8-K/A 1 v64422a1e8-ka.txt FORM 8-K/A 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 8-K/A CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported): October 11, 2000 (July 28, 2000) JAKKS PACIFIC, INC. (Exact name of registrant as specified in its charter) Delaware 0-28104 95-4527222 (State or other jurisdiction of (Commission (I.R.S. Employer incorporation or organization) File Number) Identification No.) 22761 Pacific Coast Highway, Malibu, California 90265 (Address of principal executive offices ) (Zip Code) Registrant's telephone number, including area code: (310) 456-7799 2 THIS FORM 8-K/A IS AN AMENDMENT TO THE REGISTRANT'S CURRENT REPORT ON FORM 8-K FILED ON AUGUST 11, 2000 (RELATING TO THE REGISTRANT'S ACQUISITION OF PENTECH INTERNATIONAL INC.) TO FILE THE FINANCIAL STATEMENTS AND PRO FORMA FINANCIAL INFORMATION OMITTED FROM THE INITIAL FILING OF THE CURRENT REPORT, IN ACCORDANCE WITH ITEMS 7(a)(4) AND (b)(2), RESPECTIVELY. ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS. For a description of the Registrant's acquisition of Pentech International Inc. ("Pentech"), refer to Item 2 of the Registrant's Current Report on Form 8-K, filed on August 11, 2000, which Item 2 is incorporated in its entirety herein by this reference. 2 3 ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS. (a) Financial Statements of Businesses Acquired. 1. Pentech's consolidated financial statements as of September 30, 1999 and 1998 and for the three years ended September 30, 1999. 2. Pentech's condensed consolidated financial statements as of June 30, 2000 and September 30, 1999 and for the three and nine month periods ended June 30, 2000 and 1999 (unaudited). (b) Pro Forma Financial Information. (c) Exhibits.
Number Description ------- ----------- 2.1 Agreement of Merger dated as of May 22, 2000 among JAKKS Pacific, Inc., JAKKS Acquisition II, Inc. and Pentech International Inc.(1) 2.2 First Amendment dated as of July 13, 2000 to Agreement of Merger(1) 2.3 Voting and Lock-Up Agreement dated May 22, 2000 among JAKKS Pacific, Inc. and certain stockholders of Pentech International Inc.(1) 10.1 Loan and Security Agreement dated as of January 13, 1997 among Pentech International Inc., certain subsidiaries thereof and Bank of America, N.A. (formerly BankAmerica Business Credit, Inc.)(2) 10.2 Waiver and First Amendment dated as of January 11, 1999 to Loan and Security Agreement(3) 10.3 Waiver, Consent and Second Amendment dated as of December 20, 1999 to Loan and Security Agreement(4) 10.4 Consent, Waiver and Third Amendment dated as of July 27, 2000 to Loan and Security Agreement(1) 23.1 Consent of Ernst & Young LLP(5)
--------------------- (1) Previously filed (2) Incorporated by reference to exhibit 10.7 of the Annual Report on Form 10-K of Pentech International Inc. for its fiscal year ended September 30, 1996 (3) Incorporated by reference to exhibit 10.5 of the Annual Report on Form 10-K of Pentech International Inc. for its fiscal year ended September 30, 1998 (4) Incorporated by reference to exhibit 10.6 of the Annual Report on Form 10-K of Pentech International Inc. for its fiscal year ended September 30, 1999 (5) Filed herewith 3 4 INDEX TO FINANCIAL STATEMENTS AND PRO FORMA FINANCIAL INFORMATION
Page ---- Consolidated Financial Statements of Pentech and Subsidiaries (Audited) Report of Independent Auditors.............................................. F-1 Consolidated Balance Sheets as of September 30, 1999 and 1998........................................................................ F-2 Consolidated Statements of Operations for the years ended September 30, 1999, 1998 and 1997 .............................. F-4 Consolidated Statements of Shareholders' Equity for the years ended September 30, 1999, 1998 and 1997........................... F-5 Consolidated Statements of Cash Flows for the years ended September 30, 1999, 1998 and 1997............................... F-6 Notes to Consolidated Financial Statements.................................. F-8 Condensed Consolidated Financial Statements of Pentech and Subsidiaries (Unaudited) Condensed Consolidated Balance Sheets as of June 30, 2000 and September 30, 1999................................................. F-26 Condensed Consolidated Statements of Operations for the three month periods and nine month periods ended June 30, 2000 and 1999................................................ F-28 Condensed Consolidated Statements of Cash Flows for the nine month periods ended June 30, 2000 and 1999......................... F-29 Notes to Condensed Consolidated Financial Statements........................ F-31 Unaudited Pro Forma Consolidated Financial Statements Introduction................................................................ F-39 Unaudited Pro Forma Consolidated Balance Sheet as of June 30, 2000.......... F-40 Unaudited Pro Forma Consolidated Statements of Operations for the year ended December 31, 1999 and the six month period ended June 30, 2000............................................................... F-41 Notes to Unaudited Pro Forma Consolidated Financial Statements.............. F-42
5 REPORT OF INDEPENDENT AUDITORS Board of Directors Pentech International Inc. We have audited the accompanying consolidated balance sheets of Pentech International Inc. and subsidiaries as of September 30, 1999 and 1998 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended September 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pentech International Inc. and subsidiaries as of September 30, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1999, in conformity with generally accepted accounting principles. s/ERNST & YOUNG LLP ------------------- ERNST & YOUNG LLP MetroPark, New Jersey December 8, 1999, except for Note 3(c), as to which the date is December 20, 1999 F-1 6 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Consolidated Balance Sheets Assets (Note 3)
September 30, 1999 1998 ----------- ----------- Current Assets: Cash and cash equivalents $ - $ 759,349 Accounts receivable, net of allowance for doubtful accounts $35,654 and $128,814 in 1999 and 1998, respect- ively) 15,300,613 14,327,195 Inventory (Note 2) 15,415,326 20,015,241 Income taxes receivable (Note 5) 300 448,087 Prepaid expenses and other 1,632,401 1,436,415 Available-for-Sale Security (Notes 1 and 13) 181,400 621,875 ----------- ----------- Total current assets 32,530,040 37,608,162 ----------- ----------- Equipment: Equipment and furniture 9,472,206 8,934,327 Less accumulated depreciation (6,317,823) (5,372,044) ----------- ----------- 3,154,383 3,562,283 ----------- ----------- Other assets: Trademarks, net of amortization of $762,388 and $666,766 in 1999 and 1998, respectively 236,301 239,530 Due from officer 173,512 173,512 ----------- ----------- 409,813 413,042 ----------- ----------- $36,094,236 $41,583,487 =========== ===========
See accompanying notes. F-2 7 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Consolidated Balance Sheets Liabilities and Shareholders' Equity
September 30, 1999 1998 ----------- ----------- Current liabilities: Notes payable (Note 3) $13,881,901 $18,618,186 Accounts payable 3,322,094 2,455,073 Accrued expenses (Note 11) 3,055,309 3,351,962 Settlement note payable (Note 8) 300,000 300,000 ----------- ----------- Total current liabilities 20,559,304 24,725,221 ----------- ----------- Other liabilities: Royalty payable, long-term (Note 8) 50,000 100,000 Settlement note payable, long-term (Note 8) 1,500,000 2,000,000 ----------- ----------- 1,550,000 2,100,000 ----------- ----------- Commitments and contingencies (Note 6) Shareholders' equity (Notes 1 and 4): Preferred stock, par value $.10 per share; authorized 500,000 shares; issued and outstanding, none - - Common stock, par value $.01 per share; authorized 20,000,000 shares; issued and outstanding 12,571,258 and 12,570,258 in 1999 and 1998, respectively 125,713 125,703 Capital in excess of par 6,838,723 6,837,983 Retained earnings 6,839,096 7,172,705 Accumulated other comprehensive income (Notes 1 and 13) 181,400 621,875 ----------- ----------- 13,984,932 14,758,266 ----------- ----------- $36,094,236 $41,583,487 =========== ===========
See accompanying notes. F-3 8 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Consolidated Statements of Operations
