-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NToBt7GJ1opmtwCXVrWSNj0b1NFfSxbYrzEy4ixXnWThz/8WSSJMPQ2BbktnWjrU 08E7Br/juiS1qIRO/44Muw== 0000806384-99-000002.txt : 19990114 0000806384-99-000002.hdr.sgml : 19990114 ACCESSION NUMBER: 0000806384-99-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PENTECH INTERNATIONAL INC CENTRAL INDEX KEY: 0000760461 STANDARD INDUSTRIAL CLASSIFICATION: PENS, PENCILS & OTHER ARTISTS' MATERIALS [3950] IRS NUMBER: 232259391 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-15374 FILM NUMBER: 99505500 BUSINESS ADDRESS: STREET 1: 195 CARTER DRIVE CITY: EDISON STATE: NJ ZIP: 08817 BUSINESS PHONE: 9082876640 MAIL ADDRESS: STREET 2: 195 CARTER DR CITY: EDISON STATE: NJ ZIP: 08817 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file No. 0-15374 PENTECH INTERNATIONAL INC. (Exact Name of Registrant as Specified in Charter) Delaware 23-2259391 (State or other jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 195 Carter Drive, Edison, New Jersey 08817 (Address of principal executive offices (Zip Code) Registrant's telephone number, including area code (732) 287-6640 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) Indicate by check mark whether the registrant (i) 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 (ii) 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 [X] The aggregate market value of the shares of Common Stock held by non- affiliates of the registrant on December 21, 1998, was approximately $7,408,269 based on the average of the bid and asked quotations of the registrant's Common Stock, par value $.01 share, as reported by NASDAQ on December 21, 1998. On December 21, 1998, there were outstanding 12,570,258 shares of the registrant's Common Stock. The Proxy Statement of the registrant to be filed on or before January 29, 1999 is incorporated herein by reference. PART I Item 1. BUSINESS. (a) Pentech International Inc. (the "Company") was formed in April 1984 to design and market writing and drawing instruments and other stationery products. In November 1989, the Company formed a wholly-owned subsidiary, Sawdust Pencil Co. ("Sawdust"), to manufacture certain of the Company's writing instruments. The Company and its wholly-owned subsidiaries are collectively referred to herein as the "Company." (b) 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. For financial information relating to this business segment, please refer to the financial statements contained elsewhere herein. (c) The Company's product line consists of pens, markers, pencils, activity products and miscellaneous products. These products compete on the basis of special features, packaging design, quality and price, or a combination of these characteristics. The Company believes its reputation and ability to develop innovative products and marketing programs for its products, through the industry experience and marketing expertise of its management, are principal success factors. The Company has also had an ongoing program to secure select license agreements with licensors of established trademarks to utilize with certain of the Company's products. The Company views its licenses as an important ingredient in offering a strong product line with strong consumer appeal. (i) The Company markets its product line on a direct basis as well as through approximately 100 independent, nonexclusive, sales representatives throughout the United States. Generally sales initiated by the sales representatives are made directly to retail chains including mass merchants, chain drug stores, grocery stores, warehouse clubs, and office supply super stores. The Company also has limited sales to the stationery, military and college store markets and some sales through distributors and wholesalers. Additionally, the Company sells its products in Canada, Europe, Mexico and other selected countries, generally through a variety of distribution arrangements. The percentages of revenues contributed by the following classes of products over the Company's last three fiscal years are as follows: Activity Miscellaneous Pens Markers Pencils Products Products FY 1996 21.1% 21.7% 36.4% 16.0% 4.8% FY 1997 27.8% 19.2% 33.4% 14.4% 5.2% FY 1998 18.8% 26.5% 42.0% 11.7% 1.0% (ii) The Company conducts market research to stay abreast of consumer trends and to gauge the demand for new writing instruments and related products. Once the Company identifies a product for marketplace introduction it either selects a suitable overseas manufacturer to manufacture the product or elects to manufacture the product itself. The Company's domestic pencil and marker manufacturing facility, Sawdust, is presently being utilized by the Company to manufacture a significant portion of the Company's writing instruments. Sawdust's capacity (on a two shift basis) is approximately $34,500,000 (wholesale value) of pencils, markers and other writing instruments. During the Company's fiscal year ended September 30, 1998 ("Fiscal 1998"), the Company manufactured approximately $23,926,000 wholesale value of products at Sawdust, which represents 69% of its current capacity and approximately 42% of the Company's current sales requirements. During its fiscal year ended September 30, 1997 ("Fiscal 1997"), the Company manufactured 39% of the wholesale value of the products it sold. An important part of the product development process is packaging. The Company leverages its unique packaging style to reinforce its image as a marketer of modern, well-designed, high quality, and reasonably priced writing instruments and children's activity products. (iii) The Company utilizes foreign manufacturers to supply a large percentage of the products it sells. It acquires a majority of its products from contract manufacturers located in Taiwan, China, Korea, Italy, India and other foreign countries. Such products are manufactured to the Company's order. The Company generally acquires its imported products pursuant to purchase orders, which typically provide for delivery within 60 to 90 days after the order. Prior to fiscal 1997, the Company financed a large percentage of its purchases pursuant to letters of credit. The present policy is to establish with a majority of its vendors payment terms ranging from 30 to 60 days and finance the remainder pursuant to letters of credit. To date, the Company has experienced limited supply shortages with respect to these imported products. The Company has occasionally incurred additional costs by shipping goods into its warehouse via airfreight, as opposed to by ship when the manufacturers did not timely deliver products or the Company required faster delivery. The Company is unable to predict whether it will experience similar or more severe product shortages in the future. The Company has successfully developed alternative sources of supply for virtually all of its important items to ensure timely deliveries in the event of a disruption in deliveries due to a dispute with any overseas manufacturer or any other reason. The Company has achieved this through building Sawdust and developing multiple sources in Taiwan, China, Korea, Italy, India and other foreign countries. As a result, the loss of any one overseas manufacturer would probably not create any long-term disruptions in the Company's ability to ship its goods to its customers on a timely basis. Management believes that it is not now dependent, upon any one manufacturer for its product lines. It believes that products of quality comparable to its present products could, if necessary, be acquired from a variety of overseas manufacturers at comparable rates. The Company obtains raw materials for Sawdust from domestic and foreign suppliers. It has not faced material supply shortages, and it generally has multiple sources for most of its product requirements. Due to a determination by the United States International Trade Commission that certain manufacturers of Chinese pencils were dumping these pencils in the United States, the Company has been required to pay "Dumping Duties" to acquire pencils from certain of its Chinese suppliers of pencils. The Company has also been developing additional sources for its supply of certain of its pencils, which, to date, it has been successful in doing. In some instances, this has resulted in increased costs to the Company for the wood for its pencils. Recently, certain of the Company's Chinese suppliers of pencils and related products have been the subject of a redetermination which, in certain instances, increased the amount of Dumping Duties the Company has or may be required to pay. The Company has accrued for any additional duties which may arise from this redetermination. (iv) The Company generally markets its products under the individual product's name and either the Company's name or the trademark of one of its licensors. In the event opportunities present themselves which the Company determines are advantageous for it to import certain products in bulk on a private label basis (i.e., store brand), the Company may capitalize on such opportunity. In such event, the Company may request an advance deposit from the customer before effecting such transaction, depending on the credit worthiness of the customer. This, historically, has been a small segment of the Company's business. The Company's marketing efforts include the development of special promotions in connection with purchases of merchandise by certain major chain stores. These promotions often feature advertising allowances, free goods and free displays or permit the sale of several of the Company's products at one favorable price. The funding for these special promotions is substantially derived from the revenues to be received from the sales themselves, and generally the Company is not required to allocate a large portion of its working capital to such efforts. The Company also has designed point of purchase product displays which it offers to its customers. The Company has entered into license agreements with entities such as Lucasfilm, Ltd (Star Wars), The Walt Disney Company (Mickey Mouse and Winnie the Pooh), the NBA (National Basketball Association), the NHL (National Hockey League), the NFL (National Football League), and Coca-Cola Company, using these trademark names on the Company's products. In most situations, the licensor requires an advance royalty, a royalty against net sales for licensed products and a minimum royalty. Generally, the Company satisfies the minimum royalty; occasionally it does not. In such a case, the Company must pay the minimum royalty and possibly incur losses as a result thereof. The Company evaluates its licenses carefully and attempts to minimize such losses. These licenses have terms ranging from one to three years and are renewed by mutual consent from both parties. Except when the Company uses trademarks owned by others, the Company follows a policy of registering with the U.S. Patent and Trademark Office trademarks covering the names of items in its product line and proposed names for new items. The Company has been awarded trademarks in the past. There is no assurance that any pending trademarks will be registered. (v) The business of the Company has certain seasonal aspects. Sales tend to increase during the months of May through August, because retailers buy in anticipation of fall school opening, and to decrease during the months of September through December. The Company has been developing marketing programs to reduce this seasonality. (vi) The Company maintains a warehouse in North Brunswick, NJ, for a portion of its inventory. Generally, the Company does not require any of its customers to post letters of credit or to advance any deposits on orders, except in certain instances, depending upon the creditworthiness of the customer, for special orders. The Company analyzes each special order customer independently to determine whether any deposits should be paid. The Company considers credit rating, location, and amount of order, among other factors, to determine whether a deposit is required. Normal credit terms are "net 30 days." The Company, in certain instances, follows the industry practice of "School Dating," which is the shipment of products from May through August, for which payment is not due until September or October. The Company reviews its credit practices regularly and currently attempts to insure 80% of its receivables through credit insurance. In the past, the Company has experienced a limited amount of bad debts from its customers, usually as a result of a bankruptcy. In such a case the Company's policy has been to liquidate its claims as promptly as reasonable under the circumstances. This has been further ameliorated since the Company obtained credit insurance. The Company believes it has sufficient resources to manage its credit functions. (vii) The Company's primary customers include major mass market retailers in the United States. In Fiscal 1998, one customer accounted for 12% of the Company's revenues. While the loss of this customer could have a material adverse impact upon the Company in the short-term, the Company believes such impact would be minimized in the long-term since the Company could either reduce its expenses related to this customer or sell all or a portion of these products to other customers. Certain of the Company's customers include: - Office Max - Walgreen Drug - Walmart - Eckerd - Target - Staples The above list of customers does not include independent distributors nor products the Company sells to the stationery, military and college store markets. The Company advertises in trade journals on a limited basis and maintains display booths for use at trade shows. It owns several booths that attractively display its line of products for such trade shows. The Company has no current plans for any other major advertising campaign, however it is investigating additional advertising avenues. The Company warrants its merchandise against manufacturing defects. In the event of any such returns the Company evaluates the problem and attempts to rectify the problem for the customer, if possible. The Company believes it maintains adequate product liability insurance. (viii) As of December 16, 1998 and December 11, 1997, the Company's backlog of firm written orders was approximately $1,600,000 and $2,100,000, respectively. This backlog is comprised of the normal delay between receipt and processing of orders and orders for delayed delivery. All orders were delivered or are expected to be filled within the applicable fiscal year. (x) The industry in which the Company is engaged is highly competitive. The Company competes with a large number of companies, including such well-known companies as Bic Pen Company, Papermate, RoseArt Industries, Inc. and Newell. Some of the Company's competitors have far greater financial resources and sales. The Company generally competes on the basis of the special features of its products, quality, packaging design (which includes the individual product's name and the Company's name and logo or the trademark of one of the Company's licensors) and price. (xiii) As of November 30, 1998, the Company had approximately 208 employees. The Company's sales are made primarily by independent sales organizations which are compensated exclusively on a commission basis with commissions ranging from two and one half to seven percent. The Company does not anticipate a substantial increase in the number of its employees in the near future. The Company considers its relations with its employees to be good. 