UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended May 29, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ____________
Commission File Number: 0-18926
INNOVO GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware 11-2928178
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
5804 East Slauson Avenue, Commerce, California 90040
(Address of principal executive offices) (Zip Code)
(323) 725-5516
(Registrant's telephone number, including area code)
NO CHANGE
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. |X| Yes |_| No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). |_| Yes |X| No
As of July 13, 2004, there were 29,090,390 shares of the issuer's only
class of common stock outstanding.
INNOVO GROUP INC.
QUARTERLY REPORT ON FORM 10-Q
Part I. FINANCIAL INFORMATION Page
----
Item 1. Financial Statements 1
Consolidated Condensed Balance Sheets 1
Consolidated Condensed Statement of Operations 2
Consolidated Condensed Statement of Cash Flows 3
Notes to Consolidated Condensed Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 56
Item 4. Controls and Procedures 57
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 60
Item 2. Changes in Securities and Use of Proceeds 60
Item 3. Defaults Upon Senior Securities 61
Item 4. Submission of Matters to a Vote of Security Holders 61
Item 5. Other Information 62
Item 6. Exhibits and Reports on Form 8-K 62
Signatures 64
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands, except per share data)
05/29/04 11/29/03
----------- -----------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 7 $ 7,248
Accounts receivable and due from factor, net of allowance for
customer credits and allowances of $2,026 (2004) and $2,158 (2003) 1,394 1,683
Inventories 11,596 7,524
Prepaid expenses and other current assets 332 2,115
----------- -----------
TOTAL CURRENT ASSETS 13,329 18,570
----------- -----------
PROPERTY, PLANT and EQUIPMENT, net 1,121 2,067
GOODWILL 12,592 12,592
INTANGIBLE ASSETS, NET 12,374 13,058
OTHER ASSETS 58 78
----------- -----------
TOTAL ASSETS $ 39,474 $ 46,365
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 11,160 $ 6,128
Due to factor 263 332
Due to related parties 141 579
Note payable to officer 500 500
Current maturities of long-term debt (including related parties) 93 168
----------- -----------
TOTAL CURRENT LIABILITIES 12,157 7,707
LONG-TERM DEBT, less current maturities (including related parties) 9,632 22,176
Commitments and Contingencies
8% Redeemable preferred stock, $0.10 par value: Authorized shares-5,000,
194 shares (2004) and (2003) -- --
STOCKHOLDERS' EQUITY
Common stock, $0.10 par - shares, Authorized 40,000
Issued and outstanding 29,166 (2004), and 25,785 (2003) 2,917 2,579
Additional paid-in capital 71,582 59,077
Accumulated deficit (53,523) (41,824)
Promissory note-officer (703) (703)
Treasury stock, 76 shares (2004) and (2003) (2,588) (2,588)
Accumulated other comprehensive loss -- (59)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 17,685 16,482
----------- -----------
TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $ 39,474 $ 46,365
=========== ===========
See accompanying notes
1
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three Months Ended Six Months Ended
-------------------------- --------------------------
05/29/04 05/31/03 05/29/04 05/31/03
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
NET SALES $ 30,023 $ 12,013 $ 46,627 $ 23,928
COST OF GOODS SOLD 26,593 8,655 40,327 17,311
----------- ----------- ----------- -----------
Gross profit 3,430 3,358 6,300 6,617
OPERATING EXPENSES
Selling, general and administrative 8,935 3,596 15,817 6,383
Depreciation and amortization 414 85 869 164
----------- ----------- ----------- -----------
9,349 3,681 16,686 6,547
INCOME (LOSS) FROM OPERATIONS (5,919) (323) (10,386) 70
INTEREST EXPENSE (279) (215) (698) (365)
OTHER INCOME 65 109 85 234
OTHER EXPENSE (630) (74) (692) (97)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (6,763) (503) (11,691) (158)
INCOME TAXES (35) (10) 6 53
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (6,728) $ (493) $ (11,697) $ (211)
=========== =========== =========== ===========
NET INCOME (LOSS) PER SHARE:
Basic $ (0.23) $ (0.03) $ (0.43) $ (0.01)
Diluted $ (0.23) $ (0.03) $ (0.43) $ (0.01)
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 28,928 15,020 27,358 14,931
Diluted 28,928 15,020 27,358 14,931
See accompanying notes
2
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
Six Months Ended
--------------------------
05/29/04 05/31/03
----------- -----------
(unaudited) (unaudited)
CASH USED IN OPERATING ACTIVITIES $ (7,349) $ (1,296)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from investment in real estate 98 853
Redemption of preferred shares -- (368)
Purchases of fixed assets (116) (103)
----------- -----------
Cash (used in) provided by investing activities $ (18) $ 382
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of treasury stock $ -- $ (16)
Payments on notes payables and long term debt (119) (370)
Repayments of factor borrowings (69) 847
Proceeds from note payable to officer -- 500
Proceeds from issuance of stock and
exercise of stock options, net of expense 314 593
----------- -----------
Cash provided by financing activities $ 126 $ 1,554
Effect of exchange rate on cash -- 20
NET CHANGE IN CASH AND CASH EQUIVALENTS $ (7,241) $ 660
CASH AND CASH EQUIVALENTS, at beginning of period 7,248 222
----------- -----------
CASH AND CASH EQUIVALENTS, at end of period $ 7 $ 882
=========== ===========
See accompanying notes
3
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting of only
normal recurring and consolidating adjustments) considered necessary to present
fairly the balance sheets, the results of operations and cash flows for the
period reported. The accompanying unaudited condensed consolidated financial
statements include the financial results of Innovo Group Inc. (Innovo Group) and
all its wholly-owned subsidiaries (collectively, in these Notes to Consolidated
Financial Statements as Innovo Group). All inter-company balances have been
eliminated. As used in these accompanying notes to unaudited condensed
consolidated financial statements, Innovo Group's subsidiaries include the
following entities: Innovo, Inc., (Innovo), Joe's Jeans, Inc. (Joe's), Innovo
Azteca Apparel, Inc. (IAA), Leaseall Management, Inc., (Leaseall) and Innovo
Realty, Inc. (IRI).
These accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. The balance
sheet at November 29, 2003 has been derived from the audited financial
statements at that date, but does not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements.
While management believes that the disclosures presented are adequate to
make the information not misleading, it is recommended that the condensed
consolidated financial statements and footnotes be read in conjunction with the
consolidated financial statements included in our Annual Report on Form 10-K for
the year ended November 29, 2003. Operating results for the three and six month
period ended May 29, 2004, or second quarter of fiscal 2004, are not necessarily
indicative of the results that may be expected for the year ended November 27,
2004.
NOTE 2 - INVENTORY
Inventories are stated at the lower of cost, which is determined by the
first-in-first-out method or market. Inventories consisted of the following (in
thousands):
05/29/04 11/29/03
--------------------------
Finished goods $ 8,323 $ 10,189
Work in progress 4,880 199
Raw materials 1,918 1,329
--------------------------
15,121 11,717
Less allowance for obsolescence and
slow moving items (3,525) (4,193)
--------------------------
$ 11,596 $ 7,524
==========================
4
NOTE 3 - LONG-TERM DEBT
A summary of our long-term debt follows (in thousands):
05/29/04 11/29/03
--------------------------
First mortgage loan on Springfield property $ 425 $ 476
Promissory note to Azteca (Blue Concepts) 9,300 21,800
Promissory note to Azteca (Knit Div.) -- 68
--------------------------
Total long-term debt 9,725 22,344
Less current maturities 93 168
--------------------------
Total long-term debt $ 9,632 $ 22,176
==========================
As used herein, Azteca means Azteca Production International, Inc., an
entity which two of our substantial stockholders, Hubert Guez and Paul Guez,
have a controlling interest.
NOTE 4 - DUE FROM FACTOR AND SHORT TERM DEBT
CIT Commercial Services
On June 1, 2001, Innovo Group's subsidiaries, Innovo and Joe's, entered
into accounts receivable factoring agreements with CIT Commercial Services, a
unit of CIT Group, Inc. (CIT), which may be terminated with 60 days notice by
CIT, on the anniversary date by Innovo or Joe's or earlier as may be permitted
by the agreements. Under the terms of the agreements, Innovo or Joe's has the
option to factor receivables with CIT on a non-recourse basis, provided the CIT
approves the receivable in advance. Innovo or Joe's may, at their option, also
factor non-approved receivables on a recourse basis. Innovo or Joe's continues
to be obligated in the event of product defects and other disputes, unrelated to
the credit worthiness of the customer. Innovo or Joe's has the ability to obtain
advances against factored receivables up to 85% of the face amount of the
factored receivables. The agreement calls for a 0.8% factoring fee on invoices
factored with CIT and a per annum rate equal to the greater of the Chase prime
rate plus 0.25% or 6.5% on funds borrowed against the factored receivables. On
September 10, 2001, IAA entered into a similar factoring agreement with CIT upon
the same terms.
On or about August 20, 2002, each of Innovo and Joe's entered into certain
amendments to their respective factoring agreements, which included inventory
security agreements, to permit the subsidiaries to obtain advances of up to 50%
of the eligible inventory up to $400,000 each. According to the terms of the
agreements, amounts loaned against inventory are to bear an interest rate equal
to the greater of the bank's prime rate plus 0.75% or 6.5% per annum.
On or about June 10, 2003, the existing financial facilities with CIT for
each of Innovo and Joe's were amended, to be effective as of April 11, 2003,
primarily to remove the fixed aggregate cap of $800,000 on their inventory
security agreement to allow for Innovo and Joe's to borrow up to 50% of the
value of certain eligible inventory calculated on the basis of the lower of cost
or market, with cost calculated on the first-in-first-out basis. In connection
with these amendments, IAA, entered into an inventory security agreement with
CIT based on the same terms as Joe's and Innovo also with no fixed aggregate
cap. IAA did not previously have an inventory security agreement with CIT. Under
the factoring arrangements, Innovo Group though its subsidiaries may borrow up
to 85% of the value of eligible factored receivables outstanding. The factoring
rate that Innovo Group pays to CIT to factor accounts, on which CTI bears some
of all of the credit risk, was lowered to 0.4% and the interest rate associated
with borrowings under the inventory lines and factoring facility were reduced to
the bank's
5
prime rate. Innovo Group has also established a letter of credit
facility with CIT whereby Innovo Group can open letters of credit, for 0.125% of
the face value, with international and domestic suppliers provided Innovo Group
has availability on its inventory line of credit. In addition, Innovo Group also
may elect to factor with CIT its receivables by utilizing an adjustment of the
interest rate as set on a case-by-case basis, whereby certain allocation of risk
would be borne by Innovo Group, depending upon the interest rate adjustment.
Innovo Group records its accounts receivable on the balance sheet net of
receivable factored with CIT, since the factoring of receivable is non-recourse
to Innovo Group. Further, in the event Innovo Group's loan balance with CIT
exceeds the face value of the receivables factored with CIT, Innovo Group
records the difference between the face value of the factored receivables and
the outstanding loan balance as a liability on Innovo Group's balance sheet as
"Due to Factor." At May 29, 2004, Innovo Group's loan balance with CIT was
$9,316,000 and an aggregate amount of $327,000 of open letters of credit were
outstanding. On June 10, 2003, cross guarantees were executed by and among
Innovo, Joe's, and IAA and Innovo Group entered into a guarantee for its
subsidiaries' obligations in connection with the amendments to the existing
credit facilities. In connection with the agreements with CIT, all of our
inventory, merchandise, and/or goods, including raw materials through finished
goods and receivables are pledged to CIT.
NOTE 5 - EARNINGS PER SHARE
A reconciliation of the numerator and denominator of basic earnings
(loss) per share and diluted earnings (loss) per share is as follows:
Three Months Ended Six Months Ended
(in thousands, except (in thousands, except
per share data) per share data)
-------------------------- --------------------------
05/29/04 05/31/03 05/29/04 05/31/03
----------- ----------- ----------- -----------
Basic EPS Computation:
Numerator $ (6,728) $ (493) $ (11,697) $ (211)
Denominator:
Weighted average common shares outstanding 28,928 15,020 27,358 14,931
----------- ----------- ----------- -----------
Total shares 28,928 15,020 27,358 14,931
----------- ----------- ----------- -----------
Basic EPS $ (0.23) $ (0.03) $ (0.43) $ (0.01)
=========== =========== =========== ===========
Diluted EPS Calculation:
Numerator $ (6,728) $ (493) $ (11,697) $ (211)
Denominator:
Weighted average common shares
outstanding 28,928 15,020 27,358 14,931
Incremental shares outstanding
from assumed exercise of options
and warrants -- -- -- --
----------- ----------- ----------- -----------
Total shares 28,928 15,020 27,358 14,931
----------- ----------- ----------- -----------
Diluted EPS $ (0.23) $ (0.03) $ (0.43) $ (0.01)
=========== =========== =========== ===========
6
A total of 3,471,661 options and warrants were excluded from calculation of
diluted EPS at May 29, 2004 because these options and warrants either had an
exercise price in excess of the average market price of Innovo Group's common
stock during the quarter or their effect would have been anti-dilutive.
A total of 8,214,604 options and warrants were excluded from calculation of
diluted EPS at May 31, 2003 because these options and warrants either had an
exercise price in excess of the average market price of Innovo Group's common
stock during the quarter or their effect would have been anti-dilutive.
NOTE 6 - OTHER INCOME AND EXPENSE
Other Income and Expense consists of the following:
Three Months Ended Six Months Ended
(in thousands) (in thousands)
-----------------------------------------------------
05/29/04 05/31/03 05/29/04 05/31/03
----------- ----------- ----------- -----------
Rental, real estate, and management fee income $ 13 $ 82 $ 27 $ 176
Realized/unrealized gain on foreign currency 5 -- 5 27
Other items 47 27 53 31
----------- ----------- ----------- -----------
Total other income $ 65 $ 109 $ 85 $ 234
=========== =========== =========== ===========
Rental expense $ 6 $ 20 $ 13 $ 43
Realized/unrealized loss on foreign currency 47 54 102 54
Loss on fixed asset disposal 3 -- 3 --
Asset impairment charge on rental property 574 -- 574 --
----------- ----------- ----------- -----------
Total other expense $ 630 $ 74 $ 692 $ 97
=========== =========== =========== ===========
Subsequent to the quarter ended May 29, 2004, management made a
determination to offer for sale our former headquarters located in Springfield,
Tennessee, which we have partially rented since relocating our headquarters.
Management decided that maintaining the property was no longer a beneficial use
of our working capital. As a result of the change in intended use and other
impairment factors, Innovo Group recorded an impairment loss on the property of
$574,000 reducing the carrying value from $1,174,000 to $600,000. The remaining
mortgage balance on the property is approximately $425,000. The property will be
reclassified as held for sale in the third quarter financial statements.
In connection with the termination of Joe's Jeans Japan's operations,
during the six months ended May 29, 2004, the accumulated other comprehensive
loss resulting from the translation of the subsidiary's financial statements
from yen to dollars was reclassified to the statement of operations, resulting
in a $55,000 loss during the period.
NOTE 7 -INCOME TAXES
Innovo Group income tax expense for the six months ended May 29, 2004 and
May 31, 2003, respectively, represents estimated state and foreign income and
franchise tax expense. For the 2004 period, Innovo Group recorded $6,000 of
income tax, which represents estimated state taxes net of a tax benefit from the
recovery of taxes previously paid in Japan. For the 2004 and 2003 periods, the
effective tax rate differs from the statutory rate primarily as a result of the
accrual for state and foreign taxes and the recording of a valuation allowance
which fully offset the benefit of the losses for the period.
7
NOTE 8 - STOCK COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for Stock
Based Compensation" (SFAS No. 123), encourages, but does not require, companies
to record compensation cost for stock-based employee compensation plans at fair
value. Innovo Group has chosen to continue to account for employee stock-based
compensation using the method prescribed in Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
Innovo Group has adopted the disclosure-only provisions of SFAS No. 123.
Accordingly, no compensation expense has been recorded in conjunction with the
fair value of the options at the grant date and amortized over the option's
vesting period, consistent with the method prescribed by SFAS No. 123, Innovo
Group's net income (loss) would have been increased to the pro forma amounts
indicated below for the six months ended May 29, 2004 and May 31, 2003:
Three Months Ended Six Months Ended
(in thousands, except (in thousands, except
per share data) per share data)
-------------------------- --------------------------
05/29/04 05/31/03 05/29/04 05/31/03
-------------------------- --------------------------
Net loss as reported $ (6,728) $ (493) $ (11,697) $ (211)
Add:
Stock based employee compensation
expense included in reported net loss, net of
related tax effects -- 25 -- 50
Deduct:
Total stock based employee compensation
expense determined under fair market value
based method for all awards, net of related
tax effects 92 142 184 295
-------------------------- --------------------------
Pro forma net loss $ (6,820) $ (610) $ (11,881) $ (456)
========================== ==========================
Net loss per share
As reported - basic $ (0.23) $ (0.03) $ (0.43) $ (0.01)
As reported - diluted $ (0.23) $ (0.03) $ (0.43) $ (0.01)
Pro forma - basic $ (0.24) $ (0.04) $ (0.43) $ (0.03)
Pro forma - diluted $ (0.24) $ (0.04) $ (0.43) $ (0.03)
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option pricing model with the following assumptions used
for grants in 2003:
2003
----
Estimated dividend yield................... 0.0%
Expected stock price volatility............ 48%
Risk-free interest rate.................... 5.0%
Expected life of options................... 4 yrs.
The Black-Scholes 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
Innovo Group's employee stock options have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially affect the fair value estimates, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
8
NOTE 9 - BLUE CONCEPT ACQUISITION
On July 17, 2003, our IAA subsidiary entered into an asset purchase
agreement (APA) with Azteca, Hubert Guez and Paul Guez, whereby IAA acquired the
Blue Concept Division of Azteca. The Blue Concept Division sells primarily denim
jeans to American Eagle Outfitters, Inc. (AEO), a national retailer. Hubert Guez
and Paul Guez, two of our substantial stockholders and parties to the APA,
together have a controlling interest in Azteca.
Pursuant to the terms of the APA, IAA paid $21.8 million for the Blue
Concept Division, subject to adjustment as noted below. Pursuant to the APA, IAA
employed all 30 of the existing employees of the Blue Concept Division, but did
not assume any of the Blue Concept Division's or Azteca's existing liabilities.
The purchase price was paid through the issuance of a seven-year, partially
convertible promissory note (the Blue Concept Note). The Blue Concept Note bears
interest at a rate of 6% and requires payment of interest only during the first
24 months and then is fully amortized over the remaining five-year period. The
terms of the transaction further allowed Innovo Group, upon stockholder
approval, to convert a portion of the Blue Concept Note into 3,125,000 shares of
common stock valued at the greater of $4.00 per share or the market value of
Innovo Group's common stock at the date stockholder approval is obtained. On
March 5, 2004 in accordance with the APA and Nasdaq rules, Innovo Group
conducted a special meeting of its stockholders to convert up to $12.5 million
of the debt into up to 4,166,667 shares of common stock. The conversion was
approved by stockholders and as a result, Azteca has initially been issued
3,125,000 shares of common stock at a conversion price of $4.00 per share with
the possible issuance of up to 1,041,667 additional shares of common stock upon
the occurrence of certain contingencies described in the Blue Concept APA. As a
result of this conversion, the Blue Concept Note was reduced from $21.8 million
to $9.3 million and the shares issued pursuant to the conversion are subject to
certain lock-up periods. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Debt Conversions" for a further discussion
of the conversion of the Blue Concept Note.
In the event that sales of the Blue Concept Division fall below $70
million during the first 17 month period (Period I) following the closing of the
acquisition, or $65 million during the 12 month period (Period II) following
Period I, certain terms of the APA allow for a reduction in the purchase price
through a decrease in the principal balance of the Blue Concept Note and/or the
return of certain locked-up shares of Innovo Group's common stock. In the event
the Blue Concept Note is reduced during Period I and the sales of the Blue
Concept Division in Period II are greater than $65 million, the Blue Concept
Note shall be increased by half of the amount greater than the decrease in
Period I.
In the event that principal amount of the Blue Concept Note needs to be
reduced beyond the outstanding principal balance of such Blue Concept Note, then
an amount of the locked-up shares equal to the balance of the required reduction
shall be returned to Innovo Group. For these purposes, the locked-up shares
shall be valued at $4.00 per share. Additionally, if during the 12-month period
following the closing, AEO is no longer a customer of IAA, the locked-up shares
will be returned to Innovo Group, and any amount remaining on the balance of the
Blue Concept Note will be forgiven.
In the event the revenues of the Blue Concept Division decrease to $35
million or less during Period I or Period II, IAA shall have the right to sell
the purchased assets back to Azteca, and Azteca shall have the right to buy back
the purchased assets for the remaining balance of the Blue Concept Note and any
and all Locked Up Shares shall be returned to Innovo Group. In addition, IAA
will pay to Sweet Sportswear, LLC, an entity owned by Hubert Guez and Paul Guez
who were parties to the Blue Concept asset purchase agreement, an amount equal
to 2.5% of IAA's revenues generated as a result of sales to AEO.