Year ended September 30, 1999 1998 1997 ----------- ----------- ----------- Net sales (Note 9) $60,949,084 $57,485,045 $60,806,386 Cost of sales 41,529,037 41,350,327 39,975,368 ----------- ----------- ----------- Gross profit 19,420,047 16,134,718 20,831,018 Selling, general and administrative expenses 18,286,990 18,474,161 17,988,791 Loss from cosmetics operation (Note 7) - - 687,000 ----------- ----------- ----------- Income (loss) from operations 1,133,057 (2,339,443) 2,155,227 ----------- ----------- ----------- Other (income) expense: (Income) from litigation (Note 14) (965,542) - Interest expense 1,470,699 1,528,779 1,583,750 Interest income (4,033) (33,392) (9,660) ----------- ----------- ----------- 1,466,666 529,845 1,574,090 ----------- ----------- ----------- (Loss) income before taxes (333,609) (2,869,288) 581,137 Income tax expense (benefit) (Note 5) - 635,015 (18,877) ----------- ----------- ----------- Net (loss) income $ (333,609) $(3,504,303) $ 600,014 =========== =========== =========== Basic and diluted (loss) earnings per common share (Note 1) ($.03) ($.28) $.05 =========== =========== ===========
See accompanying notes. F-4 9 Pentech International Inc. and Subsidiaries Consolidated Statements of Shareholders' Equity Years ended September 30, 1999, 1998 and 1997
Common Stock Capital Number of Shares in Accumulated Excess Retained Comprehensive Other Comprehen- Authorized Issued Amount of Par Earnings Income (loss) sive Income ---------- ---------- ------- --------- ---------- ------------- --------------- Balance, September 30, 1996 20,000,000 10,496,758 104,968 5,845,781 10,076,994 - Issuance of Common Stock 2,007,500 20,075 943,362 Net income 600,014 $600,014 ---------- ---------- -------- ---------- ----------- =============== ---------------- Balance, September 30, 1997 20,000,000 12,504,258 125,043 6,789,143 10,677,008 - Comprehensive (loss): Net loss (3,504,303) $(3,504,303) Other comprehensive income: Unrealized gain on available-for-sale security 621,875 621,875 --------------- Comprehensive (loss) $(2,882,428) =============== Issuance of Common Stock 66,000 660 48,840 ---------- ---------- -------- ---------- ----------- ---------------- Balance, September 30, 1998 20,000,000 12,570,258 125,703 6,837,983 7,172,705 621,875 Comprehensive (loss): Net loss (333,609) $(333,609) Other comprehensive (loss) Unrealized loss on available-for-sale security (440,475) (440,475) --------------- Comprehensive (loss) $(774,084) =============== Issuance of Common Stock 1,000 10 740 ---------- ---------- -------- ---------- ----------- ---------------- 20,000,000 12,571,258 $125,713 $6,838,723 $ 6,839,096 $ 181,400 ========== ========== ======== ========== =========== ================
See accompanying notes. F-5 10 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows
Year ended September 30, 1999 1998 1997 ----------- ------------ ----------- Cash flows from operating activities Net (loss) income $ (333,609) $ (3,504,303) $ 600,014 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation 945,779 942,432 982,702 Amortization 95,622 100,363 116,925 Provision for losses on accounts receivable 95,753 134,974 15,401 Deferred income taxes - 635,015 290,099 Provision for loss from cosmetics operation - - 687,000 Change in assets and liabilities: (Increase) decrease in accounts receivable (1,069,171) 1,746,117 (1,771,187) Decrease (increase) in inventory 4,599,915 (1,957,743) (152,916) (Increase) decrease in prepaid expenses and other (195,986) 118,620 (605,228) (Increase) in due from officer - (32,000) (32,001) (Decrease) in bankers' acceptances payable - - (1,488,757) Increase (decrease) in accounts payable 867,021 1,121,468 (331,698) (Decrease) in accrued expenses (296,653) (88,742) (386,426) (Decrease) in settlement payables (550,000) (500,000) (1,000,000) Change in income taxes payable/ receivable 447,787 (25,641) 723,968 ----------- ------------ ----------- Net cash provided by (used in) operating activities 4,606,458 (1,309,440) (2,352,104)
See accompanying notes. F-6 11 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (cont'd)
Year ended September 30, 1999 1998 1997 ----------- ---------- ---------- Cash flows from investing activities Sale of cosmetics assets - 758,426 - Purchase of equipment and furniture (537,879) (697,884) (793,006) Increase in trademarks (92,393) (70,185) (118,891) ----------- ---------- ---------- Net cash used in investing (630,272) (9,643) (911,897) activities Cash flows from financing activities Net (decrease) increase in notes payable (4,736,285) 1,380,120 (4,114,432) Proceeds from the issuance of Common Stock 750 49,500 963,437 ----------- ---------- ---------- Net cash (used in) provided by financing activities (4,735,535) 1,429,620 (3,150,995) ----------- ---------- ---------- Net (decrease) increase in cash and cash equi- valents (759,349) 110,537 (6,414,996) Cash and cash equivalents, beginning of year 759,349 648,812 7,063,808 ----------- ---------- ---------- Cash and cash equivalents, end of year $ - $ 759,349 $ 648,812 =========== ========== ========== Supplemental disclosures of cash flow information Non-cash investing activities: (Decrease) increase in fair value of available for sale equity security $ (440,475) $ 621,875 Purchase of fixed assets by capital lease - - $ 72,050 Cash paid during the year for: Interest $ 1,557,011 $1,454,840 1,773,920 Income taxes - - 30,931
See accompanying notes. F-7 12 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements September 30, 1999 1. Summary of Significant Accounting Policies Organization Pentech International Inc. (the "Company") was formed in April 1984. A wholly-owned subsidiary, Sawdust Pencil Co. ("Sawdust"), was formed in November 1989. The Company and its subsidiary are engaged in the production, design, and marketing of writing and drawing instruments. In October 1993, the Company formed another wholly-owned subsidiary, Pentech Cosmetics, Inc., to manufacture and distribute cosmetic pencils. During Fiscal 1997, the Company decided to dispose of this product line. The Company primarily operates in one business segment: the manufacture and marketing of pens, markers, pencils, other writing instruments and activity kits, primarily to major mass market retailers located in the United States, under the "Pentech" name or licensed trademark brand. The Company's fiscal year ends September 30. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated. Cash Equivalents The Company considers all time deposits with a maturity of three months or less to be cash equivalents. Inventory and Cost of Sales Inventory is stated at the lower of cost (first-in, first-out) or market. Cost of sales for imported products includes the invoice cost, duty, freight in, display and packaging costs. Cost of domestically manufactured products includes raw materials, labor, overhead and packaging costs. Equipment and Depreciation Equipment is stated at cost. Depreciation is provided by the straight-line method over the estimated useful lives of the assets, which range between five to ten years. Major improvements to existing equipment are capitalized. Expenditures for maintenance and repairs which do not extend the life of the assets are charged to expense as incurred. F-8 13 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1999 1. Summary of Significant Accounting Policies (cont'd) Trademarks Costs related to trademarks are being amortized over a five year period on a straight-line basis. Revenue recognition Revenue is recognized upon shipment of product to the customer. Fair Value of Financial Instruments The fair value for cash and accounts receivable approximate carrying amounts due to the short maturity of these instruments. The fair value amounts for notes payable approximate carrying amounts due to the variable interest rates. 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. (Loss) Earnings Per Share: In February 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings Per Share, which was adopted by the Company in December 1997. SFAS No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earning per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share for all periods have been presented and conform to the SFAS No. 128 requirements. F-9 14 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1999 1. Summary of Significant Accounting Policies (cont'd) The following table sets forth the computation of basic and diluted earnings per share:
