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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the quarterly period ended September 30, 2002.
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 1-13669
TAG-IT PACIFIC, INC.
(Exact Name of Issuer as Specified in its Charter)
DELAWARE 95-4654481
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
21900 BURBANK BOULEVARD, SUITE 270
WOODLAND HILLS, CALIFORNIA 91367
(Address of Principal Executive Offices)
(818) 444-4100
(Issuer's Telephone Number)
Indicate by check whether the issuer: (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes /X/ No / /
State the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Common Stock, par value $0.001
per share, 9,319,909 shares issued and outstanding as of November 14, 2002.
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TAG-IT PACIFIC, INC.
INDEX TO FORM 10-Q
PART I FINANCIAL INFORMATION PAGE
----
Item 1. Consolidated Financial Statements....................................3
Consolidated Balance Sheets as of
September 30, 2002 (unaudited) and December 31, 2001.................3
Consolidated Statements of Operations (unaudited)
for the Three Months and Nine Months Ended
September 30, 2002 and 2001..........................................4
Consolidated Statements of Cash Flows (unaudited)
for the Nine months Ended September 30, 2002 and 2001................5
Notes to the Consolidated Financial Statements.......................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk.........................................................27
Item 4. Controls and Procedures.............................................27
PART II OTHER INFORMATION
Item 1. Legal Proceedings...................................................28
Item 6. Exhibits and Reports on Form 8-K....................................28
2
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
TAG-IT PACIFIC, INC.
Consolidated Balance Sheets
September December 31,
30, 2002 2001
----------- -----------
Assets (unaudited)
Current Assets:
Cash and cash equivalents ...................... $ 241,995 $ 46,948
Due from factor ................................ 775,014 105,749
Trade accounts receivable, net ................. 4,750,361 3,037,034
Trade accounts receivable, related parties ..... 15,898,500 7,914,838
Refundable income taxes ........................ 259,605 259,605
Due from related parties ....................... 855,889 814,219
Inventories .................................... 24,329,857 20,450,740
Prepaid expenses and other current assets ...... 568,628 408,146
Deferred income taxes .......................... 107,599 107,599
----------- -----------
Total current assets .................... 47,787,448 33,144,878
Property and Equipment, net of accumulated
depreciation and amortization ................ 2,365,805 2,592,965
Tradename ...................................... 4,110,750 4,110,750
Other assets ................................... 1,384,488 944,912
----------- -----------
Total assets ................................... $55,648,491 $40,793,505
=========== ===========
Liabilities, Convertible Redeemable
Preferred Stock and Stockholders'
Equity
Current Liabilities:
Line of credit .............................. $16,039,467 $ 9,660,581
Accounts payable and accrued expenses ....... 11,746,446 6,785,814
Deferred Revenue ............................ 1,250,000 --
Note payable ................................ 25,200 25,200
Subordinated notes payable to related
parties ................................... 849,971 849,971
Current portion of capital lease
obligations ............................... 71,121 180,142
Current portion of subordinated note
payable ................................... 1,300,000 1,100,000
----------- -----------
Total current liabilities ............. 31,282,205 18,601,708
Capital lease obligations, less current
portion ..................................... 121,741 69,030
Subordinated note payable, less current
portion ..................................... 2,900,000 3,800,000
----------- -----------
Total liabilities ..................... 34,303,946 22,470,738
----------- -----------
Convertible redeemable preferred stock
Series C, $0.001 par value; 759,494
shares authorized; 759,494 shares
issued and outstanding at September 30,
2002 and December 31, 2001 (stated
value $3,000,000) ........................... 2,895,001 2,895,001
Stockholders' equity:
Preferred stock, Series A $0.001 par
value; 250,000 shares authorized,
no shares issued or outstanding ......... -- --
Convertible preferred stock Series B,
$0.001 par value; 850,000 shares
authorized; no shares issued or
outstanding ............................. -- --
Common stock, $0.001 par value,
30,000,000 shares authorized;
9,314,409 shares issued and
outstanding at September 30, 2002;
8,769,910 at December 31, 2001 .......... 9,315 8,771
Additional paid-in capital .................. 16,763,060 15,048,971
Retained earnings ........................... 1,677,169 370,024
----------- -----------
Total stockholders' equity .................... 18,449,544 15,427,766
----------- -----------
Total liabilities, convertible redeemable
preferred stock and stockholders' equity .... $55,648,491 $40,793,505
=========== ===========
See accompanying notes to consolidated financial statements
3
TAG-IT PACIFIC, INC.