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 expires August 31, 1999. (d) The Company exported approximately 5.8% of its sales, primarily to customers in Canada, Europe and Mexico, during Fiscal 1998. Item 2. PROPERTIES. The Company's present executive offices are located at 195 Carter Drive, Edison, New Jersey 08817, where it occupies general office, sales and warehouse space of approximately 40,500 square feet pursuant to a five year lease, with an unaffiliated party, expiring March 1, 2003. The Company extended its lease for five years commencing June 1, 1995 (the "Sawdust Lease") with an unaffiliated company for approximately 50,000 square feet for Sawdust's premises. These premises are located at 44 National Road, Edison, New Jersey 08817. The Sawdust Lease, which is triple net, currently requires annual rental payment of $179,256 with yearly increment additions in each subsequent year of the Sawdust Lease's term. The Sawdust Lease contains an option to renew on terms providing for moderate increases in rent for up to an additional five years. The Company entered into a five year lease for a warehouse at 1101 Corporate Road, North Brunswick, New Jersey (the "Warehouse Lease") with an unaffiliated company for approximately 130,000 square feet, which commenced on September 1, 1995. The Warehouse Lease provides for annual base rent of approximately $436,000 per year. The Company entered into a year-to-year lease for a sales office in Madison, Wisconsin (the "Madison Lease"). The Madison Lease, which is with an unaffiliated party, is for approximately 1,885 square feet and commenced May 1, 1997. The Madison Lease calls for annual rental of $28,321, which increases by 3.5 percent each subsequent lease year until termination. The Company entered into a month-to-month lease for a studio at 75 Broad Street, Red Bank, New Jersey with an unaffiliated company for approximately 2,400 square feet which commenced on April 1, 1997. The Studio Lease provides for monthly rent of $3,600. Item 3. LEGAL PROCEEDINGS. 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. There are no other legal proceedings to which the Company is a party or known to be contemplated that are deemed material by the Company at the present time, and the Company knows of no material legal proceedings pending or threatened, or judgments entered, against any director or officer of the Company in his capacity as such. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS. Not applicable. PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. (a) The shares of Common Stock are traded on the National Association of Securities Dealers Automatic Quotation System ("NASDAQ") National Market System under the symbol PNTK. The following table shows the closing high and low "bid" prices of these shares as reported by NASDAQ during the Company's last two fiscal years presented on a calendar year basis. Such quotations represent prices between dealers without retail markups, markdowns or commissions and may not represent actual transactions. High Low 1997 1st Quarter 1 3/16 21/32 2nd Quarter 1 3/4 1 1/16 3rd Quarter 2 7/16 1 3/8 4th Quarter 3 1/16 2 5/16 1998 1st Quarter 3 1/16 2 1/2 2nd Quarter 2 31/32 1 1/8 3rd Quarter 2 1 1/8 4th Quarter 1 13/16 15/16 On December 24, 1998, the closing "bid" and "ask" prices for the Common Stock were $.78125 and $.8125 respectively, as reported by NASDAQ. (b) On December 22, 1998, the number of shareholders of record of the Common Stock was 449. The Company is aware that it has a substantial number of additional shareholders who hold their shares of Common Stock in "street name." (c) The Company has not declared a cash dividend in the past and is not permitted to do so without the consent of its lender. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." Item 6. SELECTED FINANCIAL DATA The following summary of financial information should be read in conjunction with the Financial Statements and notes thereto included elsewhere in this Form 10-K. STATEMENT OF OPERATIONS DATA Fiscal Years Ended September 30, ------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- ($ 000s omitted except per share amounts) Net sales $ 57,485 $ 60,806 $ 61,679 $ 54,892 $ 62,136 Net (loss) income (3,504) 600 (5,317) (1,059) 4,701 Basic and diluted net (loss) income per share ($.28) $.05 ($.51) ($.10) $.40 Weighted average number of shares outstanding 12,537 12,297 10,497 10,661 11,855 Dividends - - - - - BALANCE SHEET DATA September 30, 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- ($ 000s omitted) Working capital $ 12,883 $ 15,452 $ 13,676 $ 16,928 $ 21,451 Total assets 41,583 42,503 48,189 44,518 42,558 Notes and bankers' acceptances payable (included in current liabil- ities) 18,618 17,238 22,841 17,011 11,023 Long- term debt 2,000 2,300 2,300 - - Share- holders' equity 14,758 17,591 16,028 21,345 26,479 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Fiscal 1998 Compared to Fiscal 1997 Net sales for Fiscal 1998 were $57,485,045 as compared to $60,806,386 for Fiscal 1997, reflecting a decrease of $3,321,341 or approximately 5.5%. Sales from three of the Company's licensed products were down from the previous year as were sales from promotional and holiday programs. This was offset, in part, by the success of the children's activity products as well as commodity programs. In Fiscal 1998, the Company had a loss from operations of $2,339,443 as compared to income from operations of $2,155,227 in Fiscal 1997. The Company's gross profit of 28.1% in Fiscal 1998 decreased from 34.3% in Fiscal 1997. The Company's gross profit decreased principally due to the decline in licensee products which historically offer higher margins and to a lesser extent to an inventory write-down and the effect of a large return of promotional back-to-school products. The Company also made an investment to gain shelf space for its activity product line through aggressive pricing and various other promotions. The Company's selling, general and administrative ("SG&A") expenses increased during Fiscal 1998 to $18,474,161 from $17,988,791 in Fiscal 1997, reflecting an increase of $485,370. SG&A expenses as a percentage of sales also increased from 29.6% to 32.1%. The increase was primarily related to higher promotional costs associated with the Company's launch of its activity product line to new retail stores. The Company incurred higher bad debt expense as a result of bankruptcies of two customers. The Company also incurred additional costs for the development of products for two of its new licenses. Warehouse and freight expenses also increased as a percentage of sales due to a decline in the average order size as a result of increased sales to the office superstores. Finally, the percentage of SG&A expenses to revenues increased as a result of higher levels of fixed costs incurred but there was lower sales volume. In the second quarter of Fiscal 1998, the Company as part of the settlement of a lawsuit, was awarded $965,000, net of legal fees. During Fiscal 1998, the Company's average level of short-term borrowings remained unchanged from the prior year at approximately $16,000,000. This was due to the sale of assets, related to the cosmetic product line, plus the litigation settlement offset by an increase in inventory levels and the operating loss. The Company's effective interest rate decreased from 8.7% to 8.4%. In addition, interest incurred on the settlement note from the patent infringement lawsuit was lower than the prior year as a result of quarterly principal payments, which began in January 1998. As a result, the Company's interest expense decreased during Fiscal 1998 to $1,528,779 from $1,583,750. During Fiscal 1998, the Company increased its valuation allowance against its deferred tax assets from $965,565 to $2,614,202. The increase of $1,648,637 was recorded due to the uncertainty of the Company's ability to fully utilize federal and state net operating loss carryforwards. Based on the above, the Company recognized a net loss of $3,504,303 in Fiscal 1998 as compared to net income of $600,014 in Fiscal 1997. Fiscal 1997 Compared to Fiscal 1996 Net sales for Fiscal 1997 were $60,806,386 as compared to $61,679,499 for Fiscal 1996, reflecting a decrease of $873,113 or approximately 1.4%. Sales of the Company's children's activity and licensed products lines grew, but this was offset by declines in sales in some of its older product lines which the Company had been deemphasizing. The Company increased its sales through the office superstore channel which were offset by some softness with its traditional mass merchandiser channel. In Fiscal 1997, the Company had income from operations of $2,155,227 as compared to a loss from operations of $872,603 in Fiscal 1996. The Company's gross profit of 34.3% in Fiscal 1997 increased from 30.2% in Fiscal 1996. The Company's gross profit increased primarily due to improved product mix featuring less slower moving items, improved manufacturing costs, improved profitability of its cosmetic line (now discontinued) and higher gross profit on its licensed items. The Company's SG&A expenses decreased during Fiscal 1997 to $17,988,791 from $19,521,690 in Fiscal 1996, reflecting a decrease of $1,532,899. SG&A as a percentage of sales also decreased from 31.7% to 29.6%. This decrease was primarily related to certain non-recurring expenses from the prior year including higher legal and consulting fees due to litigation during that year, a bankruptcy of a customer, higher warehouse costs due to relocation costs of its distribution center and certain relocation costs of key new hires. Offsetting these decreases were higher royalty fees for sales of licensed products and higher software costs used for the Company's computer operating system. In the second quarter of Fiscal 1997, the Company recorded a $687,000 write-down of its cosmetic line to its net realizable value. This was due to the Company's decision to dispose of this product line and focus on its core stationery line of products. As discussed in a subsequent section, the Company reached an agreement to sell this line of business in November 1997. During Fiscal 1997, the Company decreased its short-term borrowings to an average level of $16,080,000 from $18,507,000 in Fiscal 1996. This decrease was due to the decrease in the Company's inventory levels as well as to improved profitability. Offsetting the decline in average borrowings was an increase in interest annual rates under the terms of the Company's new financing arrangement which began in January of 1997. The Company's effective annual interest rate increased from 7.8% to 8.7%. In addition, the Company incurred higher interest costs due to interest on the settlement note payable resulting from settlement of the patent infringement case. As a result, the Company's interest expense increased during Fiscal 1997 to $1,583,750 from $1,447,499. During Fiscal 1997, the Company reduced its valuation allowance against its deferred tax assets $277,626 from $1,243,191 to $965,565 resulting in a net benefit from income taxes. Based on the above, the Company recognized net income of $600,014 in Fiscal 1997 as compared to a net loss of $5,317,408 in Fiscal 1996. (b) Liquidity and Capital Resources Cash and cash equivalents increased to $759,349 at September 30, 1998 from $648,812 at September 30, 1997. Accounts receivable decreased to $14,327,195 at September 30, 1998 from $16,293,286 at September 30, 1997, primarily due to lower fourth quarter sales volume and stronger collection efforts. The Company believes that its allowance for doubtful accounts and its accrual for returns and advertising allowances are adequate given the Company's detailed review of its accounts receivable aging, its review of subsequent cash receipts, its use of credit limits and its on-going credit evaluation and account monitoring. In addition, the Company has credit insurance on most of its major accounts receivable. Inventory increased to $20,015,241 at September 30, 1998 