YEAR ENDED SEPTEMBER 30, ---------------------------------------- 1999 1998 1997 Numerator: Net (loss) income $ (333,609) $(3,504,303) $ 600,014 =========== =========== =========== Denominator: Denominator for basic earnings per share- weighted average shares 12,570,508 12,537,258 12,297,124 Effect of dilutive securities: Employee stock options 0 0 194,043 ----------- ----------- ----------- Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions: 12,570,508 12,537,258 12,491,167 =========== =========== =========== Basic and diluted (loss) income per share ($.03) ($.28) $.05 =========== =========== ===========
F-10 15 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1999 1. Summary of Significant Accounting Policies (cont'd) Stock Based Compensation Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Other Recently Issued Accounting Standard In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" which is effective for years beginning after June 15, 2000. The Company has completed its review of SFAS 133 and has concluded that the adoption of this statement would not have any effect on the Company and its reporting. F-11 16 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1999 2. Inventory
1999 1998 ----------- ----------- Raw materials $ 4,261,866 $ 6,634,833 Work-in-process 1,748,504 1,641,162 Finished goods 10,510,956 12,849,246 Allowance for slow- moving items (1,106,000) (1,110,000) ----------- ----------- $15,415,326 $20,015,241 =========== =========== 3. Notes Payable 1999 1998 ----------- ----------- Revolving line of credit interest payable monthly at prime plus .5% (8.75% at September 30, 1999 and 9% at September 30, 1998) $ 1,881,901 $ 4,618,186 Revolving line of credit, interest payable monthly at libor plus 2.5% (ranging from 7.76% to 7.87% at September 30, 1999 and 7.813% to 8.188% at September 30, 1998) 12,000,000 14,000,000 ----------- ----------- $13,881,901 $18,618,186 =========== ===========
F-12 17 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1999 3. Notes Payable (cont'd) (a) In January 1997, the Company entered into a three year $30,000,000 Revolving Credit Agreement with BankAmerica Business Credit, Inc. now known as Bank of America, N.A. ("BABC") (the "Credit Agreement"). Borrowings under the Credit Agreement are subject to limitations based upon eligible inventory and accounts receivable as defined in the Credit Agreement. Amounts borrowed under the Credit Agreement accrue interest, at the Company's option, at either prime plus .5% or libor plus 2.5%. The Credit Agreement is collateralized by a security interest in substantially all of the assets of the Company. In connection with the Credit Agreement, the Company has agreed, among other things, to the maintenance of certain minimum amounts of tangible net worth and interest coverage ratios and the Company cannot declare a cash divided without the consent of BABC. (b) In January 1999, the Company and BABC entered into an agreement to amend the Credit Agreement. This amendment, among other things, waived compliance with the violated covenants, reduced the revolving credit facility to $25,000,000, modified the financial covenants for Fiscal 1999, lowered the maximum inventory advance and allowed for a seasonal over-advance. (c) In December 1999, the Company and BABC entered into an agreement to renew the Credit Agreement for an additional three years (the "Renewal"). The Renewal, among other things, waives compliance with certain financial covenants violated at September 30, 1999, modifies the financial covenants for the next three fiscal years, increases the maximum inventory advance and allows for a seasonal over-advance. The weighted average annual interest rate during the periods on the outstanding short-term borrowings was 8.0% and 8.4% for fiscal years ended September 30, 1999 and 1998, respectively. 4. Shareholders' Equity Stock Options During Fiscal 1997, the Company granted options (outside of the plans discussed herein) covering in the aggregate 20,000 shares of common stock at an exercise price of $1.19 per share (representing fair market value at date of grant). In addition, options covering in the aggregate of 175,000 shares were canceled. F-13 18 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1999 4. Shareholders' Equity (cont'd) Stock Option Plans On January 5, 1989, the Company adopted a stock option plan ("1989 Plan"). The 1989 Plan provides for options and limited stock appreciation rights ("Limited SARs") to be granted in tandem to issue up to 600,000 shares of common stock. Limited SARs may only be granted in conjunction with related options. The exercise price of options granted may not be less than the fair market value of the shares on the date of the grant (110% of such fair market value for a holder of more than 10% of the Company's voting securities), nor may options be exercised more than ten years from date of grant (5 years for a holder of more than 10% of the Company's voting securities). No SARs have been granted. The 1989 Plan was terminated on January 5, 1999. Outstanding options continue to be exercisable according to their terms and remain subject to all the terms and conditions of the 1989 Plan, however no more grants can be issued. On April 14, 1993, the Company adopted a Stock Option Plan ("1993 Plan"). The 1993 Plan provides for the issuance of incentive and nonstatutory stock options to employees, consultants, advisors and/or directors for a total up to 700,000 shares of common stock. The exercise price of options granted may not be less than the fair market value of the shares on the date of grant (110% of such fair market value for a holder of more than 10% of the Company's common stock), nor may options be exercised more than five years from date of grant. The 1993 Plan will terminate on January 4, 2003. On May 9, 1995, the Company adopted a Stock Option Plan ("1995 Plan"). The 1995 Plan provides for the issuance of incentive and nonstatutory stock options to employees, consultants, advisors and/or directors for a total of up to 700,000 shares of Common Stock. The determination of the exercise price of the options granted under the 1995 Plan are the same as those of the 1993 Plan. The 1995 Plan will terminate on January 4, 2005. On November 26, 1996, the Board of Directors offered to cancel and reissue certain options (at a reduced level) in the 1989 and 1993 Plans at the fair market value of the Company's Common Stock on such date. Upon acceptance by the option holders, the vesting period began one year from the date of the offer and the options become exercisable ratably over a period of three years and expire four years from the date of issuance. F-14 19 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1999 4. Shareholders' Equity (cont'd) The table below presents option information for the 1989 Plan:
Year ended Year ended Year ended Sept. 30, 1999 Sept. 30, 1998 Sept. 30, 1997 Price range Shares Price range Shares Price Range Shares ----------- ------- ----------- ------- ------------ ------- Outstanding, beginning of year $0.75-2.875 270,600 $0.75 285,600 $3.125-7.875 351,000 Options granted 1.50-2.875 105,000 0.75 285,600 Canceled 0.75-2.875 (78,600) 0.75 (72,000) 3.125-7.875 (351,000) Exercised 0.75 (48,000) ----------- ------- ----------- ------- ------------ ------- Outstanding, end of year $0.75-2.875 192,000 $0.75-2.875 270,600 $0.75 285,600 =========== ======= =========== ======= ============ ======= Eligible for exercise currently $0.75-2.875 107,835 $0.75 51,200 - - =========== ======= =========== ======= ============ =======
F-15 20 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1999 4. Shareholders' Equity (cont'd) The table below presents option information for the 1993 Plan:
Year ended Year ended Year ended Sept. 30, 1999 Sept. 30, 1998 Sept. 30, 1997 Price range Shares Price range Shares Price Range Shares ---------- ------- ---------- ------- ------------ ------- Outstanding, beginning of year $0.75-5.50 310,500 $0.75-5.50 440,500 $3.125-6.125 647,500 Options granted 0.75-1.25 155,600 - - 0.75 -0.875 385,500 Canceled 0.75-5.50 (125,500) 0.75-4.50 (112,000) 3.125-6.125 (592,500) Exercised 0.75 (1,000) 0.75 ( 18,000) ---------- ------- ---------- ------- ------------ ------- Outstanding, end of year $0.75-5.50 339,600 $0.75-5.50 310,500 $0.75 -5.50 440,500 ========== ======= ========== ======= =========== ======= Eligible for exercise currently $0.75-5.50 133,500 $0.75-5.50 96,000 $4.50 -5.50 43,000 ========== ======= ========== ======= =========== =======