Consolidated Statements of Operations
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net sales ................. $16,349,906 $11,039,211 $45,468,306 $35,796,926
Cost of goods sold ........ 12,424,257 8,173,816 33,931,051 26,084,269
----------- ----------- ----------- -----------
Gross profit ........... 3,925,649 2,865,395 11,537,255 9,712,657
Selling expenses .......... 472,680 367,266 1,445,598 1,248,390
General and administrative
expenses ............... 2,649,188 2,439,587 7,246,100 6,847,656
Restructuring Charges
(Note 3) ............... -- -- -- 1,257,598
----------- ----------- ----------- -----------
Total operating expenses 3,121,868 2,806,853 8,691,698 9,353,644
Income from operations .... 803,781 58,542 2,845,557 359,013
Interest expense, net ..... 344,585 308,426 912,856 1,147,875
----------- ----------- ----------- -----------
Income (loss) before income
taxes ................. 459,196 (249,884) 1,932,701 (788,862)
Provision (benefit) for
income taxes .......... 115,265 (51,240) 488,455 (154,607)
----------- ----------- ----------- -----------
Net income (loss) ...... $ 343,931 $ (198,644) $ 1,444,246 $ (634,255)
=========== =========== =========== ===========
Less: Preferred stock
dividends .............. 47,100 4,950 137,100 4,950
----------- ----------- ----------- -----------
Net income (loss) to common
shareholders ........... $ 296,831 $ (203,594) $ 1,307,146 $ (639,205)
=========== =========== =========== ===========
Basic earnings (loss) per
share .................. $ 0.03 $ (0.03) $ 0.14 $ (0.08)
=========== =========== =========== ===========
Diluted earnings (loss)
per share .............. $ 0.03 $ (0.03) $ 0.14 $ (0.08)
=========== =========== =========== ===========
Weighted average number
of common shares
outstanding:
Basic .................. 9,310,099 8,003,244 9,203,078 8,000,570
=========== =========== =========== ===========
Diluted ................ 9,615,355 8,003,244 9,499,855 8,000,570
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
4
TAG-IT PACIFIC, INC.
Consolidated Statements of Cash Flows
(unaudited)
Nine Months Ended
September 30,
---------------------------
2002 2001
------------ ------------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net income (loss) ............................ $ 1,444,246 $ (634,255)
Adjustments to reconcile net income (loss) to
net cash used in operating activities:
Depreciation and amortization ................. 869,586 1,126,766
Increase in allowance for doubtful accounts ... 72,096 291,518
Loss on sale of assets ........................ -- 312,418
Warrants issued for services .................. -- 5,170
Changes in operating assets and liabilities:
Receivables, including related parties ..... (10,438,350) (1,560,999)
Inventories ................................ (3,879,117) (581,411)
Other assets ............................... (66,680) (462,431)
Prepaid expenses and other current assets .. (160,481) 97,940
Accounts payable and accrued expenses ...... 4,347,340 (975,685)
Accrued restructuring charges .............. -- 335,000
Deferred revenue ........................... 1,250,000 --
Income taxes payable ....................... 483,807 (168,887)
------------ ------------
Net cash used in operating activities ............ (6,077,553) (2,214,856)
------------ ------------
Cash flows from investing activities:
Additional loans to related parties .......... -- (251,921)
Acquisition of property and equipment ........ (437,823) (397,821)
Proceeds from sale of fixed assets ........... -- 118,880
------------ ------------
Net cash used in investing activities ............ (437,823) (530,862)
------------ ------------
Cash flows from financing activities:
Bank overdraft ............................... -- (584,831)
Proceeds from bank line of credit, net ....... 6,378,886 453,149
Proceeds from private placement transactions . 1,029,997 --
Proceeds from preferred stock issuance ....... -- 2,895,001
Proceeds from exercise of stock options ...... 57,850 19,500
Proceeds from capital leases ................. -- 207,240
Repayment of capital leases .................. (56,310) (234,415)
Proceeds from notes payable .................. -- 180,000
Repayment of notes payable ................... (700,000) (179,346)
------------ ------------
Net cash provided by financing activities ........ 6,710,423 2,756,298
------------ ------------
Net increase in cash ............................. 195,047 10,580
Cash at beginning of period ...................... 46,948 128,093
------------ ------------
Cash at end of period ............................ $ 241,995 $ 138,673
============ ============
Supplemental disclosures of cash flow
information:
Cash paid during the period for:
Interest ................................... $ 829,725 $ 1,110,794
Income taxes ............................... $ 5,280 $ 2,430
Non-cash financing activity:
Common stock issued in acquisition of
assets .................................. $ -- $ 500,000
Common stock issued in acquisition of
license rights .......................... $ 577,500 $ --
See accompanying notes to consolidated financial statements.