from $18,480,924 the year before. This was due to lower than forecasted sales volume and the Company's decision to stock higher levels of certain commodity products. The decrease to $3,562,283 for equipment at September 30, 1998 from $3,963,831 at September 30, 1997 primarily reflects the sale of the fixed assets related to the Company's cosmetics product line. Notes payable at September 30, 1998 were $18,618,186 as compared to $17,238,066 at September 30, 1997. This was primarily due to the increased inventory levels and funding of the operating loss. Net cash used in operating activities for the Fiscal 1998 was $1,309,440 as compared to $2,352,104 for Fiscal 1997. This change was primarily due to the operating loss, and to a lesser extent, the decrease in accounts receivable and the increase in accounts payable offset by the increase in inventory. Cash used in investing activities during Fiscal 1998 of $9,643 was lower than $911,897 in the prior year due to the decrease in fixed asset additions and the sale of the cosmetic assets. The cash provided by financing activities during Fiscal 1998 was $1,429,620 as compared to cash used in financing activities of $3,150,995 in Fiscal 1997. The increase in cash provided by financing activities was primarily due to the increase in notes payable. As a result of these activities, cash and cash equivalents increased $110,537 during Fiscal 1998 as compared to a decrease of $6,414,996 during Fiscal 1997. The Company's working capital decreased to $12,882,941 at September 30, 1998 from $15,452,308 at September 30, 1997. This decrease was primarily due to the net loss incurred during Fiscal 1998. In January 1997, the Company entered into a three year $30,000,000 revolving credit facility with BankAmerica Business Credit, Inc. ("BABC") (the "Credit Agreement"). The amount of drawings under the facility is subject to limitations based upon eligible inventory and accounts receivable as described in the Credit Agreement. The Credit Agreement is collateralized by a security interest in substantially all of the assets of the Company. In addition, in accordance with the Credit Agreement, the Company has agreed, among other things, to the maintenance of certain minimum amounts of tangible net worth and minimum interest coverage ratios. The Company was in violation of its tangible net worth and interest coverage covenants at March 31, 1998, June 30, 1998 and September 30, 1998, but such violations were waived by BABC. In January 1999, the Company and BABC entered into an agreement to amend the original loan agreement (the "Amendment"). This amendment, among other things, reduced the revolving credit facility to $25,000,000, modified the financial covenants for Fiscal 1999 to allow the Company to be in compliance based upon the Company's operating plan, lowered the maximum inventory advance and allowed for a seasonal over-advance. The note issued in connection with the legal settlement referred to above requires $100,000 quarterly principal payments through April 1, 2004. The Company continued several actions to increase its liquidity during Fiscal 1998. It established a policy of obtaining 30 to 60 days vendor credit to finance a majority of its purchases; previously these purchases had been financed pursuant to letters of credit. It continues to reduce the number of items held in inventory and has taken steps to reduce its headcount. In the second quarter of Fiscal 1997, the Board of Directors voted to dispose of its cosmetics product line and to focus its efforts primarily on its writing instruments business. The main reason for this decision was to better utilize the Company's cash flow towards its writing instruments business. In November 1997, the Company reached an agreement to sell the fixed assets and inventory of its cosmetics product line to Fun Cosmetics, Inc. ("Fun") (a company significantly owned by a former employee) for its net book value of $758,000. This amount was paid during Fiscal 1998. The Company also received 200,000 shares of Common Stock of Fun. As a result of the seasonal nature of the Company's business, the Company's use of credit increases significantly in the months of May, June, July and August as the Company finances its inventory and receivables, and declines in September and October after collection of the invoices from its Back-to-School sales. The Company anticipates that its revolving credit line provided by the Credit Agreement, together with anticipated cash flow from operations, will be sufficient to provide liquidity on both a short-term and long-term basis to finance current and future operations. The Company believes these resources are sufficient to support its operating expenses. With respect to the Year 2000 issue, the Company is in the process of ensuring that all internal computer equipment, manufacturing, distribution and business equipment will be Year 2000 compliant. Upon completion of that review, the Company will make a full assessment of the risk associated with the Year 2000 issue and determine whether the consequences will have a material effect on the Company's business. In addition, if necessary, upon completion of the assessment, the Company will develop a contingency plan. The Company utilizes a third party software package to run its internal operating and accounting systems and has purchased the Year 2000 compliant version of this software and was placed in operation in December 1998. In addition, all telecommunications equipment and computer applications are Year 2000 compliant. The Company is also contacting its vendors and customers in order to asses any third party risk. The Company does not expect the costs associated with becoming Year 2000 compliant to be material and believes that it will be absorbed, for the most part, in its normal information technology budget. (c) Safe Harbor Statement Statements which are not historical facts, including statements about the Company's confidence and strategies and its expectations about new and existing products, technologies and opportunities, market and industry segment growth, demand and acceptance of new and existing products are forward looking statements that involve risks and uncertainties. These include, but are not limited to, product demand and market acceptance risks; the impact of competitive products and pricing; the results of financing efforts; the loss of any significant customers of any business; the effect of the Company's accounting policies; the effects of economic conditions and trade, legal, social, and economic risks, such as import, licensing, and trade restrictions; the results of the Company's business plan and the impact on the Company of its relationship with its lender. Item 8. FINANCIAL STATEMENTS. This information is contained on pages F-1 through F-25 hereof. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III The information required by this section will be incorporated by reference to the Proxy Statement of the Company to be filed with the Securities and Exchange Commission on or before January 29, 1999. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) (1) Financial Statements Page Independent Auditors' Report............................ F-1 Consolidated Balance Sheets as of September 30, 1998 and 1997.................................................... F-2-3 Consolidated Statements of Operations for the years ended September 30, 1998, 1997 and 1996 .......... F-4 Consolidated Statements of Shareholders' Equity for the years ended September 30, 1998, 1997 and 1996....... F-5 Consolidated Statements of Cash Flows for the years ended September 30, 1998, 1997, and 1996.......... F-6-7 Notes to Consolidated Financial Statements.............. F-8-27 (a) (2) Financial Statement Schedules Schedule II - Valuation and Qualifying Accounts and Reserves............................................... F-28 All other schedules are omitted because they are not applicable, not required, or because the required information is included in the financial statements or notes thereto. (a) (3) Exhibits 3.1 The Company's Certificate of Incorporation, as amended, incorporated by reference to Exhibit 3.1 to Registration Statement No. 2-95102-NY of the Company ("Form S-18"). 3.2 The Company's By-laws incorporated by reference to Exhibit 3.2 of Form S-18. 10.1 1989 Stock Option Plan incorporated by reference to Exhibit 4.2 to the Registration Statement No. 33-27009 on Form S-8. 10.2 1993 Stock Option Plan incorporated by reference to Exhibit 4.1 to the Registration Statement No. 33-67802 on Form S-8. 10.3 1995 Stock Option Plan is incorporated by reference to Exhibit 4.1 to the Registration Statement No. 333-30595 filed on Form S-8. 10.4 Loan and Security Agreement dated as of January 13, 1997, among the Company, Pentech Cosmetics, Inc., Sawdust Pencil Co. and BankAmerica Business Credit, Inc. incorporated by reference to Exhibit 10.7 of the Company's Form 10-K Annual Report for it fiscal year ended September 30, 1996. 10.5 Waiver and First Amendment to Loan and Security Agreement among the Company, Pentech Cosmetics, Inc., Sawdust Pencil Co. and BankAmerica Business Credit, Inc. dated as of January 11, 1999. 10.6 Agreement for Sale and Purchase of Assets dated as of November 1997, among the Company, Pentech Cosmetics, Inc., Fun Cosmetics, Inc. and David Blau incorporated by reference to Exhibit 10.11 of the Company's Form 10-K Annual Report for its fiscal year ended September 30, 1997. 10.7 Settlement Agreement dated March, 1998 between the Company, Cooper & Dunham, L.L.P. and Lewis H. Esligner. 10.8 Subsidiaries of the Company. 11.0 Consent of Ernst & Young LLP dated January 11, 1999. 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. PENTECH INTERNATIONAL, INC. January 12, 1999 By: s/David Melnick David Melnick, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons in the capacities and on the dates indicated. s/ Norman Melnick Chairman of the Board January 12, 1999 Norman Melnick of Directors s/ David Melnick President and Chief January 12, 1999 David Melnick Executive Officer and Director (principal operating officer) s/ John F. Kuypers Executive Vice President- John F. Kuypers Sales and Director January 12, 1999 s/ Richard S. Kalin Secretary and Director January 12, 1999 Richard S. Kalin s/ Roy L. Boe Director January 12, 1999 Roy L. Boe s/ Robert K. Semel Director January 12, 1999 Robert Semel s/ William Visone (principal accounting January 12, 1999 William Visone officer) N:\ANNE\PTK\10K-98.10 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, 1998 and 1997 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended September 30, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule 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, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects the information set forth therein. s/ERNST & YOUNG LLP ERNST & YOUNG LLP MetroPark, New Jersey December 21, 1998, except for Notes 3 (b) and 13 as to which the date is January 11, 1999. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Balance Sheets Assets (Note 3) September 30, 1998 1997 ---- ---- Current Assets: Cash and cash equivalents $ 759,349 $ 648,812 Accounts receivable, net of allowance for doubtful accounts ($128,814 and $30,087 in 1998 and 1997, respect- ively) 14,327,195 16,293,286 Inventory (Note 2) 20,015,241 18,480,924 Income taxes receivable (Note 5) 448,087 422,446 Deferred tax assets (Note 5) - 271,180 Prepaid expenses and other 1,436,415 1,648,035 Available-for-Sale Security (Notes 1 and 13) 621,875 - ---------- ---------- Total current assets 37,608,162 37,764,683 ---------- ---------- Equipment: Equipment and furniture 8,934,327 8,895,443 Less accumulated depreciation (5,372,044) (4,931,612) ---------- ---------- 3,562,283 3,963,831 ---------- ---------- Other assets: Deferred tax assets, long term (Note 5) - 363,835 Trademarks, net of amortization 239,530 269,708 Due from officer 173,512 141,512 ---------- ---------- 413,042 775,055 ---------- ---------- $41,583,487 $42,503,569 ========== ========== See accompanying notes. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Balance Sheets Liabilities and Shareholders' Equity September 30, 1998 1997 ----- ---- Current liabilities: Notes payable (Note 3) $18,618,186 $17,238,066 Accounts payable 2,455,073 1,333,605 Accrued expenses (Note 11) 3,351,962 3,440,704 Settlement note payable (Note 8) 300,000 300,000 ---------- ---------- Total current liabilities 24,725,221 22,312,375 ---------- ---------- Other liabilities: Royalty payable, long-term (Note 8) 100,000 300,000 Settlement note payable, long-term (Note 8) 2,000,000 2,300,000 ---------- ---------- 2,100,000 2,600,000 ---------- ---------- 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 12,570,258 and 12,504,258 in 1998 and 1997, respectively 125,703 125,043 Capital in excess of par 6,837,983 6,789,143 Retained earnings 7,172,705 10,677,008 Unrealized gain on available-for- sale security (Notes 1 and 13) 621,875 - ---------- ---------- 14,758,266 17,591,194 ---------- ---------- $41,583,487 $42,503,569 ========== ========== See accompanying notes. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Statements of Operations Year ended September 30, 1998 1997 1996 ---- ---- ---- Net sales (Note 9) $57,485,045 $60,806,386 $61,679,499 Cost of sales 41,350,327 39,975,368 43,030,412 ---------- ---------- ---------- Gross profit 16,134,718 20,831,018 18,649,087 Selling, general and administrative expenses 18,474,161 17,988,791 19,521,690 Loss from cosmetics operation (Note 7) - 687,000 - ---------- ---------- ---------- (Loss) income from operations (2,339,443) 2,155,227 (872,603) ---------- ---------- ---------- Other (income) expense: (Income) loss from litigation (Note 14) (965,542) - 4,433,920 Interest expense 1,528,779 1,583,750 1,447,499 Interest income (33,392) (9,660) (39,661) ---------- ---------- ---------- 529,845 1,574,090 5,841,758 ---------- ---------- ---------- (Loss) income before taxes (2,869,288) 581,137 (6,714,361) Income tax expense (benefit) (Note 5) 635,015 (18,877) (1,396,953) ---------- ---------- ---------- Net (loss) income $(3,504,303) $ 600,014 $ (5,317,408) ========== ========== ========== Basic and diluted (loss) earnings per common share (Note 1) ($.28) $.05 ($.51) ========== ========== ========== See accompanying notes. Pentech International, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity Years ended September 30, 1998, 1997 and 1996 Common Stock Capital Unrealized Gain Number of Shares in on Available- Excess Retained for-Sale Authorized Issued Amount of Par Earnings Security ---------- ------ ------ ------- -------- ------------- Balance, September 30, 1995 20,000,000 10,496,758 $104,968 $5,845,781 $15,394,402 $ - Net loss (5,317,408) ---------- ---------- ------- --------- ---------- ------------- 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 ---------- ---------- ------- --------- ---------- ------------- Balance, September 30, 1997 20,000,000 12,504,258 125,043 6,789,143 10,677,008 - Issuance of Common Stock 66,000 660 48,840 Net loss (3,504,303) Unrealized gain on available-for-sale security 621,875 Balance, September 30, ---------- ---------- ------- --------- --------- ------------ 1998 20,000,000 12,570,258 $125,703 $6,837,983 $ 7,172,705 $621,875 ========== ========== ======= ========= ========= ============ See accompanying notes.
PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Year ended September 30, 1998 1997 1996 Cash flows from operating -------- -------- --------- activities Net (loss) income $ (3,504,303) $ 600,014 $(5,317,408) Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation and amortiza- tion 1,042,795 1,099,627 1,044,920 Provision for losses on accounts receivable 134,974 15,401 401,620 Paradise Settlement - - 4,000,000 Deferred income taxes 635,015 290,099 (699,701) Provision for loss from cosmetics operation - 687,000 - Change in assets and liabilities: Decrease (increase) in accounts receivable 1,746,117 (1,771,187) (2,488,160) (Increase) decrease in inventory (1,957,743) (152,916) 4,116,474 Decrease (increase) in prepaid expenses and other 118,620 (605,228) 184,622 (Increase) in due from officer (32,000) (32,001) - (Decrease) in bankers' acceptances payable - (1,488,757) (353,228) Increase (decrease) in accounts payable 1,121,468 (331,698) (789,706) (Decrease) increase in accrued expenses (88,742) (386,426) 713,405 (Decrease) in settlement payables (500,000) (1,000,000) - Change in income taxes payable/ receivable (25,641) 723,968 676,627 -------- ---------- --------- Net cash (used in) provided by operating activities (1,309,440) (2,352,104) 1,489,465 See accompanying notes. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (cont'd) Year ended September 30, 1998 1997 1996 Cash flows from investing ---- ---- ---- activities Sale of cosmetics assets 758,426 - - Purchase of equipment and furniture (697,884) (793,006) (488,176) Increase in trademarks (70,185) (118,891) (120,876) ------- --------- --------- Net cash used in investing (9,643) (911,897) (609,052) activities Cash flows from financing activities Net increase (decrease) in notes payable 1,380,120 (4,114,432) 6,183,395 Proceeds from the issuance of Common Stock 49,500 963,437 Net cash provided --------- --------- ---------- by (used in) financing activities 1,429,620 (3,150,995) 6,183,395 Net increase (decrease) --------- --------- --------- in cash and cash equi- valents 110,537 (6,414,996) 7,063,808 Cash and cash equivalents, beginning of year 648,812 7,063,808 0 Cash and cash equivalents, --------- --------- --------- end of year $ 759,349 $ 648,812 $7,063,808 ========= ========= ========= Supplemental disclosures of cash flow information Non-cash investing activities: Increase in fair value of available for sale equity security $ 621,875 Purchase of fixed assets by capital lease $ 72,050 Cash paid during the year for: Interest $1,454,840 1,773,920 $1,319,958 Income taxes - 30,931 140,000 See accompanying notes. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements September 30, 1998 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. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1998 1. Summary of Significant Accounting Policies (cont'd) 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. 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 where appropriate, restated to conform to the SFAS No. 128 requirements. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1998 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, 1998 1997 1996 Numerator: Net (loss) income $(3,504,303) $600,014 $(5,317,408) ========== ======= ========= Denominator: Denominator for basic earnings per share- weighted average shares 12,537,258 12,297,124 10,496,758 Effect of dilutive securities: Employee stock options 0 194,043 0 ---------- ---------- ---------- Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions: 12,537,258 12,491,167 10,496,758 ========== ========== ========== Basic and diluted (loss) income per share ($.28) $.05 ($.51) ========== ========== ========== PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1998 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. Impact of Recently Issued Accounting Standards In June 1997, the Financial Accounting Stands Board issued Statement of Financial Accounting Standards No. 130 "Reporting Comprehensive Income" ("SFAS No.130"), which is effective for years beginning after December 15, 1997. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gain, and losses) in a full set of general- purpose financial statements. This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company will adopt the new requirements in Fiscal 1999. The adoption of this statement would have resulted in the Company reporting $621,875 of additional comprehensive income to its existing net loss of $3,504,303, resulting in a net comprehensive loss of $2,882,428 for the fiscal year ended September 30, 1998. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 "Disclosures about Segments of an Enterprise and Related Information" which is effective for years beginning after December 15, 1997 and 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, 1998. The Company has completed its review of both SFAS 131 and SFAS 133 and has concluded that the adoption of these statements would not have any effect on the Company and its reporting. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1998 2. Inventory 1998 1997 Raw materials $ 6,634,833 $6,245,696 Work-in-process 1,641,162 1,579,274 Finished goods 12,849,246 11,865,954 Allowance for slow- moving items (1,110,000) (1,210,000) ---------- ---------- $20,015,241 $18,480,924 ========== ========== 3. Notes Payable 1998 1997 Revolving line of credit interest payable monthly at prime plus .5% (9% at September 30, 1998 and 1997) $ 4,618,186 $ 4,238,066 Revolving line of credit, interest payable monthly at libor plus 2.5% (ranging from 7.813% to 8.188% at September 30, 1998 and 8.128% at September 30, 1997) 14,000,000 13,000,000 ---------- ---------- $18,618,186 $17,238,066 ========== ========== PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1998 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. (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. Borrowing under the Credit Agreement accrues 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, interest coverage ratios and cannot declare a cash divided without the consent of BankAmerica Business Credit, Inc. The Company was in violation of its tangible net worth and interest rate coverage covenants at March 31, 1998, June 30, 1998 and September 30, 1998. (b) On January 11, 1999, the Company and BABC further entered into an agreement to amend the original loan agreement ("the Amendment"). This amendment, among other things, waived compliance with the aforementioned violated covenants, reduced the revolving credit facility to $25,000,000, modified the financial covenants for Fiscal 1999 to allow the Company to be in compliance based upon the current operating plan, lowered the maximum inventory advance and allowed for a seasonal over-advance. The weighted average interest rate during the periods on the outstanding short-term borrowings was 8.4% and 8.7% for fiscal years ended September 30, 1998 and 1997, 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, 175,000 shares were cancelled. During Fiscal 1996, the Company granted options covering in the aggregate 175,000 shares of common stock at an exercise price of $3.125 per share (representing fair market value at date of grant). During these periods, no options were exercised. At September 30, 1998, 195,000 options remain outstanding at prices ranging from $1.19 to $3.125 per share, of which all are presently exercisable. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) 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 will terminate on January 5, 1999. 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. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 4. Shareholders' Equity (cont'd) The table below presents option information for the 1989 Plan: Year ended Year ended Year ended Sept. 30, 1998 Sept. 30, 1997 Sept. 30, 1996 Price range Shares Price range Shares Price range Shares ----------- ------ ----------- ------ ----------- ------ Outstanding, beginning of year $0.75 285,600 $3.125-7.875 351,000 $4.00-$7.875 392,000 Options granted 1.50-2.875 105,000 0.75 285,600 3.125 180,000 Cancelled 0.75 (72,000) 3.125-7.875 (351,000) 4.00-6.50 (221,000) Exercised 0.75 (48,000) ----------- ------- ----------- -------- ---------- ------- Outstanding, end of year $0.75-2.875 270,600 0.75 285,600 $3.125-7.875 351,000 ----------- ------- ----------- ------- ----------- ------- Eligible for exercise currently $0.75 51,200 - - $4.50-7.875 118,600 ========== ======= =========== ======= ============ =======
PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1998 4. Shareholders' Equity (cont'd) The table below presents option information for the 1993 Plan: Year ended Year ended Year ended Sept. 30, 1998 Sept. 30, 1997 Sept. 30, 1996 Price range Shares Price range Shares Price Range Shares ----------- ------ ----------- ------ ----------- ------ Outstanding, beginning of year $0.75-5.50 440,500 $3.125-6.125 647,500 $4.50-6.125 668,750 Options granted - - 0.75 -0.875 385,500 3.125 20,000 Cancelled 0.75-4.50 (112,000) 3.125-6.125 (592,500) 4.50-6.125 (41,250) Exercised 0.75 ( 18,000) --------- ------- ----------- ------- ----------- ------- Outstanding, end of year $0.75-5.50 310,500 0.75 -5.50 440,500 $3.125-6.125 647,500 ========= ======= =========== ======= =========== ======= Eligible for exercise currently $0.75-5.50 96,000 $4.50 -5.50 43,000 $4.50-6.125 301,500 ========= ======= =========== ======= =========== =======
PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (cont'd) September 30, 1998 4. Shareholders' Equity (cont'd) The table below presents option information for the 1995 Plan: Year Ended Year Ended Year Ended Sept. 30, 1998 Sept. 30,1997 Sept. 30, 1996 Price range Shares Price range Shares Price range Shares ----------- ------ ----------- ------ ----------- ------ Outstanding, beginning of year $0.75-2.9375 123,000 $3.00 10,000 - - Options granted 1.625-1.688 9,500 0.75-2.9375 123,000 $3.00 10,000 Cancelled 1.4375-2.9375 (57,498) 3.00 (10,000) Exercised - - - - - - ------------- ------ ----------- ------- ----- ------ Outstanding, end of year $ 0.75-2.9375 75,002 $0.75-2.9375 123,000 $3.00 10,000 ============ ====== =========== ======= ===== ====== Eligible for exercise currently $ 0.75-2.9375 29,750 1.4375 12,000 - - =========== ====== =========== ======= ===== ======
PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 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 4.34% Expected dividend yield 0% Expected stock price volatility .658% Expected life of options 3-5 years The weighted average fair value of options granted during Fiscal 1998 and Fiscal 1997 is $.74 and $.78 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): PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 4. Shareholders' Equity (cont'd) Sept. 30, 1998 Sept. 30, 1997 As reported Pro forma As reported Pro forma Net (loss) income ($3,504) ($3,594) $ 600 $ 491 (Loss) earnings per share ($ .28) ($ .29) $ .05 $ .04 PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 5. Income Taxes 1998 1997 1996 ---- ---- ---- Expense/(Benefit) Federal: Current $ - $(309,276) $ (697,252) Deferred 349,002 273,730 (421,047) State: Current - 300 - Deferred 286,013 16,369 (278,654) ------- ------- --------- $ 635,015 $ (18,877) $(1,396,953) ======= ======= ========= Reconciliations of the statutory federal income tax rate of 34% to the effective tax rates are as follows: 1998 1997 1996 ---- ---- ---- Statutory tax rate (34.00%) 34.00% (34.00%) State income taxes, net of federal tax (benefit) expense (4.84%) 1.86 (6.00) IRS audit adjustment 5.32 Permanent differences 1.37% 9.99 Increase (decrease) in valuation allowance 57.46% (47.77%) 18.5% Other 2.14% (6.65%) .7% ------ ----- ----- Effective tax rate 22.13% (3.25%) (20.80%) ====== ===== ===== PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 5. Income Taxes (cont'd) Significant components of the Company's deferred tax assets and liabilities as of September 30, 1998 and 1997 are as follows: September 30, 1998 1997 ---- ---- Current deferred tax liability: State taxes on deferred federal items $ (68,687) $ (149,823) ------ ------- Current deferred tax assets: Bad debts 55,390 12,938 Inventory reserve 477,300 520,300 Reserve for returns and allowances 303,528 313,042 Unicap 7,787 12,813 Cosmetics fixed asset reserve 123,410 ------- ------- Total current deferred tax assets 844,005 982,503 Valuation allowance on current deferred tax assets (775,318) (561,500) ------- ------- 68,687 421,003 ------- ------- Net current deferred tax assets $ - $ 271,180 ======= ======= Long-term deferred tax liabilities: Depreciation $(932,290) $ (832,800) ------- ------- Long-term deferred tax assets: Reserve for litigation 1,053,500 1,290,000 State net operating loss carryforwards 535,598 310,700 Federal net operating loss carry- forward 1,182,076 - --------- --------- Total long-term deferred tax assets 2,771,174 1,600,700 Valuation allowance on long-term deferred tax assets (1,838,884) (404,065) --------- -------- 932,290 1,196,635 --------- --------- Net long-term deferred tax assets $ - $ 363,835 ========= ======== PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 5. Income Taxes (cont'd) The Company has generated state net operating loss carryforwards of $5,951,094, which will expire in varying amounts beginning on September 30, 2001. The Company has also generated a federal net operating loss carry-forward of $3,476,694, which will expire on September 30, 2013. In 1996, the Company recorded a valuation allowance of $1,243,191 against deferred tax assets due to the uncertainty of its ability to recognize a full tax benefit for future payments against the litigation reserve and its ability to fully utilize the state net operating loss carry-forwards. 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. 6. Commitments and Contingencies Letters of Credit The Company was contingently liable for outstanding letters of credit of $53,520 at September 30, 1998. Leases Rent expense for the years ended September 30, 1998, 1997 and 1996 amounted to $1,056,934, $1,024,491 and $940,650 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 Company and it contains two options to renew for two five year periods. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 6. Commitments and Contingencies (cont'd) Future minimum rental payments under operating leases are as follows: 1999 $785,364 2000 715,268 Thereafter 413,368 --------- $1,914,000 ========= 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 expires August 31, 1999. As of September 30, 1998, 49% of the Company's employees were members of the Union. 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 reflects the write-down of certain assets of this operation to their estimated net realizable value (Note 13). PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 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 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 were made in December 1997 and in April, July and October 1998. The Company also has paid $200,000 against the minimum royalty. 9. Major Customer and Concentration of Credit Risk For the years ended September 30, 1998, 1997 and 1996, the Company had one customer who accounted for 12%, 13% and 11%, 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 adopted a defined contribution 401(k) plan effective April 1, 1993, 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, 1998, 1997, 1996 the Company contributed $32,558, $36,273 and $16,941, respectively. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 11. Accrued Expenses September 30, 1998 1997 ---- ---- Accrued returns and advertising rebates $ 1,878,847 $1,833,450 Accrued royalties 346,940 637,477 Other accrued expenses 1,126,175 969,777 --------- --------- $ 3,351,962 $3,440,704 ========= ========= 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 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, 1998, the value of this stock (based on quoted market prices) was $3.11 a share. The price as of January 11, 1999 was $4.125 a share. The Company has the right to begin selling its shares in Fun in January 1999. 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. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd) September 30, 1998 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. 15. Fourth Quarter Results (unaudited) The results for the quarter ended September 30, 1998 was impacted by several events including a write down of inventory, a large return of promotional back to school products and, to a lesser extent, foreign exchange losses from its Canadian and European operations and the results of a sales and use tax audit. The gross profit for the fourth quarter was also effected by the decline in licensed products, including the effects from the National Basketball Association lockout. 16. Impact of Year 2000 (unaudited) With respect to the Year 2000 issue, the Company is in the process of ensuring that all internal computer equipment, manufacturing, distribution and business equipment will be Year 2000 compliant. Upon completion of that review, the Company will make a full assessment of the risk associated with the Year 2000 issue and determine whether the consequences will have a material effect on the Company's business. In addition, if necessary, upon completion of the assessment, the Company will develop a contingency plan. The Company utilizes a third party software package to run its internal operating and accounting systems and has purchased the Year 2000 compliant version of this software which was placed in operation in December 1998. In addition, all telecommunications equipment and computer applications are Year 2000 compliant. The Company is also contacting its vendors and customers in order to asses any third party risk. The Company does not expect the costs associated with becoming Year 2000 compliant to be material and believes that it will be absorbed, for the most part, in its normal information technology budget. PENTECH INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES Years Ended September 30, 1998, 1997 and 1996 Column A Column B Column C Column D Column E - -------- -------- -------- -------- -------- Charged Balance at to Costs Balance Beginning and End of Description of Period Expenses Deductions(1) Period Year ended September 30, 1998 Allowance for doubtful accounts $ 30,087 $ 134,974 $36,247 $ 128,814 ========= ========= ======= ========= Allowance for slow moving items $1,210,000 $ 300,000 $400,000 $1,110,000 ========= ========= ======= ========= Valuation allowance for deferred taxes $ 965,565 $1,648,637 - $2,614,202 ========= ========= ======= ========= Year ended September 30, 1997 Allowance for doubtful accounts $ 402,513 $ 15,401 $387,827 $ 30,087 ========= ========= ======= ========= Allowance for slow moving items $1,386,000 $ 400,000 $576,000 $1,210,000 ========= ========= ======= ========= Valuation allowance for deferred taxes $1,243,191 $ 237,009 $514,635 $ 965,565 ========= ========= ======= ========= Year ended September 30, 1996 Allowance for doubtful accounts $ 70,314 $ 401,620 $ 69,421 $ 402,513 ========= ========= ======= ========= Allowance for slow moving items $1,386,000 - - $1,386,000 ========= ========= ======= ========= Valuation allowance for deferred taxes $ - $1,243,191 $ - $1,243,191 ========= ========= ======= ========= (1) Amount represents various accounts written off during the year, net of recoveries. EXHIBIT INDEX Exhibit 10.5 Waiver and First Amendment to Loan and Security Agreement among the Company, Pentech Cosmetics, Inc., Sawdust Pencil Co. and BankAmerica Business Credit, Inc. dated as of January 11, 1999. Exhibit 10.7 Settlement Agreement dated March 1998 between the Company, Cooper & Dunham, L.L.P. and Lewis H. Eslinger. Exhibit 21 Subsidiaries of the Company. Exhibit 23.1 Consent of Ernst & Young LLP dated January 11, 1999. EX-10.5 2 EXHIBIT 10.5 EXECUTION WAIVER AND FIRST AMENDMENT TO LOAN AND SECURITY AGREEMENT WAIVER AND FIRST AMENDMENT (this Waiver and Amendment ) dated as of January 11, 1999, by and among BANKAMERICA BUSINESS CREDIT, INC., a Delaware corporation, with offices at 40 East 52nd Street, New York, New York 10022 (the Lender ); PENTECH INTERNATIONAL, INC., a Delaware corporation with chief executive offices at 195 Carter Drive, Edison, New Jersey 08817 ( Pentech ); PENTECH COSMETICS, INC., a Delaware corporation with chief executive offices at 195 Carter Drive, Edison, New Jersey 08817 ( Cosmetics ); and SAWDUST PENCIL CO., a Delaware corporation with chief executive offices at 195 Carter Drive, Edison, New Jersey 08817 ( Sawdust ) (Pentech, Cosmetics and Sawdust, individually, a Borrower, and collectively, the Borrowers ). W I T N E S S E T H : WHEREAS, the Lender and the Borrowers have entered into a Loan and Security Agreement dated as of January 13, 1997 (as amended, restated, modified or supplemented from time to time, the Loan Agreement ); and WHEREAS, the Borrowers have been in non-compliance (the Financial Covenant Non- compliance ) with the Minimum Interest Coverage Ratio and Tangible Net Worth covenants set forth in Sections 10.21 and 10.22 of the Loan Agreement for the fiscal quarter ending September 30, 1998 and during the period from October 1, 1998 through December 30, 1998; and WHEREAS, the Borrowers have requested that the Lender waive the Financial Covenant Non- compliance; and WHEREAS, the Borrowers have requested that the Lender agree to provide new seasonal overadvances, modify in certain respects certain of the financial covenants set forth in the Loan Agreement, provide a bankers acceptance subfacility and modify the Loan Agreement in certain other respects; and WHEREAS, the Lender is willing to waive the Financial Covenant Non-compliance and to agree to such other modifications on the condition that certain other amendments be made to the Loan Agreement and otherwise on the terms and conditions herein set forth. NOW, THEREFORE, in consideration of the mutual covenants contained herein and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows: SECTION 1. Defined Terms. Terms defined in the Loan Agreement and not otherwise defined herein shall have the meanings set forth in the Loan Agreement. SECTION 2. Waiver of Financial Covenant Non-compliance. The Lender hereby waives compliance by the Borrowers with the provisions of Section 10.21 and 10.22 of the Loan Agreement solely for and with respect to the fiscal quarter ending September 30, 1998 and the period from October 1, 1998 through December 30, 1998; provided, however, that such waiver is subject to the conditions set forth in Section 5 of this Waiver and Amendment. SECTION 3. Amendments to Loan Agreement. Effective as of December 31, 1998, the Loan Agreement shall be amended in the following respects. 3.1 Section 1.1 of the Loan Agreement is hereby amended by adding the following new definitions thereto, in appropriate alphabetical order: Applicable Inventory Advance Sublimit means the amount indicated below for the corresponding periods: Period Amount Prior to January 15, 1999 $12,000,000 January 15-May 31, 1999 $10,500,000 June 1-June 30, 1999 $10,000,000 July 1-July 31, 1999 $ 9,500,000 August 1-August 31, 1999 $ 9,000,000 At all times after August 31, 1999 $ 8,500,000 Banker s Acceptance means a banker s acceptance issued or caused to be issued for the account of any Borrower pursuant to Section 2.5 to the beneficiary of a Letter of Credit upon such beneficiary s compliance with all of the conditions required to draw upon such Letter of Credit. Banker s Acceptance Fee has the meaning specified in Section 3.6. 3.2 Section 1.1 of the Loan Agreement is hereby amended by restating the definitions of Aggregate Availability, Aggregate Maximum Revolver Amount, Allowable Seasonable Overadvance, Availability, Loans, Maximum Revolver Amount, Overadvance Repayment Date, Seasonal Overadvance and Seasonal Overadvance Limit set forth therein in their entirety as follows: Aggregate Availability means, at any time of determination, (a) the Aggregate Maximum Revolver Amount minus (b) the sum of (i) the unpaid principal balance of Revolving Loans outstanding to all Borrowers, (ii) the aggregate undrawn face amount of all outstanding Letters of Credit which the Lender has caused to be issued or obtained for the account of all Borrowers, and (iii) the aggregate face amount of all outstanding Banker s Acceptances which the Lender has caused to be issued or obtained for the account of all Borrowers. Aggregate Maximum Revolver Amount means at any time, for all Borrowers, the lesser of: (a) The amount of the Total Facility, or (b) The sum of (i) up to eighty percent (80%) of the Net Amount of Eligible Accounts of all Borrowers; the lesser of a) the Applicable Inventory Advance Sublimit; or the sum of: (i) up to 65% of all Eligible Inventory of all Borrowers not covered by any outstanding Merchandise Letter of Credit; and (ii) up to 60% of all Eligible Inventory of all Borrowers covered by any outstanding Merchandise Letter of Credit; and (iii) Allowable Seasonal Overadvances available at such time; provided, however, that the aggregate amount of all Loans outstanding at any one such time to all Borrowers shall not exceed an amount equal to the respective percentages indicated below of the Net Amount of Eligible Accounts of all Borrowers for the corresponding periods: Period Percentage At all times before February 1999 80% February 1999 85% March 1999 90% April 1999 90% May 1999 85% At all times after May 1999 80% plus 65% of all Eligible Inventory of all Borrowers not covered by any outstanding Merchandise Letter of Credit plus 60% of all Eligible Inventory of all Borrowers covered by any outstanding Merchandise Letter of Credit; and provided further, however, that at all times the Aggregate Maximum Revolver Amount shall be reduced (without duplication) by the sum of: (A) reserves for accrued interest on the Revolving Loans; (B) the Environmental Compliance Reserve; (C) the ACH