9
As part of the transaction, IAA and AZT International SA de CV, a Mexico
corporation and wholly-owned subsidiary of Azteca (AZT), entered into a
two-year, renewable, non-exclusive supply agreement (Supply Agreement) for
products to be sold by Blue Concept Division. Under the terms of the Supply
Agreement, Innovo Group has agreed to market and sell the products to be
purchased from AZT Innovo Group's customers, more particularly the customers of
the Blue Concept Division. In addition to the customary obligations, the Supply
Agreement requires that: (i) Innovo Group shall submit written purchase orders
to AZT on a monthly basis specifying (x) the products to be supplied and (y) a
specified shipping date for products to be shipped; (ii) Innovo Group shall give
AZT reasonable time allowances upon placing its purchase orders with AZT prior
to delivery of the products by AZT; (iii) AZT shall receive payment immediately
upon receipt by Innovo Group of invoices for its purchase orders; (iv) Innovo
Group shall have a guaranteed profit margin of 15% on a "per unit" basis; and
(v) the products to be supplied shall be subject to quality control measures by
Innovo Group and by the customer of the Blue Concept Division.
The results of operations of the Blue Concept Division have been included
in Innovo Group's statement of operations from July 17, 2003.
The following table shows Innovo Group's unaudited pro forma consolidated
results of operations for the six months ended May 29, 2004 and May 31, 2003
assuming the Blue Concept Division acquisition had occurred at the beginning of
the respective fiscal years:
Three Months Ended Six Months Ended
(in thousands, except (in thousands, except
per share data) per share data)
-------------------------- --------------------------
05/29/04 05/31/03 05/29/04 05/31/03
----------- ----------- ----------- -----------
Net sales $ 30,023 $ 33,700 $ 46,627 $ 64,826
Net income (loss) (6,728) 348 (11,697) 1,731
Earnings (loss) per share:
Basic $ (0.23) $ 0.02 $ (0.43) $ 0.10
Diluted $ (0.23) $ 0.02 $ (0.43) $ 0.10
Management and the board of directors entered into the Blue Concept
acquisition for the following reasons: (i) Innovo Group was able to enter into
an acquisition with a seller with which Innovo Group has a long-standing
relationship; (ii) Innovo Group was able to acquire a profitable business that
has (x) a financial history of producing conservative profit margins with
significant revenues; (iii) Blue Concept had a strong customer relationship with
AEO, (iv) the manufacturing relationships with Azteca to produce effectively and
efficiently; and (v) was able to acquire the personnel and talent of a
profitable business. Further, although there can be no assurance, the Blue
Concept Division is expected to increase Innovo Group's revenue growth and is
expected to maintain positive cash flows. In the second quarter of fiscal 2004,
the Blue Concept Division accounted for $15,761,000 or 52% of our net revenue.
Furthermore, the APA protects Innovo Group if revenue expectations are not
realized by providing "downside" protections, such as guaranteed sales minimums,
and a buy-sell provision that allows for the sale of the business if revenues do
not reach $35 million.
The acquisition of the Blue Concept Division was accounted for under the
purchase method of accounting. Of the $21.8 million purchase price, $13.2
million was recorded as an intangible asset representing the value of the
customer relationship, $361,000 was recorded as an intangible asset representing
the fair value of the existing purchase orders at the closing of the
acquisitions and the balance of the purchase price of $8.32 million was recorded
as goodwill. The purchase price allocation was based upon a third party
valuation.
10
NOTE 10 - REPORTABLE SEGMENTS
Current Operating Segments
During the six-months ended May 29, 2004, Innovo Group continued to
operate in two segments, accessories and apparel. The accessories segment
represents Innovo Group's historical line of business as conducted by Innovo.
The apparel segment is comprised of the operations of Joe's and IAA, both of
which began in fiscal 2001, as a result of acquisitions. Innovo Group's real
estate operations and real estate transactions of its Leaseall and IRI
subsidiaries do not require substantial management oversight and have therefore
been treated as "other" for purposes of segment reporting. The operating
segments have been classified based upon the nature of their respective
operations, customer base and the nature of the products sold.
Innovo Group evaluates performance and allocates resources based on gross
profits, and profit or loss from operations before interest and income taxes.
The accounting policies of the reportable segments are the same as those
described in the summary of significant accounting policies.
Information for each reportable segment during each of the periods ending
May 29, 2004 and May 31, 2003 is as follows:
11
Three Months Ended 5/29/04 Accessories Apparel Other Total
--------------------------------------------------------
(in thousands)
Net Sales to External Customers $ 4,477 $ 25,546 $ -- $ 30,023
Gross Profit 970 2,460 -- 3,430
Depreciation & Amortization (19) (365) (30) (414)
Operating Loss (37) (4,558) (1,324) (5,919)
Total Assets 4,208 30,387 4,879 39,474
Three Months Ended 5/31/03 Accessories Apparel Other Total
--------------------------------------------------------
(in thousands)
Net Sales to External Customers(1) $ 3,185 $ 8,828 $ -- $ 12,013
Gross Profit 765 2,593 -- 3,358
Depreciation & Amortization (10) (52) (23) (85)
Operating Income (Loss) 68 333 (724) (323)
Total Assets 3,737 12,195 1,920 17,852
1. Excludes intercompany sales of $532,000 in the second quarter of fiscal 2003.
Six Months Ended 5/29/04 Accessories Apparel Other Total
--------------------------------------------------------
(in thousands)
Net Sales to External Customers $ 8,092 $ 38,535 $ -- $ 46,627
Gross Profit 1,843 4,457 -- 6,300
Depreciation & Amortization (38) (775) (56) (869)
Operating Loss (71) (7,788) (2,527) (10,386)
Total Assets 4,208 30,387 4,879 39,474
Six Months Ended 5/31/03 Accessories Apparel Other Total
--------------------------------------------------------
(in thousands)
Net Sales to External Customers(2) $ 5,928 $ 18,000 $ -- $ 23,928
Gross Profit 1,530 5,087 -- 6,617
Depreciation & Amortization (17) (104) (43) (164)
Operating Income (Loss) 125 1,155 (1,210) 70
Total Assets 3,737 12,195 1,920 17,852
2. Excludes intercompany sales of $906,000 in the six months ended May 31, 2003.
12
NOTE 11 - SUBSEQUENT EVENTS
Sale of Convertible Notes and Warrants
Subsequent to the end of our second quarter of fiscal 2004, on June 15,
2004, June 18, 2004 and June 22, 2004, Innovo Group executed agreements for the
sale of convertible promissory notes and common stock purchase warrants which
resulted in aggregate gross proceeds of $2.5 million and will result in an
additional $451,875 in aggregate gross proceeds upon exercise of the warrants.
The convertible promissory notes in the aggregate principal amount of $2.5
million, together with common stock purchase warrants to purchase an aggregate
of 312,500 shares of Innovo Group's common stock were sold to three "accredited
investors," as defined in Regulation D promulgated under the Securities Act of
1933, as amended, or the Securities Act. The transaction documents executed with
each purchaser were substantially similar.
The convertible promissory note issued to each purchaser bears interest at
a rate of 7.5% per annum and has a maturity date twelve months from the date of
issuance. The convertible note is convertible at any time from the date of
issuance into shares of common stock at a price per share equal to 110% of the
average of the closing price of Innovo Group's common stock for the five trading
days immediately prior to the date of issuance, which, for each purchaser,
resulted in a conversion price of $1.53, $1.41 and $1.35, respectively. Innovo
Group will pay interest only payments until the maturity date of the convertible
note, unless it is converted or prepaid. Innovo Group has an option to make one
prepayment of the note, in whole or in part, without penalty at any time after
three months. However, in the event that Innovo Group elects to prepay all or a
portion of the convertible note, a purchaser may elect within 3 days to convert
all or a portion of the note into common stock and thus prevent Innovo Group's
prepayment of the convertible note.
Each purchaser was also issued warrants to purchase shares of common
stock. The number of shares that the purchaser will be eligible to purchase is
equal to 12.5% of the aggregate amount of the convertible promissory note and
the exercise price of the warrants on a per share basis is equal to 110% of the
average of the closing price of Innovo Group's common stock for the five trading
days immediately prior to the date of issuance of the warrant, which, for each
purchaser, resulted in an exercise price of $1.53, $1.41 and $1.35,
respectively. The warrants expire five years from the date of issuance and are
exercisable immediately. In connection with both the convertible notes and the
warrants, Innovo Group entered into a registration rights agreement with each of
the purchasers, whereby Innovo Group agreed to register for resale the shares
underlying the convertible notes and warrants.
NOTE 12 - TERMINATION OF LICENSE AGREEMENTS
As disclosed in Innovo Group's Quarterly Report on Form 10-Q for the three
months ended February 28, 2004, filed with the Securities and Exchange
Commission on April 13, 2004, Innovo Group has been re-evaluating the license
agreements associated with its branded label apparel operating segments. As a
result of this re-evaluation process, two of its branded label apparel licenses
were terminated in the second quarter of fiscal 2004, as discussed in detail
below.
Fetish(TM)
On May 13, 2004, IAA mutually agreed to terminate the license agreement
for the manufacture and sale of apparel and accessories bearing the Fetish(TM)
mark with Blondie Rockwell, Inc., the licensor of entertainment personality
Eve's Fetish(TM) mark.
13
On May 25, 2004, the parties executed a definitive Settlement Agreement
and Release. Under the terms of the settlement, the license agreement was
immediately terminated; however, IAA continued to have the ability to market,
distribute and sell the 2004 summer Fetish(TM) line, other excess apparel
inventory and unsold and returned merchandise to certain approved customers
until December 31, 2004. Furthermore, IAA agreed to pay to Blondie Rockwell a
termination fee, which included unpaid and future accelerated royalties, in
three installments over a three month period. As of July 13, 2004, Innovo Group
has made two installment payments totaling $587,171 and has one installment
payment in the amount of $250,000 remaining, which is payable on July 15, 2004.
In exchange for the termination fee and accelerated royalties, IAA has no
further obligation to pay any additional royalties on sales from the 2004
Fetish(TM) summer line, excess apparel inventory or unsold or returned
merchandise. In addition, IAA continues to have the right to finish the
production, marketing, distribution and sale of Fetish(TM) accessories
identified in the Settlement Agreement through March 31, 2005, and will pay a
royalty in the amount of 8% on all such accessory sales. As part of the
Settlement Agreement and Release, Innovo Group executed a Guaranty Agreement to
and in favor of Blondie Rockwell, Inc. guaranteeing payment in full and
performance of all of IAA's obligations and liabilities in the Settlement
Agreement and Release.
In connection with the termination of the Fetish(TM) license agreement,
IAA recorded a charge in the amount of $750,000 to reflect the termination
payment as well as $1,355,000 representing the write-off of fixed assets related
to the licensed brand and prepaid advertising license expenses. IAA also
recorded a charge of $1,707,000 related to the write-down to estimated net
realizable value of the Fetish(TM) inventory during the quarter ended May 29,
2004.
Hot Wheels(R)
In July of 2002, IAA entered into a license agreement with Mattel, Inc.
for Hot Wheels(R) branded adult apparel and accessories. Since that time, due to
lack of interest in the consumer marketplace, IAA did not have any sales under
this license agreement. Due to these and other factors, IAA terminated the
license agreement for Hot Wheels(R) branded apparel and accessory products. In
connection with the termination, IAA paid $70,000, representing the final
payment of royalty obligations to Mattel. Due to the termination, IAA reversed
an accrual of approximately $224,000 during the second quarter of fiscal 2004
which represented the maximum contractual future royalty obligations originally
due under the license agreement.
NOTE 13 - EXERCISE OF WARRANTS
During the second quarter of fiscal 2004, Innovo Group issued 247,500
shares of its common stock in connection with the exercise of certain previously
issued warrants. These warrants ranged in exercise price from $0.90 to $2.50.
All but two of the warrants exercised expired on March 31, 2004. Two of the
warrants exercised expired on December 19, 2005. On May 20, 2004, an aggregate
of 168,500 warrants ranging in exercise price from $2.50 to $3.00 expired
unexercised. These shares issued upon exercise of the warrants have been
registered for resale by Innovo Group.
NOTE 14 - ASSET IMPAIRMENT
Subsequent to the quarter ended May 29, 2004, management made a
determination to offer for sale our former headquarters located in Springfield,
Tennessee, which we have partially rented since relocating our headquarters.
Management decided that maintaining the property was no longer a beneficial use
of our working capital. As a result of the change in intended use and other
impairment factors, Innovo Group recorded an impairment loss on the property of
$574,000 reducing the carrying
14
value from $1,174,000 to $600,000. The remaining mortgage balance on the
property is approximately $425,000. The property will be reclassified as held
for sale in the third quarter financial statements.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation.
Forward-Looking Statements
When used in this Quarterly Report on Form 10-Q, the words "may," "will,"
"expect," "anticipate," "intend," "estimate," "continue," "believe" and similar
expressions are intended to identify forward-looking statements. Similarly,
statements that describe our future expectations, objectives and goals or
contain projections of our future results of operations or financial condition
are also forward-looking statements. Statements looking forward in time are
included in this Quarterly Report on Form 10-Q pursuant to the "safe harbor"
provision of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, which could cause
actual results to differ materially, including, without limitation, continued
acceptance of our product, product demand, competition, capital adequacy and the
potential inability to raise additional capital if required, and the risk
factors contained in our reports filed with the Securities and Exchange
Commission pursuant to the Securities Exchange Act of 1934, as amended,
including our Annual Report on Form 10-K and Amendment No. 1 to our Annual
Report of Form 10-K for the year ended November 29, 2003. Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof. Our future results, performance or achievements
could differ materially from those expressed or implied in these forward-looking
statements. We do not undertake and specifically decline any obligation to
publicly revise these forward-looking statements to reflect events or
circumstances occurring after the date hereof or to reflect the occurrence of
unanticipated events.
The following discussion provides information and analysis of our results
of operations for the six month period ended May 29, 2004 and May 31, 2003, and
our liquidity and capital resources. The following discussion and analysis
should be read in conjunction with our Notes to Consolidated Condensed Financial
Statements included elsewhere herein.
We completed our acquisition of the Blue Concept Division from Azteca
Production International, Inc., on July 17, 2003. The results of operations of
the Blue Concept Division are included in our operating results from the date of
acquisition. Accordingly, the financial position and results of operations
presented and discussed herein are not directly comparable between years. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Recent Acquisitions and Licenses" for a further discussion of the
Blue Concept Division Acquisition.
Introduction
This discussion and analysis summarizes the significant factors affecting
our results of operations and financial conditions during the six month periods
ended May 29, 2004 and May 31, 2003. This discussion should be read in
conjunction with our Consolidated Condensed Financial Statements, Notes to
Consolidated Condensed Financial Statements and supplemental information in Item
1 of this Quarterly Report on Form 10-Q for the period ended May 29, 2004. The
discussion and analysis contains statements that may be considered
forward-looking. These statements contain a number of risks and uncertainties as
discussed here, under the heading "Forward-Looking Statements" of this Quarterly
Report on Form 10-Q for the period ended May 29, 2004 that could cause actual
results to differ materially.
16
Executive Overview
Our principal business activity involves the design, development and
worldwide marketing of high quality consumer products for the apparel and
accessory markets. We do not manufacture any apparel or accessory products, but
may, from time to time at our cost, produce sample apparel and accessory
products for new or existing customers or internal use. We sell our products to
many retail, distributors and private label customers around the world. Retail
customers and distributors purchase finished goods directly from us. Retail
customers then sell the products through their retail stores and distributors
sell our products to retailers in the international market place. Private label
customers outsource the production and sourcing of their private label products
to us and then sell through their own distribution channels. Private label
customers are generally retail chains who desire to sell apparel and accessory
products under their own brand name. We work with our private label customers to
create their own brand image by custom designing products. In creating a unique
brand, our private label customers may provide samples to us or may select
styles already available in our showrooms. We believe we have established a
reputation among these private label buyers for the ability to arrange for the
manufacture of apparel and accessory products on a reliable, expeditious and
cost-effective basis.
Our branded label products, which include accessories and apparel, are
designed, developed and marketed by us internally pursuant to the license
agreement under which we have licensed the brand and/or mark or as a
company-owned brand, such as indie(TM) for apparel and Friendship(TM) and Clear
Gear(TM) for accessories. We then outsource the manufacturing and distribution
of the branded products. We sell our branded products to retail customers or
distributors. We are then obligated to pay a certain percentage of royalties on
our net sales of the branded products to the licensor, if it is a licensed
product. Since the beginning of the second quarter of fiscal 2004, we have
reduced our non-denim branded apparel operations by the termination of our
license agreement for Fetish(TM) apparel, the termination of our license
agreement for Hot Wheels(R) apparel and accessories, and the cessation of
production for Shago(R) apparel and accessories. Without these non-denim branded
apparel licenses, as well as their respective royalty obligations, we have been
able to reduce our headcount and direct our resources to focus primarily on
denim wear and accessories. While there can be no assurance that this direction
will result in profitability, we believe that these changes represent steps for
growth and profitability in areas of proven ability. We continue to retain our
branded accessory licenses for Fetish(TM) on a limited basis and Bongo(R), as
well as our licenses for our branded denim and denim related apparel, such as
Joe's Jeans(R), Betsey Johnson(R) and our new line, indie(TM).
Reportable Segments
For the periods ended May 29, 2004 and May 31, 2003, we operated in two
segments: apparel and accessories. The apparel segment is conducted by our Joe's
Jeans, Inc., or Joe's, and Innovo Azteca Apparel, Inc., or IAA, subsidiaries,
both of which are involved in the design, development and marketing of apparel
products. The accessory segment, which represents our historical business, is
conducted by our Innovo, Inc., or Innovo, subsidiary. The apparel and accessory
operating segments have been classified based upon the nature of their
respective operations, customer base and the nature of the products sold.
Our real estate transactions and our other corporate activities are
categorized under "other" and are represented by the operations of Innovo Group
Inc., or IGI, the parent company, and our two-wholly owned subsidiaries,
Leaseall Management Inc., or Leaseall, and Innovo Realty Inc., or IRI, which
conduct our real estate operations. Our real estate operations do not currently
require a substantial allocation of our resources and are not a significant part
of management's daily operational functions.
17
Our Principal Sources of Revenue
Joe's
Since its introduction in 2001, Joe's has gained national and
international recognition, primarily in the women's denim market. However, since
this introduction and beginning in fiscal 2003, Joe's has expanded its offerings
to include women's sportswear and men's apparel items. Further, Joe's has
announced that it is developing a new line of branded denim apparel under the
direction of Joe's Jeans design team under the brand name indie(TM). indie(TM)
will initially include women's denim jeans and skirts, tops and jackets, with
the collection targeted for the fall/holiday season in 2004 on a limited basis
and a full launch to better department and specialty stores for Spring of 2005.
IAA
Under our IAA subsidiary, we design and market private and branded apparel
products under various license agreements and other arrangements, such as
purchase orders. The private label business represents our largest source of
sales, both under IAA and in the aggregate of all our subsidiaries, primarily
because of our knowledge, resources and experience particularly within the denim
business. Through private label arrangements, we sell denim products primarily
to American Eagle Outfitters, Inc., or AEO, and Target Corporation. We
anticipate growth in private label sales throughout fiscal 2004 compared to
previous reporting periods, primarily because we will have conducted a full
fiscal year of sales to AEO as a result of the acquisition of the Blue Concept
Division from Azteca.
Since the beginning of fiscal 2004, we have been re-evaluating the license
agreements in our branded label apparel operating segments. On May 25, 2004, we
entered into a settlement agreement, or Settlement Agreement, whereby we
terminated our license agreement for Fetish(TM) branded apparel with Blondie
Rockwell, Inc., the licensor of entertainment personality Eve's Fetish(TM) mark.
Under the terms of the Settlement Agreement, we continue to have the ability to
market, distribute and sell the 2004 summer Fetish(TM) line, other excess
apparel inventory and unsold and returned merchandise to certain approved
customers until December 31, 2004 with no obligation to pay additional royalties
on sales, in exchange for a termination fee, which included past and accelerated
royalty payments. IAA agreed to pay to Blondie Rockwell the termination fee and
accelerated royalty payments in three installments over a three month period. As
of July 13, 2004, we have made two installment payments totaling $587,171 and
have one installment payment in the amount of $250,000 remaining, which is
payable on July 15, 2004. In addition, we continue to have the right to finish
the production of, market, distribute and sell Fetish(TM) accessories already
identified by the parties through March 31, 2005, and will pay royalties in the
amount of 8% on net sales, as originally defined in the license agreement, on
all such accessory sales.
In June of 2004, we also terminated our license agreement with Mattel,
Inc., or Mattel, for Hot Wheels(R) branded apparel and accessory products.
Because we did not have any sales in fiscal 2003 or through the second quarter
of fiscal 2004 under this license agreement due to lack of interest in the
consumer marketplace, we were able to terminate the license agreement. In
connection with the termination, we paid $70,000, representing the final payment
of royalty obligations to Mattel. Due to the termination, we reversed an accrual
of approximately $224,000 during the second quarter of fiscal 2004, which
represents the maximum contractual future royalty obligations due under the
original license agreement.
With respect to the license agreement for Shago(R) branded apparel and
accessories, we have also been in discussion with Bravado International Group,
Inc., the licensor of the entertainment personality Bow Wow's Shago(R) mark,
regarding the future of the Shago(R) branded apparel. As of July 13, 2004, we
have had discussions with representatives with the Shago(R) brand regarding its
future, but have not yet formally terminated the license agreement. We believe
that we will be able to terminate this license
18
agreement amicably and on terms favorable to us, however, there can be no
assurance that such a termination will take place. In the interim, we have
ceased production on Shago(R) branded apparel and accessories.
