantially all of the assets of
the Company and its subsidiaries. The Facility is used 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 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 therein. This Facility has also been used for letters of credit and
deferred payment letters of credit aggregating approximately $2,164,000 at
January 31, 1999. During fiscal year 1999 the Company borrowed $26,000,000 as
working capital loans against the Facility, of which $14,500,000 was outstanding
at January 31, 1999. The Company was in default of certain financial covenants
at year end and has received waivers from the banks.
HAPL sells most of its leases to financial institutions on either a
non-recourse basis or a limited-liability basis within 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 approximately
$192,180,000 in lease agreements through January 31, 1999. As of January 31,
1999, approximately $174,777,000, or 90.9%, of the leases written have been sold
to third-party financial institutions.
On January 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% and is payable in equal monthly
principal installments of $19,125. The obligation under the Mortgage is secured
by a lien on the premises and the related improvements thereon. The Company was
in default of the Mortgage financial covenant at year end and has received a
waiver from the bank. In connection with the waiver, the bank Mortgage was
amended to provide for, among other things, an increase in the annual interest
rate to 9.3% effective April 30, 1999.
Future Capital Requirements
The Company believes that its existing cash and funds generated from
operations, together with its existing revolving credit facility, will be
sufficient to meet its working capital and capital expenditure requirements and
to finance planned growth.
Year 2000 Compliance
The Year 2000 issue exists because many computer systems and applications
use two-digit date fields to designate a year. As the century date change
occurs, date sensitive systems may not be able to recognize the year 2000 or may
do so incorrectly as the year 1900. This inability to recognize or properly
interpret the year 2000 may result in the incorrect processing of financial and
operational information.
The Company has established a steering committee to address Year 2000
issues, including senior members of the management team, which will report
regularly to the Board of Directors. The committee has initiated a program to
upgrade its internal information systems to address any Year 2000 compliance
issues. This program includes a focus on internal policies, methods and tools,
as well as inquiries of and coordination with customers and suppliers.
The Company expects its Year 2000 program to be completed on a timely
basis, and is currently implementing new computer systems that will
substantially insure that the Company's operating systems are not subject to
Year 2000 transition problems. To the extent current systems that will not be
replaced have been determined to be non-compliant, the Company is working with
the suppliers of such systems to obtain upgrades and/or enhancements to insure
Year 2000 compliance.
The Company has made a thorough review of its proprietary software products
and believes that its current products are Year 2000 compliant. Many of the
Company's customers may be, however, using earlier versions of the Company's
software products, which may not be Year 2000 compliant. The Company has
initiated programs to proactively notify such customers of the risks associated
with using these products and to actively encourage such customers to migrate to
the Company's current software products.
Based upon the Company's current estimates, incremental out-of-pocket costs
of its Year 2000 program will aggregate approximately $300,000. These costs are
expected to be incurred primarily in fiscal year 2000 and consist mainly of
remediation of and/or upgrades to existing computer hardware and software and
telecommunication systems. Such costs do not include internal management time
and the deferral of other projects, the effects of which are not expected to be
material to the Company's results of operations or financial condition.
The Company's total Year 2000 project costs include the estimated costs and
time associated with the impact of third party Year 2000 issues based on
presently available information. The Company has initiated a vendor compliance
program and has inquired with its key vendors as to the status of such vendors'
Year 2000 compliance. Based on the responses to date, the Company believes that
its key vendors either currently are Year 2000 compliant, or will complete their
Year 2000 programs on a timely basis. However, there can be no guarantee that
such vendors upon which the Company relies will be able to timely address their
Year 2000 compliance issues. A reasonable worst case Year 2000 scenario would be
the failure of key vendors and/or suppliers to have corrected their own Year
2000 issues which could cause disruption of the Company's operations, the
effects of which may have an adverse impact on the Company's results of
operations. The impact of such disruption cannot be estimated at this time. In
the event the Company believes that any of its key suppliers are unlikely to be
able to resolve their Year 2000 issues, it will obtain an alternative source of
supply.
Backlog and Inventory
The ability of the Company to fill orders quickly is an important part of
its customer service strategy. The embroidery machines held in inventory by the
Company are generally shipped within a week from the date the customer's orders
are received, and as a result, backlog is not meaningful as an indicator of
future sales.
Inflation
The Company does not believe that inflation has had, or will have in the
foreseeable future, a material impact upon the Company's operating results.
Recent Pronouncements of the Financial Accounting Standards Board
In fiscal 1999, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), Statement of
Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" ("SFAS 131") and Statement of Financial
Accounting Standards No. 132, "Employers' Disclosure about Pensions and Other
Post-Retirement Benefits - an amendment to FASB Statement No. 87, 88 and 106"
("SFAS 132"). Each of these statements required additional disclosure in the
Company's consolidated financial statements but did not have a material effect
on the Company's consolidated financial position or results of operations.
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 No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for fiscal quarters
of all fiscal years beginning after June 15, 1999. Based upon current data the
adoption of this pronouncement is not expected to have a material impact on the
Company's consolidated financial statements.
Market Risk Sensitivity
The Company is exposed to various market risks, including changes in
foreign currency exchange rates and interest rates. Market risk is the potential
loss arising from adverse changes in market rates and prices, such as foreign
currency exchange and interest rates. The Company has a formal policy that
prohibits the use of currency derivatives or other financial instruments for
trading or speculative purposes. The policy permits the use of financial
instruments to manage and reduce the impact of changes in foreign currency
exchange rates that may arise in the normal course of the Company's business.
Currently, the Company does not use interest rate derivatives.
The Company enters into forward foreign exchange contracts principally to
hedge the currency fluctuations in transactions denominated in foreign
currencies, thereby limiting the Company's risk that would otherwise result from
changes in exchange rates. During fiscal 1999, the principal transactions hedged
were purchases of machinery from the Company's major supplier. The periods of
the forward foreign exchange contracts correspond to the periods of the hedged
transactions. The cost of such contracts is included in the cost of the related
machinery in inventory. A 5% strengthening or weakening of the U.S. dollar
against purchases denominated in foreign currencies could have had approximately
a $3,031,000 million impact on the net pre-tax operations of the Company. The
Company does not use foreign exchange contracts to hedge expected earnings.
All of the Company debt is U.S. dollar denominated. At year-end,
approximately 91.2% of this indebtedness to third parties was floating
rate-based. Although the Company has exposure to rising and falling rates, a 1%
rise in rates on the average outstanding floating rate-based borrowings during
the fiscal year would have had approximately a $127,000 adverse impact on net
pre-tax operations. The Company does not use interest rate derivatives to
protect its exposure to interest rate market movements.