Settlement Risk Reserve; (D) the Royalty Reserve; and (E) all other reserves which the Lender in its reasonable discretion deems necessary or desirable to maintain with respect to any Borrower s account, including, without limitation, any amounts which the Lender may be obligated to pay in the future for the account of any Borrower. The Lender agrees to give the Borrowers at least three Business Day s notice prior to reducing any of the advance rates set forth above, but the failure to give such notice shall not affect the Lender s right to make such reduction or the validity thereof. Allowable Seasonal Overadvance means, at any time during the months of February through May, 1999, and prior to the Overadvance Repayment Date, the Seasonal Overadvance Limit. Availability means, at any time of determination, with respect to any Borrower, (a) the Maximum Revolver Amount for such Borrower at such time minus (b) the sum of (i) the unpaid principal balance of Revolving Loans outstanding to such Borrower at such time, (ii) the aggregate undrawn face amount of all outstanding Letters of Credit which the Lender has caused to be issued or obtained for such Borrower s account at such time and (iii) the aggregate face amount of all outstanding Banker s Acceptances which the Lender has caused to be issued or obtained for such Borrower s account at such time. Loans means, collectively, all loans and advances provided for in Section 2 (including the aggregate face amounts of all letters of credit and banker s acceptances caused hereunder to be issued by the Lender and any outstanding Seasonal Overadvances). Maximum Revolver Amount means at any time, for any Borrower, the lesser of: (a) The amount of the Total Facility, or (b) The sum of (i) up to eighty percent (80%) of the Net Amount of Eligible Accounts of such Borrower; the lesser of a) the Applicable Inventory Advance Sublimit; or the sum of: (i) up to 65% of such Borrower s Eligible Inventory not covered by any outstanding Merchandise Letter of Credit; and (ii) up to 60% of such Borrower s Eligible Inventory covered by any outstanding Merchandise Letter of Credit; and (iii) Allowable Seasonal Overadvances available at such time; provided, however, that the aggregate amount of all Loans outstanding at any one such time to such Borrower shall not exceed an amount equal to the respective percentages indicated below of the Net Amount of Eligible Accounts of such Borrower for the corresponding periods: Period Percentage At all times before February 1999 80% February 1999 85% March 1999 90% April 1999 90% May 1999 85% At all times after May 1999 80% plus 65% of such Borrower s Eligible Inventory not covered by any outstanding Merchandise Letter of Credit plus 60% of such Borrower s Eligible Inventory covered by any outstanding Merchandise Letter of Credit; and provided further, however, that at all times the Maximum Revolver Amount shall be reduced (without duplication) by the sum of: (A) reserves for accrued interest on the Revolving Loans; (B) the Environmental Compliance Reserve; (C) the ACH Settlement Risk Reserve; (D) the Royalty Reserve; and (E) all other reserves which the Lender in its reasonable discretion deems necessary or desirable to maintain with respect to any Borrower s account, including, without limitation, any amounts which the Lender may be obligated to pay in the future for the account of any Borrower. The Lender agrees to give the Borrowers at least three Business Day s notice prior to reducing any of the advance rates set forth above, but the failure to give such notice shall not affect the Lender s right to make such reduction or the validity thereof. Overadvance Repayment Date means May 31, 1999. Seasonal Overadvance means special advances to be made available to the Borrowers in each of the months of February through May 1999, up to the Seasonal Overadvance Limit. Seasonal Overadvance Limit means $750,000. 3.3 The last sentence of the definition of the term Obligations set forth in Section 1.1 of the Loan Agreement is hereby amended to read in its entirety as follows: Obligations includes, without limitation, (a) all debts, liabilities, and obligations now or hereafter owing from Borrower to Lender under or in connection with the Letters of Credit, (b) all debts, liabilities, and obligations now or hereafter owing from Borrower to Lender under or in connection with the Banker s Acceptances, and (c) all debts, liabilities and obligations now or hereafter owing from the Borrower to the Lender arising from or related to ACH Transactions. 3.4 Clause (c)(ii) of the definition of the term Performance Pricing Period is hereby amended in its entirety to read as follows: (ii) after taking into account the Revolving Loans and the Letters of Credit and Banker s Acceptances issued or to be issued at each such time and 3.5 The caption to Article 2 of the Loan Agreement is hereby amended to read in its entirety as follows: 2 LOANS, LETTERS OF CREDIT AND BANKER S ACCEPTANCES. 3.6 Section 2.1 of the Loan Agreement is hereby amended to read in its entirety as follows: 2.1 Total Facility Subject to all of the terms and conditions of this Agreement, the Lender shall make available a total credit facility of up to $25,000,000 (the Total Facility ) for Borrower s use from time to time during the term of this Agreement. The Total Facility shall be comprised of a revolving line of credit up to the limits, for each Borrower, of such Borrower s Maximum Revolver Amount, and for all Borrowers, of the Aggregate Maximum Revolver Amount, consisting of revolving loans, seasonal overadvances, letters of credit and banker s acceptances as described in Sections 2.2, 2.3 and 2.5. 3.7 Clause (i) of Section 2.3(a) of the Loan Agreement is hereby amended to read in its entirety as follows: (i) the maximum face amount of the requested Letter of Credit, plus the aggregate undrawn face amount of all outstanding Letters of Credit, plus the aggregate face amount of all outstanding Banker s Acceptances, would exceed $10,000,000; 3.8 Clause (1) of Section 2.3(d) of the Loan Agreement is hereby amended to read in its entirety as follows: (1) Payment of Letter of Credit Obligations. Each Borrower agrees to reimburse the issuer for any draw (other than the unreimbursed amount of drawings under Letters of Credit with respect to which Banker s Acceptances have been issued at such time) under any Letter of Credit immediately upon demand, and to pay the issuer of the Letter of Credit the amount of all other obligations and other amounts payable to such issuer under or in connection with any Letter of Credit immediately when due, irrespective of any claim, setoff, defense or other right which such Borrower may have at any time against such issuer or any other Person. 3.9 Subsection (g) of Section 2.3 of the Loan Agreement is hereby deleted in its entirety. 3.10 The Loan Agreement is hereby amended by adding a new Section 2.5 thereto, which new section shall read in its entirety as follows: 2.5 Banker s Acceptances. (a) Subject to the terms and conditions of this Agreement, the Lender shall, upon Pentech s request on behalf of a Borrower, from time to time, cause Banker s Acceptances to be issued for such Borrower s account. The Lender will not cause any Banker s Acceptance to be issued if: (i) the face amount of the requested Banker s Acceptance, plus the aggregate face amount of all outstanding Banker s Acceptances, would exceed $4,000,000; (ii) the face amount of the requested Banker s Acceptance, plus the aggregate undrawn face amount of all outstanding Letters of Credit, plus the aggregate face amount of all outstanding Banker s Acceptances, would exceed $10,000,000; (iii) the face amount of the requested Banker s Acceptance, and all commissions, fees, and charges due from the Borrowers to Lender in connection with the issuance thereof, would cause such Borrower s Availability or the Aggregate Availability of all Borrowers to be exceeded at such time; or (iv) the draft to which such Banker s Acceptance relates has a maturity later than 90 days after the date of issuance thereof. All payments made and expenses incurred by the Lender pursuant to or in connection with the Banker s Acceptances will be charged to the Borrowers loan account as Revolving Loans. (b) Other Conditions. In addition to being subject to the satisfaction of the applicable conditions precedent contained in Section 11, the obligation of the Lender to cause any Banker s Acceptance to be issued is subject to the following conditions precedent having been satisfied in a manner satisfactory to the Lender: (1) Pentech, on behalf of the Borrower requesting a Banker s Acceptance, shall have delivered to the proposed issuer of such Banker s Acceptance, at such times and in such manner as such proposed issuer may prescribe, an application in form and substance satisfactory to such proposed issuer and the Lender for the issuance of the Banker s Acceptance and such other documents as may be required pursuant to the terms thereof, and the form and terms of the proposed Banker s Acceptance shall be satisfactory to the Lender and such proposed issuer; (2) As of the date of issuance, no order of any court, arbitrator or Public Authority shall purport by its terms to enjoin or restrain money center banks generally from issuing banker s acceptances of the type and in the amount of the proposed Banker s Acceptance, and no law, rule or regulation applicable to money center banks generally and no request or directive (whether or not having the force of law) from any Public Authority with jurisdiction over money center banks generally shall prohibit, or request that the proposed issuer of such Banker s Acceptance refrain from, the issuance of banker s acceptances generally or the issuance of such Banker s Acceptance; and (3) Prior to the issuance of a Banker s Acceptance, the beneficiary of the Letter of Credit to which such Banker s Acceptance shall relate, shall have complied duly with all of the conditions required to draw upon such Letter of Credit. (c) Payments Pursuant to Banker s Acceptances. (1) Payment of Banker s Acceptance Obligations. Each Borrower agrees to reimburse the issuer for any draw or payment under any Banker s Acceptance immediately upon demand, and to pay the issuer of the Banker s Acceptance the amount of all other obligations and other amounts payable to such issuer under or in connection with any Banker s Acceptance immediately when due, irrespective of any claim, setoff, defense or other right which such Borrower may have at any time against such issuer or any other Person. (2) Revolving Loans to Satisfy Reimbursement Obligations. In the event that the issuer of any Banker s Acceptance honors a draw or makes payment under such Banker s Acceptance and the relevant Borrower shall not have repaid such amount to the issuer of such Banker s Acceptance pursuant to Section 2.5(c)(1), the Lender shall pay the issuer and such amount when paid shall constitute a Revolving Loan which shall be deemed to have been requested by such Borrower. (d) Compensation for Banker s Acceptances. (1) Banker s Acceptance Fee. Each Borrower agrees to pay to the Lender, with respect to each Banker s Acceptance, the Banker s Acceptance Fee specified in, and in accordance with the terms of, Section 3.6. (2) Issuer Fees and Charges. Each Borrower shall pay to the issuer of any Banker s Acceptance, or to the Lender, for the account of the issuer of any such Banker s Acceptance, solely for such issuer s account, such fees and other charges as are charged by such issuer for banker s acceptances issued by it, including, without limitation, its standard fees for issuing, administering, amending, renewing, paying and canceling banker s acceptances and all other fees associated with issuing or servicing banker s acceptances, as and when assessed. (e) Indemnification; Exoneration; Power of Attorney (1) Indemnification. In addition to amounts payable as elsewhere provided in this Section 2.5, each Borrower hereby agrees to protect, indemnify, pay and save the Lender harmless from and against any and all claims, demands, liabilities, damages, losses, costs, charges and expenses (including reasonable attorneys fees) which the Lender may incur or be subject to as a consequence, direct or indirect, of the issuance of any Banker s Acceptance or the provision of any credit support or enhancement in connection therewith. The agreement in this Section 2.5(e)(1) shall survive payments of all Obligations and the termination of this Agreement. (2) Assumption of Risk by the Borrowers. As between the Borrowers and the Lender, the Borrowers assume all risks of the acts and omissions of, or misuse of any of the Banker s Acceptances by, the respective beneficiaries or holders of such Banker s Acceptances. In furtherance and not in limitation of the foregoing, the Lender shall not be responsible for: (A) the form, validity, sufficiency, accuracy, genuineness or legal effect of any document submitted by any Person in connection with the application for and issuance of and presentation of, or of drafts with respect to, any of the Banker s Acceptances, even if it should prove to be in any or all respects invalid, insufficient, inaccurate, fraudulent or forged; (B) the validity or sufficiency of any instrument transferring or assigning or purporting to transfer or assign any Banker s Acceptance or the rights or benefits thereunder or proceeds thereof, in whole or in part, which may prove to be invalid or ineffective for any reason; (C) the failure of the beneficiary or holder of any Banker s Acceptance to comply duly with conditions required in order to draw upon or receive payment under such Banker s Acceptance; (D) errors, omissions, interruptions, or delays in transmission