On February 6, 2004, we entered into an assignment with Blue Concept LLC,
which is controlled by Paul Guez, one of our significant stockholders, for all
the rights, benefits and obligations of a license agreement between Blue Concept
LLC and B.J. Vines, Inc., the licensor of the Betsey Johnson(R) apparel brand.
The license agreement provides for the exclusive right to design, market and
distribute women's jeans and coordinating denim related apparel, such as
t-shirts and tops, under the Betsey Johnson(R) brand name in the United States,
its territories and possessions, and Canada. As of July 13, 2004, we have
received a limited number of orders for our Betsey Johnson(R) branded apparel
products. We believe this license agreement, because it is limited to denim and
denim-related apparel, will allow us to utilize our strength in the denim and
denim-related apparel market.
Innovo
Our accessory business is conducted through our Innovo subsidiary. We
produce craft accessories to sell to large retailers such as Wal-Mart and
Michaels Stores, Inc, as well as private label and branded label accessories
through license agreements under which we have licensed brands, such as Bongo(R)
and Fetish(TM) or as company-owned brands, such as Friendship(TM) and Clear Gear
(TM). In addition, even though our IAA subsidiary has terminated certain of its
branded apparel licenses, we have been granted permission to continue to finish
the production and sale of accessories identified by the parties in the
Settlement Agreement under the Fetish(TM) brand through March 31, 2005.
Strategic relationship with two of our significant stockholders, Hubert Guez and
Paul Guez, and affiliated companies
Beginning in the summer of 2000, we entered into a series of transactions
with two of our significant stockholders, Hubert Guez and Paul Guez, and their
affiliated companies, such as Azteca Production International, Inc., or Azteca,
and/or Commerce Investment Group LLC, or Commerce. The Guez brothers and their
affiliated companies have in the aggregate more that fifty years of experience
in the apparel industry with a specialty in denim apparel and related products.
As discussed in greater detail below, our strategic relationship with the Guez
brothers and their affiliated companies has had many tangible benefits for us.
Our relationship with the Guez brothers began in the summer of 2000 when
the Guez brothers through their affiliated company, Commerce, which the Guez
brothers control, invested in our company. Pursuant to a stock and warrant
purchase agreement, Commerce acquired 2,863,637 shares of our common stock and
3,300,000 common stock purchase warrants. An investor rights agreement also
provides Commerce with a contractual right to nominate three individuals to our
board of directors. Commerce has not exercised this right at this time. Based
upon the Schedule 13D/A filed on May 18, 2004 and a Form 4 filed on May 20,
2004, the Guez brothers and/or their affiliates beneficially own in the
aggregate approximately 24.98% of our common stock outstanding as of July 13,
2004.
As part of Commerce's equity investment in our company, we entered into
several other arrangements with Commerce in order to reduce our manufacturing
and distribution costs and to increase the effectiveness and capacity of our
distribution network. Pursuant to a supply agreement and distribution agreement
with Commerce, we agreed to purchase all of our accessory products, which at the
time primarily consisted of denim tote bags and aprons, from Commerce and to
have Commerce distribute these products out of its Los Angeles distribution
facility. Commerce manufactures our accessory products out of its facilities in
Mexico. These agreements were renewed in August 2002 for an
19
additional two-year term and are automatically renewed for additional two-year
terms unless terminated by either party with 90 days notice.
Our strategic relationship with Commerce allowed us to close our domestic
manufacturing and distribution facilities and to move forward with diversifying
our product mix and offerings to include apparel products in addition to
accessory products. In an effort to enter the apparel market quickly and
efficiently we, through IAA, acquired Azteca's knit apparel division in August
2001 in exchange for 700,000 shares of our common stock and promissory notes in
the amount of $3.6 million. To further solidify our presence in the apparel
market and enhance and complement our existing private label business, in July
2003, we acquired the Blue Concept Division from Azteca in exchange for a
convertible promissory note in the original amount of $21.8 million dollars, or
the Blue Concept Note. In connection with the acquisition of the Blue Concept
Division, we obtained the rights relating to the design, manufacture and
wholesaling of denim jeans to AEO. On March 5, 2004, our stockholders approved
the conversion of $12.5 million of principal amount of the Blue Concept Note
into 3,125,000 shares of our common stock initially, with the potential issuance
of up to 1,041,667 additional shares of our common stock upon the occurrence of
certain contingencies described in the purchase agreement. As a result of this
conversion, the Blue Concept Note has been reduced to $9.3 million.
During fiscal 2003, we moved our headquarters and principal executive
offices from 5900 S. Eastern Avenue, Suite 120, Commerce, California 90040 to
5804 East Slauson Avenue, Commerce, California 90040. The 5804 East Slauson
Avenue space is utilized under a verbal agreement with Azteca, pursuant to which
we pay to Azteca a fee for allocated expenses associated with our use of office
and warehouse space and expenses incurred in connection with maintaining such
office and warehouse space. These allocated expenses include, but are not
limited to: rent, security, office supplies, machine leases and utilities. In
addition, we have verbal agreements with Azteca and/or its affiliates regarding
the supply and distribution of other apparel products we sell.
Results of Operations
We completed our acquisition of the Blue Concept Division from Azteca on
July 17, 2003. The results of operations of the Blue Concept Division are
included in our operating results from the date of acquisition.
Accordingly, the financial position and results of operations presented
and discussed herein are not directly comparable between years. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Recent Acquisitions and Licenses" for a further discussion of the
Blue Concept acquisition.
The following table sets forth certain statements of operations data for
the three and six-month periods as indicated:
20
Three Months Ended
(in thousands)
--------------------------------------------------------
05/29/04 05/31/03 $ Change % Change
----------- ----------- ----------- -----------
Net Sales $ 30,023 $ 12,013 $ 18,010 150%
Cost of Goods Sold 26,593 8,655 17,938 207
----------- ----------- ----------- -----------
Gross Profit 3,430 3,358 72 2
Selling, General & Administrative 8,935 3,596 5,339 148
Depreciation & Amortization 414 85 329 387
----------- ----------- ----------- -----------
Loss from Operations (5,919) (323) (5,596) 1,733
Interest Expense (279) (215) (64) 30
Other Income 65 109 (44) (40)
Other Expense (630) (74) (556) (A)
----------- ----------- ----------- -----------
Loss before Income Taxes (6,763) (503) (6,260) (A)
Income Taxes (35) (10) (25) 250
----------- ----------- ----------- -----------
Net Loss $ (6,728) $ (493) $ (6,235) (A)
=========== =========== ===========
(A) Not Meaningful
Six Months Ended
(in thousands)
--------------------------------------------------------
05/29/04 05/31/03 $ Change % Change
----------- ----------- ----------- -----------
Net Sales $ 46,627 $ 23,928 $ 22,699 95%
Cost of Goods Sold 40,327 17,311 23,016 133
----------- ----------- ----------- -----------
Gross Profit 6,300 6,617 (317) (5)
Selling, General & Administrative 15,817 6,383 9,434 148
Depreciation & Amortization 869 164 705 430
----------- ----------- ----------- -----------
Income (Loss) from Operations (10,386) 70 (10,456) (A)
Interest Expense (698) (365) (333) 91
Other Income 85 234 (149) (64)
Other Expense (692) (97) (595) (A)
----------- ----------- ----------- -----------
Loss before Income Taxes (11,691) (158) (11,533) (A)
Income Taxes 6 53 (47) (89)
----------- ----------- ----------- -----------
Net Loss $ (11,697) $ (211) $ (11,486) (A)
=========== =========== ===========
(A) Not Meaningful
21
Comparison of Three Months Ended May 29, 2004 to Three Months Ended May 31, 2003
Three Months Ended May 29, 2004 Overview
For the three months ended May 29, 2004, or the second quarter of fiscal
2004, our net sales increased to $30,023,000 from $12,013,000 for the three
months ended May 31, 2003, or the second quarter fiscal 2003, or a 150%
increase. We generated a net loss of $6,728,000 for the second quarter of fiscal
2004 compared to a net loss of $493,000 for the second quarter fiscal 2003, or a
1,222% increase. As further discussed below, we have identified the issues
associated with our continued losses in the second quarter of fiscal 2004 and we
are taking steps to address these issues.
The primary reasons for our net loss in the second quarter of fiscal 2004
compared to the second quarter of fiscal 2003 were the following:
o Lower gross margins as a result of: (i) sales of slow moving and
out-of-season Fetish(TM) and Shago(R) branded apparel and
accessories, (ii) $1,707,000 of additional charges taken against the
remaining Fetish(TM) inventory, (iii) lower gross margins for Joe's
Jeans as a result of a change in inventory purchasing, and (iv) an
increased percentage of sales coming from private label apparel and
accessories, which historically carry lower gross margins;
o An increase in employee wages and related benefits of $1,266,000
primarily as a result of hiring 31 employees related to the Blue
Concept Division acquisition and the hiring of additional employees
to support or facilitate the establishment of and increase sales for
Fetish(TM), Shago(R) and Joe's(R) branded products;
o An increase in advertising, marketing, tradeshow and related costs
of $280,000 incurred in order to market the Joe's(R), Shago(R)and
Fetish(TM)brands;
o An increase in royalties and commissions associated with our
Fetish(TM) and Shago(R) branded apparel products and the earnout
associated with the Blue Concept Division purchase of $813,000;
o An increase in our legal and accounting fees of $336,000;
o An increase in depreciation and amortization costs of $329,000
primarily associated with the acquisition of the Blue Concept
Division from Azteca in July 2003;
o Costs of $2,105,000 associated with the termination of our
Fetish(TM)license agreement; and
o An asset impairment charge of $574,000 to reflect a change in the
market value of our former manufacturing facility and headquarters
in Springfield, Tennessee. See "Management's Discussion and Analysis
of Financial Condition and Result of Operations - Other Income -
Leasall" for a further discussion of our Springfield facility.
As discussed above, we classify our business in two reportable segments.
The following table sets forth certain statements of operations data by segment
for the periods indicated.
22
Three Months Ended
5/29/04 Accessories Apparel Other (A) Total
--------------------------------------------------------
(in thousands)
Net Sales $ 4,477 $ 25,546 $ -- $ 30,023
Gross Profit 970 2,460 -- 3,430
Depreciation & Amortization (19) (365) (30) (414)
Interest Expense (21) (241) (17) (279)
Three Months Ended
5/31/03 Accessories Apparel Other (A) Total
--------------------------------------------------------
(in thousands)
Net Sales $ 3,185 $ 8,828 $ -- $ 12,013
Gross Profit 765 2,593 -- 3,358
Depreciation & Amortization (10) (52) (23) (85)
Interest Expense (57) (145) (13) (215)
Three Months Ended
5/29/04 to 5/31/04 Accessories Apparel Other (A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
---------------------------------------------------------------------------------------------
(in thousands)
Net Sales $ 1,292 41% $ 16,718 189% $ -- N/A $ 18,010 150%
Gross Profit 205 27 (133) (5) -- N/A 72 2
Depreciation & Amortization (9) 90 (313) 602 (7) 30 (329) 387
Interest Expense 36 (63) (96) 66 (4) 31 (64) 30
Net Sales
Our net sales increased to $30,023,000 in the second quarter of fiscal
2004 from $12,013,000 in the second quarter of fiscal 2003, or a 150% increase.
The primary reasons for this increase in our net sales were due to: (i)
increased sales to our private label customers in both the apparel and
accessories segments, a large portion of which is attributable to sales
generated as a result of the Blue Concept Division acquisition; (ii) growth in
sales of Joe's Jeans in both the domestic and international markets; and (iii)
sales from our Fetish(TM) branded apparel and accessory products. As previously
discussed, we terminated our license agreement for Fetish(TM) branded apparel
and accessory products on May 25, 2004. Based upon the termination of this and
other branded apparel and accessory license agreements, we expect our net sales
attributed to licensed branded labels to decrease in subsequent quarters.
Accessory
Innovo
Net sales for our accessory segment increased to $4,477,000 in the second
quarter of fiscal 2004 from $3,185,000 in the second quarter of fiscal 2003, or
a 41% increase. The increase is primarily a result of higher sales of Innovo's
private label accessory products and continued sales of our Fetish(TM) branded
accessory products.
23
Net Sales
($ in thousands) % of Total Net Sales
------------------- --------------------
Three Months Ended Three Months Ended
------------------- --------------------
5/29/04 5/31/03 % Chg. 5/29/04 5/31/03
------------------- -------- --------------------
Craft $ 1,327 $ 1,231 8% 30% 39%
Private Label 1,993 1,506 32% 45% 47%
Branded 1,157 448 158% 26% 14%
-------------------
Total Net Sales $ 4,477 $ 3,185 41% 100% 100%
===================
Craft Accessories
Innovo's net sales from its craft accessories business increased to
$1,327,000 in the second quarter of fiscal 2004 from $1,231,000 in the second
quarter of fiscal 2003, or an 8% increase. Craft accessories sales accounted for
30% of Innovo's net sales in the second quarter of fiscal 2004 compared to 39%
in the second quarter of fiscal 2003. Our net sales in the craft market remained
relatively flat. However, our craft sales grew by 8% because certain orders that
were scheduled to ship in February of our first quarter of fiscal 2004 were
delayed and subsequently shipped in March of our second quarter of fiscal 2004.
Private Label Accessories
Innovo's net sales from its private label business increased to $1,993,000
in the second quarter of fiscal 2004 from $1,506,000 in the second quarter of
fiscal 2003, or a 32% increase. Private label accessories sales accounted for
45% of Innovo's net sales in the second quarter of fiscal 2004. This increase
was due to increased sales to a private label customer with which we did minimal
business in the second quarter of fiscal 2003 and increased sales volume with
one of our largest existing customers, AEO. In fiscal 2004, we expect sales to
private label customers to increase as we continue to expand sales with existing
customers and increase our customer base through the introduction of washed bags
in other fabrications such as canvas and corduroy in addition to denim.
Branded Accessories
Innovo's net sales from its branded accessory business increased to
$1,157,000 in the second quarter of fiscal 2004 from $448,000 the second quarter
of fiscal 2003, or a 158% increase. Branded accessories sales accounted for 26%
on Innovo's net sales in the second quarter of fiscal 2004 compared to 14% in
the second quarter of fiscal 2003. Innovo's branded accessories carry the
following brand names: Bongo(R), Fetish(TM), Friendship(TM) and Clear Gear(TM).
Sales of branded accessories increased primarily as a result of the addition of
sales of Fetish(TM) branded accessories products, which we did not have in the
second quarter of fiscal 2003. As discussed previously, while IAA's license for
Fetish(TM) branded apparel was terminated on May 25, 2004, Innovo will continue
to have the right to finish the production of, market, distribution and sale of
Fetish(TM) branded accessory products as identified in the Settlement Agreement
through March 31, 2005. The parties have been in discussions to continue the
license for the Fetish(TM) branded accessory products. However, if Innovo does
not secure a separate license to continue the production, manufacture and sale
of the Fetish(TM) branded accessory products beyond March 2005, Innovo expects
its net sales from its branded accessory business to decrease in the same
quarter for fiscal 2005.
24
Net sales of Bongo(R) accessories, our second largest licensed accessories
brand as measured by net sales, did not increase in the second quarter of fiscal
2004 compared to the second quarter of fiscal 2003. The lack of sales growth is
attributable to a shift in buying by some of our customers, which includes
certain larger better department stores, away from low-end junior bags to
higher-end and urban junior bags. As a result of this shift, we have changed and
expanded our Bongo(R) branded line of bags to include a signature print series.
We expect that this change and expansion in our Bongo(R) branded line of bags
will result in an increase in sales in subsequent quarters, as we expect the
product to be attractive to mid-tier retailers. Throughout the remainder of
fiscal 2004, we anticipate net sales of certain other company-owned branded
accessories, such as Friendship(TM) and Clear Gear(TM), to continue to decrease
in future quarters of fiscal 2004 as we continue to sell off existing inventory.
Apparel
Joe's
Joe's net sales increased to $4,394,000 in the second quarter of fiscal
2004 from $2,638,000 in the second quarter of fiscal 2003, or a 67% increase as
a result of increased sales in both the domestic and international markets. The
increase in net sales is attributable to a higher number of units of Joe's sold.
At the end of the first quarter of fiscal 2004, we incurred a number of
production delays that resulted in a decline in sales. In the second quarter of
fiscal 2004, we completed the consolidation of Joe's production under the
existing production department we use for our other private and branded label
apparel products. As a result, we incurred fewer production delays and were able
to fulfill the vast majority of our backlog. Further, throughout fiscal 2004, to
increase Joe's net sales we have been expanding our collection of products to
include pants in materials other than denim, and tops, such as shirts and
jackets and expanding our denim pants line to include six fits that are tailored
to different body types.
Net Sales % of Total
($ in thousands) Net Sales
------------------- --------------------
Three Months Ended Three Months Ended
------------------- -------- --------------------
5/29/04 5/31/03 % Chg. 5/29/04 5/31/03
------------------- -------- -------- --------
Domestic $ 3,028 $ 1,705 78% 69% 65%
International 1,366 933 46% 31% 35%
-------------------
Total Net Sales $ 4,394 $ 2,638 67% 100% 100%
===================
25
Domestic
Joe's domestic net sales increased to $3,028,000 in the second quarter of
fiscal 2004 from $1,705,000 in the second quarter of fiscal 2003, or a 78%
increase. The increase in domestic net sales is attributable to a higher number
of units Joe's sold in the domestic market. In order to increase Joe's net sales
in the domestic market, we increased advertising spending to include billboards
as well as print ads. We expect Joe's net sales to continue to grow throughout
the remainder of fiscal 2004 based upon orders on-hand and a strong denim market
in the United States.
International
Joe's net sales to international markets increased to $1,366,000 in the
second quarter of fiscal 2004 from $933,000 in the second quarter of fiscal
2003, or a 46% increase. Currently, Joe's products are sold internationally
primarily in Japan, France, England, Canada, Australia, Norway and Korea. The
increase in international sales is attributable to an increase in the number of
international markets into which Joe's is selling product and growth in Joe's
key international markets. In fiscal 2004, we expect sales to international
distributors to increase as a result of partnering with Beyond Blue. Beyond Blue
is responsible for managing the existing relationships with Joe's international
distributors and opening new territories by obtaining additional international
sub-distributors and sales agents. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation - Recent Acquisitions and Licenses"
for a further discussion regarding the international distribution agreement with
Beyond Blue.
IAA
IAA's net sales increased to $21,151,000 in the second quarter of fiscal
2004 from $6,189,000 in the second quarter of fiscal 2003, or a 242% increase.
IAA segregates its operations between two businesses: private label and branded
apparel. IAA's increase in net sales is attributable to an increase in sales
from its private label business, most notably due to sales within the Blue
Concept Division, which we acquired from Azteca, Hubert Guez and Paul Guez in
July 2003. See "Management's Discussion and Analysis of Financial Condition and
Results of Operation - Recent Acquisitions and Licenses" for a further
discussion regarding the acquisition of the Blue Concept Division from Azteca.
Due to limited continuing sales of Fetish(TM) and Shago(R) related apparel sold
pursuant to the under the license agreements entered into during fiscal 2002 and
2003, IAA generated approximately only 12% of its net sales from its branded
business in the second quarter of fiscal 2004. For the second quarter of fiscal
2004, net sales of Shago(R) and Fetish(TM) branded apparel were $228,000 and
$2,392,000, respectively. For a further discussion of the termination of the Hot
Wheels(R), and Fetish(TM) license agreements and the status of the Shago(R)
license agreement, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Executive Overview."
Net Sales
($ in thousands) % of Total Net Sales
------------------- --------------------
Three Months Ended Three Months Ended
------------------- --------------------
5/29/04 5/31/03 % Chg. 5/29/04 5/31/03
------------------- -------- --------------------
Branded $ 2,620 $ 68 (A) 12% 1%
Private Label 18,531 6,121 203% 88% 99%
-------------------
Total Net Sales $ 21,151 $ 6,189 242% 100% 100%
===================
(A) Not Meaningful
26
Private Label Apparel
IAA's net sales from its private label business increased to $18,531,000
in the second quarter of fiscal 2004 from $6,121,000 in the second quarter of
fiscal 2003, or a 203% increase. The increase in sales is attributable to sales
generated as a result of acquisition of the Blue Concept Division from Azteca in
July 2003. In fiscal 2004, we expect sales from IAA's private label division to
increase as we anticipate benefiting from a full year's contribution of sales
from the Blue Concept Division compared to only four months in fiscal 2003, as
well as opening new private label accounts.
Branded Apparel
IAA's net sales from its branded apparel business increased to $2,620,000
in the second quarter of fiscal 2004 from $68,000 in the second quarter of
fiscal 2003. Branded apparel sales accounted for 12% of IAA's net sales in the
second quarter of fiscal 2004 compared to just 1% in the second quarter of
fiscal 2003. Due to the termination of the license agreement for Fetish(TM) and
Hot Wheels(R) branded apparel, as well as limited sales and the cessation of
production under the existing Shago(R) license, we expect sales within our
branded apparel business to be limited in the subsequent quarters of fiscal
2004. For a further discussion of the termination of the Hot Wheels(R) and
Fetish(TM) license agreements and the status of the Shago(R) license agreement,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Executive Overview."