ITEM 8. FINANCIAL STATEMENTS IN SUPPLEMENTARY DATA
The information contained in pages F-1 through F-25 hereof.
ITEM 9. CHANGES IN A DISAGREEMENT WITH ACCOUNTANT ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART IV
ITEM 14. 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 Auditors' Report.............................................F-2
Consolidated Balance Sheets..............................................F-3
Consolidated Statements of Income .......................................F-5
Consolidated Statements of Stockholders' Equity..........................F-6
Consolidated Statements of Cash Flows....................................F-7
Notes to Consolidated Financial Statements........................F-8 - F-25
(a)(2) FINANCIAL STATEMENT SCHEDULE.....................................S-1
(a)(3) EXHIBITS
%3.1 Restated Certificate of Incorporation of the Registrant
^3.2 Amended and Restated By-Laws of the Registrant
*4.1 Specimen of Class A Common Stock Certificate
*4.2 Specimen of Class B Common Stock Certificate
^10.1 $60,000,000 Revolving Credit Facility and $10,000,000 Credit Facility
Dated as of September 26, 1997 among Hirsch International Corp., HAPL Leasing
Co., Inc., Sewing Machine Exchange, Inc., Pulse Microsystems, Ltd., Sedeco,
Inc., The Bank of New York, Mellon Bank, N.A., Fleet Bank, N.A., and The Bank of
New York, as agent.
10.2 Second Amendment to Loan Agreement among Hirsch International Corp.,
HAPL Leasing Co., Inc., Sewing Machine Exchange, Inc., Pulse Microsystems Ltd.,
Sedeco, Inc., Hirsch Equipment Connection, Inc., The Bank of New York, Fleet
Bank, N.A., Mellon Bank N.A., and The Bank of New York, as agent.
10.3 Waiver Agreement among Hirsch International Corp., HAPL Leasing Co.,
Inc., Sewing Machine Exchange, Inc., Pulse Microsystems Ltd., Sedeco, Inc.,
Hirsch Equipment Connection, Inc., The Bank of New York, Fleet Bank, N.A.,
Mellon Bank N.A., and The Bank of New York, as agent.
**10.4 $2,295,000 Mortgage Note from Hirsch International Corp. to Chemical
Bank
**10.5 Mortgage between Hirsch International Corp. and Chemical Bank
**10.6 Guaranty of Payment of HAPL Leasing Co, Inc. and Pulse Microsystems
Ltd. to Chemical Bank
10.7 Waiver and First Amendment to Mortgage between Hirsch International
Corp. and The Chase Manhattan Bank, dated as of April 30, 1999.
10.8 Agreement of Modification of Note between Hirsch International Corp.
and The Chase Manhattan Bank dated as of April 30, 1999.
10.9 Joinder by Guarantors among HAPL Leasing Co., Inc., Pulse
Microsystems, Ltd. and The Chase Manhattan Bank.
****10.10 Stock Purchase Agreement, dated June 7, 1996 by and among Hirsch
International Corp. and Ronald H. Krasnitz and Martin Krasnitz
*****10.11 Stock Purchase Agreement, Dated December 20, 1996 by and between
Hirsch International Corp. and Jimmy L. Yates.
*10.12 Employment Agreement between Henry Arnberg and the Registrant
*10.13 Employment Agreement between Paul Levine and the Registrant
*10.14 Employment Agreement between Tas Tsnosis and Pulse Microsystems,
Ltd.
*10.15 Employment Agreement between Brian Goldberg and Pulse Microsystems,
Ltd.
***10.16 Employment Agreement between Ronald H. Krasnitz and Sewing Machine
Exchange, Inc.
***10.17 Employment Agreement between Martin Krasnitz and Sewing Machine
Exchange, Inc.
@10.18 Employment Agreement between Jimmy L. Yates and Sedeco, Inc.
+10.19 Amendment to Employment Agreement between Tas Tsonis and Pulse
Microsystems, Ltd.
+10.20 Amendment to Employment Agreement between Brian Goldberg and Pulse
Microsystems, Ltd.
*10.21 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")
@10.22 Amendment Number Two to Hirsch Distributorship Agreement, Dated June
7, 1996
@10.23 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.
@10.24 West Coast Distributorship Agreement, Dated February 21, 1997, among
Tajima Industries, Ltd., Nomura Trading Co. Ltd. and Nomura (America) Corp., and
Hirsch International Corp.
%10.25 Stock Option Plan, as Amended
#10.26 1994 Non-Employee Director Stock Option Plan
@10.27 Registration Rights Agreement, Dated December 20, 1996, between
Hirsch International Corp. and Jimmy L. Yates
@10.28 Non-Qualified Stock Option Agreement between Hirsch International
Corp. and Jimmy L. Yates, Dated December 6, 1996
@10.29 Non-Qualified Stock Option Agreement between Hirsch International
Corp. and Ronald H. Krasnitz, Dated June 7, 1996
@10.30 Non-Qualified Stock Option Agreement between Hirsch International
Corp. and Martin Krasnitz, Dated June 7, 1996
+10.31 Agreement dated as of December 20, 1997 between the Registrant and
Tokai Industrial Sewing Machine Company, Ltd. for sale of a forty (40%) per cent
interest in Tajima USA, Inc. 21.1 List of Subsidiaries of the Registrant
21.1 List of Subsidiaries of Registrant
23.1 Consent of Auditors
27.1 Financial Data Schedule
%Incorporated by reference from the Registrant's Form 10-Q filed for the
quarter ended July 31, 1997.
^Incorporated by reference from the Registrant's Form 10-Q filed for the
quarter ended October, 31, 1997.
*Incorporated by reference from the Registrant's Registration Statement on
Forms S-1, Registration Number 33-72618.
**Incorporated by reference from the Registrant's From 10-K filed for the
fiscal year ended January 21, 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 From 8-K filed with the
Commission on January 3, 1997.
@Incorporated by reference from the Registrant's Form 10-K filed for the
year ended January 31, 1997.
+ Incorporated by reference from Registrant's Form 10-K filed for the
fiscal year ended January 31, 1998.
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.