F-16 21 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1999 4. Shareholders' Equity (cont'd) The table below presents option information for the 1995 Plan:
Year Ended Year Ended Year Ended Sept. 30, 1999 Sept. 30, 1998 Sept. 30, 1997 Price range Shares Price range Shares Price range Shares -------------- ------ ------------- ------ ------------ ------- Outstanding, beginning of year $ 0.75-2.9375 75,002 $ 0.75-2.9375 123,000 $ 3.00 10,000 Options granted - - 1.625-1.688 9,500 0.75-2.9375 123,000 Canceled 0.75-1.4375 (8,500) 1.4375-2.9375 (57,498) 3.00 (10,000) Exercised - - - - - - -------------- ------ ------------- ------- ------------ ------- Outstanding, end of year $1.4375-2.9375 66,502 $ 0.75-2.9375 75,002 $0.75-2.9375 123,000 ============== ====== ============= ======= ============ ======= Eligible for exercise currently $1.4375-2.9375 49,002 $ 0.75-2.9375 29,750 $ 1.4375 12,000 ============== ====== ============= ======= ============ =======
F-17 22 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1999 4. Shareholders' Equity (cont'd) The Financial Accounting Standards Board has issued Financial Accounting Standard No. 123 "Accounting for Stock-Based Compensation" ("FAS 123"). FAS 123 took effect for transactions entered into during the fiscal year beginning October 1, 1996; with respect to disclosures required for entities that elect to continue to measure compensation cost using prior permitted accounting method, such disclosures must include the effects of all awards granted in the fiscal year beginning October 1, 1995. The Company has elected to follow Accounting Principles Board Opinion No. 25. "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net income and earnings per share is required by Statement No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. This fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions: Risk-free interest rate 6.01% Expected dividend yield 0% Expected stock price volatility .605% Expected life of options 2-6 years The weighted average fair value of options granted during Fiscal 1999 and Fiscal 1998 is $.68 and $.74 per share, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can mutually affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information is as follows (in thousands except for earnings per share amounts): F-18 23 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1999 4. Shareholders' Equity (cont'd)
Sept. 30, 1999 Sept. 30, 1998 Sept. 30, 1997 -------------- -------------- -------------- As reported Pro forma As reported Pro forma As reported Pro forma ----------- --------- ----------- --------- ----------- --------- Net (loss) income ($334) ($404) ($3,504) ($3,594) $600 $491 (Loss) earn- ings per share ($.03) ($.03) ($ .28) ($ .29) $.05 $.04
F-19 24 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1999 5. Income Taxes
1999 1998 1997 --------- ---------- --------- Expense/(Benefit) Federal: Current $ - $ - $(309,276) Deferred - 349,002 273,730 State: Current - - 300 Deferred - 286,013 16,369 --------- ---------- --------- $ - $ 635,015 $ (18,877) ========= ========== =========
Reconciliations of the statutory federal income tax rate of 34% to the effective tax rates are as follows:
1999 1998 1997 ------ ------ ------ Statutory tax rate (34.00%) (34.00%) 34.00% State income taxes, net of federal tax expense (benefit) 9.88% (4.84%) 1.86 IRS audit adjustment 5.32 Permanent differences 10.04% 1.37% Increase (decrease) in valuation allowance 16.94% 57.46% (47.77%) Other (2.86%) 2.14% (6.65%) ------ ------ ------ Effective tax rate - 22.13% (3.25%) ====== ====== ======
F-20 25 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1999 5. Income Taxes (cont'd) Significant components of the Company's deferred tax assets and liabilities as of September 30, 1999 and 1998 are as follows:
September 30, 1999 1998 ---------- ---------- Current deferred tax liability: State taxes on deferred federal items $ (51,957) $ (68,687) ---------- ---------- Current deferred tax assets: Bad debts 15,331 55,390 Inventory reserve 475,580 477,300 Reserve for returns and allowances 267,018 303,528 Unicap 8,364 7,787 ---------- ---------- Total current deferred tax assets 766,293 844,005 Valuation allowance on current deferred tax assets (714,336) (775,318) ---------- ---------- 51,957 68,687 ---------- ---------- Net current deferred tax assets $ - $ - ========== ========== Long-term deferred tax liabilities: Depreciation $ (853,163) $ (932,290) ---------- ---------- Long-term deferred tax assets: Reserve for litigation 817,000 1,053,500 State net operating loss carryforwards 552,210 535,598 Federal net operating loss carry- forward 1,440,331 1,182,076 ---------- ---------- Total long-term deferred tax assets 2,809,541 2,771,174 Valuation allowance on long-term deferred tax assets (1,956,378) (1,838,884) ---------- ---------- 853,163 932,290 ---------- ---------- Net long-term deferred tax assets $ - $ - ========== ==========
F-21 26 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1999 5. Income Taxes (cont'd) The Company has generated state net operating loss carryforwards of $6,135,663, which will expire in varying amounts beginning on September 30, 2001. The Company has also generated a federal net operating loss carry-forward of $4,206,218, which will expire in varying amounts on September 30, 2013. In 1997, approximately $277,000 of the valuation allowance was recognized as a tax benefit. In 1998, the Company increased the valuation allowance to $2,614,202 due to the uncertainty of its ability to fully utilize the federal and state net operating loss carry-forward. In 1999, there was a net increase in the valuation allowance to $2,670,714. As in the prior year, in 1999 no tax benefit was recognized due to the uncertainty of utilizing the net loss carry-forwards. 6. Commitments and Contingencies Letters of Credit The Company was contingently liable for outstanding letters of credit of $158,202 at September 30, 1999. Leases Rent expense for the years ended September 30, 1999, 1998 and 1997 amounted to $1,022,852, $1,056,934 and $1,024,491, respectively. In May 1990, the Company entered into a 60 month lease for manufacturing space. The lease provides for all real estate taxes and operating expenses to be paid by the Company and it contains options to renew for two 60 month periods. The Company exercised its first option and extended the lease for an additional 60 months commencing in June 1995. In March 1993, the Company entered into a 60 month lease for office, warehouse and manufacturing space. The lease provides for all real estate taxes and operating expenses to be paid by the Company and it contains an option to renew for an additional 60 month period. In October 1997, the Company exercised its option to renew. In August 1995, the Company entered into a 60 month lease for its 130,000 square foot distribution center. The lease provides for all real estate taxes and operating expenses to be paid by the F-22 27 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1999 6. Commitments and Contingencies (cont'd) Company and it contains two options to renew for two five year periods. Future minimum rental payments under operating leases are as follows: 2000 744,932 2001 177,743 2002 141,375 2003 82,469 ---------- $1,146,519 ========== Concentration of Labor In December 1992, the production and maintenance employees of the Company's wholly owned subsidiary, Sawdust, voted to join local 478 of the International Brotherhood of Teamsters (the "Union"). In the Company's fiscal year ended September 30, 1996 ("Fiscal 1996"), Sawdust renewed its labor agreement with the Union for the benefit of these employees, which agreement expired August 31, 1999. The Union has agreed to work under the terms and conditions of the expired contract until a new contract is negotiated and a determination is made as to the impact of the Company"s investigation into moving a portion of its manufacturing facility overseas. As of September 30, 1999, 47% of the Company's employees were members of the Union. To date, the Company has maintained a favorable relationship with the Union. 