In February 2004, we were assigned a license agreement with B.J. Vines,
Inc., licensor of the Betsey Johnson(R) brand for the exclusive right to design,
market and distribute women's jeans and coordinating denim related apparel, such
as t-shirts and tops, under the Betsey Johnson(R) brand name in the United
States, its territories and possessions, and Canada. As a result, we expect to
generate sales under this license agreement in the fourth quarter in fiscal
2004. Production of the apparel under the Betsey Johnson(R) brand name is
currently underway and we anticipate introducing the Betsey Johnson(R) products
in the third quarter of fiscal 2004. See "Management's Discussion and Analysis
of Financial Condition and Results of Operation - Recent Acquisitions and
Licenses" for a further discussion of the Betsey Johnson(R) license.
Gross Margin
Our gross profit increased to $3,430,000 in the second quarter of fiscal
2004 from $3,358,000 in the second quarter of fiscal 2003, or a 2% increase.
Overall, gross margin, as a percentage of net sales, decreased to 11% in the
second quarter of fiscal 2004 from 28% in the second quarter of fiscal 2003. The
decline was attributable to: (i) sales of slow moving and out-of-season
Fetish(TM) and Shago(R) branded apparel and accessories at cost; (ii) a charge
we recorded against our remaining slow moving and out-of-season Fetish(TM)
branded apparel; (iii) an increased percentage of our sales coming from
international distributors and domestic discounters, which carry lower margins;
and (iv) a higher percentage of sales coming from private label apparel, which
also carries lower margins.
Accessory
Innovo
Innovo's gross profit increased to $970,000 in the second quarter of
fiscal 2004 from $710,000 in the second quarter of fiscal 2003, or a 37%
increase. Innovo's gross margin was 22% in the second quarter of fiscal 2004
compared to 22% in the second quarter of fiscal 2003. Innovo's gross margin is a
27
function of its product mix, such as private label, craft and branded accessory
products, for a given period. Our craft and private label accessory products
have traditionally experienced lower gross margins than our branded accessory
products. Despite higher sales of higher margin branded accessories in the
second quarter of fiscal 2004 compared to the second quarter of fiscal 2003,
gross margin remained at the same level primarily as a result of increased air
freight due to late shipments. Increased air freight impacted gross margins by
three percentage points.
Apparel
Joe's
Joe's gross profit increased to $1,417,000 in the second quarter of fiscal
2004 from $1,416,000 in the second quarter of fiscal 2003, or a 0.1% increase.
Joe's gross margin decreased to 32% in the second quarter of fiscal 2004 from
54% in the second quarter of fiscal 2003 for the following two reasons: (i)
increased sales to domestic discounters, and (ii) higher cost of goods sold. We
had a higher level of sales to domestic discounters during the second quarter of
fiscal 2004 than in the second quarter of fiscal 2003 because we chose to sell
slow moving inventory at lower margins. Further, our cost of goods sold
increased as a result of no longer being able to purchase finished goods from
our domestic supplier at prices previously offered, which resulted in the need
to change our inventory purchasing strategy during at the end of the second
quarter of fiscal 2003 from buying finished goods to buying raw materials and
outsourcing the manufacturing of our goods. Joe's cost to buy raw materials and
outsource the manufacturing of its own goods was significantly higher than its
cost to buy finished goods. However, we expect Joe's margins to continue to
improve throughout the remainder of fiscal 2004 as a result of consolidating
Joe's production under the existing production department we use for our other
private and branded label apparel products.
IAA
IAA's gross profit decreased to $1,044,000 in the second quarter of fiscal
2004 from $1,176,000 in the second quarter of fiscal 2003, or an 11% decrease.
IAA's gross margin decreased to 5% in the second quarter of fiscal 2004 from 19%
in the second quarter of fiscal 2003. The decrease in gross margin is primarily
attributable to lower gross margins associated with sales of private label
apparel products, primarily sales associated with the purchase of the Blue
Concept Division and lower gross margins associated with sales of our
out-of-season and slow moving Shago(R) and Fetish(TM) inventory.
Private Label Apparel
IAA's private label gross profit increased to $2,868,000 in the second
quarter of fiscal 2004 from $1,150,000 in the second quarter of fiscal 2003, or
a 149% increase. IAA's private label gross margin decreased to 16% in the second
quarter of fiscal 2004 from 19% in the second quarter of fiscal 2003. The
decrease in gross margin is attributable to lower gross margins associated with
sales as a result of the acquisition of the Blue Concept Division and the
acquisition's related fixed margin supply agreement with Azteca.
Branded Apparel
IAA's branded apparel gross profit decreased to a loss of $1,824,000 in
the second quarter of fiscal 2004 from a profit of $26,000 in the second quarter
of fiscal 2003. IAA's branded apparel gross margins decreased to negative 70% in
the second quarter of fiscal 2004 from positive 38% in the second quarter of
fiscal 2003. The decrease in gross margin is attributable to charges we took
against our Fetish(TM) inventory as a result of termination of the license
agreement. In the second quarter of fiscal
28
2004 we recorded a charge of an additional $444,000 against out-of-season Fall
and Holiday Fetish(TM) inventory, and we recorded a charge of an additional
$1,263,000 against Spring and Summer Fetish(TM) inventory.
Selling, General and Administrative Expense
Selling, general and administrative, or SG&A, expenses increased to
$8,935,000 in the second quarter of fiscal 2004 from $3,694,000 in the second
quarter of fiscal 2003, or a 142% increase.
The SG&A increase in the second quarter of fiscal 2004 compared to the
second quarter of fiscal 2003 is largely a result of the following factors: (i)
an increase in advertising expenditures to establish and market our Fetish(TM),
Shago(R) and Joe's(R) branded products through both advertising and tradeshows;
(ii) the hiring of additional employees to support or facilitate the
establishment of and increase sales for Fetish(TM), Shago(R) and Joe's(R)
branded products and the addition of the personnel hired in connection with
acquisition of the Blue Concept Division from Azteca; (iii) an increase in
royalty and commission expense associated with our existing and new branded
accessory and apparel lines; (iv) an increase in outside legal and accounting
fees as a result of increased business activity; and (v) an earn-out expense and
other SG&A expenses associated with the purchase of Blue Concept Division; and
(vi) a charge directly related to the termination of the Fetish(TM) license.
As discussed in greater detail below, we incurred the following SG&A
expenses in the second quarter of fiscal 2004: (i) $448,000 of expense in the
second quarter of fiscal 2004 from $168,000 of expense in the second quarter of
fiscal 2003, or a 167% increase, to establish and market our branded products
through advertising and tradeshows; (ii) $2,592,000 of expense in the second
quarter of fiscal 2004 from $1,326,000 of expense in the second quarter of
fiscal 2003, or a 95% increase, for hiring additional employees and wage
increase; (iii) $919,000 of expense in the second quarter of fiscal 2004 from
$276,000 of expense in the second quarter of fiscal 2003, or a 233% increase,
for royalties and commissions associated with our existing and new branded
accessory and apparel lines; (iv) $667,000 of expense in the second quarter of
fiscal 2004 from $331,000 of expense in the second quarter of fiscal 2003, or a
102% increase, for increased legal and accounting fees as a result of increased
business activity associated with the Fetish(TM) termination, trademark matters,
registration of unregistered shares sold in fiscal 2003, and the conversion of
the Blue Concept Note; (v) $394,000 of earn-out expense and $187,000 of other
SG&A expense associated with the purchase of Blue Concept Division from Azteca;
and (vi) $2,105,000 of expense directly related to the termination of the
Fetish(TM) license, namely: (a) $300,000 to write off the Fetish(TM) tradeshow
booth; (b) $1,055,000 to write off the outstanding prepaid advertising balance
relating to the Fetish(TM) license; and (c) $750,000 to terminate the Fetish(TM)
license.
Accessory
Innovo
Innovo's SG&A expenses increased to $988,000 in the second quarter of
fiscal 2004 from $689,000 in the second quarter of fiscal 2003, or a 43%
increase. This SG&A expense increase is primarily attributable to wage and
related benefit increases. Innovo's employee wages and related benefits
increased to $454,000 in the second quarter of fiscal 2004 from $313,000 in the
second quarter of fiscal 2003, or a 45% increase. Employee wages and related
benefits increases are a result of hiring of additional salespeople to replace
outsourced sales personnel working on a "commission-only" basis and the hiring
of additional employees in our sourcing office in Hong Kong in fiscal 2004.
Due to the expansion of the branded accessories product line in the second
quarter of fiscal 2004 compared to the second quarter of fiscal 2003, three
other SG&A expense categories increased, namely:
29
(i) royalty expense; (ii) travel expenses; and (iii) rent. First, the addition
of sales of Fetish(TM) branded accessories resulted in an increase in our
royalty expense to $87,000 in the second quarter of fiscal 2004 from $16,000 in
the second quarter of fiscal 2003, or a 444% increase. Second, as a result of
increased travel overseas to expand our Hong Kong sourcing office and the travel
associated with attending additional sales shows, our travel and related
expenses increased to $65,000 in the second quarter of fiscal 2004 from $16,000
in the second quarter of fiscal 2003, or a 306% increase. Third, rent expenses
increased to $63,000 in the second quarter of fiscal 2004 from $28,000 in the
second quarter of fiscal 2003, or a 125% increase. The increase in rent is
primarily attributable to expansion of our New York showroom to include support
for the branded accessory lines. While we will continue to have the right to
continue the production of, the market, sale and distribution of Fetish(TM)
branded accessories until March 2005 and there can be no assurance that we will
be able to secure a license to produce Fetish(TM) branded accessories after this
date, until then, we will continue to incur expenses associated with the
Fetish(TM) branded accessories.
Apparel
Joe's
Joe's SG&A expenses increased to $1,820,000 during the second quarter of
fiscal 2004 from $1,443,000 in the second quarter of fiscal 2003, or a 26%
increase. This increase is primarily attributable to the following factors: (i)
wage and related benefits increase in connection with the hiring additional
employees in order to expand Joe's product lines from denim pants to a full
sportswear collection of pants and tops bearing the Joe's(R) brand for Spring
2004; (ii) an increase in advertising expenditures on marketing and advertising
the Joe's(R) and Joe's Jeans(R) brand through print and billboard; (iii) an
increase in legal, accounting and professional fees associated with the
dissolution of our Joe's Jeans subsidiary in Japan and with the filing and
prosecution for the protection of its trademarks domestically and
internationally; (iv) an increase in royalties and commissions as a result of
increased sales; (v) an increase in sample expense as a result of increased
distribution in the international markets; and (vi) an increase in tradeshow
expenses due to purchasing a booth rather than continuing to rent.
More specifically, Joe's employee wages and related benefits expenses
increased to $608,000 in the second quarter of fiscal 2004 from $469,000 in the
second quarter of fiscal 2003, or a 30% increase. Advertising expenditures
increased to $201,000 in the second quarter of fiscal 2004 from $89,000 in the
second quarter of fiscal 2003, or a 126% increase. Legal, accounting and
professional fees increased to $117,000 in the second quarter of fiscal 2004
from $78,000 in the second quarter of fiscal 2003, or a 50% increase. Royalty
and commission expense increased to $446,000 in the second quarter of fiscal
2004 from $231,000 in the second quarter of fiscal 2003, or a 93% increase as a
result of higher sales. Joe's sample expense increased to $112,000 in the second
quarter of fiscal 2004 from $65,000 in the second quarter of fiscal 2003, or a
72% increase. Tradeshow expense increased to $117,000 in the second quarter of
fiscal 2004 from $37,000 in the second quarter of fiscal 2003, or a 216%
increase.
IAA
IAA's SG&A expenses increased to $4,833,000 in the second quarter of
fiscal 2004 from $764,000 in the second quarter of fiscal 2003, or a 533%
increase. The increase in SG&A expense is primarily attributable to the growth
in IAA's branded apparel business and the acquisition of the Blue Concept
Division from Azteca.
IAA had higher employee costs associated with the expansion of its branded
apparel business and the acquisition of the Blue Concept Division. In addition,
we expanded our Hong Kong sourcing office to include sourcing for apparel
products, as discussed in the Innovo section above. As a result, employee
30
wages and benefits increased to $1,211,000 in the second quarter of fiscal 2004
from $319,000 in the second quarter of fiscal 2003, or a 280% increase.
During the second quarter of fiscal 2004, we incurred $126,000 of royalty
and commission expense versus only $18,000 in the second quarter of fiscal 2003,
or an increase of 600%. The increase in royalty and commission expense is a
result of sales of our Fetish(TM) and Shago(R) branded apparel lines. In the
second quarter of fiscal 2003, we had only $68,000 of Shago(R) sales and the
minimum royalty payment associated with the Hot Wheels(R) license. The $126,000
of royalty and commission expense we incurred in the second quarter of fiscal
2004 includes a reversal of $224,000 of a $294,000 accrual we recorded in fiscal
2003 against our future minimum royalty payments to Hot Wheels(R).
During the second quarter of fiscal 2004, we recognized $2,105,000 of
expense in connection with the termination of the Fetish(TM) license. We
recognized the following three expenses: (i) $300,000 to write-off the
Fetish(TM) tradeshow booth; (ii) $1,055,000 to write-off the outstanding prepaid
advertising royalty balance; and (iii) $750,000 to terminate the Fetish(TM)
license.
During the second quarter of fiscal 2004, we incurred $90,000 of tradeshow
expense to promote and sell our Fetish(TM) and Shago(R) branded apparel lines
compared to $11,000 in the second quarter of fiscal 2003. In addition, sample
expense including freight increased to $140,000 in the second quarter of fiscal
2004 from $86,000 in the second quarter of fiscal 2003, or a 63% increase.
Rental expense increased to $184,000 in the second quarter of fiscal 2004
from $15,000 in the second quarter of fiscal 2003. The primary reason for the
increase was due to our branded apparel showroom in New York. IAA did not have a
New York showroom in the second quarter of fiscal 2003. In addition, our
computer support expenses increased to $26,000 in the second quarter of fiscal
2004 from $4,000 in the second quarter of fiscal 2003, or a 550% increase for
support for our New York showroom and for additional licenses for our apparel
management software. In an effort to decrease rental expenses and due to the
termination of the our branded apparel licenses for Fetish(TM), Shago(R) and Hot
Wheels(R), we are in the process of evaluating our New York showroom sublease
agreement and obtaining permission from all necessary parties to further
sublease all or a portion of the New York showroom space.
Travel, meals and entertainment expense increased to $88,000 in the second
quarter of fiscal 2004 from $52,000 in the second quarter of fiscal 2003, or a
69% increase, as a result of the larger employee and customer base.
As a part of the acquisition of the Blue Concept Division, IAA pays to
Azteca a fee for allocated expenses associated with the use of its office space
and expenses incurred in connection with maintaining office space. These
allocated expenses include, but are not limited to: rent, security, office
supplies, machine leases and utilities. In the second quarter of fiscal 2004,
IAA recorded $181,000 for such expenses compared to no allocation in the second
quarter of fiscal 2003 since the business was not acquired until the third
quarter of fiscal 2003.
During fiscal 2003, we incurred $394,000 of expense to Sweet Sportswear
LLC, or Sweet Sportswear, pursuant to an earn-out agreement. In connection with
the Blue Concept Division acquisition, IAA pays to Sweet Sportswear, an entity
owned by Hubert Guez and Paul Guez who were parties to the Blue Concept asset
purchase agreement, an earn-out on a quarterly basis equal to 2.5% of the gross
sales of the division. This earn-out agreement was additional consideration for
the acquisition of the Blue Concept Division. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Recent Acquisitions
and Licenses" for further discussion regarding the
31
acquisition of the Blue Concept Division. We expect earn-out expenses to
increase as we anticipate sales growth from the Blue Concept Division for a full
year of sales in fiscal 2004.
Other
IGI
IGI, which reflects our corporate expenses and operates under the "other"
segment, does not have sales. IGI's expense, excluding interest, depreciation
and amortization, increased to $1,220,000 in the second quarter of fiscal 2004
from $682,000 in the second quarter of fiscal 2004, or a 79% increase. IGI's
management level wages and related benefits increased to $318,000 in the second
quarter of fiscal 2004 from $199,000 in the second quarter of fiscal 2003, or a
60% increase, primarily as a result of hiring five additional management level
employees to provide the infrastructure necessary to manage our growth. In the
second quarter of fiscal 2004, we recorded a charge of $161,000 for liquidated
damages payable to certain purchasers associated with a previous equity offering
because we were not able to have a registration statement declared effective by
the SEC within the time periods prescribed within the related equity financing
documents. Legal, accounting and professional fees increased to $540,000 in the
second quarter of fiscal 2004 compared to $246,000 in the second quarter of
fiscal 2003, or a 120% increase as a result of increased business activity,
registration of unregistered shares sold in fiscal 2003 and the termination of
the Fetish(TM) license.
Leaseall
Leaseall's SG&A expense increased to $73,000 in the second quarter of
fiscal 2004 from $10,000 in the second quarter of fiscal 2003, or a 630%
increase, due to $64,000 of expenses incurred to maintain and operate our former
manufacturing facility and headquarters located in Springfield, Tennessee, which
is now partially leased to third party tenants.
Depreciation and Amortization Expenses
Our depreciation and amortization expenses increased to $414,000 in the
second quarter of fiscal 2004 from $85,000 in the second quarter of fiscal 2003,
or a 387% increase. The increase is primarily attributable the amortization of
$330,000 of the intangible asset related to the value of the customer list
obtained through the purchase of the Blue Concept Division from Azteca. The
remaining depreciation and amortization expense of $84,000 is due to: (i)
depreciation of $24,000 in connection with the Springfield, Tennessee facility
and related leasehold improvements; (ii) amortization of $12,000 in connection
with the licensing rights to the Joe's(R) and Joe's Jeans(R) marks acquired on
February 7, 2001; and (iii) depreciation of $48,000 related to small operational
assets such as furniture, fixtures, machinery and software.
Interest Expense
Our combined interest expense increased to $279,000 in the second quarter
of fiscal 2004 from $215,000 in the second quarter of fiscal 2003, or a 30%
increase. Our interest expense is primarily associated with: (i) $111,000 of
interest expense from our factoring and inventory lines of credit and letter's
of credit from CIT used to help support our working capital increases; (ii)
$150,000 of interest expense incurred as a result of the $21,800,000 convertible
note issued as a part of the purchase of the Blue Concept Division in July of
2003 (which such interest expense has been partially eliminated due to the
$12,500,000 conversion of the convertible note at our March 5, 2004 special
meeting of stockholders); (iii) $10,000 of interest expense from two loans
totaling $500,000 provided by Marc Crossman, our Chief
32
Financial Officer, to Innovo Group on February 7, 2003 and February 13, 2003;
and (iv) $7,000 of interest expense from a mortgage on our former manufacturing
facility and headquarters in Springfield, Tennessee.
Other Income
IRI
Other income in the second quarter of fiscal 2004 included no income from
a quarterly sub-asset management fee that IRI is entitled to receive pursuant to
a sub-asset management agreement entered into on April 5, 2002, in connection
with the acquisition by IRI of a 30% limited partnership interest in 22 separate
limited partnerships, which acquired 28 apartment complexes at various locations
throughout the United States. Because the outstanding balance due to Innovo
Group at the end of the second quarter of fiscal 2004 was $77,000, we have
elected not to record the sub-asset management fee as income during the quarter
as collectability of the balance was not deemed probable. Part of the
consideration accepted by the sellers in the Limited Partnership Real Estate
Acquisition was 195,000 shares of our $100 Redeemable 8% Cumulative Preferred
Stock, Series A, or the Series A Preferred Stock. We are not entitled to any
cash flow or proceeds from the sales of the properties until all shares of the
Series A Preferred Stock have been redeemed. Until such time, we only receive
the quarterly sub-asset management fee. IRI generated $74,000 of income from the
sub-asset management fee in the second quarter of fiscal 2003.
Joe's
Joe's had $1,000 other income in the second quarter of fiscal 2004
compared to $54,000 of other expense in the second quarter of fiscal 2003, which
is principally attributable to foreign currency translation income.
Leaseall
Leaseall incurred other expense of $566,000 in the second quarter of
fiscal 2004 primarily related to an asset impairment charge of $574,000 to
reflect what management has determined to be the fair market value of the
property. Also included in other expense is net rental income of $8,000 from
tenants who are occupying our former manufacturing facility located in
Springfield, Tennessee.