Registrant
By: /s/Henry Arnberg
----------------------------------
Henry Arnberg, Chief Executive Officer
Dated: May 17, 1999
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 and Chief May 17, 1999
- --------------------------- Executive Officer (Principal Executive Officer)
Henry Arnberg
/s/Paul Levine President and Director May 17, 1999
- ------------------------------
Paul Levine
/s/ Tas Tsonis Vice President and Director May 17, 1999
- ------------------------------
Tas Tsonis
/s/ Richard M. Richer Vice President-Finance and Chief Financial Officer May 17, 1999
- ------------------------------ (Principal Accounting and Financial Officer)
Richard M. Richer
/s/ Ronald Krasnitz Chief Operating Officer, Secretary and May 17, 1999
- ------------------------------ Director
Ronald Krasnitz
/s/ Marvin Broitman Director May 17, 1999
- ------------------------------
Marvin Broitman
s/s Herbert M. Gardner Director May 17, 1999
- ------------------------------
Herbert M. Gardner
/s/Douglas Schenendorf Director May 17, 1999
- ------------------------------
Douglas Schenendorf
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
TABLE OF CONTENTS
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Page
INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED JANUARY 31, 1999,
1998 AND 1997:
Consolidated Balance Sheets 2-3
Consolidated Statements of Operations 4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7-24
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, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended January 31, 1999. 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, 1999 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended January 31, 1999 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
Jericho, New York
April 22, 1999
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JANUARY 31, 1999 AND 1998
- -----------------------------------------------------------------------------
ASSETS 1999 1998
CURRENT ASSETS:
Cash and cash equivalents $ 3,078,000 $ 2,956,000
Accounts receivable, net of an allowance for
doubtful accounts of approximately $4,033,000
and $3,160,000, respectively 22,956,000 34,427,000
Net investment in sales-type leases -
current portion (Note 5) 2,254,000 2,180,000
Inventories, net (Notes 4 and 11) 36,335,000 34,166,000
Prepaid income taxes (Note 9) 1,786,000 -
Other current assets (Note 9) 5,284,000 3,284,000
--------- -----------
Total current assets 71,693,000 77,013,000
NET INVESTMENT IN SALES-TYPE LEASES - Noncurrent
portion (Note 5) 11,256,000 12,055,000
EXCESS OF COST OVER NET ASSETS ACQUIRED - Net of accumulated amortization
of approximately $2,686,000 and $1,581,000, respectively (Notes 3 and 7) 14,139,000 15,979,000
PURCHASED TECHNOLOGIES - Net of accumulated
amortization of approximately $940,000 and $749,000,
respectively 399,000 590,000
PROPERTY, PLANT AND EQUIPMENT - Net of accumulated
depreciation and amortization (Notes 6 and 8) 7,602,000 7,193,000
OTHER ASSETS (Note 9) 1,846,000 2,002,000
--------- -----------
TOTAL ASSETS $ 106,935,000 $ 114,832,000
=========== ===========
See notes to consolidated financial statements.
(Continued)
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JANUARY 31, 1999 AND 1998
- ------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998
CURRENT LIABILITIES:
Trade acceptances payable (Note 11) $2,164,000 $ 15,286,000
Accounts payable and accrued expenses (Note 7) 17,338,000 20,592,000
Current maturities of long-term debt (Note 8) 252,000 231,000
Income taxes payable (Note 9) - 735,000
---------- -----------
Total current liabilities 19,754,000 36,844,000
LONG-TERM DEBT - Less current maturities (Note 8) 15,640,000 1,421,000
---------- -----------
Total liabilities 35,394,000 38,265,000
MINORITY INTEREST (Note 1) 1,334,000 944,000
----------- ----------
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,
6,815,000 and 6,811,000 shares, respectively 68,000 68,000
Class B common stock, $.01 par value;
authorized: 3,000,000 shares, outstanding:
2,668,000 shares 27,000 27,000
Additional paid-in capital 41,397,000 41,377,000
Retained earnings 29,543,000 34,151,000
------------ ----------
71,035,000 75,623,000
Less: Treasury stock at cost, 90,300 shares 828,000 -
------------ ----------
Total stockholders' equity 70,207,000 75,623,000
------------ ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 106,935,000 $ 114,832,000
============ ============
See notes to consolidated financial statements.
(Concluded)
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE YEARS ENDED JANUARY 31, 1999, 1998 AND 1997
- -----------------------------------------------------------------------------
1999 1998 1997
REVENUES:
Net sales $122,198,000 $147,045,000 $122,195,000
Interest income related to sales-type leases 5,348,000 5,432,000 3,243,000
----------- ----------- -----------
Total revenue 127,546,000 152,477,000 125,438,000
----------- ----------- -----------
COST OF SALES:
Cost of sales 81,604,000 96,099,000 80,820,000
Inventory write-down (Notes 4 and 7) 3,450,000 - -
----------- ----------- ----------
Total cost of sales 85,054,000 96,099,000 80,820,000
----------- ----------- ----------
GROSS PROFIT 42,492,000 56,378,000 44,618,000
----------- ----------- ----------
OPERATING EXPENSES:
Selling, general and administrative expenses 44,381,000 41,055,000 29,070,000
Restructuring costs (Note 7) 2,377,000 - -
----------- ----------- ----------
Total operating expenses 46,758,000 41,055,000 29,070,000
----------- ----------- ----------
OPERATING (LOSS) INCOME (4,266,000) 15,323,000 15,548,000
----------- ----------- ----------
OTHER EXPENSE (INCOME)
Interest expense (Note 8) 1,567,000 934,000 832,000
Other 233,000 90,000 (454,000)
----------- ---------- ---------
Total other expense 1,800,000 1,024,000 378,000
----------- ---------- ---------
(LOSS) INCOME BEFORE INCOME TAX
(BENEFIT) PROVISION AND MINORITY
INTEREST IN NET EARNINGS OF
CONSOLIDATED SUBSIDIARY (6,066,000) 14,299,000 15,170,000
INCOME TAX (BENEFIT) PROVISION (Note 9) (1,848,000) 6,059,000 6,402,000
MINORITY INTEREST IN NET EARNINGS
OF CONSOLIDATED SUBSIDIARY (Note 1) 390,000 44,000 -
---------- ---------- ----------
NET (LOSS) INCOME $ (4,608,000) $ 8,196,000 $ 8,768,000
========== ========== ==========
(LOSS) EARNINGS PER SHARE:
Basic $ (0.49) 0.92 1.13
========== ========== ==========
Diluted $ (0.49) $ 0.89 $ 1.10
========== ========== ==========
WEIGHTED AVERAGE NUMBER OF SHARES
IN THE CALCULATION OF (LOSS)
EARNINGS PER SHARE (Note 12)
Basic 9,413,000 8,953,000 7,782,000
=========== ========== ==========
Diluted 9,436,000 9,236,000 7,967,000
=========== ========== ==========
See notes to consolidated financial statements.