7. Loss from Cosmetics Operation: During the second quarter of 1997, the Board of Directors determined to discontinue its cosmetics operation and focus its efforts primarily on its writing instruments business. The loss from cosmetics operation reported in the second quarter of 1997 reflects the write-down of certain assets of this operation to their estimated net realizable value (Note 13). 8. Paradise Settlement In October 1987, the Company commenced an action against Leon Hayduchok, All-Mark Corporation and Paradise Creations, Inc., (collectively, "Paradise") in the United States District Court for the Southern District of New York which resulted in an adverse multi-million dollar judgment against Pentech. In December 1996, the parties to such litigation entered into a settlement agreement providing, among other things, for Pentech to pay $500,000 at the date of signing, deliver a $3,000,000 promissory note plus interest at the rate of 7% per annum (the "Note") and enter into a five year F-23 28 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1999 8. Paradise Settlement (Cont'd) non-exclusive license to sell such products for a 10% royalty, with an aggregate minimum royalty of $500,000 (the "Paradise Settlement"). The Company paid Paradise the $500,000 at the date of signing in January 1997 and a required payment against the Note of $400,000 in February 1997. In addition, the Note required $100,000 quarterly principal payments commencing January 1, 1998. Quarterly principal payments have been made through October, 1999. The Company also has paid $300,000 against the minimum royalty. 9. Major Customer and Concentration of Credit Risk For the years ended September 30, 1999, 1998 and 1997, the Company had one customer who accounted for 9%, 12% and 13%, respectively, of net sales. Concentration of credit risk with respect to trade receivables is generally limited due to the Company's use of credit limits, credit insurance and ongoing credit evaluations and account monitoring procedures. 10. 401(k) Plan The Company has a defined contribution 401(k) plan, covering substantially all employees not covered under a collective bargaining agreement. The plan provides employees an opportunity to make pre-tax payroll contributions to the plan. The plan was amended on April 1, 1996 to incorporate an employer discretionary match of 1/3 of the first 6% of employee contributions. For the years ended September 30, 1999, 1998, 1997 the Company contributed $37,500, $32,558 and $36,273, respectively. 11. Accrued Expenses
September 30, 1999 1998 ---------- ---------- Accrued returns and advertising rebates $2,038,410 $1,878,847 Accrued royalties 430,000 346,940 Other accrued expenses 586,899 1,126,175 ---------- ---------- $3,055,309 $3,351,962 ========== ==========
12. Private Placement In January 1997, the Company completed a private offering of 20 Units, each Unit consisting of 100,000 shares of Common Stock of the Company for $50,000 per Unit (the "Private Offering"). The Company received net proceeds of $963,000 from the Private F-24 29 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1999 12. Private Placement (Cont'd) Offering. Officers and directors of the Company acquired 52.5% of the Units sold in the Private Offering and participated on the same terms as the other investors in the Private Offering. The terms of the Private Offering were established by a Special Committee of the Board of Directors who did not participate in the Private Offering. The Company was required by its banks (at that time) to raise funds in the Private Offering in order to fund the $500,000 payment referred to in Note 8 and to enable the Company to fund its requirements for capital expenditures. 13. Sale of Cosmetic Assets/Available-for-Sale Security In November 1997, the Company entered into an agreement to sell the fixed assets and inventory of its Cosmetics subsidiary to an outside company, Fun Cosmetics Inc. ("Fun") (significantly owned by a former employee) for its net book value of $758,000 plus 200,000 shares of Fun. In December 1997, $100,000 was received as a down payment, $150,000 was received at closing and a note was issued for approximately $508,000 bearing interest at a rate of 9% per annum. The terms of the note provided that the principal be reduced by $150,000 a month commencing February 1998, until paid. This note was paid in full in March 1998. At the time of sale, the Company assigned no value to the shares received since the acquiring company was a start-up company with minimal assets and was still seeking financing. Since November 1997, Fun has raised additional equity and funding and has become a non-reporting company whose shares are listed on the NASD Electronic Bulletin Board. At September 30, 1999, the value of this stock (based on quoted market prices) was $.907 a share. The Company has the right to begin selling its shares in Fun. However, due to the historically low level of trading activity, the number of shares the Company owns and the fact that the shares are unregistered, there is no assurance the Company will realize the current market value. 14. Income from Lawsuit Settlement: In June 1997, the Company commenced an action against Cooper and Dunham LLP and Lewis H. Eslinger (collectively, "Defendants") in the Supreme Court of the State of New York and County of New York for legal malpractice, gross negligence, misrepresentation and breach of contract in connection with the adverse, multi-million dollar judgment resulting from a patent infringement case which the defendants had been retained to pursue. On April 10, 1998, the Company terminated this action and received a payment of $1,250,000. All actions arising from the patent infringement case have now been discontinued with prejudice. F-25 30 PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS (000's omitted) (Substantially all pledged or assigned)
June 30, September 30, ----------------------------- 2000 1999 ---- ---- (unaudited) Current Assets: Accounts Receivable, net of allowances for doubtful accounts of $90 at June 30, 2000 and $36 at September 30, 1999, respectively $ 21,307 $ 15,301 Inventories 14,215 15,415 Prepaid expenses and other 2,555 1,633 Joint venture receivable 1,225 -- Available-for-sale security 8 181 ----------------------- Total current assets 39,310 32,530 ----------------------- Furniture and equipment 8,452 9,472 Less accumulated depreciation (6,220) (6,318) ----------------------- 2,232 3,154 ----------------------- Other assets: Investment in joint venture 150 -- Trademarks, net of accumulated amortization of $836 at June 30, 2000 and $762 at September 30, 2000 244 236 Due from officer 174 174 ----------------------- 568 410 ----------------------- $ 42,110 $ 36,094 ========================
F-26 31 PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND SHAREHOLDERS' EQUITY (000's omitted)
June 30, September 30, ------------------------- 2000 1999 ---- ---- (unaudited) Current liabilities: Notes payable, banks $21,637 $13,882 Accounts payable 3,542 3,322 Accrued expenses 2,070 3,056 Settlement note payable 300 300 Deferred Income from joint venture 238 -- --------------------- Total current liabilities 27,787 20,560 --------------------- Other liabilities: Royalty payable, long term 50 50 Settlement note payable, long term 1,300 1,500 --------------------- 1,350 1,550 --------------------- Shareholders' equity: Preferred stock, par value $.10 per share; authorized 500,000 shares; issued and outstanding none Common stock, par value $.01 per share; authorized 20,000,000 shares; 12,571,258 shares issued and outstanding at June 30, 2000 and September 30, 1999, respectively 125 125 Capital in excess of par 6,839 6,839 Retained earnings 6,001 6,839 Accumulated Other Comprehensive Income 8 181 --------------------- 12,973 13,984 --------------------- $42,110 $36,094 =====================
F-27 32 PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (000's omitted except for per share amounts) (unaudited)