Net Loss
We generated a net loss of $6,728,000 in the second quarter of fiscal 2004
compared to net loss of $493,000 in the second quarter of fiscal 2003. The net
loss in the second quarter of fiscal 2004 compared to the net loss in the second
quarter of fiscal 2003 is largely the result of the following factors: (i) lower
gross margins as a result of: (a) sales of slow moving and out-of-season
Fetish(TM) and Shago(R) branded apparel and accessories, (b) $1,707,000 of
additional charges taken against the remaining Fetish(R) inventory, (c) lower
gross margins for Joe's Jeans as a result of a change in inventory purchasing,
and (d) an increased percentage of sales coming from private label apparel and
accessories; (ii) increased employee wages and related benefits of $1,266,000
primarily as a result of hiring 31 employees related to the Blue Concept
Division acquisition and the hiring of additional employees to support or
facilitate the establishment of and increase sales for Fetish(TM), Shago(R) and
Joe's(R) branded products; (iii) increased advertising, marketing, tradeshow and
related costs of $280,000 incurred in order to market the Joe's(R), Shago(R) and
Fetish(TM) brands; (iv) increased royalties and commissions associated with our
Fetish(TM) and Shago(R) branded apparel products and the earnout associated with
the Blue Concept Division purchase of
33
$813,000; (v) increases in legal and accounting fees of $336,000; (vi) increase
in depreciation and amortization costs of $329,000 primarily associated with the
acquisition of the Blue Concept Division from Azteca in fiscal 2003; (vii) cost
of $2,105,000 associated with the termination our Fetish(R) licensing agreement;
and (viii) a charge of $574,000 to reflect the fair market value of our former
manufacturing facility and headquarters in Springfield, Tennessee.
Comparison of Six Months Ended May 29, 2004 to Six Months Ended May 31, 2003
Six Months Ended May 29, 2004 Overview
For the six months ended May 29, 2004, our net sales increased to
$46,627,000 from $23,928,000 for the six months ended May 31, 2003, or a 95%
increase. We generated a net loss of $11,697,000 and $211,000, respectively. As
further discussed below, we have identified the issues associated with our
continued losses in the six months ended May 29, 2004 and we are taking steps to
address these issues.
The primary reasons for our net loss in the six months ended May 29, 2004
were the following:
o lower gross margins as a result of: (a) sales of slow moving and
out-of-season Fetish(TM) and Shago(R) branded apparel and accessories, (b)
charges taken against the remaining Fetish(R) inventory, (c) lower gross
margins for Joe's Jeans as a result of a change in inventory purchasing,
and (d) an increased percentage of sales coming from private label apparel
and accessories;
o increased employee wages and related benefits of $3,007,000 primarily as a
result of hiring 31 employees related to the Blue Concept Division
acquisition and the hiring of additional employees to support or
facilitate the establishment of and increase sales for Fetish(TM),
Shago(R) and Joe's(R) branded products;
o increased advertising, marketing, tradeshow and related costs of $680,000
incurred in order to market the Joe's(R), Shago(R) and Fetish(TM) brands;
o increased royalties and commissions associated with our Fetish(TM) and
Shago(R) branded apparel products and the earnout associated with the Blue
Concept Division purchase of $1,376,000;
o increases in legal and accounting fees of $613,000;
o increase in depreciation and amortization costs of $705,000 primarily
associated with the acquisition of the Blue Concept Division from Azteca
in fiscal 2003;
o cost of $2,105,000 associated with the termination our Fetish(R)licensing
agreement; and
o an asset impairment charge of $574,000 to reflect the fair market value of
our former manufacturing facility and headquarters in Springfield,
Tennessee.
As discussed elsewhere, we classify our business in two reportable
segments. The following table sets forth certain statements of operations data
by segment for the periods indicated.
34
Six Months Ended
5/29/04 Accessories Apparel Other (A) Total
--------------------------------------------------------
(in thousands)
Net Sales $ 8,092 $ 38,535 $ -- $ 46,627
Gross Profit 1,843 4,457 -- 6,300
Depreciation & Amortization (38) (775) (56) (869)
Interest Expense (39) (621) (38) (698)
Six Months Ended
5/31/03 Accessories Apparel Other (A) Total
--------------------------------------------------------
(in thousands)
Net Sales $ 5,928 $ 18,000 $ -- $ 23,928
Gross Profit 1,530 5,087 -- 6,617
Depreciation & Amortization (17) (104) (43) (164)
Interest Expense (95) (248) (22) (365)
Six Months Ended
5/29/04 to 5/31/04 Accessories Apparel Other (A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
----------------------------------------------------------------------------------------------
(in thousands)
Net Sales $ 2,164 37% $ 20,535 114% $ -- N/A $ 22,699 95%
Gross Profit 313 20 (630) (12) -- N/A (317) (5)
Depreciation & Amortization (21) 124 (671) 645 (13) 30 (705) 430
Interest Expense 56 (59) (373) 150 (16) 73 (333) 91
Net Sales
Our net sales increased to $46,627,000 for the six months ended May 29,
2004 from $23,928,000 for the six months ended May 31, 2003, or a 95% increase.
The primary reasons for this increase in our net sales were due to: (i)
increased sales to our private label customers in both the apparel and
accessories segments, a large portion of which is attributable to sales
generated as a result of the Blue Concept Division acquisition; (ii) growth in
sales of Joe's Jeans in both the domestic and international markets; and (iii)
sales from our Fetish(TM) branded apparel and accessory products. As previously
discussed, we terminated our license agreement for Fetish(TM) branded apparel
and accessory products on May 25, 2004. Based upon the termination of this and
other branded apparel and accessory license agreements, we expect our net sales
attributed to licensed branded labels to decrease in subsequent quarters.
Accessory
Innovo
Net sales for our accessory segment increased to $8,092,000 for the six
months ended May 29, 2004 from $5,929,000 for the six months ended May 31, 2003,
or a 36% increase. The increase is primarily a result of higher sales of
Innovo's private label accessory products and continued sales of our Fetish(TM)
branded accessory products.
35
Net Sales
($ in thousands) % of Total Net Sales
------------------- --------------------
Six Months Ended Six Months Ended
------------------- --------------------
5/29/04 5/31/03 % Chg. 5/29/04 5/31/03
------------------- -------- --------------------
Craft $ 2,352 $ 2,574 -9% 29% 43%
Private Label 3,687 2,453 50% 46% 41%
Branded 2,053 902 128% 25% 15%
-------------------
Total Net Sales $ 8,092 $ 5,929 36% 100% 100%
===================
Craft Accessories
Innovo's net sales from its craft accessories business decreased to
$2,352,000 for the six months ended May 29, 2004 from $2,574,000 for the six
months ended May 31, 2003, or a 9% decrease. Craft accessories sales accounted
for 29% of Innovo's sales for the six months ended May 29, 2004 compared to 43%
for the six months ended May 31, 2003. Sales in the craft market remain
relatively flat. However, our craft sales declined 9% because of a reduction in
sales with one of our largest craft customers in the first quarter of fiscal
2004 due to a late delivery.
Private Label Accessories
Innovo's net sales from its private label business increased to $3,687,000
for the six months ended May 29, 2004 from $2,453,000 for the six months ended
May 31, 2003, or a 50% increase. Private label accessories sales accounted for
46% of Innovo's sales for the six months ended May 29, 2004 compared to 41% for
the six months ended May 31, 2003. This increase was due to increased sales to a
private label customer with which we did minimal business in the six months
ended May 31, 2003 and increased sales volume with one of our largest existing
customers, AEO.
Branded Accessories
Innovo's net sales from its branded accessory business increased to
$2,053,000 for the six months ended May 29, 2004 from $902,000 for the six
months ended May 31, 2003, or a 128% increase. Branded accessories sales
accounted for 25% of Innovo's net sales for the six months ended May 29, 2004
compared to 15% for the six months ended May 31, 2003. Innovo's branded
accessories carry the following brand names: Bongo(R), Fetish(TM),
Friendship(TM) and Clear Gear(TM). Sales of branded accessories increased
primarily as a result of the addition of sales of Fetish(TM) branded accessories
products, which we did not have in six months ended May 31, 2003. As discussed
previously, while IAA's license for Fetish(TM) branded apparel was terminated on
May 25, 2004, Innovo will continue to have the right finish the production of,
market, distribute and sale of Fetish(TM) branded accessories products as
identified in the Settlement Agreement until March 31, 2005. The parties have
been in discussions to continue the license for the Fetish(TM) branded accessory
products. However, if Innovo does not secure a separate license to continue the
production, manufacture and sale of the Fetish(TM) branded accessory products
beyond March 2005, Innovo expects its net sales from its branded accessory
business to decrease in the same quarter for fiscal 2005.
In addition, net sales of our Bongo(R) branded line of bags did not
increase. Sales of Bongo accessories, our second largest licensed accessories
brand as measured by sales, did not increase for the six months ended May 29,
2004 compared to the six months ended May 31, 2003. The lack of sales growth is
attributable to a shift in buying by some of our customers, which includes
certain larger better department stores, away from low-end junior bags to
higher-end and urban junior bags. As a result of this shift, we have changed and
expanded our Bongo(R) branded line of bags to include a signature print series.
We expect that this change and expansion in our Bongo(R) branded line of bags
will result in an increase in
36
sales in subsequent quarters, as we expect the product to be attractive to
mid-tier retailers. Throughout the remainder of fiscal 2004, we anticipate sales
of certain other branded accessories, such as Friendship(TM) and Clear Gear(TM),
to decrease as we continue to sell off existing inventory.
Apparel
Joe's
Joe's net sales increased to $6,064,000 for the six months ended May 29,
2004 from $4,766,000 for the six months ended May 31, 2003, or a 27% increase as
a result of increased sales in both the domestic and international markets. The
increase in net sales in attributable to a higher number of units Joe's sold. At
the end of the first quarter of fiscal 2004, we incurred a number of production
delays that resulted in a decline in sales. In the second quarter of fiscal
2004, we completed the consolidation of Joe's production under the existing
production department we use for our other private and branded label apparel
products. As a result, we incurred fewer production delays and were able to
fulfill the vast majority of our backlog. Our sales growth of 67% in the second
quarter of fiscal 2004 more than offset the 22% decline in net sales in the
first quarter of fiscal 2004. Further, throughout fiscal 2004, to increase Joe's
net sales we have been expanding our collection of products to include pants in
materials other than denim, and tops, such as shirts and jackets and expanding
our denim pants line to include six fits that are tailored to different body
types.
Net Sales % of Total
($ in thousands) Net Sales
------------------- --------------------
Six Months Ended Six Months Ended
------------------- --------------------
5/29/04 5/31/03 % Chg. 5/29/04 5/31/03
-------- -------- -------- -------- --------
Domestic $ 4,289 $ 3,221 33% 71% 68%
International 1,775 1,545 15% 29% 32%
-------------------
Total Net Sales $ 6,064 $ 4,766 27% 100% 100%
===================
Domestic
Joe's domestic net sales increased to $4,289,000 for the six months ended
May 29, 2004 from $3,221,000 for the six months ended May 31, 2003, or a 33%
increase. The increase in domestic net sales in attributable to a higher number
of units Joe's sold in the domestic market. In order to increase Joe's net sales
in the domestic market, we increased advertising spending to include billboards
as well as print ads. We expect Joe's net sales to continue to grow in the
second half of fiscal 2004 based upon orders on-hand and a strong denim market
in the United States.
International
Joe's net sales to international markets increased to $1,775,000 for the
six months ended May 29, 2004 from $1,545,000 for the six months ended May 31,
2003, or a 15% increase. Currently, Joe's products are sold internationally
primarily in Japan, France, England, Canada, Australia, Norway and Korea. The
increase in international sales is attributable to an increase in the number of
international
37
markets into which Joe's is selling product and growth in Joe's key
international. In fiscal 2004, we expect sales to international distributors to
increase as a result of partnering with Beyond Blue. Beyond Blue is responsible
for managing the existing relationships with Joe's international distributors
and opening new territories by obtaining additional international
sub-distributors and sales agents. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation - Recent Acquisitions and Licenses"
for a further discussion regarding the international distribution agreement with
Beyond Blue.
IAA
IAA's net sales increased to $32,471,000 for the six months ended May 29,
2004 from $13,233,000 for the six months ended May 31, 2003, or a 145% increase.
IAA segregates its operations between two businesses: private label and branded
apparel. IAA's increase in net sales is attributable to an increase in sales
from the private label business, most notably due to sales within the Blue
Concept Division, which we acquired from Azteca, Hubert Guez and Paul Guez in
July 2003. See "Management's Discussion and Analysis of Financial Condition and
Results of Operation - Recent Acquisitions and Licenses" for a further
discussion regarding the acquisition of the Blue Concept Division from Azteca.
Due to limited continuing sales of Fetish(TM) and Shago(R) related apparel sold
pursuant to the under the license agreements entered into during fiscal 2002 and
2003, IAA generated approximately only 18% of its net sales from its branded
business in the six months ended May 31, 2004. For the six months ended May 29,
2004, net sales of Shago(R) and Fetish(TM) branded apparel were $1,267,000 and
$4,329,000, respectively. For a further discussion of the termination of the Hot
Wheels(R), and Fetish(TM) license agreements and the status of the Shago(R)
license agreement, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Executive Overview."
Net Sales % of Total
($ in thousands) Net Sales
------------------- --------------------
Six Months Ended Six Months Ended
------------------- --------------------
5/29/04 5/31/03 % Chg. 5/29/04 5/31/03
------------------- -------- --------------------
Branded $ 5,616 $ 68 (A) 17% 1%
Private Label 26,855 13,165 104% 83% 99%
-------------------
Total Net Sales $ 32,471 $ 13,233 145% 100% 100%
===================
(A) Not Meaningful
Private Label Apparel
IAA's net sales from its private label business increased to $26,855,000
for the six months ended May 29, 2004 from $13,165,000 for the six months ended
May 31, 2003, or a 104% increase. The increase in sales is attributable to sales
generated in connection with the acquisition of the Blue Concept Division from
Azteca in July 2003. In fiscal 2004, we expect sales from IAA's private label
division to increase as a result of the benefit of a full year's contribution of
sales from the Blue Concept Division versus only four months in fiscal 2003, as
well as continued sales to Target Corporation.
Branded Apparel
IAA's net sales from its branded apparel business increased to $5,616,000
for the six months ended May 29, 2004 from $68,000 for the six months ended May
31, 2003. Branded apparel sales
38
accounted for 17% of IAA's net sales for the six months ended May 29, 2004
compared to just 1% for the six months ended May 31, 2003. However, as discussed
previously, on May 25, 2004, we entered into a Settlement Agreement to terminate
the Fetish(TM) license. Under the terms of the Settlement Agreement, we continue
to have the right to sell certain inventory until December 31, 2004 in exchange
for advanced royalty payments made in May, June and July of 2004 in the
aggregate of $837,000. Due to the termination of the license agreement for
Fetish(TM), as well as limited sales under the existing Shago(R) license, we
expect sales within our branded apparel business to be limited in the subsequent
quarters of fiscal 2004. As of the second quarter of fiscal 2004, we have ceased
production of Shago(R) apparel. Further, in June of 2004, we also terminated our
license agreement with Mattel, Inc. for Hot Wheels(R) branded apparel products.
We did not have any sales in fiscal 2003 or through the second quarter of fiscal
2004 under this license agreement due to lack of interest in the consumer
marketplace. For a further discussion of the termination of the Hot Wheels(R),
Shago(R) and Fetish(TM) license agreements, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Executive Overview."
In the first quarter of fiscal 2004, we entered into a license agreement
with Betsey Johnson for the exclusive right to design, market and distribute
women's jeans and coordinating denim related apparel, such as t-shirts and tops,
under the Betsey Johnson(R) brand name in the United States, its territories and
possessions, and Canada. As a result, we expect to generate sales under this
license agreement in the fourth quarter in fiscal 2004. Production of the
apparel under the Betsey Johnson(R) brand name is currently underway and we
anticipate introducing the Betsey Johnson(R) products in the third quarter of
fiscal 2004. See "Management's Discussion and Analysis of Financial Condition
and Results of Operation - Recent Acquisitions and Licenses" for a further
discussion of the Betsey Johnson(R) license.
Gross Margin
Our gross profit decreased to $6,299,000 for the six months ended May 29,
2004 from $6,616,000 for the six months ended May 31, 2003, or a 5% decrease.
Overall, gross margin, as a percentage of net sales, decreased to 14% for the
six months ended May 29, 2004 from 28% for the six months ended May 31, 2003.
The decline was attributable to: (i) sales of slow moving and out-of-season
Fetish(TM) and Shago(R) branded apparel and accessories at cost; (ii) charges we
recorded against our remaining slow moving and out-of-season Fetish(TM) branded
apparel; (iii) an increased percentage of our sales coming from international
distributors and domestic discounters, which carry lower margins; and (iv) a
higher percentage of sales coming from private label apparel, which also carries
a lower margin.
Accessory
Innovo
Innovo's gross profit increased to $1,842,000 for the six months ended May
29, 2004 from $1,422,000 for the six months ended May 31, 2003, or a 30%
increase. Innovo's gross margin is a function of its product mix, such as
private label, craft and branded accessory products, for a given period. Our
craft and private label accessory products have traditionally experienced lower
gross margins than our branded accessory products. Innovo's gross margin
decreased to 23% for the six months ended May 29, 2004 from 24% for the six
months ended May 31, 2003. The decrease in gross margin is primarily a result of
increased air freight as a result of late shipments and higher distribution
costs on our craft products.
Apparel
39
Joe's
Joe's gross profit decreased to $1,694,000 for the six months ended May
29, 2004 from $2,693,000 for the six months ended May 31, 2003, or a 37%
decrease. Joe's gross margin decreased to 28% for the six months ended May 29,
2004 from 57% for the six months ended May 31, 2003 for the following three
reasons: (i) an increased percentage of our sales coming from international
distributors (ii) increased sales to domestic discounters, and (iii) higher cost
of goods sold. We shipped a higher percentage of our goods to international
distributors in the six months ended May 29, 2004 compared to the six months
ended May 31, 2003. For the six months ended May 29, 2004, 30% of our sales were
to international distributors compared to 23% for the six months ended May 31,
2003. Furthermore, sales to international distributors carry lower gross margins
than domestic sales because we sell to our international distributors at a lower
selling price than our domestic selling price. We had a higher level of sales to
domestic discounters during the six months ended May 29, 2004 than in the six
months ended May 31, 2003 because we chose to sell slow moving inventory at
lower margins. Further, our cost of goods sold increased as a result of no
longer being able to purchase finished goods from our domestic supplier at
prices previously offered, which resulted in the need to change our inventory
purchasing strategy during at the end of the second quarter of fiscal 2003 from
buying finished goods to buying raw materials and outsourcing the manufacturing
of our goods. Joe's cost to buy raw materials and outsource the manufacturing of
its own goods was significantly higher than its cost to buy finished goods.
However, we expect Joe's margins to continue to improve through fiscal 2004 as a
result of consolidating Joe's production under the existing production
department we use for our other private and branded label apparel products.
IAA
IAA's gross profit increased to $2,763,000 for the six months ended May
29, 2004 from $2,393,000 for the six months ended May 31, 2003, or a 15%
increase. However, gross margin decreased to 9% for the six months ended May 29,
2004 from 18% for the six months ended May 31, 2003. The decrease in gross
margin is primarily attributable to: (i) lower gross margins associated with
sales coming from the purchase of the Blue Concept Division; (ii) lower gross
margins associated with sales of our out-of-season Shago(R) and Fetish(TM)
inventory; and (iii) charges recorded against our remaining Fetish(TM)
inventory.
Private Label Apparel
IAA's private label gross profit increased to $4,092,000 for the six
months ended May 29, 2004 from $2,367,000 for the six months ended May 31, 2003,
or a 55% increase. IAA's private label gross margin decreased to 15% for the six
months ended May 29, 2004 from 18% for the six months ended May 31, 2003. The
decrease in gross margin is attributable to lower gross margins associated with
sales from the purchase of the Blue Concept Division and the related fixed
margin supply agreement with Azteca.
Branded Apparel
IAA's branded apparel gross profit decreased to a loss of $1,329,000 for
the six months ended May 29, 2004 from a profit of $26,000 for the six months
ended May 31, 2003. IAA's branded apparel gross margins decreased to negative
24% for the six months ended May 29, 2004 from 38% for the six months ended May
31, 2003. The decrease in gross margin is attributable to charges we took
against our slow-moving and out-of-season branded apparel inventory. The charges
were taken as a result of our discontinuation of our Shago(R) program and the
termination of the Fetish(TM) apparel license.
40
Selling, General and Administrative Expense
Selling, general and administrative, or SG&A, expenses increased to
$15,817,000 for the six months ended May 29, 2004 from $6,382,000 for the six
months ended May 31, 2003, or a 148% increase.
The SG&A increase is largely a result of the following factors: (i) an
increase in advertising expenditures to establish and market our Fetish(TM),
Shago(R) and Joe's(R) branded products through both advertising and tradeshows;
(ii) the hiring of additional employees to support or facilitate the
establishment of and increase sales for Fetish(TM), Shago(R) and Joe's(R)
branded products and the addition of the personnel hired in connection with the
Blue Concept Division acquisition; (iii) increased royalty and commission
expense associated with our existing and new branded accessory and apparel
lines; (iv) increased outside legal and accounting fees as a result of continued
growth of the business in fiscal 2004; (v) an earn-out expense and other SG&A
expense associated with the purchase of Blue Concept Division; and (vi) a charge
directly related to the termination of the Fetish(TM) license.