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED JANUARY 31, 1999, 1998 AND 1997
- ------------------------------------------------------------------------------
Accumulated other
Comprehensive
Class A Class B Income
Common Stock Common Stock ------------
(Note 10) (Note 10) Additional Unrealized
---------------- ----------------- Paid-In Holdings Retained Treasury
Shares Amount Shares Amount Capital (Loss)Gain Earnings Stock Total
BALANCE, FEBRUARY 1, 1996 3,288,000 $33,000 2,869,000 $28,000 $11,886,000 $(715,000)$17,202,000 $ - $ 29,134,000
Issuance of shares in connection
with acquisitions (Note 3) 143,000 2,000 - - 2,636,000 - - - 2,638,000
Transfer of Class B stock to
Class A stockholder 137,000 1,000 (137,000) (1,000) - - - - -
Stock dividend (25%) (Note 10d) 1,542,000 15,000 - - - - (15,000) - -
Exercise of stock options and warrants 203,000 2,000 - - 1,104,000 - - - 1,106,000
Comprehensive income:
Unrealized holding gain (Note 2o) - - - - - 36,000 - - -
Net income - - - - - - 8,768,000 - -
Total comprehensive income: 8,804,000
-------- ------ ------- ------- -------- ------- ------- ------ ---------
BALANCE, JANUARY 31, 1997 5,313,000 53,000 2,732,000 27,000 15,626,000 21,000 25,955,000 - 41,682,000
Proceeds from public offering
of common stock, net (Note 1) 1,333,000 13,000 - - 24,289,000 - - - 24,302,000
Issuance of shares in connection
with acquisitions (Note 3) 20,000 - - - 392,000 - - - 392,000
Issuance of Class A stock 49,000 1,000 - - 819,000 - - - 820,000
Transfer of Class B stock to
Class A stockholder 64,000 - (64,000) - - - - - -
Exercise of stock options and warrants 32,000 1,000 - - 251,000 - - - 252,000
Comprehensive income:
Unrealized holding loss (Note 2o) - - - - - (21,000) - - -
Net income - - - - - - 8,196,000 - -
Total comprehensive income: 8,175,000
-------- ------ ------- ------- -------- ------- ------- ------ ---------
BALANCE, JANUARY 31, 1998 6,811,000 68,000 2,668,000 27,000 41,377,000 - 34,151,000 - 75,623,000
Exercise of stock options 4,000 - - - 20,000 - - - 20,000
Purchase of treasury shares (Note 10e) - - - - - - - (828,000) (828,000)
Comprehensive income:
Net loss - - - - - - (4,608,000) - -
Total comprehensive income: (4,608,000)
-------- ------- ---------- ------- ----------- ------- ---------- -------- ----------
BALANCE, JANUARY 31, 1999 6,815,000 $68,000 2,668,000 $27,000 $41,397,000 $ - $29,543,000 $(828,000)$70,207,000
========= ======= ========== ======= =========== ===== ============ ======== ===========
See notes to consolidated financial statements.
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED JANUARY 31, 1999, 1998 AND 1997
- ------------------------------------------------------------------------------
1999 1998 1997
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (4,608,000) $ 8,196,000 $ 8,768,000
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization 3,754,000 3,214,000 1,763,000
Provisions for reserves 1,643,000 807,000 663,000
Deferred income taxes (2,826,000) (621,000) (193,000)
Gain on disposal of assets - (42,000) 18,000
Minority interest 390,000 44,000 -
Write-off of goodwill 711,000 - -
Changes in assets and liabilities:
Accounts receivable 10,598,000 (14,382,000) (5,012,000)
Net investments in sales-type leases 213,000 (3,591,000) (2,287,000)
Inventories (3,467,000) (18,749,000) (2,778,000)
Other current assets and other assets 614,000 (1,251,000) (808,000)
Trade acceptances payable (13,122,000) 1,954,000 4,676,000
Accounts payable and accrued expenses (3,375,000) 8,254,000 (1,797,000)
Prepaid income taxes and income taxes payable (2,521,000) (807,000) 409,000
----------- ----------- ---------
Net cash (used in) provided by
operating activities (11,996,000) (16,974,000) 3,422,000
----------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,314,000) (2,096,000) (1,447,000)
Acquisition of Sewing Machine Exchange, Inc. - - (4,973,000)
Acquisition of Sedeco, Inc. - - (4,153,000)
Acquisition of Equipment Connection, Inc. - (553,000) -
Sales (purchases) of short-term investments - 2,570,000 (392,000)
---------- ---------- ----------
Net cash used in
investing activities (1,314,000) (79,000) (10,965,000)
--------------- ----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds of bank financing 26,021,000 17,260,000 11,946,000
Repayments of long-term debt (11,781,000) (31,390,000) (4,209,000)
Proceeds from public offering 24,302,000 -
Proceeds from issuance of stock and
exercise of stock options and warrants 20,000 1,072,000 1,106,000
Purchase of treasury shares (828,000) - -
Contributions from minority interest - 900,000 -
--------------- ---------- ---------
Net cash provided by financing
activities 13,432,000 12,144,000 8,843,000
--------------- ---------- ---------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 122,000 (4,909,000) 1,300,000
CASH AND CASH EQUIVALENTS, BEGINNING
OF PERIOD 2,956,000 7,865,000 6,565,000
-------------- ---------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,078,000 $ 2,956,000 $ 7,865,000
============== ========== =========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Interest paid $ 1,483,000 $ 966,000 $ 796,000
================ ========== =========
Income taxes paid $ 3,537,000 $ 7,621,000 $ 5,788,000
================ =========== =========
See notes to consolidated financial statements.
HIRSCH INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JANUARY 31, 1999, 1998 AND 1997
- -----------------------------------------------------------------------------
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"), Sedeco, Inc. ("Sedeco"), Hirsch Equipment Connection, Inc. ("HECI"),
and Tajima USA, Inc. ("TUI") (collectively, the "Company"). The operations of
SMX, Sedeco, and HECI are included in consolidated operations since their
acquisitions on June 7, 1996, December 20, 1996, and March 26, 1997,
respectively (Note 3). The operations of TUI have been included in consolidated
operations since inception in June 1997.