Three months ended Nine months ended June 30, June 30, ----------------------------------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Net Sales $ 23,457 $ 25,472 $ 44,238 $ 45,228 Cost of Sales 15,533 16,976 29,662 30,361 ---------------------------------------------------- Gross Profit 7,924 8,496 14,576 14,867 Selling, general and administrative expenses 5,964 6,093 13,839 13,234 Plant relocation costs 52 -- 839 -- ---------------------------------------------------- Income (loss) from operations 1,908 2,403 (102) 1,633 (Income) from joint venture (237) -- (237) -- Interest expense 387 358 973 1,042 ---------------------------------------------------- Income (loss) before taxes 1,758 2,045 (838) 591 Income taxes -- -- -- -- ---------------------------------------------------- Net income (loss) $ 1,758 $ 2,045 $ (838) $ 591 ==================================================== Net income (loss) per share fully diluted $ 0.14 $ 0.16 $ (0.07) $ 0.05 ====================================================
F-28 33 PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (000's omitted) (unaudited)
Nine months ended June 30, --------------------- 2000 1999 ---- ---- Cash flows from operating activities: Net (loss) income $ (838) $ 591 ------- ------- Adjustments to reconcile net (loss) income to net cash provided for operating activities: Depreciation and amortization 784 788 (Increase) decrease in: Accounts receivable (6,006) (6,975) Inventories 705 3,605 Prepaid expenses and other (922) (224) Income taxes receivable -- 448 Increase (decrease) in: Accounts payable 220 1,073 Accrued expenses (986) (330) Settlement payable (200) (450) ------- ------- Total adjustments (6,405) (2,065) ------- ------- Net cash (used in) operating activities (7,243) (1,474) ------- ------- Cash flows (used in) investing activities: (Increase) in investment in joint venture (150) -- (Purchase) of furniture/equipment (280) (365) (Increase) decrease in trademarks (82) 7 ------- ------- Net cash (used in) investing activities (512) (358) ------- -------
F-29 34 PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) (000's omitted) (unaudited)
Nine months ended June 30, ----------------------- 2000 1999 ---- ---- Cash flows from financing activities: Net increase in notes payable $ 7,755 $ 1,073 --------------------- Net cash provided by financing activities 7,755 1,073 --------------------- Net (decrease) in cash and cash equivalents -- (759) Cash and cash equivalents, beginning of period -- 759 --------------------- Cash and cash equivalents, end of period $ -- $ -- ===================== Supplemental disclosures of cash flow information: Non-cash operating activities: (Increase) in joint venture receivable $(1,225) Increase in deferred revenue from joint venture $ 238 Decrease in fixed assets due to transfer to joint venture $ 491 Decrease in inventory due to transfer to joint venture $ 495 Non-cash investing activities: (Decrease) in fair value of available-for-sale security $ (173) $ (297) Cash paid during the period for: Interest $ 936 $ 1,142
F-30 35 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (The information for the three and nine months ended June 30, 2000 and 1999 is unaudited.) 1. Summary of Significant Accounting Policies: Organization: Pentech International Inc. (the "Company") was formed in April 1984. A wholly-owned subsidiary, Sawdust Pencil Company ("Sawdust") was formed in November 1989 and commenced operations in January 1991. The Company and its subsidiary are engaged in the production, design and marketing of writing and drawing instruments. The Company primarily operates in one business segment: the manufacture and marketing of pens, markers, pencils and other writing instruments and related products to major mass market retailers located in the United States, under the "Pentech" name or licensed trademark brand. The Company's business is subject to certain seasonal conditions in which sales tend to be concentrated in the third and fourth quarters of the fiscal year. The Company's fiscal year ends September 30. Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated. Cash Overdraft: Any bank overdrafts are included within accounts payable in the accompanying consolidated balance sheet. Unaudited Financial Statements: The unaudited financial information includes adjustments (consisting of normal recurring adjustments) which the Company considers necessary for a fair presentation of the financial position at June 30, 2000 and the results of operations for the three and nine month periods ended June 30, 2000 and 1999 and cash flows for the nine months ended June 30, 2000 and 1999. F-31 36 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (The information for the three and nine months ended June 30, 2000 and 1999 is unaudited.) 1. Summary of significant accounting policies (Cont'd): Inventory and Cost of Sales: Inventory is stated at the lower of cost or market (first-in, first-out). Interim inventories are based on an estimated gross profit percentage by product, calculated monthly. Cost of sales for imported products includes the invoice cost, duty, freight in, display and packaging costs. Cost of domestically manufactured products includes raw materials, labor, overhead and packaging costs. Equipment and depreciation: Equipment is stated at cost. Depreciation is provided by the straight-line method over the estimated useful lives of the assets, which range from five to ten years. Major improvements to existing equipment are capitalized. Expenditures for maintenance and repairs which do not extend the life of the assets are charged to expense as incurred. Trademarks: Costs related to trademarks are being amortized over a five year period on a straight-line basis. Revenue recognition: Revenue is recognized upon shipment of product to the customer. Fair Value of Financial Instruments: The fair value for cash and accounts receivable approximates carrying amounts due to the short maturity of these instruments. The fair value for notes payable approximates carrying amounts due to the variable interest rates. 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 amounts reported in the financial statements and F-32 37 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (The information for the three and nine months ended June 30, 2000 and 1999 is unaudited.) 1. Summary of significant accounting policies (Cont'd): accompanying notes. Actual results could differ from those estimates. Stock Based Compensation: Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. F-33 38 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (The information for the three and nine months ended June 30, 2000 and 1999 is unaudited.) 1. Summary of significant accounting policies (Cont'd): (Loss) Earnings per share: The following table sets forth the computation of basic and diluted earnings per share:
Three months ended Nine months ended June 30, June 30, ---------------------------- ------------------------------ 2000 1999 2000 1999 ----------- ----------- ------------ ----------- Numerator: Net income(loss) $ 1,758,000 $ 2,045,000 $ (838,000) $ 591,000 =========== =========== ============ =========== Denominator: Denominator for basic earnings per share - weighted average shares 12,571,258 12,570,258 12,571,258 12,570,258 Effect of dilutive securities: Employee stock options -- -- -- 37,140 ----------- ----------- ------------ ----------- Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions: 12,571,258 12,570,258 12,571,258 12,607,398 =========== =========== ============ =========== Basic and diluted (loss) per share $ .14 $ .16 $ (.07) $ .05 =========== =========== ============ ===========
Other Recently Issued Accounting Standard: In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" which was amended by the Statement of Financial Accounting Standards No. 137 "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133" and is effective for years beginning after June 15, 2000. The Company has completed its review of SFAS 133 and has concluded that the adoption of this statement would not have any effect on the Company and its reporting. F-34 39 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (The information for the three and nine months ended June 30, 2000 and 1999 is unaudited.) 2. Inventory
June 30, September 30, 2000 1999 ------------ ------------- Raw materials $ 4,937,000 $ 4,262,000 Work-in-process 1,017,000 1,748,000 Finished goods 9,158,000 10,511,000 Allowance for slow-moving items (897,000) (1,106,000) ------------ ------------ $ 14,215,000 $ 15,415,000 ============ ============