As discussed in greater detail below, we incurred the following SG&A
expenses for the six months ended May 29, 2004: (i) 1,176,000 of expense in the
six months ended May 29, 2004 from $496,000 of expense in the six months ended
May 31, 2003, or a 137% increase, to establish and market our branded products
through advertising and tradeshows; (ii) $5,361,000 of expense in the six months
ended May 29, 2004 from $2,354,000 of expense in the second quarter of fiscal
2003, or a 128% increase, for hiring additional employees and wage increase;
(iii) $1,617,000 of expense in the six months ended May 29, 2004 from $571,000
of expense in the six months ended May 31, 2003, or a 183% increase, for
royalties and commissions associated with our existing and new branded accessory
and apparel lines; (iv) $1,163,000 of expense in the six months ended May 29,
2004 from $550,000 of expense in the six months ended May 31, 2003, or a 111%
increase, for increased legal and accounting fees as a result of increased
business activity associated with the Fetish(TM) termination, trademark matters,
registration of unregistered shares sold in fiscal 2003, and the conversion of
the Blue Concept Note; (v) $554,000 of earn-out expense and $511,000 of other
SG&A expense associated with the purchase of the Blue Concept Division; and (vi)
$2,105,000 of expense directly related to the termination of the Fetish(TM)
license, namely: (a) $300,000 to write-off the Fetish(TM) tradeshow booth; (b)
$1,055,000 to write-off the outstanding prepaid advertising balance; and (c)
$750,000 to terminate the Fetish(TM) license.
Accessory
Innovo
Innovo's SG&A expenses increased to $1,877,000 for the six months ended
May 29, 2004 from $1,301,000 for the six months ended May 31, 2003, or a 44%
increase. This SG&A expense increase is primarily attributable to wage and
related benefits increases. Innovo's employee wages and related benefits
increased to $870,000 for the six months ended May 29, 2004 from $684,000 for
the six months ended May 31, 2003, or a 27% increase. Employee wages and related
benefits increases are a result of hiring of additional salespeople to replace
outsourced sales personnel working on a "commission-only" basis and the hiring
of additional employees in our sourcing office in Hong Kong.
Due to the expansion of the branded accessories product line, four other
SG&A expense categories increased, namely: (i) royalty expense; (ii) travel
expenses; (iii) sample expense; and (iv) rent. First, the addition of sales of
Fetish(TM) branded accessories resulted in an increase in our royalty expense to
$149,000 for the six months ended May 29, 2004 from $43,000 for the six months
ended May 31,
41
2003, or a 247% increase. Second, as a result of increased travel overseas to
expand our Hong Kong sourcing office and the travel associated with attending
additional sales shows, our travel expenses increased to $107,000 for the six
months ended May 29, 2004 from $55,000 for the six months ended May 31, 2003, or
a 95% increase. Third, as a result of increased sales activity, our sample and
related expenses increased to $86,000 for the six months ended May 29, 2004 from
$49,000 for the six months ended May 31, 2003, or a 76% increase. Fourth, rent
expenses increased to $126,000 in the second quarter of fiscal 2004 from $58,000
in the second quarter of fiscal 2003, or a 125% increase. The increase in rent
is primarily attributable to our expansion of our New York showroom to include
support for the branded accessory lines. While the license agreement for the
Fetish(TM) branded apparel was terminated in May of 2004, we will continue to
have the right to continue the production of, market, sale and distribution of
Fetish(TM) branded accessories identified by the parties until March 2005. There
can be no assurance that we will be able to secure a license to produce
Fetish(TM) branded accessories after this date, however, until then, we will
continue to incur expenses associated with the Fetish(TM) branded accessories.
Apparel
Joe's
Joe's SG&A expenses increased to $3,106,000 during the second quarter of
fiscal 2004 from $2,651,000 for the six months ended May 31, 2003, or a 17%
increase. This increase is primarily attributable to the following factors: (i)
wage and related benefits increase in connection with the hiring additional
employees in order to expand Joe's product lines from denim pants to a full
sportswear collection of pants and tops bearing the Joe's(R) brand for Spring
2004; (ii) an increase in advertising expenditures on marketing and advertising
the Joe's(R) and Joe's Jeans(R) brand through print and billboard; (iii) an
increase in legal, accounting and professional fees associated with the
dissolution of our Joe's Jeans subsidiary in Japan and with the filing and
prosecution for the protection of its trademarks domestically and
internationally; (iv) an increase in royalties and commissions as a result of
increased sales; (v) an increase in sample expense as a result of increased
distribution in the international markets; and (vi) an increase in tradeshow
expenses due to purchasing a booth rather than continuing to rent.
More specifically, Joe's employee wages and related benefits expenses
increased to $1,099,000 for the six months ended May 29, 2004 from $880,000 for
the six months ended May 31, 2003, or a 25% increase. Advertising expenditures
increased to $413,000 for the six months ended May 29, 2004 from $217,000 for
the six months ended May 31, 2003, or a 90% increase. Legal and accounting fees
increased to $242,000 for the six months ended May 29, 2004 from $162,000 for
the six months ended May 31, 2003, or a 49% increase. Royalty and commission
expense increased to $565,000 for the six months ended May 29, 2004 from
$439,000 for the six months ended May 31, 2003, or a 29% increase as a result of
higher sales. Joe's sample expense increased to $251,000 for the six months
ended May 29, 2004 from $100,000 for the six months ended May 31, 2003, or a
151% increase. Tradeshow expense increased to $199,000 for the six months ended
May 29, 2004 from $130,000 for the six months ended May 31, 2003, or a 53%
increase.
IAA
IAA's SG&A expenses increased to $8,362,000 for the six months ended May
29, 2004 from $1,176,000 for the six months ended May 31, 2003, or a 611%
increase. The increase in SG&A expense is primarily attributable to the growth
in IAA's branded apparel business and the acquisition of the Blue Concept
Division from Azteca.
IAA had higher employee costs associated with the expansion of its branded
apparel business and the acquisition of the Blue Concept Division. In addition,
we expanded our Hong Kong sourcing office to
42
include sourcing for apparel products, as discussed in the Innovo section above.
As a result, employee wages and benefits increased to $2,730,000 for the six
months ended May 29, 2004 from $458,000 for the six months ended May 31, 2003,
or a 496% increase.
In the six months ended May 29, 2004, we incurred $611,000 of royalty and
commission expense versus only $51,000 in the six months ended May 31, 2003. The
increase in royalty and commission expense is a result of sales of our
Fetish(TM) and Shago(R) branded apparel lines. In the six months ended May 31,
2003, we had only $68,000 of Shago(R) sales and the minimum royalty payment
associated with the Hot Wheels(R) license.
In the six months ended May 29, 2004, we recognized $2,105,000 of expense
in connection with the termination of the Fetish(TM) license. We recognized the
following three expenses: (i) $300,000 to write-off the Fetish(TM) tradeshow
booth; (ii) $1,055,000 to write-off the outstanding prepaid advertising royalty
balance; and (iii) $750,000 to terminate the Fetish(TM) license.
In the six months ended May 29, 2004, we incurred $419,000 of tradeshow
expense to promote and sell our Fetish(TM) and Shago(R) branded apparel lines, a
336% increase compared to $96,000 in the six months ended May 31, 2003. In
addition, sample expense including freight increased to $295,000 in the six
months ended May 29, 2004 from $99,000 in the six months ended May 31, 2003, or
a 198% increase.
Rental expense increased to $214,000 in the six months ended May 29, 2004
from $15,000 in the six months ended May 31, 2003. The primary reason for the
increase was the opening of our branded apparel showroom in New York. IAA did
not have a New York showroom in the six months ended May 31, 2003. Travel, meals
and entertainment expense increased to $238,000 in the six months ended May 29,
2004 from $78,000 in the six months ended May 31, 2003, or a 205% increase, as a
result of the larger employee and customer base. In an effort to decrease rental
expenses and due to the termination of the our branded apparel licenses for
Fetish(TM), Shago(R) and Hot Wheels(R), we are in the process of evaluating our
New York showroom sublease agreement and obtaining permission from all necessary
parties to further sublease all or a portion of the New York showroom space.
As a part of the acquisition of the Blue Concept Division, IAA pays to
Azteca a fee for allocated expenses associated with the use of its office space
and expenses incurred in connection with maintaining office space. These
allocated expenses include, but are not limited to: rent, security, office
supplies, machine leases and utilities. In the six months ended May 29, 2004,
IAA recorded $499,000 for such expenses compared to no allocation in the six
months ended May 31, 2003 since the business was not acquired until the third
quarter of fiscal 2003.
In the six months ended May 29, 2004, we incurred $554,000 of expense to
Sweet Sportswear LLC, or Sweet Sportswear, pursuant to an earn-out agreement. In
connection with the Blue Concept Division acquisition, IAA pays to Sweet
Sportswear, an entity owned by Hubert Guez and Paul Guez who were parties to the
Blue Concept asset purchase agreement, an earn-out on a quarterly basis equal to
2.5% of the gross sales of the division. This earn-out agreement was additional
consideration for the acquisition of the Blue Concept Division. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Recent Acquisitions and Licenses" for further discussion regarding
the acquisition of the Blue Concept Division. We expect earn-out expenses to
increase as we anticipate sales growth from the Blue Concept Division for a full
year of sales in fiscal 2004.
43
Other
IGI
IGI, which reflects our corporate expenses and operates under the "other"
segment, does not have sales. IGI's expense, excluding interest, depreciation
and amortization, increased to $2,229,000 for the six months ended May 29, 2004
from $1,138,000 for the six months ended May 29, 2004, or a 96% increase. IGI's
management level wages and related benefits increased to $662,000 for the six
months ended May 29, 2004 from $332,000 for the six months ended May 31, 2003,
or a 99% increase, primarily as a result of hiring five additional management
level employees to provide the infrastructure necessary to manage our growth. In
the six months ended May 29, 2004, we recorded a charge of $161,000 for
liquidated damages payable to certain purchasers associated with a previous
equity offering because we were not able to have a registration statement
declared effective by the SEC within the time periods prescribed within the
related equity financing documents. Legal accounting fees increased to $873,000
for the six months ended May 29, 2004 compared to $380,000 for the six months
ended May 31, 2003, or a 130% increase as a result of increased business
activity, registration of unregistered shares sold in fiscal 2003, and the
termination of the Fetish(TM) license.
Leaseall
Leaseall's SG&A expense increased to $243,000 for the six months ended May
29, 2004 from $19,000 for the six months ended May 31, 2003, or a 1,179%
increase, due to $223,000 of expenses incurred to maintain and operate our
former manufacturing facility and headquarters located in Springfield,
Tennessee, which is now partially leased to third party tenants.
IRI
IRI had no SG&A expense in either the six months ended May 29, 2004
compared to $7,000 of legal fees in the six months ended May 31, 2003.
Depreciation and Amortization Expenses
Our depreciation and amortization expenses increased to $869,000 for the
six months ended May 29, 2004 from $164,000 for the six months ended May 31,
2003, or a 430% increase. The increase is primarily attributable the
amortization of $660,000 of the intangible asset related to the value of the
customer list obtained through the purchase of the Blue Concept Division from
Azteca. The remaining depreciation and amortization expense of $209,000 is due
to: (i) depreciation of $40,000 in connection with our former manufacturing
facility and headquarters in Springfield, Tennessee facility and related
leasehold improvements; (ii) amortization of $24,000 in connection with the
licensing rights to the Joe's(R) and Joe's Jeans(R) marks acquired on February
7, 2001; and (iii) depreciation of $145,000 related to small operational assets
such as furniture, fixtures, machinery and software.
Interest Expense
Our combined interest expense increased to $698,000 for the six months
ended May 29, 2004 from $365,000 for the six months ended May 31, 2003, or a 30%
increase. Our interest expense is primarily associated with: (i) $187,000 of
interest expense from our factoring and inventory lines of credit and letter's
of credit from CIT used to help support our working capital increases; (ii)
$473,000 of interest expense incurred as a result of the $21,800,000 convertible
note issued as a part of the purchase of the Blue Concept Division in July of
2003 (which such interest expense has been partially eliminated due to
44
the $12,500,000 conversion of the convertible note at our March 5, 2004 special
meeting of stockholders); (iii) $20,000 of interest expense from two loans
totaling $500,000 provided by Marc Crossman, our Chief Financial Officer, to
Innovo Group on February 7, 2003 and February 13, 2003; and (iv) $18,000 of
interest expense from a mortgage on our former manufacturing facility and
headquarters in Springfield, Tennessee.
Other Income
IRI
Other income for the six months ended May 29, 2004 included no income from
a quarterly sub-asset management fee that IRI is entitled to receive pursuant to
a sub-asset management agreement entered into on April 5, 2002, in connection
with the acquisition by IRI of a 30% limited partnership interest in 22 separate
limited partnerships, which acquired 28 apartment complexes at various locations
throughout the United States. Because the outstanding balance due to Innovo
Group at the end of the second quarter of fiscal 2004 was $77,000, we have
elected not to record the sub-asset management fee as income during the quarter
as collectability of the balance was not deemed probable. Part of the
consideration accepted by the sellers in the Limited Partnership Real Estate
Acquisition was 195,000 shares of our $100 Redeemable 8% Cumulative Preferred
Stock, Series A, or the Series A Preferred Stock. We are not entitled to any
cash flow or proceeds from the sales of the properties until all shares of the
Series A Preferred Stock have been redeemed. Until such time, we only receive
the quarterly sub-asset management fee. IRI generated $159,000 of income from
the sub-asset management fee for the six months ended May 31, 2003.
Joe's
Joe's had $50,000 other expense for the six months ended May 29, 2004
compared to $22,000 of other expense for the six months ended May 31, 2003, both
of which are principally attributable to foreign currency translation expense.
Leaseall
Leaseall incurred other expense of $559,000 for the six months ended May
29, 2004 primarily related to a charge of $574,000 to reflect what management
has determined to be the market value of the property. Also included in other
expense is net rental income of $15,000 from tenants who are occupying our
former manufacturing facility and headquarter located in Springfield, Tennessee.
Net Loss
We generated a net loss of $11,697,000 for the six months ended May 29,
2004 compared to net loss of $211,000 for the six months ended May 31, 2003. The
net loss for the six months ended May 29, 2004 compared to the net loss for the
six months ended May 31, 2003 is largely the result of the following factors:
(i) lower gross margins as a result of: (a) sales of slow moving and
out-of-season Fetish(TM) and Shago(R) branded apparel and accessories, (b)
charges taken against the remaining Fetish(R) inventory, (c) lower gross margins
for Joe's Jeans as a result of a change in inventory purchasing, and (d) an
increased percentage of sales coming from private label apparel and accessories;
(ii) increased employee wages and related benefits of $3,007,000 primarily as a
result of hiring 31 employees related to the Blue Concept Division acquisition
and the hiring of additional employees to support or facilitate the
establishment of and increase sales for Fetish(TM), Shago(R) and Joe's(R)
branded products; (iii) increased advertising, marketing, tradeshow and related
costs of $680,000 incurred in order to market the Joe's(R), Shago(R) and
45
Fetish(TM) brands; (iv) increased royalties and commissions associated with our
Fetish(TM) and Shago(R) branded apparel products and the earnout associated with
the Blue Concept Division purchase of $1,376,000; (v) increases in legal and
accounting fees of $613,000; (vi) increase in depreciation and amortization
costs of $705,000 primarily associated with the acquisition of the Blue Concept
Division from Azteca in fiscal 2003; (vii) cost of $2,105,000 associated with
the termination our Fetish(R) licensing agreement; and (viii) a charge of
$574,000 to reflect the fair market value of our former manufacturing facility
and headquarters in Springfield, Tennessee.
Liquidity and Capital Resources
Our primary sources of liquidity are: (i) cash flows from operations; (ii)
trade payables credit from vendors and related parties; (iii) equity financings
and borrowings from the factoring of accounts receivables and borrowing against
inventory. Cash used for operating activities was $7,349,000 in the six months
ended May 29, 2004 compared to $1,296,000 in the six months ended May 31, 2003.
During the period, we used cash to fund our operating expenses, reduce related
party payables and reduce trade credit extended to us by our suppliers. Cash
used in operating activities, combined with $18,000 of cash used in investing
activities, was funded by $7,248,000 of cash on hand at the beginning of the
first quarter of fiscal 2004 and $126,000 of cash provided by financing
activities. We ended the second quarter of fiscal 2004 with $7,000 of cash.
We are dependent on credit arrangements with suppliers and factoring and
inventory based lines of credit agreements for working capital needs. From time
to time, we have conducted equity financing through private placements and
obtained short-term working capital loans from senior members of management and
from members of our Board of Directors. Subsequent to the end of the second
quarter of fiscal 2004, in June 2004, we raised $2.5 million in additional
working capital through the sale of promissory notes convertible into shares of
our common stock and common stock purchase warrants. See "Notes to Consolidated
Financial Statements - Note 11" for a further discussion of the sale of
convertible notes and common stock purchase warrants.
Our primary capital needs are for our operating expenses and working
capital necessary to fund inventory purchases and extensions of our trade credit
to our customers. During the remainder of fiscal 2004, we anticipate funding
operating expenses and working capital through the following: (i) utilizing our
receivable and inventory based line of credit with CIT; (ii) utilizing cash
flows from operations; (iii) maximizing our trade payables with our domestic and
international suppliers; (iv) managing our inventory levels; and (v) reducing
the trade credit we extend to our customers.
In the second quarter of fiscal 2004, we relied on the following primary
sources to fund operations:
o A financing and inventory based line of credit agreements with CIT
o Cash balances
o Trade Payables
o Reduction of credit we extend to our domestic and international
customers; and
o Reduction of inventory levels
On June 1, 2001, our subsidiaries, Innovo and Joe's, entered into accounts
receivable factoring agreements with CIT which may be terminated with 60 days
notice by CIT, or on the anniversary date, by Innovo or Joe's or earlier as may
be permitted by the agreements. Under the terms of the agreements, Innovo or
Joe's has the option to factor receivables with CIT on a non-recourse basis,
provided that CIT approved the receivable in advance. Innovo or Joe's may, at
their option, also factor non-approved
46
receivables on a recourse basis. Innovo or Joe's continue to be obligated in the
event of product defects or other disputes, unrelated to the credit worthiness
of the customer. Innovo or Joe's has the ability to obtain advances against
factored receivables up to 85% of the face amount of the factored receivables.
The agreement calls for a 0.8% factoring fee on invoices factored with CIT and
per annum rate equal to the greater of the Chase prime rate plus 0.25% of 6.5%
on funds borrowed against the factored receivable. On September 10, 2001, IAA
entered into a similar factoring agreement with CIT upon the same terms.
On or about August 20, 2002, each of Innovo and Joe's entered into certain
amendments to their respective factoring agreements, which included inventory
security agreements, to permit the subsidiaries to obtain advanced of up to 50%
of the eligible inventory up to $400,000 each. According to the terms of the
agreements, amounts loaned against inventory are to bear an interest rate equal
to the greater of the Chase prime rate plus 0.75% or 6.5% per annum.
On or about June 10, 2003, the existing financing facilities with CIT for
each of Innovo and Joe's were amended, to be effective as of April 11, 2003,
primarily to remove the fixed aggregate cap of $800,000 on their inventory
security agreement to allow for Innovo and Joe's to borrow up to 50% of the
value of certain eligible inventory calculated on the basis of the lower of cost
or market, with cost calculated on a first-in-first out basis. In connection
with these amendments, IAA, entered into an inventory security agreement with
CIT based on the same terms as Joe's and Innovo, which did not include a fixed
aggregate cap. IAA did not previously have an inventory security agreement with
CIT. Under the factoring arrangements, we, through our subsidiaries, may borrow
up to 85% of the value of eligible factored receivables outstanding. The
factoring rate that we pay to CIT to factor accounts, on which CIT bears some or
all of the credit risk, was lowered to 0.4% and the interest rate associated
with borrowings under the inventory lines and factoring facility were reduced to
the Chase prime rate. We have also established a letter of credit facility with
CIT whereby we can open letters of credit for 0.125% of the face value with
international and domestic suppliers provided we have availability on our
inventory line of credit. In addition, we also may elect to factor our
receivables with CIT by utilizing an adjustment of the interest rate as set on a
case-by-case basis, whereby certain allocation of risk would be borne by us,
depending upon the interest rate adjustment. We record our account receivables
on the balance sheet net of receivable factored with CIT, since the factoring of
receivables is non-recourse to us. Further, in the event our loan balance with
CIT exceeds the face value of the receivables factored with CIT, we record the
difference between the face value of the factored receivables and the
outstanding loan balance as a liability on our balance sheet as "Due to Factor."
On June 10, 2003, cross guarantees were executed by and among Innovo, Joe's and
IAA and Innovo Group entered into a guarantee for its subsidiaries' obligations
in connection with the amendments to the existing credit facilities. Our loan
balance as of May 29, 2004 with CIT was $9,316,000 and an aggregate amount of
$327,000 of open letter of credit was outstanding.
In connection with the agreements with CIT, certain assets of Innovo,
Joe's and IAA are pledged to CIT. The pledge assets include all of our
inventory, merchandise, and/or goods, including raw materials through finished
goods and receivables.
As a result of our increased business activities, we used a substantial
amount of cash during the latter portion of fiscal 2003 and through the first
two quarters of fiscal 2004, large portion of which was used to fund necessary
costs associated primarily with the Fetish(TM), Shago(R) and Joe's(R) brands.
During the second quarter of fiscal 2004, while we had eligible inventory to
obtain working capital through our factoring arrangement with CIT, we also
experienced closer monitoring and review of our factoring activity from CIT in
accordance with its discretionary rights under the terms of the agreements, as a
result of the losses we incurred during fiscal 2003 and the first quarter of
2004. As a result, and in response to our losses in the second quarter of 2004
which are largely attributable to expenses incurred in connection with the
termination of the
47
Fetish(TM) license and cessation of production under the Shago(R) brand, we are
currently in discussions with CIT to reestablish our factoring capacity to be
consistent with the terms of our existing agreements with CIT.