On January 6, 1998, Tokai Industrial Sewing Machine Company ("Tokai")
purchased a 45 percent interest in TUI for $900,000. For financial purposes, the
assets, liabilities and earnings of TUI are consolidated in the Company's
financial statements. Tokai's 45 percent interest in TUI has been reported as
minority interest in the Company's Consolidated Balance Sheet and the earnings
have been reported as minority interest in the Company's Consolidated Statements
of Operations.
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 embroiders, 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.
On June 6, 1997, the Company consummated a secondary public offering of
Class A common stock (the "Secondary Offering"). The Company sold 1,210,528
shares at $20.00 per share. Another 750,022 shares were sold by certain
stockholders of the Company ("Selling Stockholders'). On July 7, 1997, the
underwriters exercised their over-allowance option to purchase an additional
294,082 shares of Class A common stock, 122,592 shares of which were sold by the
Company and 171,490 shares sold by the selling stockholders. Net proceeds of
approximately $24,300,000 were received by the Company after expenses and
underwriting discount.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Principles of Consolidation - The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries, and since
January 1998, the majority interest in the operations of TUI. All intercompany
balances and transactions have been eliminated in consolidation.
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 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. The operating method of
accounting for leases is 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 - Cash equivalents consist of money market accounts
with initial maturities of three months or less.
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 evidence that the product is not salable or the
market value is less than cost (see Note 4).
f. Foreign Operations - The functional currency of the Company's foreign
subsidiary is the U.S. dollar. Assets and liabilities of the foreign subsidiary
are translated at year-end exchange rates and the 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 by 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.
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. Such costs are included in other assets on the accompanying
consolidated balance sheets. Amortization expense for the years ended January
31, 1999, 1998 and 1997 was approximately $205,000, $205,000 and $84,000,
respectively.
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.
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. Purchased Technologies - Purchased technologies represent the cost in
excess of the fair value of the assets of Pulse at the date of acquisition.
Purchased technologies are being amortized over a period of seven years using
the straight-line method.
l. 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 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.
m. Earnings Per Share - The Company has adopted Financial Accounting
Standards No. 128 "Earnings per Share" ("SFAS No. 128"), which requires dual
presentation of basic and diluted earnings per share on the face of the income
statement.
Basic earnings per share are based on the weighted average number of shares
of common stock outstanding during the period. Diluted earnings per share are
based on the weighted average number of shares of common stock and common stock
equivalents (options and warrants) outstanding during the period, computed in
accordance with the treasury stock method.
n. 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").
o. Comprehensive Income - In fiscal 1999, the Company adopted Statement of
Financial Accounting Standards No. 130. "Reporting Comprehensive Income" ("SFAS
130"). This statement established rules for reporting comprehensive income and
its components. Comprehensive income consists of net income and unrealized
holding gains and losses on short term investments available for sale and is
presented in the consolidated statements of stockholders equity. Prior year
financial statements have been reclassified to conform to the SFAS 130
requirements.
p. 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.
q. Fair Value of Financial Instruments - Financial instruments consist
primarily of investments in cash, cash equivalents, trade account receivables,
accounts payable and debt obligations. At January 31, 1999 and 1998, the fair
value of the Company's financial instruments approximated the carrying value
(Note 2c).
r. Reclassifications - Certain prior year amounts have been reclassified to
conform with current year presentations.
3. ACQUISITIONS
a. Acquisition of Equipment Connection - On March 26, 1997, the Company
acquired all of the assets of Equipment Connection, Inc. ("ECI"). 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 purchase
price was $805,000, paid in the form of $605,000 in cash and $200,000 in the
company's Class A Common Stock. Concurrent with the acquisition, the Company
entered into five-year employment contracts with ECI's two former principals.
On the basis of a pro forma consolidation of the results of operations as
if the acquisition of ECI had taken place at the beginning of fiscal 1997,
management believes that the acquisition would not have had a material effect on
the reported amounts. Such pro forma amount is not necessarily indicative of
what the actual consolidated results might have been if the acquisition had been
effective at the beginning of fiscal 1997.
In the fourth quarter of fiscal 1999, the Company commenced a restructuring
plan in connection with certain of its operations, including the closing of ECI.
In connection with the closing of ECI, the ECI goodwill was written off (Notes 4
and 7).
b. 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 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 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. Concurrent with the acquisition, the Company entered into five-year
employment contracts with SMX's former shareholders pursuant to which they
received approximately 331,000 options to purchase shares of Hirsch Class A
Common Stock (Note 10b). 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 thereof.
c. 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 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 approximately 60,000 options to
purchase shares of Hirsch Class A Common Stock (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.
4. INVENTORIES
January 31,
1999 1998
Machines $ 32,465,000 $ 29,613,000
Parts and accessories 6,383,000 6,808,000
Less: Reserve for slow-moving inventory (2,513,000) (2,255,000)
---------------- ---------------
Total $ 36,335,000 $ 34,166,000
================ ===============
In connection with the Company's restructuring (Note 7), the Company
wrote-down used machine and ESW inventories by $3,450,000 in the fourth quarter
of fiscal 1999. Such write-down is included in cost of sales on the accompanying
statements of operations.
5. NET INVESTMENT IN SALES-TYPE LEASES
January 31,
1999 1998
Total minimum lease payments receivable $ 9,944,000 $ 12,681,000
Estimated residual value of leased property (unguaranteed) 7,360,000 5,594,000
Reserve for estimated uncollectible lease payments (1,100,000) (588,000)
Less: Unearned income (2,694,000) (3,452,000)
----------- ----------
Net investment 13,510,000 14,235,000
Less: Current portion 2,254,000 2,180,000
------------ ----------
Non-current portion $ 11,256,000 $ 12,055,000
============ ===========
At January 31, 1999 future annual lease payments receivable (including
estimated residual values) under sales-type leases are as follows:
Fiscal Year
Ending
January 31,
2000 $ 3,266,000
2001 3,299,000
2002 3,300,000
2003 3,523,000
2004 3,361,000
Thereafter 555,000
---------
$ 17,304,000
==========
6. PROPERTY, PLANT AND EQUIPMENT
January 31,
1999 1998
Land and building $ 3,288,000 $ 3,288,000
Machinery and equipment 5,131,000 4,296,000
Furniture and fixtures 1,930,000 1,865,000
Rental equipment 1,195,000 -
Automobiles 338,000 450,000
Leasehold improvements 1,798,000 1,579,000
-------------- ------------
Total at cost 13,680,000 11,478,000
Less: Accumulated depreciation and amortization (6,078,000) (4,285,000)
-------------- ------------
Property, plant and equipment, net $ 7,602,000 $ 7,193,000
============= ============
7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
January 31,
1999 1998
Accounts payable $ 11,684,000 $ 14,310,000
Accrued restructuring costs 1,544,000 -
Accrued commissions payable 1,091,000 1,519,000
Accrued payroll costs 316,000 693,000
Accrued warranty and installation costs 922,000 626,000
Customer deposits payable 634,000 598,000
Other accrued expenses 1,147,000 2,846,000
--------- ---------
Total accounts payable and accrued expenses $ 17,338,000 $ 20,592,000
========== ==========
In the fourth quarter of fiscal 1999, the Company initiated a restructuring
plan in connection with certain of its operations. The plan was designed to
eliminate certain operating divisions, enhance the interface of operations to
meet the changing needs of the Company's customers and to improve its cost
structure and efficiency. The restructuring initiatives involve the closing of
the ECI operations, the consolidation of the ESW operations with existing Hirsch
operations and the closing of four decentralized sales and training offices. The
restructuring costs of $2,377,000 primarily relate to severance and related
benefits ($454,000), lease termination costs ($1,012,000), the write down of ECI
Goodwill ($711,000) and other costs ($200,000). As of January 31, 1999, payments
of $122,000 have been made for these costs. The company anticipates that
substantially all of the remaining restructuring costs will be paid in fiscal
2000.