June 30, September 30, 2000 1999 ----------- ------------ 3. Notes Payable, bank: Revolving line of credit with interest payable monthly at prime plus .5% (10.0% at June 30, 2000 and 8.75% at September 30, 1999) $ 1,637,000 $ 1,882,000 Revolving line of credit with interest payable at maturity at libor plus 2.5% (9.18% at June 30, 2000 and ranging from 7.76% to 7.87% at September 30, 1999) 20,000,000 12,000,000 ----------- ----------- $21,637,000 $13,882,000 =========== ===========
In January 1997, the Company entered into a three year Revolving Credit Agreement with BankAmerica Business Credit, Inc. now known as Bank of America, N.A. (BABC) (the "Credit Agreement"). Borrowings under the Credit Agreement are subject to limitations based upon eligible inventory and accounts receivable as defined in the Credit Agreement. Borrowings under the Credit Agreement accrue F-35 40 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (The information for the three and nine months ended June 30, 2000 and 1999 is unaudited.) interest, at the Company's option, at either prime plus .5% or libor plus 2.5%. In December 1999, the Company and BABC entered into an agreement to renew the Credit Agreement for an additional three years (the "Renewal"). The Renewal, among other things, waives compliance with certain financial covenants violated at September 30, 1999, modifies the financial covenants for the next three fiscal years, increases the maximum inventory advance and allows for a seasonal over-advance. The Renewal is collateralized by a security interest in substantially all of the assets of the Company. In connection with the Renewal, the Company has agreed to the maintenance of certain financial covenants and cannot declare a cash divided without the consent of BABC. 4. Contingency: At June 30, 2000, the Company was contingently liable for outstanding letters of credit of $224,012. 5. Income Taxes: Following is a reconciliation to income taxes at the statutory rate:
Three months ended Nine months ended June 30, 2000 June 30, 2000 ------------- ------------- Income tax at Federal statutory rate applied to income before taxes $ 598,000 $(285,000) State income taxes, net of Federal tax benefit 54,000 (26,000) (Decrease)increase in valuation allowance (652,000) 311,000 --------- --------- $ -- $ -- ========= =========
F-36 41 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (The information for the three and nine months ended June 30, 2000 and 1999 is unaudited.) 6. Paradise Settlement In Fiscal 1997, the Company entered into a settlement agreement with Leon Hayduchok, All-Mark Corporation and Paradise Creations, Inc., (collectively, "Paradise") providing, among other things, for Pentech to pay $500,000, deliver a $3,000,000 promissory note plus interest at the rate of 7% per annum (the "Note") and enter into a five year non-exclusive license to sell such products for a 10% royalty, with an aggregate minimum royalty of $500,000 (the "Paradise Settlement"). The Company paid $500,000 at the date of signing in January 1997 and a required payment against the Note of $400,000 in February 1997. In addition, the Note required $100,000 quarterly principal payments commencing January 1, 1998. Quarterly principal payments have been made through July 2000. The Company also paid $400,000 against the minimum royalty. 7. Available-for-Sale Security The value of Fun Cosmetics, Inc. stock (based on quoted market prices) as of June 30, 2000 was $.04 a share. However, due to the historically low level of trading activity, the number of shares the Company owns, the shares are unregistered and the Company has recently became aware that Fun has discontinued active operations, there is no assurance the Company will realize the current market value.
Accumulated Other Comprehensive Income -------------------- June 30, June 30, 2000 1999 ------- ------- Net (loss) income $ (838) $ 591 Unrealized loss on available-for- sale security (173) (297) ------- ------- Comprehensive (loss) income $(1,011) $ 294 ======= =======
F-37 42 PENTECH INTERNATIONAL INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (The information for the three and nine months ended June 30, 2000 and 1999 is unaudited.) 8. Joint Venture During the quarter ended December 31, 1999, the Company formed a strategic partnership with a manufacturer in Shanghai, China with the purpose of developing and manufacturing both existing products and many of the Company's new products in development. The terms of the joint venture provide for Pentech to receive cash for some of its manufacturing equipment and obtain a 50% ownership in the new entity being formed in China. In addition, there are costs associated with the relocation of the Company's domestic manufacturing facility. As of June 30, 2000, the Company has shipped approximately $1,462,000 worth of equipment and inventory and incurred relocating costs of approximately $839,000. F-38 43 UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS The following unaudited pro forma consolidated financial statements as of June 30, 2000 and for the six months ended June 30, 2000 and for the year ended December 31, 1999 give effect to the acquisition of Pentech International. The pro forma consolidated balance sheet presents our financial position as if the acquisition of Pentech International had occurred on June 30, 2000. The pro forma consolidated statements of operations present our results as if the acquisition of Pentech International had occurred on January 1 of each period presented. Our fiscal year end is December 31 and Pentech Internationals' fiscal year end is September 30. Our second quarter for our current fiscal year ended June 30, 2000, while the third quarter of Pentech Internationals' fiscal year ended June 30, 2000. The pro forma consolidated balance sheet as of June 30, 2000 is based upon our historical balance sheet as of June 30, 2000 which has been adjusted for the effects of the Pentech International acquisition. The pro forma consolidated statement of operations for the six months ended June 30, 2000 is based upon our historical results and the pro forma statement of operations for Pentech International for the six months ended June 30, 2000. The pro forma consolidated statement of operations for the year ended December 31, 1999 is based on our historical statement of operations and the pro forma statement of operations of Pentech International for the year ended December 31, 1999. The pro forma consolidated financial statements include, in management's opinion, all material adjustments necessary to reflect the acquisition of Pentech International. The pro forma consolidated financial statements do not represent the Company's actual results of operations, including the acquisitions, nor do they purport to predict or indicate our financial position or results of operations at any future date or for any future period. The pro forma consolidated financial statements should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," our consolidated financial statements and the related notes thereto and Pentech Internationals' financial statements and the related notes thereto included elsewhere herein. F-39 44 JAKKS PACIFIC, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET JUNE 30, 2000