5
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
1. PRESENTATION OF INTERIM INFORMATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and in accordance 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 generally accepted
accounting principles in the United States for complete financial statements.
The accompanying unaudited consolidated financial statements reflect all
adjustments that, in the opinion of the management of Tag-It Pacific, Inc. and
Subsidiaries (collectively, the "Company"), are considered necessary for a fair
presentation of the financial position, results of operations, and cash flows
for the periods presented. The results of operations for such periods are not
necessarily indicative of the results expected for the full fiscal year or for
any future period. The accompanying financial statements should be read in
conjunction with the audited consolidated financial statements of the Company
included in the Company's Form 10-K for the year ended December 31, 2001.
Certain reclassifications have been made to the prior periods financial
statements to conform with the 2002 presentation.
2. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:
INCOME PER
THREE MONTHS ENDED SEPTEMBER 30, 2002: (LOSS) SHARES SHARE
- -------------------------------------- --------- --------- --------
Basic earnings per share:
Income available to common stockholders $ 296,831 9,310,099 $ 0.03
Effect of Dilutive Securities:
Options ................................ 250,271
Warrants ............................... 54,985
--------- --------- --------
Income available to common stockholders $ 296,831 9,615,355 $ 0.03
========= ========= ========
THREE MONTHS ENDED SEPTEMBER 30, 2001:
- --------------------------------------
Basic loss per share:
Loss available to common stockholders .. $(203,594) 8,003,244 $ (0.03)
Effect of Dilutive Securities:
Options ................................ --
Warrants ............................... --
--------- --------- --------
Loss available to common stockholders .. $(203,594) 8,003,244 $ (0.03)
========= ========= ========
6
INCOME PER
THREE MONTHS ENDED SEPTEMBER 30, 2002: (LOSS) SHARES SHARE
- -------------------------------------- --------- --------- --------
BASIC EARNINGS PER SHARE:
Income available to common stockholders $1,307,146 9,203,078 $ 0.14
EFFECT OF DILUTIVE SECURITIES:
Options ................................ 242,252
Warrants ............................... 54,525
---------- --------- --------
Income available to common stockholders $1,307,146 9,499,855 $ 0.14
========== ========= ========
NINE MONTHS ENDED SEPTEMBER 30, 2001:
- -------------------------------------
BASIC LOSS PER SHARE:
Loss available to common stockholders .. $ (639,205) 8,000,570 $ (0.08)
EFFECT OF DILUTIVE SECURITIES:
Options ................................ --
Warrants ............................... --
---------- --------- --------
Loss available to common stockholders .. $ (639,205) 8,000,570 $ (0.08)
========== ========= ========
Warrants to purchase 523,332 shares of common stock at between $4.34 and
$6.00, options to purchase 646,000 shares of common stock at between $4.00 and
$4.63, convertible debt of $500,000 convertible at $4.50 per share and 759,494
shares of preferred Series C stock convertible at $4.94 per share were
outstanding for the three and nine months ended September 30, 2002, but were not
included in the computation of diluted earnings per share because exercise or
conversion would have an antidilutive effect on earnings per share.