or delivery of any messages, by mail, cable, telegraph, telex or otherwise, whether or not they be in cipher; (E) errors in interpretation of technical terms; (F) any loss or delay in the transmission or otherwise of any document required in order make a drawing or receive payment under any Banker s Acceptance or of the proceeds thereof; (G) the misapplication by the beneficiary or holder of any Banker s Acceptance of the proceeds of any drawing or payment under such Banker s Acceptance; or (H) any consequences arising from causes beyond the control of the Lender, including, without limitation, any act or omission, whether rightful or wrongful, of any present or future de jure or de facto Public Authority. None of the foregoing shall affect, impair or prevent the vesting of any rights or powers of the Lender under this Section 2.5. (3) Exoneration. In furtherance and extension, and not in limitation, of the specific provisions set forth above, any action taken or omitted by the Lender under or in connection with any of the Banker s Acceptances or any related certificates, if taken or omitted in the absence of gross negligence or willful misconduct, shall not put the Lender under any resulting liability to any Borrower or relieve any Borrower of any of its obligations hereunder to any such Person. (4) Power of Attorney. In connection with all Inventory financed by Banker s Acceptances, each Borrower hereby appoints the Lender, or the Lender s designee, as its attorney, with full power and authority: (a) to sign and/or endorse such Borrower s name upon any warehouse or other receipts; (b) to sign such Borrower s name on bills of lading and other negotiable and non-negotiable documents; (c) to clear Inventory through customs in the Lender s or such Borrower s name, and to sign and deliver to customs officials powers of attorney in such Borrower s name for such purpose; (d) to complete in such Borrower s or the Lender s name, any order, sale, or transaction, obtain the necessary documents in connection therewith, and collect the proceeds thereof; and (e) to do such other acts and things as are necessary in order to enable the Lender to obtain possession of the Inventory and to obtain payment of the Obligations. Neither the Lender nor its designee, as each Borrower s attorney, will be liable for any acts or omissions, nor for any error of judgment or mistakes of fact or law. This power, being coupled with an interest, is irrevocable until all Obligations have been paid and satisfied. (5) Control of Inventory. In connection with all Inventory financed by Banker s Acceptances, each Borrower will, at the Lender s request, instruct all suppliers, carriers, forwarders, warehouses or others receiving or holding cash, checks, Inventory, documents or instruments in which the Lender holds a security interest to deliver them to the Lender and/or subject to the Lender s order, and if they shall come into any Borrower s possession, to deliver them, upon request, to the Lender in their original form. Each Borrower shall also, at the Lender s request, designate the Lender as the consignee on all bills of lading and other negotiable and non-negotiable documents. 3.11 The Loan Agreement is hereby amended by adding a new Section 2.6 thereto, which new section shall read in its entirety as follows: 2.6 Supporting Letter of Credit; Cash Collateral. If, notwithstanding the provisions of Sections 2.3, 2.5 and 14, any Letter of Credit or Banker s Acceptance is outstanding upon the termination of this Agreement, then upon such termination the Borrowers shall deposit with the Lender, at its discretion, with respect to each Letter of Credit and Banker s Acceptance then outstanding, either (A) a standby letter of credit (a Supporting Letter of Credit ) in form and substance satisfactory to the Lender, issued by an issuer satisfactory to the Lender in an amount equal to the greatest amount for which such Letter of Credit or Banker s Acceptance may be drawn, under which Supporting Letter of Credit the Lender is entitled to draw amounts necessary to reimburse the Lender for payments made by the Lender under such Letter of Credit or Banker s Acceptance or under any credit support or enhancement provided through the Lender with respect thereto, or (B) cash in amounts necessary to reimburse the Lender for payments made by the Lender under such Letter of Credit or Banker s Acceptance or under any credit support or enhancement provided through the Lender. Such Supporting Letter of Credit or deposit of cash shall be held by the Lender, as security for, and to provide for the payment of, the aggregate undrawn amount of such Letters of Credit and Banker s Acceptances remaining outstanding. 3.12 Subsection (b) of Section 3.1 of the Loan Agreement is hereby amended to read in its entirety as follows: (b) If any Event of Default occurs, then, from the date such Event of Default occurs until it is cured, or if not cured until all Obligations are paid and performed in full, the Borrowers will pay (A) interest (including the margin applicable thereto) on the unpaid principal balances of the Loans, (B) the Letter of Credit Fee and (C) the Banker s Acceptance Fee at a per annum rate two percent (2%) greater than otherwise specified herein for interest, the Letter of Credit Fee and the Banker s Acceptance Fee. 3.13. The first sentence of subsection (c) of Section 3.1 of the Loan Agreement is hereby amended to read in its entirety as follows: For every month during the term of this Agreement, the Borrowers shall pay to the Lender a fee (the Unused Line Fee ) in an amount equal to three-eighths of one percent (0.375%) per annum, multiplied by the average daily amount by which the Maximum Revolving Credit Line exceeds the sum of (i) the average daily outstanding amount of all Revolving Loans during such month, (ii) the average daily undrawn face amount of all outstanding Letters of Credit during such month and (iii) the average daily face amount of all outstanding Banker s Acceptances during such month, with the unpaid balance calculated for this purpose by applying payments immediately upon receipt. 3.14 The Loan Agreement is hereby amended by adding a new Section 3.6 thereto, which new section shall read in its entirety as follows: 3.6 Banker s Acceptance Fees. The Borrowers agree to pay to the Lender, for each Banker s Acceptance, a fee (the Banker s Acceptance Fee ) equal to two percent (2.00%) per annum of the face amount of each Banker s Acceptance plus all out- of-pocket costs, fees and expenses incurred by the Lender in connection with the application for, issuance of, or amendment to any Banker s Acceptance, which costs, fees and expenses could include a fronting fee required to be paid by the Lender to such issuer for the assumption of the settlement risk in connection with the issuance of such Banker s Acceptance and any charge associated with the discount of such Banker s Acceptance. The Banker s Acceptance Fee shall be payable monthly in arrears on the first day of each month following any month in which a Banker s Acceptance was issued and/or in which a Banker s Acceptance remains outstanding. The Banker s Acceptance Fee shall be computed on the basis of a year of three hundred sixty (360) days for the actual number of days elapsed. 3.15. The words or Banker s Acceptance or or Banker s Acceptances are hereby added immediately after the words Letter of Credit or Letters of Credit, as the respective cases may be, wherever set forth in the last sentence of Section 9.25, in the preamble to Section 11.2, in clause (ii) of Section 13(a), in the penultimate sentence of Section 14, and in Sections 15.7(h) and 15.17. 3.16 Sections 10.21 and 10.22 of the Loan Agreement are hereby amended to read in their entirety as follows: 10.21 Minimum EBITDA. The Borrowers will maintain a cumulative EBITDA, as determined at the end of each fiscal quarter set forth below, for the preceding fiscal quarter in the case of the fiscal quarter ending December 31, 1998, for the preceding two fiscal quarters in the case of the fiscal quarter ending March 31, 1999, for the preceding three fiscal quarters in the case of the fiscal quarter ending June 30, 1999, and the preceding four fiscal quarters in the case of the fiscal quarter ending September 30, 1999 and each fiscal quarter ending thereafter, of not less than the amounts indicated below: Quarter Ending Amount December 31, 1998 ($ 250,000) March 31, 1999 ($ 500,000) June 30, 1999 $2,400,000 September 30, 1999, and each fiscal quarter thereafter $3,300,000 10.22 Adjusted Tangible Net Worth. The Borrowers will have Tangible Net Worth of not less than the following amounts at the end of each of the following fiscal quarters: Fiscal Quarter Ending Amount December 31, 1998 $14,000,000 March 31, 1999 $13,000,000 June 30, 1999 $14,000,000 September 30, 1999, and each fiscal quarter thereafter $14,537,000 SECTION 4. Waiver and Amendment Fee. In order to induce the Lender to enter into this Waiver and Amendment, the Borrowers jointly and severally shall pay to the Lenders a waiver and amendment fee (the Waiver and Amendment Fee ) in the amount of $175,000. The Waiver and Amendment Fee shall be deemed fully earned upon the effectiveness of this Waiver and Amendment, shall be non-refundable when paid and shall be payable as follows: 4.1 $25,000 of the Waiver and Amendment Fee shall be paid simultaneously with the effectiveness of this Waiver and Amendment; and 4.2 the remaining $150,000 of the Waiver and Amendment fee shall be due and payable in six consecutive monthly installments in the amount of $25,000 each, payable on the last day of each month, commencing February 28, 1999; provided, however, that the entire unpaid amount of the Waiver and Amendment Fee shall be due and payable immediately upon the occurrence of an Event of Default or the termination of the Loan Agreement for any reason whatsoever. SECTION 5. Conditions to Effectiveness. This Waiver and Amendment shall be effective as of the date first above written when the Lender shall have received the following: 5.1 counterparts of this Waiver and Amendment executed by the Borrowers; 5.2 such other certificates, representations, instruments and other documents as the Agent and the Majority Lenders may require, in form and substance satisfactory to the Agent; and 5.3 payment of the $25,000 portion of the Waiver and Amendment Fee referred to in Section 4.1 of this Waiver and Amendment. SECTION 6. Representations and Warranties. The Borrowers hereby each represent and warrant to the Lender that (i) the execution, delivery and performance of this Waiver and Amendment by each of the Borrowers are within their respective corporate powers and have been duly authorized by all necessary corporate action; (ii) no consent, approval, authorization of, or declaration or filing with, any Public Authority, and no consent of any other Person, is required in connection with the execution, delivery and performance of this Waiver and Amendment, except for those already duly obtained; (iii) this Waiver and Amendment has been duly executed by each of the Borrowers and constitutes the legal, valid and binding obligation of each of the Borrowers, enforceable against them in accordance with its terms; (iv) the execution, delivery and performance by each of the Borrowers of this Waiver and Amendment does not and will not conflict with, or constitute a violation or breach of, or constitute a default under, or result in the creation or imposition of any Lien upon the property of any Borrower or any of its Subsidiaries (except as contemplated by the Loan Agreement and the other Loan Documents) by reason of the terms of (a) any contract, mortgage, lease, agreement, or instrument to which such Borrower or such Subsidiary is a party or which is binding upon it, (b) any Requirement of Law applicable to such Borrower or such Subsidiary, or (c) the Certificate or Articles of Incorporation or By-Laws of such Borrower or such Subsidiary; (v) after giving effect to this Waiver and Amendment, the representations and warranties contained in the Loan Agreement and in each other document or instrument delivered by Borrower are true and correct in all material respects as though made on and as of the date hereof, except to the extent that such representations and warranties expressly relate solely to an earlier date (in which case such representations and warranties were true and accurate on and as of such earlier date); and (vi) after giving effect to this Waiver and Amendment, there exists no Event of Default or condition which would result in an Event of Default. SECTION 7. Reference to and Effect on Loan Documents. 7.1 On and after the date hereof, each reference in the Loan Agreement to this Agreement , hereunder , hereof , herein or words of like import, and each reference in the other Loan Documents to the Loan Agreement, shall mean and be a reference to the Loan Agreement as amended hereby. 7.2 Except as specifically amended above, all of the terms of the Loan Agreement shall remain unchanged and in full force and effect. 7.3 The execution, delivery and effectiveness of this Waiver and Amendment shall not operate as a waiver of any right, power or remedy of any Lender or the Agent under the Loan Agreement or any of the other Loan Documents, nor constitute a waiver of any provision of the Loan Agreement or any of the other Loan Documents. SECTION 8. Execution in Counterparts. This Waiver and Amendment may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which taken together shall constitute one and the same instrument. SECTION 9. Governing Law. This Waiver and Amendment shall be governed by, and shall be construed and enforced in accordance with, the laws of the State of New York. SECTION 10. Headings. Section headings in this Waiver and Amendment are included herein for convenience of reference only and shall not constitute a part of this Waiver and Amendment or be given any substantive effect. IN WITNESS WHEREOF, this Waiver and Amendment has been duly executed as of the date first above written. PENTECH INTERNATIONAL, INC. By: ____________________________ Title:___________________________ PENTECH COSMETICS, INC. By: ____________________________ Title:___________________________ SAWDUST PENCIL CO. By: ____________________________ Title:___________________________ BANKAMERICA BUSINESS CREDIT, INC. By: ____________________________ Louis Alexander, Vice President EX-21 3 EXHIBIT 21 Subsidiaries of Pentech International, Inc. Jurisdiction of Name Incorporation Sawdust Pencil Co. Delaware EX-23 4 EXHIBIT 23.1 Consent of Independent Auditors We consent to the incorporation by reference in (i) the Registration Statement (Form S-8 No. 33-27009) dated February 28, 1989 pertaining to the 1989 Stock Option Plan of Pentech International, Inc. ("Pentech"); (ii) the Registration Statement (Form S-8 No. 33-67802) dated August 23, 1993 pertaining to the 1993 Stock Option Plan of Pentech and (iii) the Registration Statement (Form S-8, No. 333-30595) dated July 2, 1997 pertaining to the 1995 Stock Option Plan of Pentech, of our report dated December 21, 1998 (except for Notes 3(b) and 13 as to which the date is January 11, 1999) with respect to the consolidated financial statements and schedule of Pentech International, Inc. included in this Annual Report (Form 10-K) for the year ended September 30, 1998. ERNST & YOUNG LLP By:/s/Ernst & Young LLP MetroPark, New Jersey January 11, 1999 EX-27 5