As an additional part of the plan, which is recorded as cost of sales, the
Company wrote-down to net realizable value used machine and ESW inventories by
$3,450,000.
8. LONG-TERM DEBT
January 31,
1999 1998
Revolving Credit Facility (A) $14,500,000 $ -
Mortgage (B) 1,320,000 1,549,000
Other 72,000 103,000
---------- ---------
Total 15,892,000 1,652,000
Less: Current maturities 252,000 231,000
---------- ---------
Long-term maturities $ 15,640,000 $ 1,421,000
========== =========
(A) In February 1999 the Company amended its existing Revolving Credit
Facility (the "Facility") to, among other things, reduce the total commitment
from $60,000,000 to $40,000,000 for Hirsch and from $10,000,000 to $6,500,000
for HAPL. The Facility is used 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 certain minimum tangible net
worth, quick asset ratio and fixed charge coverage levels, as defined. In
addition to the working capital borrowings described above, this Facility has
been used for letters of credit and deferred payment letters of credit
aggregating approximately $2,164,000 at January 31, 1999. The Company was in
default of certain financial covenants at year end and has received waivers from
the banks.
(B) 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 approximately $19,000. 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. The Company was
in default of the financial covenant at year end and has received a waiver from
the bank. In connection with the waiver, the bank also amended the Mortgage such
that, effective April 30, 1999, it bears interest at 9.3 percent.
Long-term debt (including capitalized lease obligations) of the
Company at January 31, 1999 matures as follows:
Ending
January 31,
2000 $ 252,000
2001 14,748,000
2002 248,000
2003 242,000
2004 230,000
Thereafter 172,000
---------
$ 15,892,000
==========
9. INCOME TAXES
The income tax (benefit) provision for each of the periods presented herein
is as follows:
January 31,
1999 1998 1997
Current:
Federal $ 456,000 $ 4,978,000 $ 4,842,000
State and foreign 522,000 1,702,000 1,753,000
-------- --------- ---------
Total current 978,000 6,680,000 6,595,000
--------- --------- ---------
Deferred:
Federal (2,491,000) (527,000) (100,000)
State and foreign (335,000) (94,000) (93,000)
--------- --------- ---------
Total deferred (2,826,000) (621,000) (193,000)
--------- --------- ---------
Total income tax (benefit) provision $ (1,848,000) $ 6,059,000 $ 6,402,000
============= =========== ===========
The tax effects of temporary differences that give rise to deferred income
tax assets at January 31, 1999 and 1998 are as follows:
January 31, 1999 January 31, 1998
Net Net Net Net
Current Long-Term Current Long-Term
Deferred Deferred Deferred Deferred
Tax Assets Tax Assets Tax Assets Tax Assets
Accounts receivable $ 1,147,000 $ - $ 782,000 $ -
Inventories 790,000 - 703,000 -
Accrued warranty costs 264,000 - 143,000 -
Other accrued expenses 582,000 - 69,000 -
Purchased technologies and goodwill - 234,000 - 180,000
Net operating loss 1,400,000 - - -
Net investments in sales-type leases
(allowance for doubtful accounts) - 439,000 - 237,000
Capitalized software development
Costs - (40,000) - (124,000)
--------- --------- -------- ---------
$ 4,183,000 $ 633,000 $ 1,697,000 $ 293,000
========= ========= ========= =========
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 and future anticipated profitable
operations of the Company.
The Company had a net operating loss from the year ended January 31, 1999
amounting to approximately $3,800,000 which expires in 2019.
Net current and long-term deferred tax assets are included in other current
assets and other assets, respectively, 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,
1999 1998 1997
Federal statutory income tax rate (34.0)% 34.0% 34.0%
State income taxes, net of Federal benefit 5.0 7.9 8.4
Permanent differences (1.5) 0.5 (0.2)
------ ------- -----
Effective income tax rate (30.5)% 42.4 % 42.2 %
======= ======= ======
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 approximately 1,284,000 shares of Common Stock
may be granted.
The 1993 Stock Option Plan (the "1993 Plan") has 1,050,000 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. Non-qualified
options may be granted to consultants, directors (whether or not they are
employees), employees or officers of the Company.
Stock option transactions during the years ended January 31, 1999, 1998 and
1997 for the 1993 Plan are summarized below:
Shares Price Range Average Price
Options outstanding - January 31, 1996 63,000 $4.88 - $10.04 $ 6.21
Options granted 256,000 $10.20 - $17.05 $ 14.94
Options exercised (5,000) $4.88 $ 4.88
Options canceled (6,000) $14.50 $ 14.50
------- -------------- --------
Options outstanding - January 31, 1997 308,000 $4.88 - $17.05 $ 13.23
Options granted 332,000 $17.00 - $24.20 $ 17.10
Options exercised (14,000) $4.88 - $14.50 $ 11.70
Options canceled (11,000) $14.50 - $17.00 $ 15.05
------- -------------- -------
Options outstanding - January 31, 1998 615,000 $4.88 - $24.20 $ 13.74
Options exercised (2,000) $4.88 $ 4.88
Options canceled (78,000) $4.88 - $17.00 $ 15.66
------- -------------- -------
Options outstanding - January 31, 1999 535,000 $4.88 - $24.20 $ 15.53
=========== ================ ========
Options exercisable at January 31, 1999 283,000 $4.88 - $24.20 $ 14.26
=========== ================ =========
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 41,000 0.5 $ 5.60 41,000 $ 5.60
$9.12 - $10.20 15,000 1.5 $ 9.83 15,000 $ 9.83
$14.50 - $17.00 402,000 2.5 $ 16.01 201,000 $ 15.68
$18.70 67,000 2.5 $ 18.70 23,000 $ 18.70
$22.00 - $24.20 10,000 3.5 $ 23.10 3,000 $ 23.10
------- -------
535,000 283,000
======== =======
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 approximately
361,000 shares available for future grants under the 1993 Plan. Approximately
95,000 options have been canceled under this plan.