Based on our projected results for the remainder of fiscal 2004, funds
received from our financing in June 2004, availability on our CIT financing
facilities, we believe that we have the working capital resources necessary to
meet the operational needs associated with our anticipated internal growth for
the remainder of fiscal 2004. Management further believes that the losses are
being reduced in a manner that will allow working capital to be used for
continued growth.
However, if we grow beyond our current anticipated expectations or
continue to have operating losses, we believe that it will be necessary to
obtain additional working capital through debt or equity financings. We believe
that any additional capital, to the extent needed, may be obtained from the
sales of equity securities or short-term working capital loans. There can be no
assurance that this or other financings will be available if needed. Our
inability to fulfill any interim working capital requirements would force us to
constrict our operations. We believe that the relatively moderate rate of
inflation over the past few years has not had a significant impact on our
revenues or profitability.
Debt Conversion
On March 5, 2004, in connection with an asset purchase agreement with
Azteca and the Guez brothers for the acquisition of the Blue Concept Division
from Azteca and pursuant to Nasdaq rules, we conducted a special meeting of our
stockholders to approve the conversion of approximately $12.8 million seven-year
convertible promissory note issued in connection with the acquisition into a
maximum of 4,166,667 shares of our common stock. The conversion was approved by
our stockholders and as a result, Azteca has initially been issued 3,125,000
shares of our common stock at a conversion price of $4.00 per share, or the
Azteca Conversion Shares, with the possible issuance of up to 1,041,667
additional shares of common stock upon the occurrence of certain contingencies
described in the Blue Concept asset purchase agreement. The Azteca Conversion
Shares were initially issued in reliance upon Section 4(2) of the 1933 Act which
provides an exemption from registration for shares not issued in a public
offering to a singe entity.
Short-Term Debt
Crossman Loan
On February 7, 2003 and on February 13, 2003, we entered into a loan
agreement with Marc Crossman, then a member of our board of directors and now
also our Chief Financial Officer, whereby Mr. Crossman loaned us an aggregate of
$500,000. The loan was funded into two phases of $250,000 each on February 7,
2003 and February 13, 2003. In the event of default, each loan is collateralized
by 125,000 shares of our common stock as well as a general unsecured claim on
our assets. Each loan matures six months and one day from the date of its
respective funding, at which point the principal amount loaned and any unpaid
accrued interest is due and payable in full without demand. Each loan carries
and 8% annualized interest rate with interest payable in equal monthly
installments. The loan may be repaid by us at any time during the term of the
loan without penalty. Further, prior to the maturity of each loan and the
original due dates, we elected at our sole option, to extend the term of each
loan for an additional period of six months and one day. Our disinterested
directors approved each loan from Mr. Crossman. Prior to the maturity of the
loans in February 2004, the parties agreed to extend the term of each loan for
an additional period of ninety days. Further, pursuant to the extension
amendments, Mr. Crossman has the sole and exclusive option to continue to extend
the terms of the loans for three additional ninety day periods by giving us
notice of such extensions on or before the due dates of the loan. As of July 13,
2004, the loans have
48
matured. Management is currently in discussion regarding the terms of repayment
to Mr. Crossman. We and Mr. Crossman have verbally agreed to enter into a
repayment plan and the parties, which includes the audit committee of our Board,
are currently in discussion to finalize such repayment plan.
CIT Commercial Services
At May 29, 2004, our loan balance with CIT was $9,316,000 and an aggregate
amount of $327,000 of open letters of credit were outstanding. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" for further discussion of our financing
agreements with CIT.
Convertible Notes and Common Stock Purchase Warrants
On June 15, 2004, June 18, 2004 and June 22, 2004, we executed agreements
for the sale of convertible promissory notes and common stock purchase warrants
which resulted in aggregate gross proceeds to us of $2.5 million immediately and
will result in an additional $451,875 in aggregate gross proceeds to us upon
exercise of the warrants. The convertible promissory notes in the aggregate
principal amount of $2.5 million, together with common stock purchase warrants
to purchase an aggregate of 312,500 shares of our common stock were sold to
three "accredited investors," as defined in Regulation D promulgated under the
Securities Act of 1933, as amended, or the Securities Act. The transaction
documents executed with each purchaser were substantially similar.
The convertible promissory note issued to each purchaser bears interest at
a rate of 7.5% per annum and has a maturity date twelve months from the date of
issuance. The convertible note is convertible at any time from the date of
issuance into shares of our common stock at a price per share equal to 110% of
the average of the closing price of our common stock for the five trading days
immediately prior to the date of issuance, which, for each purchaser, resulted
in a conversion price of $1.53, $1.41 and $1.35, respectively. We will pay
interest only payments until the maturity date of the convertible note, unless
it is converted or prepaid. We have an option to make one prepayment of the
note, in whole or in part, without penalty at any time after three months.
However, in the event that we elect to prepay all or a portion of the
convertible note, a purchaser may elect within 3 days to convert all or a
portion of the note into common stock and thus prevent our prepayment of the
convertible note.
Each purchaser was also issued warrants to purchase shares of our common
stock. The number of shares that the purchaser will be eligible to purchase is
equal to 12.5% of the aggregate amount of the convertible promissory note and
the exercise price of the warrants on a per share basis is equal to 110% of the
average of the closing price of our common stock for the five trading days
immediately prior to the date of issuance of the warrant, which, for each
purchaser, resulted in an exercise price of $1.53, $1.41 and $1.35,
respectively. The warrants expire five years from the date of issuance and are
exercisable immediately. In connection with both the convertible notes and the
warrants, we entered into a registration rights agreement with each of the
purchasers, whereby we agreed to register for resale the shares underlying the
convertible notes and warrants.
49
Long-Term Debt
Long-term debt consists of the following (in thousands):
05/29/04 11/29/03
-------------------
First mortgage loan on Springfield property $ 425 $ 476
Promissory note to Azteca (Blue Concepts) 9,300 21,800
Promissory note to Azteca (Knit Div.) -- 68
-------------------
Total long-term debt 9,725 22,344
Less current maturities 93 168
-------------------
Total long-term debt $ 9,632 $ 22,176
===================
Springfield Property Loan
The first mortgage loan, held by First Independent Bank of Gallatin, is
collateralized by a first deed of trust on real property in Springfield,
Tennessee (with a carrying value of $600,000 as of May 29, 2004), and by an
assignment of key-man life insurance on our President, Pat Anderson, in the
amount of $1 million. The loan bears interest at 2.75% over the lender's prime
rate per annum and requires monthly principal and interest payments of $9,900
through February 2008. The loan is also guaranteed by the Small Business
Administration, or SBA. In exchange for the SBA guarantee, we, Innovo, Nasco
Products International, Inc., our wholly-owned subsidiary, and our President,
Pat Anderson, have also agreed to act as guarantors for the obligations under
the loan agreement.
Blue Concept Acquisition Note
In connection with the purchase of the Blue Concept Division from Azteca,
IAA issued a seven-year convertible promissory note for $21.8 million, or the
Blue Concept Note. The Blue Concept Note bears interest at a rate of 6% and
requires payment of interest only during the first 24 months and then is fully
amortized over the remaining five-year period. The terms of the transaction
further allowed us, upon shareholder approval, which we obtained on March 5,
2004, to convert a portion of the Blue Concept Note into equity through the
issuance of 3,125,000 shares of our common stock valued at $4.00 per share, or
the Conversion Price. On March 5, 2004, the Blue Concept Note was reduced by
$12.5 million to $9.3 million. The reduction in the Blue Concept Note was
determined by the product of the Conversion Price and 3,125,000, and the shares
issued pursuant to the conversion are subject to certain lock-up periods. Up to
1,041,667 additional shares may be issued upon the occurrence of certain future
contingencies relating to our stock price for the 30 day period ending March 6,
2005.
In the event that sales of the Blue Concept Division fall below $70
million during the first 17 month period, or Period I, following the closing of
the acquisition, or $65 million during the 12 month period, or Period II
following Period I, certain terms of the APA allow for a reduction in the
purchase price through a decrease in the principal balance of the Blue Concept
Note and/or the return of certain locked-up shares of our common stock. In the
event the Blue Concept Noted is reduced during Period I and the sales of the
Blue Concept Division in Period II are greater than $65 million, the Blue
Concept Note shall be increased by half of the amount greater than $65 million,
but in no event shall the Blue Concept Note be increased by an amount greater
than the decrease in Period I.
In the event the principal amount of the Blue Concept Note needs to be
reduced beyond the outstanding principal balance of such Blue Concept Note, then
an amount of the locked-up shares equal to the balance of the required reduction
shall be returned to us. For these purposes, the locked-up shares
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shall be valued at $4.00 per share. Additionally, if during the 12 month period
following the closing, AEO is no longer a customer of IAA, the locked-up shares
will be returned to us, and any amount remaining on the balance of the Blue
Concept Note will be forgiven.
In the event the revenues of the Blue Concept Division decreased to $35
million or less during Period I or Period II, IAA shall have the right to sell
the purchased assets back to Azteca, and Azteca shall have the right to buy back
the purchased assets for the remaining balance of the Blue Concept Note and any
and all Locked-up Shares shall be returned to us.
The following table sets forth our contractual obligations and commercial
commitments as of May 29, 2004 (in thousands):
Contractual Obligations Payments Due by Period
-------------------------------------------------------------
Total Less than 1-3 years 4-5 years After 5 years
a year
- --------------------------------------------------------------------------------------------------------------
Long Term Debt 9,725 46 4,305 3,968 1,406
Operating Leases 2,528 340 1,470 683 35
Other Long Term Obligations-Minimum Royalties 1,976 533 1,113 330 --
Open Purchase Orders 6,088 6,088 -- -- --
Recent Acquisitions and Licenses
License Agreement for Fetish(TM) by Eve
On February 13, 2003, our IAA subsidiary entered into a 44 month exclusive
license agreement for the United States, its territories and possessions with
the recording artist and entertainer Eve for the license of the Fetish(TM) mark
for use with the production and distribution of apparel and accessory products.
On May 13, 2004, IAA mutually agreed to terminate the license agreement for the
manufacture and sale of apparel and accessories bearing the Fetish(TM) mark with
Blondie Rockwell, Inc., the licensor of entertainment personality Eve's
Fetish(TM) mark.
On May 25, 2004, the parties executed a definitive Settlement Agreement
and Release. Under the terms of the settlement, the license agreement was
immediately terminated; however, IAA continued to have the ability to market,
distribute and sell the 2004 summer Fetish(TM) line, other excess apparel
inventory and unsold and returned merchandise to certain approved customers
until December 31, 2004. Furthermore, IAA agreed to pay to Blondie Rockwell a
termination fee, which included unpaid and future accelerated royalties, in
three installments over a three month period. As of July 13, 2004, Innovo Group
has made two installment payments totaling $587,171 and has one installment
payment in the amount of $250,000 remaining, which is payable on July 15, 2004.
In exchange for the termination fee and accelerated royalties, IAA has no
further obligation to pay any additional royalties on sales from the 2004
Fetish(TM) summer line, excess apparel inventory or unsold or returned
merchandise. In addition, IAA continues to have the right to finish the
production, marketing, distribution and sale of Fetish(TM) accessories
identified in the Settlement Agreement through March 31, 2005, and will pay a
royalty in the amount of 8% on all such accessory sales. As part of the
Settlement Agreement and Release, Innovo Group executed a Guaranty Agreement to
and in favor of Blondie Rockwell, Inc. guaranteeing payment in full and
performance of all of IAA's obligations and liabilities in the Settlement
Agreement and Release.
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Hot Wheels(R)
In July of 2002, IAA entered into a license agreement with Mattel, Inc.
for Hot Wheels(R) branded adult apparel and accessories. Since that time, due to
lack of interest in the consumer marketplace, IAA did not have any sales under
this license agreement. Due to these and other factors, IAA terminated the
license agreement for Hot Wheels(R) branded apparel and accessory products. In
connection with the termination, IAA paid $70,000, representing the final
payment of royalty obligations to Mattel. Due to the termination, IAA reversed
an accrual of approximately $224,000 during the second quarter of fiscal 2004
which represented the maximum contractual royalty obligations originally due
under the license agreement.
Betsey Johnson(R) License
On February 6, 2004, through IAA, we entered into an assignment with Blue
Concept LLC, which is controlled by Paul Guez, for all the rights benefits and
obligations of a license agreement between Blue Concept LLC and B.J. Vines,
Inc., the licensor of the Betsey Johnson(R) apparel brand. The license agreement
provides for the exclusive right to design, market and distribute women's jeans
and coordinating denim related apparel, such as t-shirts, and tops, under the
Betsey Johnson(R) brand name in the United States, its territories and
possessions, and Canada. The license agreement allows for an initial four-year
term with a renewal option subject to certain sales levels being met. We are
required to pay royalties of eight percent on net sales and spend two percent of
net sales on advertising. The license agreement provides that certain minimum
guaranteed royalties and minimum net sales must be met in each annual period.
The minimum royalties to be paid in the aggregate are $1.28 million and minimum
net sales range from $2.5 million to $5.5 million. The agreement may be renewed
upon expiration of the initial 4 year term for an additional three years. We
anticipate introducing the Betsey Johnson(R) products in the third quarter of
2004. We believe this license agreement, because it is limited to denim and
denim related apparel, will allow us to utilize our strength in the denim and
denim-related apparel market.
Beyond Blue, Inc. Master Distribution Agreement
On February 16, 2004, our Joe's subsidiary entered into a Master
Distribution Agreement, or MDA, with Beyond Blue, Inc., or Beyond Blue, whereby
Joe's granted Beyond Blue exclusive distribution rights for Joe's products
outside the United States. Beyond Blue, a Los Angeles-based company that
specializes in international consulting, distribution and licensing for apparel
products, secured an exclusive right to distribute Joe's products outside the
United States, subject to current license agreements such as the license with
Itochu and Joe's Canadian distributor remaining in place. Under the MDA, Beyond
Blue will be establishing sub-distributors and sales agents in certain
international markets through sub-distribution agreements. These
sub-distribution agreements shall govern, but not be limited to, such items as:
(i) minimum sample charges paid by each sub-distributor; (ii) minimum
advertising requirements to be borne by each sub-distributor; and (iii) an
assignment provision that allows Joe's to take over the sub-distribution
agreements in the event that Beyond Blue defaults under the MDA. The MDA also
provides for the continuation of existing distribution agreements, such as the
Itochu Agreement. The term of the MDA shall be for three years, subject to
Beyond Blue purchasing certain minimum amounts of product from Joe's during
three annual periods, with the first annual period being for 18 months. The MDA
was entered into in an effort to capitalize upon Joe's international brand
recognition, to utilize Beyond Blue's experience in international distribution
of high-end fashion denim apparel lines and to manage international distribution
through the use of sub-distributors and sales agents in foreign markets.
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Itochu Distribution and License Agreement
On July 1, 2003, Joe's entered into a Master distribution and Licensing
Agreement, or the Distribution and Licensing Agreement, with Itochu, pursuant to
which Itochu obtained certain manufacturing, licensing rights for the "Joe's"
and "Joe's Jeans" marks. The Distribution and Licensing Agreement grants Itochu
certain rights with respect to the manufacture, distribution, sale and/or
advertisement of certain Joe's apparel products, or Joe's Products, including,
but no limited to: (i) a non-exclusive right to use the Joe's and Joe's Jeans
marks in connection with the manufacture of certain licensed Joe's and Joe's
Jeans products, which we will refer to as the Licensed Products, throughout the
world, and an exclusive right to use the Joe's and Joe's Jeans marks to
manufacture the Licensed Products in Japan; and (ii) an exclusive right to
import and distribute certain imported Joe's Products, which we will refer to as
the Imported Products, into Japan. These Imported Products will be purchased
directly from Joe's, with Itochu being obligated to purchase a minimum of $5.75
million of Joe's over the 42 month term of the Agreement. Additionally, Itochu
shall have the right to develop, produce and distribute certain apparel products
bearing the Joe's and Joe's Jeans marks for which Joe's shall receive a running
royalty payment for each contract year equal to the aggregate amount of six
percent of the net sales of all bottoms for both men and women of the Licensed
Products, and five percent of the net sales of all tops for both men and women
and the Licensed Products. As part of the transaction, Itochu agreed to purchase
the existing inventory or JJJ for approximately $1 million, assume the
management and operations of JJJ's showroom in Tokyo and employ certain
employees of JJJ.
In the first quarter of fiscal 2004, Innovo Group ceased operations of
JJJ. Innovo Group completed the dissolution of JJJ in the second quarter of
fiscal 2004. We will continue to sell product in Japan through the licensing and
distribution agreement with Itochu.
We believe that the Distribution and License Agreement with Itochu allows
us more expediently grow the Joe's and Joe's Jeans brand and business in Japan
because Itochu, as a local Japanese corporation, is better suited to market and
distribute the Joe's and Joe's Jeans products in accordance with cultural tastes
and norms compared to JJJ which was controlled and operated out of Los Angeles,
California. We further believe that Itochu is well suited and capable of
developing additional products suited to the local environment, which we will
benefit from through additional royalty payments.
Blue Concept Division Acquisition
On July 17, 2003, IAA entered into an asset purchase agreement, or APA
with Azteca, Hubert Guez and Paul Guez, whereby IAA acquired the division known
as the Blue Concept division, or the Blue Concept Division, of Azteca. The Blue
Concept Division sells primarily denim jeans to American Eagle Outfitters, Inc,
or AEO, a national retailer. Hubert Guez and Paul Guez, two of our substantial
stockholders and parties to the APA, together have a controlling interest in
Azteca. Based upon the Schedule 13D/A filed on May 18, 2004 and a Form 4 filed
on May 20, 2004, Hubert Guez, Paul Guez and/or their affiliates beneficially
owned in the aggregate approximately 24.98% of our common stock outstanding as
of July 13, 2004.
Pursuant to the terms of the APA, IAA paid $21.8 million for the Blue
Concept Division, subject to adjustment as noted below. Pursuant to the APA, IAA
employed all of the existing employees of the Blue Concept Division but did not
assume any of the Blue Concept Division's or Azteca's existing liabilities. The
purchase price was paid through the issuance of a seven-year convertible
promissory note, or the Blue Concept Note. See "Management's Discussion and
Analysis of Financial Condition and Results of Operation - Long Term Debt" for
further discussion of the terms of the Blue Concept Note. On March 5, 2004 in
accordance with the APA and Nasdaq rules, we continued a special meeting of our
stock holders to convert up to $12.5 million of the debt into up to 4,166,667
shares of our common stock.
53
The conversion was approved by our stockholders and as a result, Azteca and the
Guez brothers have initially been issued 3,125,000 shares of our common stock at
a conversion price of $4.00 per share, or the Azteca Conversion Shares, with the
possible issuance of up to 1,041,667 additional shares of common stock upon the
occurrence of certain contingencies described in the Blue Concept APA. As a
result of this conversion, the Blue Concept Note was reduced from $21.8 million
to $9.3 million. See "Management's Discussion and Analysis of Financial
Condition and Results of Operation - Debt Conversions" for a further discussion
of the conversion of the Blue Concept Note.
As part of the transaction, IAA and AZT International SA de CV, a Mexico
corporation and wholly-owned subsidiary of Azteca, or AZT, entered into a
two-year, renewable, non-exclusive supply agreement, or Supply Agreement, for
products to be sold by our Blue Concept Division. Under the terms of the Supply
Agreement, we have agreed to market and sell the products to be purchased from
AZT to certain of our customers, more particularly the customers of our Blue
Concept Division. In addition to the customary obligations, the Supply Agreement
required that: (i) the we will submit written purchase orders to AZT on a
monthly basis specifying (x) the products to be supplied and (y) a specified
shipping date for products to be shipped; (ii) we will give AZT reasonable time
allowances upon placing its purchase orders with AZT prior to delivery of the
products by AZT; (iii) AZT will receive payment immediately upon receipt by us
of invoices for our purchase orders; (iv) we will have a guaranteed profit
margin on a "per unit" basis; and (v) the products to be supplied shall be
subject to quality control measures by us and by the customer of the Blue
Concept Division.
Management and the board of directors entered into the acquisition of the
Blue Concept Division for the following reasons: (i) the ability to enter into
an acquisition with a seller with which we have a long-standing relationship;
(ii) the ability to acquire a profitable business that has a financial history
of producing conservative profit margins with significant revenues; (iii) a
strong customer relationship with AEO; (iv) the manufacturing relationships to
produce products effectively and efficiently; and (v) the ability to acquire the
personnel and talent of a profitable business. Further, although there can be no
assurance the Blue Concept Division is expected to increase our revenue growth
and is expected to maintain positive cash flows. In the second quarter of fiscal
2004, the Blue Concept Division accounted for $15,761,000 or 52% of our net
revenue. Furthermore, the APA protects us if revenue expectations are not
realized by providing "downside" protections, such as guaranteed sales minimums,
and a buy-sell provision that allows for the sale of the business if revenues do
not reach $35 million. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Long Term Debt" for further discussion of
the above referenced "downside" protections. As noted above, Azteca is
controlled by our significant stockholders, Hubert Guez and Paul Guez, brothers
who were also individual parties to the transaction.