5 YEAR SEP-30-1998 SEP-30-1998 759,349 0 14,456,009 (128,814) 20,015,241 37,608,162 8,934,327 (5,372,044) 41,583,487 24,725,221 0 0 0 125,703 14,632,563 41,583,487 57,485,045 57,485,045 41,350,327 41,350,327 17,475,227 0 1,528,779 (2,869,288) 635,015 (3,504,303) 0 0 0 (3,504,303) (.28) (.28)
EX-10.7 6 EXHIBIT 10.7 SETTLEMENT AGREEMENT THIS SETTLEMENT AGREEMENT (the "Agreement"), entered into this [ ] day of March, 1998 by and between PENTECH INTERNATIONAL, INC., having an office at 195 Carter Drive, Edison, New Jersey 08817, (hereinafter refereed to respectively as "Plaintiff"), on the one hand, and COOPER & DUNHAM L.L.P., having an office at 1185 Avenue of the Americas, New York, New York 10036 and LEWIS H. ESLINGER (hereinafter refereed to respectively as "Defendants"), on the other hand. W I T N E S E T H WHEREAS, Plaintiff commenced an action Defendants in the Supreme Court of the State of New York, County of New York, Index No. 1100222/97 ("Action"), asserting in its complaint ("Complaint"), dated June 4, 1997, various claims against Defendants; and WHEREAS, Defendants filed their verified answer ("Answer"), dated July 25, 1997, denying any and all liability to Plaintiff and asserting affirmative defenses against Plaintiff; and WHEREAS, the parties have conducted extensive discovery, including, but not limited to, (i) review of transcripts, documents and other materials from related proceedings, and (ii) depositions and document discovery in the Action; and WHEREAS, Plaintiff and Defendants have determined that it is in their mutual interests to amicably resolve all disputes among the parties and to settle the Action on the terms and conditions set forth herein; and WHEREAS, settlement negotiations have taken place between Plaintiff and Defendants, through their respective attorneys, and the terms of this of this Agreement have been reached through arm's-length negotiations conducted by the said attorneys; and WHEREAS, this Agreement compromises the matters set forth in the Complaint and Answer which are disputed both as to validity and amount; and NOW, THEREFORE, in consideration of the mutual promises and obligations contained herein, it is agreed that each and every claim and factual allegation embraced within the scope of the Complaint and Answer, or which might have been alleged by reason of any matter or transaction referred to in the Complaint or Answer, or which arises out of or under the facts and circumstances set forth therein, shall be dismissed on the merits with prejudice and be settled and compromised upon the following terms and conditions: 1. On behalf of Defendants, $1,250,000 U.S. Dollars shall be paid to Plaintiff. Such payment shall be made on or before April 3, 1998 by check made payable to Pentech International, Inc. and Twomey, Hoppe & Gallanty LLP, as attorneys. 2. In consideration of the aforesaid payment and clearance thereof, the promises and obligations contained herein, and other good and value consideration: (i) The Plaintiff and its respective affiliates, subsidiaries, principals, partners, parent companies, directors, officers, shareholders, attorneys, agents, employees, associates, heirs, executors, administrators, successors, predecessors, assigns, other representatives and any and all other related and affiliated companies and individuals (hereinafter together refereed to as the "Plaintiff's Entities") shall release and discharge Defendants and their respective affiliates, subsidiaries, principals, partners, parent companies, directors, officers, shareholders, attorneys, agents, employees, associates, heirs, executors, administrators, successors, predecessors, assigns, other representatives, and all other related and affiliated companies and individuals (hereinafter together refereed to as "Defendants' Entities") from all actions, causes of action, claims, suits, debts, accounts, contracts, controversies, agreements, promises, damages, disciplinary complaints, administrative remedies, conflicts of interest and demands whatsoever, in law or equity, which against the Defendants and Defendants' Entities the Plaintiff or Plaintiff's Entities ever had, now have or hereafter can, shall or may have for, upon or by reason of any matter, cause to thing whatsoever from the beginning of the world to the day of the date of this Agreement, except for the rights and obligations set forth in this Agreement, all pursuant to the general release in the form annexed hereto as Exhibits "A," which shall be duly executed by the Plaintiff; (ii) The Defendants and the Defendants' Entities shall release and discharge the Plaintiff and Plaintiffs' Entities from all actions, cause of action, claims, suits, debts, accounts, contracts, controversies, agreements, promises, damages, disciplinary complaints, administrative remedies, conflicts of interest and demands whatsoever, in law or equity, which against the Plaintiff or Plaintiff's Entities, the Defendants or Defendants' Entities ever had, now have or hereafter can, shall or may have for, upon or by reason of any matter, cause or thing whatsoever from the beginning of the world to the day of the date of this Agreement, except for the rights and obligations set forth in this Agreement, all pursuant to the general releases in the forms annexed hereto as Exhibit "B," which shall be duly executed by the Defendants; (iii) A purpose and intent of this Agreement is to preclude the Defendants and Defendants' Entities, on the one hand, and the Plaintiff and Plaintiff's Entities, on the other, and any entities owned, controlled, or managed by them respectively, from ever asserting a claim, complaint or lawsuit against the other arising from any matter whatsoever up to the date of this Agreement once the payment is made and cleared pursuant to paragraph 1 of this Agreement; (iv) Plaintiff hereby agrees to indemnify and hold harmless the Defendants and Defendants' Entities from any claim interposed against Defendants and/or Defendants' Entities which arises out of the legal services performed and provided by the Defendants as set forth in the Complaint, and Plaintiff further agrees to indemnify Defendants and Defendants' Entities by reducing the amount of any judgement obtained by Plaintiff against any other judgement defendant ("Judgement Defendant"), or by releasing or giving a satisfaction for so much of such judgement, to the extent necessary to eliminate any such Judgement Defendant's right to recover against Defendants and/or Defendants' Entities on any claim which arises out of the legal services performed and provided by the Defendants as set forth in the Complaint; and (v) Plaintiff hereby agrees that any settlement agreement entered into by Plaintiff and/or Plaintiff's Entities with any individual or entity having a pending, potential or future claim against Defendants and/or Defendants' Entities which arises out of the legal services performed and provided by the Defendants as set forth in the Complaint shall contain a covenant and agreement by such individual or entity not to enforce, sue for, or collect upon any such claim that such individual or entity may have against Defendants and/or Defendants' Entities. 3. This Agreement is not intended to be a resolution on the merits and is made solely to resolve the differences between the parties and as a result of a business decision of the parties made in light of the expense and inconvenience of continuing to litigate the Action. 4. The parties hereto acknowledge that this Agreement is not intended to be, and shall not be, construed as an admission that Defendants have breached any agreement, obligation, duty, disciplinary rule, ethical consideration or contract relating to or owed to Plaintiff, or engaged in any wrongdoing or misconduct, professional or otherwise, or incurred any liability of any kind. 5. Neither this Agreement nor any of its terms and conditions, nor any negotiations or proceedings with respect to the subject matter of this Agreement shall be offered or received into evidence or be admissible in any trial or any proceeding involving Plaintiff, Defendants, or any other party or person, except for the purpose of obtaining enforcement of the Agreement. 6. The terms and conditions of this Agreement ant the documents produced during the litigation of the Action are and shall be deemed to be confidential, and shall not be disclosed to any non-party by Plaintiff, Defendants or their respective experts, agents, or attorneys except (1) pursuant to subpoena or court order; (2) to the extent that, in the opinion of counsel, disclosure thereof is necessary to comply with applicable law and/or the obligations of Plaintiff as a public company; (3) to their accountants, auditors, and attorneys; or (4) to obtain enforcement of the provisions of this Agreement. The Agreement and any related documents (except the Stipulation of Dismissal referred to in paragraph 12 below) shall not be filed with the court or, if filed, shall be filed under seal. If asked about the status of the action or the claims asserted therein, except as set forth above, Plaintiff, Defendants and their respective attorneys and agents agree to state only that the differences between the parties have been resolved satisfactorily. In order to facilitate the purpose of this paragraph and Plaintiff and Defendants and their respective attorneys agree to use their best efforts to return to the other party all transcripts of depositions of party witnesses taken in the Action in their possession and to return all documents in their respective possession, including copies made thereof, produced by the other party in response to discovery requests during the course of the Action within forty-five (45) days after the execution of this Agreement. Nothing in this Agreement shall prohibit any party from disclosing the fact of the settlement to any third party. 7. This Agreement contains the entire understanding and agreement between the parties hereto and supersedes all prior verbal and written communications between the parties and their counsel with regard to the subject matter addressed herein; it is not subject to any condition not provided for herein and there are no other collateral or oral agreements among the parties. 8. This Agreement may not be modified, terminated or discharged orally; any agreement purporting to change the terms hereof must be in writing, signed by each party hereto. 9. This Agreement shall be constructed in accordance with, and governed by, the substantive laws of the State of New York, without giving effect to conflicts of laws principles. 10. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed and delivered shall be considered an original, and may be signed and delivered by facsimile, and all of which together shall constitute one and the same document. 11. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, successors, administrators, representatives, shareholders, partners, employees, successors, executors and assigns. 12. Upon the execution and exchange of the Agreement and the delivery and clearance of the settlement payment set forth, the attorneys for the parties hereto shall execute and file a Stipulation of Dismissal of the Action with prejudice with the Supreme Court of the State of New York, County of New York, and the Plaintiff and Defendants shall each be provided with the releases specified in Paragraph 2(i) and 2(ii) hereof. Nothing in any of said releases shall excuse any party from its obligations under the Agreement itself. 13. The parties hereto and the representatives signing on behalf of each hereby warrant and represent that they are authorized to enter into this Agreement, and bind the parties to the Agreement. The relevant corporate resolutions or powers of attorney evidencing this authority have been drafted and duly executed and are incorporated herein by reference. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first set forth above. PENTECH INTERNATIONAL, INC. By: s/ COOPER & DUNHAM L.L.P. By: s/ s/ N:\ANNE\PTK\SETTLE.AGR -----END PRIVACY-ENHANCED MESSAGE-----