The 1994 Non-Employee Director Stock Option Plan (the "Directors Plan") has
approximately 234,000 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-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, 1999, 1998 and
1997 for the Directors Plan are summarized below:
Weighted
Shares Price Range Average Price
Options outstanding - February 1, 1996 47,000 $5.36 - $9.12 $ 6.30
Options granted 9,000 $ 15.50 15.50
------- ------------ --------
Options outstanding - January 31, 1997 56,000 $ 5.36 - $15.50 $ 7.83
Options granted 8,000 $ 22.00 $ 22.00
Options exercised (17,000) $ 5.36 $ 5.36
------- ------------- --------
Options outstanding - January 31, 1998 47,000 $ 5.36 - $22.00 $ 11.09
Options exercised (2,000) $ 5.36 $ 5.36
------- -------------- -------
Options outstanding - January 31, 1999 45,000 5.36 - $22.00 $ 11.35
============== ================ ========
Options exercisable at January 31, 1999 37,000 $ 5.36 - $22.00 $ 9.57
============== ================ ========
Options Outstanding Options Exercisable
Weighted Avg. Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (yrs) Price Exercisable Price
$5.36 16,000 0.5 $ 5.36 16,000 $ 5.36
$9.12 12,000 1.5 $ 9.12 12,000 $ 9.12
$15.50 9,000 2.5 $ 15.50 6,000 $ 15.50
$22.00 8,000 3.5 $ 22.00 3,000 $ 22.00
======== =======
45,000 37,000
======== =======
There are approximately 182,000 shares available for future grants under
the Directors Plan. No options have been cancelled under this plan.
In connection with the acquisitions of ECI, Sedeco, SMX, and Pulse,
approximately 453,000 non-plan options have been issued as follows:
Weighted
Shares Price Range Average
Price
Options outstanding - Pulse acquisition 36,000 $ 4.88 $ 4.88
-------- ------- ----
Options outstanding - January 31, 1995 and 1996 36,000 $ 4.88 $ 4.88
Options granted - SMX and Sedeco
acquisitions 391,000 $16.20 - $18.25 $ 16.52
-------- --------------- ------
Options outstanding - January 31, 1997 427,000 $4.88 - $18.25 $ 15.54
Options granted - ECI acquisition 26,000 $ 18.25 $ 18.25
-------- ---------------- ------
Options outstanding - January 31, 1998 and 1999 453,000 $4.88 - $18.25 $ 15.69
========= ================ ======
Options exercisable at January 31, 1999 239,000 $4.88 - $18.25 $ 14.82
========= ================ ======
Weighted Avg. Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (yrs) Price Exercisable Price
$4.88 36,000 0.5 $4.88 36,000 $4.88
$16.20 331,000 2.5 $16.20 166,000 $16.20
$18.25 86,000 2.6 $18.25 37,000 $18.25
------- -------
453,000 239,000
======= =======
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,
Sedeco and ECI 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. The options issued in connection with
the Pulse acquisition expired in February 1999. 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, 1998 and
1997, 2,700 and 198,300 warrants, respectively, were exercised at a price of
$5.56 per share. No warrants were exercised during 1999. Approximately 4,080
were exercisable at a price of $5.90 per share. These warrants expired in
February 1999.
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 1997. 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 1999, 1998 and 1997: expected life,
five years following vesting; stock volatility, 128.5 percent in 1999, 54
percent in 1998 and 28 percent in 1997, risk free interest rate of 5.0 percent
in 1999, 5.5 percent in 1998 and 6.0 percent in 1997 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 compensation cost for the Company's stock options had been determined
consistent with Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation to Employees" ("SFAS No. 123"), the Company's net
(loss) income and (loss) earnings per share would have been the pro forma
amounts indicated below:
Year Ended January 31,
1999 1998 1997
Net (loss) income:
As reported $ (4,608,000) $ 8,196,000 $ 8,768,000
Pro forma $ (5,757,000) $ 7,597,000 $ 8,464,000
Basic (loss) earnings per share
As reported $ (0.49) $ 0.92 $ 1.13
Pro forma $ (0.61) $ 0.85 $ 1.09
Diluted (loss) earnings per share:
As reported $ (0.49) $ 0.89 $ 1.10
Pro forma $ (0.61) $ 0.82 $ 1.07
d. Stock Dividend - On June 25, 1996, the Company declared a five-for-four
stock split effected in the form of a 25 percent stock dividend which was paid
on July 22, 1996 to stockholders of record on July 8, 1996. 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. Treasury Stock - Treasury stock is comprised of 90,300 shares of common
stock purchased in open market transactions for a total cost of $828,000
pursuant to a stock repurchase program authorized by the Board of Directors in
fiscal 1999.
f. 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 discretionary matching contribution by the Company up to a maximum
of two percent of an eligible employee's annual compensation. The Company
elected not to make a matching contribution for the fiscal year ended January
31, 1999. The Company contributed approximately $148,000 and $78,000 for the
years ended January 31, 1998 and 1997, respectively. The Company funds all
amounts when due.
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,
2000 $ 907,000
2001 584,000
2002 416,000
2003 95,000
2004 7,000
------------
$ 2,009,000
============
Rent expense was approximately $1,360,000, $1,292,000 and $617,000 for the
years ended January 31, 1999, 1998 and 1997, 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, 1999, the Company held foreign currency contracts for the
purchase of Japanese yen amounting to approximately $14,222,000.