Seasonality
Our business is seasonal. The majority of the marketing and sales
activities take place from late fall to early spring. The greatest volume of
shipments and sales are generally made from late spring through the summer,
which coincides with our second and third fiscal quarters and our cash flow is
strongest in its third and fourth fiscal quarters. Due to the seasonality of our
business, often our quarterly or yearly results are not necessarily indicative
of the results for the next quarter or year.
Management's Discussion of Critical Accounting Policies
We believe that the accounting policies discussed below are important to
an understanding of our financial statements because they require management to
exercise judgment and estimate the effects of uncertain matters in the
preparation and reporting of financial results. Accordingly, we caution that
these policies and the judgments and estimated they involve are subject to
revision and adjustment in the future.
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While they involve less judgment, management believes that they other accounting
policies discussed in "Note 2 - Summary of Significant Accounting Policies" of
the Notes to Consolidated Financial Statements include in our Annual Report on
Form 10-K for the year ended November 29, 2003 are also important to an
understanding of our financial statements. We believe that following critical
accounting policies affect our more significant judgments and estimates used in
the preparation of our consolidated financial statements.
Revenue Recognition
Revenues are recorded on the accrual basis of accounting when title
transfers to the customer, which is typically at the shipping point. We record
estimated reductions to revenue for customer programs, including co-op
advertising, other advertising programs or allowances, based upon a percentage
of sales. We also allow for returns based upon pre-approval or in the case of
damaged goods. Such returns are estimated and an allowance is provided at the
time of sale.
Accounts Receivable - Allowance for Returns, Discounts and Bad Debts
We evaluate our ability to collect on accounts receivable and charge-backs
(disputes from the customer) based upon a combination of factors. In
circumstances where we are aware of a specific customer's inability to meet its
financial obligations (e.g., bankruptcy filings, substantial downgrading of
credit sources), a specific reserve for bad debts is taken against amounts due
to reduce the net recognized receivable to the amount reasonable expected to be
collected. For all other customers, we recognize reserves for bad debts and
charge-backs based on our historical collection experience. If collection
experience deteriorates (i.e., an unexpected material adverse change in a major
customer's ability to meet its financial obligations to us), the estimates of
the recoverability of amounts due to us could be reduced by a material amount.
For the six months ended May 29, 2004, the balance in the allowance for
returns, discounts and bad debts reserves was $2,026,000 compared to $2,158,000
for the year ended November 29, 2003.
Inventory
We continually evaluate the composition of our inventories, assessing
slow-turning, ongoing product as well as product from prior seasons. Market
value of distressed inventory is valued based on historical sales trends or our
individual product lines, the impact of market trends and economic conditions,
and the value of current orders relating to the future sales of this type of
inventory. Significant changes in market values could cause us to record
additional inventory markdowns.
Valuation of Long-lived and Intangible Assets and Goodwill
We assess the impairment of identifiable intangibles, long-lived assets
and goodwill whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important that could
trigger an impairment review include the following:
o A significant underperformance relative to expected historical or
projected future operating results;
o A significant change in the manner of the use of the acquired asset
or the strategy for the overall business; or
o A significant negative industry or economic trend.
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When we determine that the carrying value of intangibles, long-lived
assets and goodwill may not be recoverable based upon the existence of one or
more of the above indicators of impairment, we will measure any impairment based
on a projected discounted cash flow method using a discount rate determined by
our management. In the second quarter of 2004, we recorded an asset impairment
charge of $574,000 to reflect the fair market value of our former manufacturing
facility in Springfield, Tennessee. Changes in estimated cash flows, the
discount rate assumptions or the amount actually realized upon the sale of the
Springfield facility, in the future could require us to record impairment
charges for the assets.
Income Taxes
As part of the process of preparing our consolidated financial statements,
management is required to estimate income taxes in each of the jurisdictions in
which we operate. The process involves estimating actual current tax expense
along with assessing temporary differences resulting from differing treatment of
items for book and tax purposes. These timing differences result in deferred tax
assets and liabilities, which are included in our consolidated balance sheet.
Management records a valuation allowance to reduce its deferred tax assets to
the amount that is more likely than not to be realized. Management has
considered future taxable income and ongoing tax planning strategies in
assessing the need for the valuation allowance. Increases in the valuation
allowance result in additional expense to be reflected within the tax provision
in the consolidated statement of income. Reserves are also estimated for ongoing
audits regarding Federal, state and international issues that are currently
unresolved. We routinely monitor the potential impact of these situations and
believe that it is properly reserved.
Contingencies
We account for contingencies in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies". SFAS No. 5
requires that we record an estimated loss from a loss contingency when
information available prior to issuance of our financial statements indicates
that it is probable that an asset has been impaired or a liability has been
incurred at the date of the financial statements and the amount of the loss can
be reasonably estimated. Accounting for contingencies such as legal and income
tax matters requires management to use judgment. Many of these legal and tax
contingencies can take years to be resolved. Generally, as the time period
increases over which the uncertainties are resolved, the likelihood of changes
to the estimate of the ultimate outcome increases. Management believes that the
accruals for these matters are adequate. Should events or circumstances change,
we could have to record additional accruals.
Item 3. Quantitative and Qualitative Information About Market Risks.
We are exposed to certain market risks arising from transactions in the
normal course of our business, and from debt incurred in connection with the
knit acquisition and the acquisition of the Blue Concept Division from Azteca.
Such risk is principally associated with interest rate and foreign exchange
fluctuations, as well as changes in our credit standing.
Interest Rate Risk
Our long-term debt bears a fixed interest rate. However, because our
obligation under our receivable and inventory financing agreements bear interest
at floating rates (primarily JP Morgan Chase prime rate), we are sensitive to
changes in prevailing interest rates. A 10% increase or decrease in market
interest rates that affect our financial instruments would have an immaterial
impact on earning or cash flow during the next fiscal year.
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Foreign Currency Exchange Rates
Foreign currency exposures arise from transactions, including firm
commitments and anticipated contracts, denominated in a currency other than an
entity's functional currency, and from foreign-denominated revenues translated
into U.S. dollars.
We generally purchase our products in U.S. dollars. However, we source
most of our products overseas and, as such, the cost of these products may be
affected by changes in the value of the relevant currencies. Changes in currency
exchange rates may also affect the relative prices at which we and our foreign
competitors sell products in the same market. We currently do not hedge our
exposure to changes in foreign currency exchange rates. We cannot assure you
that foreign currency fluctuations will not have a material adverse impact on
our financial condition and results of operations.
Manufacturing and Distribution Relationships
We purchase a significant portion of finished goods and obtain certain
warehousing and distribution services from Commerce and its affiliates and
obtain credit terms which we believe are favorable. The loss of Commerce as a
vendor, or material changes to the terms, could have an adverse impact on our
business. Commerce and its affiliates are controlled by two of our significant
stockholders, Hubert Guez and Paul Guez.
Our products are manufactured by contractors located in Los Angeles,
Mexico and/or Asia, including Hong Kong, China, Korea, Vietnam and India. The
products are then distributed out of Los Angeles or directly from the factory to
the customer. For the quarter ended May 29, 2004, 22% of our apparel and
accessory products were manufactured outside of North America. The rest of our
accessory and apparel products were manufactured in the United States (14%) and
Mexico (64%). All of our products manufactured in Mexico are manufactured by an
affiliate of Commerce, Azteca or its affiliates.
Item 4. Controls and Procedures.
As of May 29, 2004, the end of the period covered by this Quarterly Report
on Form 10-Q, we carried out on evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Securities and Exchange Act Rule
15d-15.
A control system, no matter how well conceived and operated, can provide
only reasonable assurance that the objectives of the control system are met. Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our disclosure controls and procedures will prevent all
error and fraud. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues within the company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdown can occur because of simple error or mistake. The
design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions. Over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
57
Our Chief Executive Officer and Chief Financial have concluded, based on
our evaluation of our disclosure controls and procedures, that our disclosures
controls and procedures under Rule 13a-15(e) and Rule 15d-15(e) of the
Securities Exchange Act of 1934 are effective, except as discussed below.
Subsequent to our evaluation, there were no significant changes in internal
controls or other factors that could significantly affect these internal
controls, except as discussed below.
Our independent auditors, Ernst & Young LLP, or Ernst & Young, on February
22, 2004, advised management and the audit committee of our board of directors
of the following matters that Ernst & Young considered to be material weaknesses
in our internal controls, which constitute reportable conditions under standards
established by the American Institute of Certified Public Accountants: (i) lack
of adequate preparation of account reconciliations and analysis necessary to
accurately prepare annual financial statements; and (ii) shared accounting
responsibilities for accounting functions between our company and Azteca
Production International, Inc., or Azteca, and its related entities.
The primary reasons for the lack of adequate preparation of account
reconciliations and analysis to accurately prepare our annual financial
statements include, but are not limited to: (i) our significant growth in fiscal
2003 in both size and complexity, which significantly increased the number of
accounting transactions from prior reporting periods; for example, our net sales
increased from $29,609,000 for fiscal 2002 to $83,129,000 in fiscal 2003, or a
181% increase; (ii) in fiscal 2003 we acquired the Blue Concept Division; and we
began shipping branded products under our license agreements for the Fetish(TM)
and Shago(R) marks for the first time; (iii) the introduction of new operating
software to track production, delivery and sales of our products during the
third quarter of fiscal 2003; (iv) the loss of key accounting personnel during
completion of account reconciliations and analysis after our fiscal year end;
and (v) certain accounting personnel were not sufficiently competent to
adequately reconcile and analyze certain accounts.
Our second material weakness resulted from our hiring of former Azteca
accounting employees in connection with the Blue Concept Division acquisition.
During this integration, some of the newly acquired accounting personnel have,
in their transitional roles, been responsible for the shared recording of
transactions between our company and Azteca, and/or its affiliates. We hired the
Azteca accounting personnel because we believed that their historical knowledge
of the Blue Concept Division accounting process and systems would help
facilitate the transition of recording the new transactions into our books and
records. Despite their historical knowledge, we discovered during the completion
of account reconciliations and analysis after our fiscal year end that this was
not the case.
These material weaknesses have been discussed in detail among the audit
committee of our board of directors, the board of directors, management and
Ernst & Young. We have assigned the highest priority to the correction of these
material weaknesses, and management and our audit committee are committed to
addressing and resolving them fully. On February 22, 2004, the audit committee
of our board of directors instructed management to improve the overall level of
our disclosure and internal controls by increasing the number and competency of
accounting personnel, including the hiring of a controller and/or chief
accounting officer at IGI, who would report directly to our Chief Financial
Officer. The audit committee instructed management to hire, subject to audit
committee approval, a controller with sufficient experience to function as the
chief accounting officer of a public company with appropriate public accounting
experience. In response, management has taken certain steps to improve its
controls and procedures since the end of fiscal 2003, including, but not limited
to: (i) hiring of additional qualified accounting personnel in positions that
are responsible for cost accounting and accounts receivable; and (ii) engaging
an executive search firm to assist it in the search process for a controller
with sufficient experience to function as the chief accounting officer.
Management has been actively searching for a suitable person for this
controller/chief accounting officer position and expects to fill this position
in the third quarter of fiscal 2004. As of July 13, 2004, the Audit Committee
has approved the
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hiring of a candidate with sufficient experience to function as the chief
accounting officer and management has extended an offer which has been accepted.
We expect the new chief accounting officer to commence employment on August 2,
2004.
In addition, prior to the report of our independent accountants dated
February 20, 2004, we had already taken the flowing actions to improve our
disclosure controls and procedures and internal controls: (i) hired a seasoned
manager for our apparel division, who will be able to supervise our continued
growth and complexity and coordinate information between operations and
accounting; (ii) hired two new staff accountants; and (iii) increased training
of staff on our new operating software. Also, we are currently transferring
responsibility for recording transactions between our company and Azteca and its
affiliate to non-Azteca related staff accountants and implementing internal
controls to reconcile and verify account balances and transactions between our
company and Azteca and/or its affiliates. In addition we are reviewing and
revising our procedures for the timely reconciliation of all accounts and for
the appropriate review of account reconciliation. In an effort to address the
issue of having accounting employees share responsibility for recording
transactions for both us and Azteca, our former controller that we shared with
Azteca will be returning on or about August 2, 2004. As a result, we have
internally promoted a staff accountant with public accounting experience to the
position of controller. We believe that this promotion, coupled with the hiring
of a chief accounting officer, will lead to the necessary improvements in our
internal controls and procedures.
We are confident that our financial statements for the fiscal year ended
November 29, 2003 and for the six months ended May 29, 2004 fairly present, in
all material respects, our financial condition, results of operations and cash
flows.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
Although we may be subject to litigation from time to time in the ordinary
course of our business, we are not party to any pending legal proceedings that
we believe will have a material adverse impact on our business. We do not
believe that it is probably that the outcome of any individual action would have
a material adverse effect in the aggregate on our financial condition. We do not
believe that it is likely that an adverse outcome of individually insignificant
actions in the aggregate would be sufficient enough, in number or magnitude, to
have a material adverse effect in the aggregate on our financial condition.
Item 2. Changes in Securities and Use of Proceeds.
Subsequent to the end of our second quarter of fiscal 2004, on June 15,
2004, June 18, 2004 and June 22, 2004, we executed agreements for the sale of
convertible promissory notes and common stock purchase warrants which resulted
in aggregate gross proceeds to us of $2.5 million immediately and will result in
an additional $451,875 in aggregate gross proceeds to us upon exercise of the
warrants. The convertible promissory notes in the aggregate principal amount of
$2.5 million, together with common stock purchase warrants to purchase an
aggregate of 312,500 shares of our common stock were sold to three "accredited
investors," as defined in Regulation D promulgated under the Securities Act of
1933, as amended, or the Securities Act. The transaction documents executed with
each purchaser were substantially similar.
The convertible promissory note issued to each purchaser bears interest at
a rate of 7.5% per annum and has a maturity date twelve months from the date of
issuance. The convertible note is convertible at any time from the date of
issuance into shares of our common stock at a price per share equal to 110% of
the average of the closing price of our common stock for the five trading days
immediately prior to the date of issuance, which, for each purchaser, resulted
in a conversion price of $1.53, $1.41 and $1.35, respectively. We will pay
interest only payments until the maturity date of the convertible note, unless
it is converted or prepaid. We have an option to make one prepayment of the
note, in whole or in part, without penalty at any time after three months.
However, in the event that we elect to prepay all or a portion of the
convertible note, a purchaser may elect within 3 days to convert all or a
portion of the note into common stock and thus prevent our prepayment of the
convertible note.
Each purchaser was also issued warrants to purchase shares of our common
stock. The number of shares that the purchaser will be eligible to purchase is
equal to 12.5% of the aggregate amount of the convertible promissory note and
the exercise price of the warrants on a per share basis is equal to 110% of the
average of the closing price of our common stock for the five trading days
immediately prior to the date of issuance of the warrant, which, for each
purchaser, resulted in an exercise price of $1.53, $1.41 and $1.35,
respectively. The warrants expire five years from the date of issuance and are
exercisable immediately. In connection with both the convertible notes and the
warrants, we entered into a registration rights agreement with each of the
purchasers, whereby we agreed to register for resale the shares underlying the
convertible notes and warrants.
Each purchaser represented to us that he, she or it is an "Accredited
Investor," as that term is defined in Rule 501(a) of Regulation D under the
Securities Act. The convertible notes and warrants were offered and sold to each
purchaser in reliance upon an exemption from registration under Rule 506 of
Regulation D the Securities Act.
60
We intend to use the proceeds from the issuance of promissory notes
convertible into shares of our common stock and the exercise of the warrants to
purchase shares of our common stock for general working capital purposes.
Item 3. Defaults upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
On April 29, 2004, we filed a Definitive Revised Proxy Statement on
Schedule 14A with the Securities and Exchange Commission relating to an annual
meeting of our stockholders to be held on June 3, 2004. The purpose of the
annual meeting was to vote on the following proposals: (1) to elect nine
directors to serve on our Board of Directors until the next annual meeting of
stockholders and until their respective successors are elected and qualified;
(2) to approve the adoption of the 2004 Stock Incentive Plan; and (3) to ratify
the appointment of Ernst & Young LLP as our independent auditors for the fiscal
year ended November 27, 2004. Our Board of Directors fixed the close of business
on April 14, 2004 as the record date for identifying those stockholders entitled
to notice of, and to vote, at the annual meeting. On May 3, 2004, the notice of
annual meeting, proxy statement and proxy cards were first mailed to
stockholders along with our Annual Report and Amendment No. 1 to our Annual
Report on Form 10-K for the fiscal year ended November 29, 2003. On June 3,
2004, after the end of the quarter covered in the Quarterly Report on Form 10-Q,
we conducted the annual meeting of our stockholders. All three proposals were
approved by our stockholders.
On June 3, 2004, a total of 20,793,953 shares were represented in person
or by proxy at the meeting, which reflected approximately 71% of total shares
outstanding, which was 29,161,350 as of April 14, 2004 according to the records
of our transfer agent, the record date of the annual meeting. The vote totals on
the three proposals were as follows:
1. Election of nine directors: For Against Abstain Votes Not Cast
-------------------------------------------------------
Samuel J. Furrow 20,482,413 311,540 0 8,367,397
Samuel J. Furrow, Jr. 20,319,078 474,875 0 8,367,397
Patricia Anderson 20,492,491 301,462 0 8,367,397
Marc B. Crossman 20,364,061 429,892 0 8,367,397
Dean Factor 20,493,217 300,736 0 8,367,397
Kelly Hoffman 20,492,590 301,363 0 8,367,397
Suhail R. Rizvi 20,491,447 302,506 0 8,367,397
Kent Savage 20,492,432 301,521 0 8,367,397
Vincent Sanfilippo 20,492,552 301,401 0 8,367,397
2. Adoption and approval of the 2004 Stock 13,757,428 1,908,501 120,063 13,375,358
Incentive Plan
61
For Against Abstain Votes Not Cast
--------------------------------------------------------
3. Appointment of Ernst & Young LLP as 20,666,348 23,625 103,980 8,367,397
independent auditors for the fiscal year
ending November 27, 2004
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits (listed according to the number assigned in the table in item 601
of Regulation S-K):
Exhibit Document
No. Description if Incorporated by Reference
- ----------------------------------------------------------------------------------------------------------------------
4.1 Form of Convertible Promissory Note Exhibit 4.1 to the Current Report on
Form 8-K filed on June 23, 2004
4.2 Form of Common Stock Purchase Warrant Exhibit 4.2 to the Current Report on
Form 8-K filed on June 23, 2004
4.3 Form of Registration Rights Agreement Exhibit 4.3 to the Current Report on
Form 8-K filed on June 23, 2004
10.1 Settlement Agreement and Release dated May 25, 2004 by and Exhibit 10.1 to the Current Report on
between Blondie Rockwell, Inc. and Innovo Azteca Apparel, Form 8-K filed on May 27, 2004
Inc.
10.2 Guaranty Agreement dated May 25, 2004 executed by Innovo Exhibit 10.2 to the Current Report on
Group Inc. on behalf of Innovo Azteca Apparel, Inc to and Form 8-K filed on May 27, 2004
in favor of Blondie Rockwell, Inc.
31.1 Certification of the Chief Executive Officer pursuant to Filed Herewith
18 U.S.C. Section 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to Filed Herewith
18 U.S.C. Section 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32 Certification of the Chief Executive Officer and Chief Filed Herewith
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
62
(b) Reports on Form 8-K
Date Purpose
- ---- -------
March 1, 2004 To report a press release dated March 1, 2004
announcing our financial results for the quarter
and year ended November 29, 2003.
March 8, 2004 To report a press release dated March 8, 2004
announcing the approval of a proposal at a special
meeting of stockholders.
April 15, 2004 To report a press release dated April 14, 2004
announcing our financial results for the quarter
ended February 28, 2004.
April 26, 2004 To report a press release dated April 26, 2004
announcing the appointment of a new member to our
Board of Directors and the resignation of a former
member of our Board of Directors.
May 18, 2004 To report the termination of our license agreement
with Blondie Rockwell, Inc. for Fetish(TM)branded
apparel.
May 27, 2004 To report the terms of the Settlement Agreement and
Release executed in connection with the termination
of our license agreement with Blondie Rockwell,
Inc. for Fetish(TM)branded apparel.
63
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INNOVO GROUP INC.
July 13, 2004 /s/ Samuel J. Furrow, Jr.
--------------------------------------------
Samuel J. Furrow, Jr.
Chief Executive Officer (Principal Executive
Officer) and Director
July 13, 2004 /s/ Marc B. Crossman
--------------------------------------------
Marc B. Crossman
Chief Financial Officer (Principal Financial
Officer) and Director
64
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
4.1* Form of Convertible Promissory Note
4.2* Form of Common Stock Purchase Warrant
4.3* Form of Registration Rights Agreement
10.1* Settlement Agreement and Release dated May 25, 2004 by and
between Blondie Rockwell, Inc. and Innovo Azteca Apparel,
Inc.
10.2* Guaranty Agreement dated May 25, 2004 executed by Innovo
Group Inc. on behalf of Innovo Azteca Apparel, Inc to and in
favor of Blondie Rockwell, Inc.
31.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32 Certification of the Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
* previously filed
65