HISTORICAL PRO FORMA PRO FORMA JAKKS ADJUSTMENTS BALANCE SHEET ASSETS CURRENT ASSETS Cash and cash equivalents................. $ 65,777,215 $(30,704,896)(1) $35,072,319 Marketable securities..................... 28,045,705 -- 28,045,705 Accounts receivable, net.................. 45,253,165 21,307,000(2) 66,560,165 Inventory, net............................ 19,640,391 14,215,000(2) 33,855,391 Prepaid expenses and other current assets................................. 3,214,020 3,780,000(2) 6,994,020 ------------ ------------ ------------ Total current assets............. 161,930,496 8,597,104 170,527,600 ------------ ------------ ------------ Property and equipment, at cost............. 21,736,186 2,232,000(2) 23,968,186 Less accumulated depreciation and amortization.............................. 7,796,954 -- 7,796,954 ------------ ------------ ------------ Property and equipment, net...... 13,939,232 2,232,000 16,171,232 ------------ ------------ ------------ Notes receivables - Officers................ 3,250,000 -- 3,250,000 Goodwill, net............................... 45,190,119 8,157,896(3) 53,348,015 Trademarks, net............................. 12,368,897 -- 12,368,897 Investment in joint venture................. 2,358,885 150,000(4) 2,508,885 Other....................................... 1,153,741 -- 1,153,741 ------------ ------------ ------------ Total assets..................... $240,191,370 $ 19,137,000 $259,328,370 ============ ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable and accrued expenses..... $ 34,605,966 $ 5,850,000(4) $ 40,455,966 Short term debt........................... -- 11,637,000(4) 11,637,000 Current portion of long term debt -- 300,000(4) 300,000 Income taxes payable...................... 3,669,104 -- 3,669,104 ------------ ------------ ------------ Total current liabilities........ 38,275,070 17,787,000 56,062,070 ------------ ------------ ------------ Long term debt.............................. -- 1,350,000(4) 1,350,000 Deferred income taxes....................... 826,020 -- 826,020 ------------ ------------ ------------ Total liabilities................ 39,101,090 19,137,000 58,238,090 ------------ ------------ ------------ Commitments STOCKHOLDERS' EQUITY Preferred stock........................... -- -- -- Common stock.............................. 19,413 -- 19,413 Additional paid-in capital................ 155,921,232 -- 155,921,232 Retained earnings......................... 45,149,635 -- 45,149,635 ------------ ------------ ------------ Total stockholders' equity....... 201,090,280 -- 201,090,280 ------------ ------------ ------------ Total liabilities and stockholders' equity........... $240,191,370 $ 19,137,000 $259,328,370 ============ ============ ============
See notes to unaudited pro forma consolidated financial statements. F-40 45 JAKKS PACIFIC, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1999
PRO FORMA PRO FORMA ACTUAL COMBINED ADJUSTMENTS RESULTS ---------------------------- PENTECH JAKKS INTERNATIONAL (AUDITED) (UNAUDITED) Net sales....................... $183,685,124 $60,666,084 $244,351,208 $ -- $244,351,208 Cost of sales................... 107,601,639 41,292,037 148,893,676 -- 148,893,676 ------------ ----------- ------------ ----------- ------------ Gross profit.................... 76,083,485 19,374,047 95,457,532 -- 95,457,532 Selling, general and administrative expenses....... 51,154,627 18,483,990 69,638,617 589,577 (5) 70,228,194 ------------ ----------- ------------ ----------- ------------ Income from operations.......... 24,928,858 890,057 25,818,915 (589,577) 25,229,338 Other (income) expense.......... (5,374,835) 1,602,666 (3,772,169) (347,417)(6) (4,119,586) ------------ ----------- ------------ ----------- ------------ Income before provision for income taxes.................. 30,303,693 (712,609) 29,591,084 (242,160) 29,348,924 Provision for income taxes...... 8,333,844 -- 8,333,844 (381,908)(7) 7,951,936 ------------ ----------- ------------ ----------- ------------ Net income...................... $ 21,969,849 $ (712,609) $ 21,257,240 $ 139,748 $ 21,396,988 ============ =========== ============ =========== ============ Basic earnings per share........ $ 1.51 ============ Weighted average shares outstanding................... 13,879,304 ============ Diluted earnings per share...... $ 1.36 ============ Weighted average shares and equivalents outstanding....... 15,839,679 ============
SIX MONTHS ENDED JUNE 30, 2000 (UNAUDITED)
PRO FORMA PRO FORMA ACTUAL COMBINED ADJUSTMENTS RESULTS ------------------------------ PENTECH JAKKS INTERNATIONAL Net sales........................ $101,359,796 $33,953,000 $135,312,796 $ -- $135,312,796 Cost of sales.................... 59,508,310 22,602,000 82,110,310 -- 82,110,310 ------------ ----------- ------------ --------- ------------ Gross profit..................... 41,851,486 11,351,000 53,202,486 -- 53,202,486 Selling, general and administrative expenses........ 31,131,931 10,104,000 41,235,931 294,789 (5) 41,530,720 ------------ ----------- ------------ --------- ------------ Income from operations........... 10,719,555 1,247,000 11,966,555 (294,789) 11,671,766 Other (income) expense........... (7,873,050) 1,065,000 (6,808,050) (169,000)(6) (6,977,050) ------------ ----------- ------------ --------- ------------ Income before provision for income taxes................... 18,592,605 182,000 18,774,605 (125,789) 18,648,816 Provision for income taxes....... 5,752,411 -- 5,752,411 22,484 (7) 5,774,895 ------------ ----------- ------------ --------- ------------ Net income....................... $ 12,840,194 $ 182,000 $ 13,022,194 $(148,273) $ 12,873,921 ============ =========== ============ ========= ============ Basic earnings per share......... $ 0.67 ============ Weighted average shares outstanding.................... 19,334,289 ============ Diluted earnings per share....... $ 0.63 ============ Weighted average shares and equivalents outstanding........ 20,340,462 ============
See notes to unaudited pro forma consolidated financial statements F-41 46 NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS The unaudited pro forma consolidated financial statements have been adjusted for the items relating to the acquisition of Pentech International as set forth below: BALANCE SHEET (1) Cash paid on or about the closing of the Pentech International acquisition: Cash paid to stockholders and option holders........... $20,429,896 Settlement of certain indebtedness..................... 10,000,000 Other acquisition costs................................ 275,000 ----------- $30,704,896 ===========
(2) Assets acquired in the Pentech International acquisition (3) Excess of consideration paid over fair market value of Pentech International assets acquired (4) Liabilities assumed in the Pentech International acquisition STATEMENTS OF OPERATIONS
PRO FORMA PRO FORMA SIX MONTHS YEAR ENDED ENDED JUNE 30, DECEMBER 31, 1999 2000 (5) Selling, general and administrative expenses are adjusted to reflect: Fees payable pursuant to supplemental and consulting services agreements entered into between certain sellers of Pentech International and JAKKS........................ $ 317,647 $ 158,824 Amortization of goodwill....... 271,930 135,965 ----------- ----------- $ 589,577 $ 294,789 =========== =========== (6) Other (income) expense is adjusted to reflect the elimination of interest expense related to borrowings made by Pentech International as if they had been repaid on January 1, 1999 $ 347,417 $ 169,000 =========== =========== (7) Provision for income taxes is adjusted to reflect the tax effect of the pro forma adjustments..................... $ (381,908) $ 22,484 =========== ===========
F-42 47 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. Dated: October 11, 2000 JAKKS PACIFIC, INC. By: /s/ Joel M. Bennett ----------------------------------- Joel M. Bennett Executive Vice President 48 EXHIBIT INDEX
Exhibit Number Description ------- ----------- 2.1 Agreement of Merger dated as of May 22, 2000 among JAKKS Pacific, Inc., JAKKS Acquisition II, Inc. and Pentech International Inc.(1) 2.2 First Amendment dated as of July 13, 2000 to Agreement of Merger(1) 2.3 Voting and Lock-Up Agreement dated May 22, 2000 among JAKKS Pacific, Inc. and certain stockholders of Pentech International Inc.(1) 10.1 Loan and Security Agreement dated as of January 13, 1997 among Pentech International Inc., certain subsidiaries thereof and Bank of America, N.A. (formerly BankAmerica Business Credit, Inc.)(2) 10.2 Waiver and First Amendment dated as of January 11, 1999 to Loan and Security Agreement(3) 10.3 Waiver, Consent and Second Amendment dated as of December 20, 1999 to Loan and Security Agreement(4) 10.4 Consent, Waiver and Third Amendment dated as of July 27, 2000 to Loan and Security Agreement(1) 23.1 Consent of Ernst & Young LLP(5)
--------------------- (1) Previously filed (2) Incorporated by reference to exhibit 10.7 of the Annual Report on Form 10-K of Pentech International Inc. for its fiscal year ended September 30, 1996 (3) Incorporated by reference to exhibit 10.5 of the Annual Report on Form 10-K of Pentech International Inc. for its fiscal year ended September 30, 1998 (4) Incorporated by reference to exhibit 10.6 of the Annual Report on Form 10-K of Pentech International Inc. for its fiscal year ended September 30, 1999 (5) Filed herewith