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 had entered into five-year
employment agreements with the Company's current Chief Executive Officer and
President, which expired by their terms on February 17, 1999. The agreements
provided that each executive receive minimum annual compensation of $350,000
(adjusted annually based upon the CPI). In addition, each employment agreement
provided for an annual bonus equal to five percent of pre-tax profits of the
Company. No bonus was paid to either executive relating to the Company's fiscal
1999 financial results. Each executive is currently employed by the Company on
an at-will basis on substantially the same terms and conditions contained in
their expired employment agreements. It is anticipated that in fiscal 2000 the
Board of Directors will approve an increase in the minimum compensation to each
executive consistent with prior practice. The Company is currently in the third
year of a five-year employment agreement with the Company's Chief Operating
Officer. The agreement provides for annual compensation of $300,000. The Company
also entered into employment agreements with the former shareholders of Pulse
for an initial term of five years. Effective February 24, 1999, these employment
agreements were renewed at the election of each executive for an additional
three-year term. The agreements provide each with an annual base salary of
$300,000 (adjusted annually based upon the CPI) and an annual bonus based on
annual pre-tax profits of Pulse.
e. Dependency Upon Major Supplier - During the fiscal years ended January
31, 1999, 1998 and 1997, the Company made purchases of approximately
$68,255,000, $90,300,000 and $69,000,000, respectively, from Tajima Industries
Ltd. ("Tajima"), the manufacturer of the embroidery machines the Company sells.
This amounted to approximately 84, 80 and 83 percent of the Company's total
purchases for the years ended January 31, 1999, 1998 and 1997, 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 and has a term of 20 years. The East Coast /
Midwest Agreement is terminable by Tajima and/or the Company on not less than
two years' prior notice. 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 quantity of embroidery machines to be sold for 1998 was met.
The minimum quantity to be sold in 1999 is approximately 1,800 machines in
various designations, as defined.
There are several manufacturers of 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.
12. RECONCILIATION OF BASIC EARNINGS PER SHARE
In accordance with SFAS No. 128, basic earnings per common share are
computed based on the weighted-average number of common shares outstanding
during each period. Diluted earnings per common share are computed based on the
weighted-average number of common shares, after giving effect to diluted common
stock equivalents outstanding during each period. The following table provides a
reconciliation between basic and diluted earnings per share:
For the Year Ended January 31,
1999 1998 1997
---------------------------------- ------------------------------- --------------------------------
Loss Shares Per Share Income Shares Per Share Income Shares Per Share
(In Thousands, Except Per Share Amounts)
Basic EPS:
Income
available to
common
stockholders $(4,608) 9,413 $ (0.49) $ 8,196 8,953 $ 0.92 $ 8,768 7,782 $ 1.13
Effect of
dilutive
securities:
options/
warrants - 23 - - 283 (0.03) - 185 (0.03)
-------- ------- -------- -------- ------ ------- -------- ----- ------
Diluted EPS:
Income
available to
common
stockholders
plus assumed
exercises $(4,608) 9,436 $ (0.49) $ 8,196 9,236 $ 0.89 $ 8,768 7,967 $ 1.10
======== ======= ======= ======= ======= ====== ======= ===== ======
13. INDUSTRY SEGMENTS
In 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which
established standards for the way in which public business enterprises report
information about operating segments in annual financial statements.
The Company operates in two reportable segments; embroidery equipment and
leasing. The Embroidery segment consists principally of the sale of new used
embroidery equipment and value added products such as parts, accessories and
software. The Leasing segment provides leasing services to customers of the
Company.
Summarized financial information concerning the Company's reportable
segments is shown in the following table. The accounting policies of the
segments are the same as those described in the summary of significant
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The "Corporate" Column includes
corporate related items not allocated to reportable segments and the elimination
of intercompany transactions. Identifiable assets are those tangible and
intangible assets used in operations in each reportable segment. Corporate
assets are principally the Company's land and building and the excess of cost
over fair value of net assets acquired.
Embroidery Leasing Corporate Consolidated
Year Ended January 31, 1999
- --------------------------- ------------ ------------ ------------ -------------
Sales to unaffiliated customers $ 118,889,000 $ 8,657,000 $ - $ 127,546,000
Transfers between segments 37,478,000 - (37,478,000) -
------------ ------------ ------------ -----------
Total revenues $ 156,367,000 $ 8,657,000 $(37,478,000) $ 127,546,000
============ ============ ============ ===========
Interest expense $ 1,550,000 $ 17,000 - $ 1,567,000
============ ============ ============ ===========
Depreciation and amortization expense $ 1,910,000 $ 332,000 $ 1,512,000 $ 3,754,000
============ ============ ============ ===========
(Loss) income before income tax
(benefit) provision $ (6,951,000) $ 1,381,000 $ (496,000) $ (6,066,000)
============ ============ ============ ===========
Income tax (benefit) provision $ (2,400,000) $ 552,000 $ - $ (1,848,000)
============ ============ ============ ===========
Identifiable assets $ 71,862,000 $17,667,000 $ 17,406,000 $106,935,000
============ ============ ============ ===========
Year Ended January 31, 1998
- ---------------------------
Sales to unaffiliated customers $ 144,557,000 $ 7,920,000 $ - $152,477,000
Transfers between segments 22,386,000 - (22,386,000) -
------------ ----------- ----------- ----------
Total revenues $ 166,943,000 $ 7,920,000 $ (22,386,000) $152,477,000
============ =========== ============ ===========
Interest expense $ 930,000 $ 4,000 $ - $ 934,000
============ =========== ============ ===========
Depreciation and amortization expense $ 1,736,000 $ 24,000 $ 1,454,000 $ 3,214,000
============ =========== ============ ===========
Income before income tax provision $ 11,136,000 $ 3,640,000 $ (477,000) $ 14,299,000
============ =========== ============ ===========
Income tax provision $ 4,617,000 $ 1,442,000 $ - $ 6,059,000
============ =========== ============ ===========
Identifiable assets $ 79,049,000 $16,275,000 $ 19,508,000 $114,832,000
============ =========== ============ ===========
Year Ended January 31, 1997
- ---------------------------
Sales to unaffiliated customers $ 121,882,000 $ 3,556,000 $ - $125,438,000
Transfers between segments 6,997,000 - (6,997,000) -
------------ ---------- ----------- -----------
Total revenues $ 128,879,000 $ 3,556,000 $ (6,997,000) $125,438,000
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Interest expense $ 826,000 $ 6,000 $ - $ 832,000
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Depreciation and amortization expense $ 1,102,000 $ 26,000 $ 635,000 $ 1,763,000
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Income before income tax provision $ 12,410,000 $ 2,339,000 $ 421,000 $ 15,170,000
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Income tax provision $ 5,421,000 $ 981,000 $ - $ 6,402,000
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Identifiable assets $ 52,385,000 $12,380,000 $ 18,931,000 $ 83,696,000
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