Warrants to purchase 299,790 shares of common stock at between $0.71 and
$6.00, options to purchase 1,384,500 shares of common stock at between $1.30 and
$4.63, convertible debt of $500,000 convertible at $4.50 per share and 759,494
shares of preferred Series C stock convertible at $4.94 per share were
outstanding for the three and nine months ended September 30, 2001, but were not
included in the computation of diluted earnings per share because exercise or
conversion would have an antidilutive effect on earnings per share. During the
three and nine months ended September 30, 2001, 850,000 shares of preferred
Series B stock convertible when the average trading price of the Company's stock
for a 30-day consecutive period is equal to or greater than $8.00 per share were
outstanding, but were not included in the computation of diluted earnings per
share because the conversion contingency related to these preferred shares was
not met.
3. RESTRUCTURING CHARGES
During the first quarter of 2001, the Company implemented a plan to
restructure certain business operations. In accordance with the restructuring
plan, the Company closed its Tijuana, Mexico, facilities and relocated its TALON
brand operations to Miami, Florida. In addition, the Company incurred costs
related to the reduction of its Hong Kong operations, the relocation of its
corporate headquarters from Los Angeles, California, to Woodland Hills,
California, and the downsizing of its corporate operations by eliminating
certain corporate expenses related to sales and marketing, customer service and
general and administrative expenses. Total restructuring charges for the first
and fourth quarters of 2001 amounted to $1,257,598 and $304,025, including
$355,769 of benefits paid to terminated employees. Included in accrued expenses
at December 31, 2001 was $114,554 of accrued restructuring charges consisting of
future payments to former employees paid in the first quarter of 2002.
7
4. PRIVATE PLACEMENTS
In a series of sales on December 28, 2001, January 7, 2002 and January 8,
2002, the Company entered into Stock and Warrant Purchase Agreements with three
private investors, including Mark Dyne, the chairman of the Company's board of
directors. Pursuant to the Stock and Warrant Purchase Agreements, the Company
issued an aggregate of 516,665 shares of common stock at a price per share of
$3.00 for aggregate proceeds of $1,549,995. The Stock and Warrant Purchase
Agreements also include a commitment by one of the private investors to purchase
an additional 400,000 shares of common stock at a price per share of $3.00 at
second closings (subject of certain conditions) on or prior to October 1, 2002
for additional proceeds of $1,200,000. Pursuant to the Stock and Warrant
Purchase Agreements, 258,332 warrants to purchase common stock were issued at
the first closing of the transactions and 200,000 warrants are to be issued at
the second closings. The warrants are exercisable immediately after closing, one
half of the warrants at an exercise price of 110% and the second half at an
exercise price of 120% of the market value of the Company's common stock on the
date of closing. The exercise price for the warrants shall be adjusted upward by
25% of the amount, if any, that the market price of the Company's common stock
on the exercise date exceeds the initial exercise price (as adjusted) up to a
maximum exercise price of $5.25. The warrants have a term of four years. The
shares contain restrictions related to the sale or transfer of the shares,
registration and voting rights. Total shares and warrants issued during the year
ended December 31, 2001 amount to 266,666 and 133,332. Total shares and warrants
issued in January 2002 amounted to 249,999 and 125,000.
In March 2002, one of the private investors purchased an additional 100,000
shares of common stock at a price per share of $3.00 pursuant to the second
closing provisions of the related agreement for total proceeds of $300,000. The
remaining commitment under this agreement is for an additional 300,000 shares
with aggregate proceeds of $900,000. Pursuant to the second closing provisions
of the Stock and Warrant Purchase Agreement, 50,000 warrants were issued to the
investor.
On October 1, 2002, the second closing provisions of one of the Stock and
Warrant Purchase Agreements were amended to provide for an extension to exercise
the purchase of the remaining commitment due under the agreement of 300,000
shares for total aggregate proceeds of $900,000 until March 1, 2003.
5. EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY RIGHTS AGREEMENT
On April 2, 2002, the Company entered into an Exclusive License and
Intellectual Property Rights Agreement (the "Agreement") with Pro-Fit Holdings
Limited ("Pro-Fit"). The Agreement gives the Company the exclusive rights to
sell or sublicense waistbands manufactured under patented technology developed
by Pro-Fit for garments manufactured anywhere in the world for the United States
market and all United States brands. In accordance with the Agreement, the
Company issued 150,000 shares of its common stock which were recorded at the
market value of the stock on the date of the Agreement. The shares contain
restrictions related to the transfer of the shares and registration rights. The
Agreement has an indefinite term that extends for the duration of the trade
secrets licensed under the Agreement. The Company has recorded an intangible
asset amounting to $577,500 and is amortizing this asset on a straight-line
basis over its estimated useful life of five years.
8
Future minimum annual royalty payments due under the Agreement are as
follows:
Years ending December 31, Amount
------------------------- --------
2002 (three months) .............................. $ 50,000
2003 ............................................. 75,000
2004 ............................................. 200,000
2005 ............................................. 400,000
2006 ............................................. 225,000
--------
Total minimum royalties .......................... $950,000
========
6. EXCLUSIVE SUPPLY AGREEMENT
On July 12, 2002, the Company entered into an exclusive supply agreement
with Levi Strauss & Co. ("Levi"). In accordance with the supply agreement, the
Company is to supply Levi with various trim products, garment components,
equipment, services and technological know-how. The supply agreement has an
exclusive term of two years and provides for minimum purchases of various trim
products, garment components and services from the Company of $10 million over
the two-year period. The supply agreement also appoints Talon(R) as an approved
zipper supplier to Levi.
The Company recognizes revenue at the time goods are shipped, at which
point title transfers to the customer, and collection is reasonably assured. The
Company received its first quarterly minimum payment due under the supply
agreement of $1.25 million from Levi in July 2002.
7. SUBSEQUENT EVENT
On October 4, 2002, the Company entered into a note payable agreement with
a related party in the amount of $500,000. The note payable is unsecured, due on
demand, bears interest at 4% and is subordinated to UPS Capital.
8. CONTINGENCIES
The Company is subject to certain legal proceedings and claims arising in
connection with its business. In the opinion of management, there are currently
no claims that will have a material adverse effect on the Company's consolidated
financial position, results of operations or cash flows.
9. NEW ACCOUNTING PRONOUNCEMENTS
In September 2001, the Financial Accounting Standards Board finalized FASB
Statements No. 141, BUSINESS COMBINATIONS (SFAS 141), and No. 142, GOODWILL AND
OTHER INTANGIBLE ASSETS (SFAS 142). SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after September 30, 2001. SFAS
141 also requires that the Company recognize acquired intangible assets apart
from goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after September 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful
9
lives of other existing recognized intangible assets, and cease amortization of
intangible assets with an indefinite useful life. An intangible asset with an
indefinite useful life should be tested for impairment in accordance with the
guidance in SFAS 142.
The Company has adopted SFAS 141 and 142 effective January 1, 2002. The
Company's previous business combinations were accounted for using the purchase
method and there are no intangible assets acquired in connection with the
business combinations that are required to be recognized separately from
goodwill. The Company ceased amortization of goodwill effective as of January 1,
2002. As provided by SFAS 142, the initial testing of goodwill for possible
impairment was completed and no impairment was identified. As of September 30,
2002, the net carrying amount of goodwill is $450,000.
Another intangible asset, totaling $4,110,750 at January 1, 2002, consists
of the Talon tradename and trademarks acquired on December 21, 2001 under an
asset purchase agreement with Talon, Inc. and Grupo Industrial Cierres Ideal,
S.A. de C.V. The Company has determined that this intangible asset has an
indefinite life and therefore, ceased amortization in accordance with SFAS 142
beginning January 1, 2002. The impairment test was completed as of January 1,
2002 and did not result in an impairment charge.
In accordance with SFAS 142, prior period amounts were not restated. The
September 30, 2001 net loss adjusted for the exclusion of amortization of
goodwill would have been $37,500 less than reported and there would have been no
difference in basic or diluted earnings per share.
In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS 144 requires that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not yet
occurred. SFAS 144 is effective for financial statements issued for fiscal years
beginning after December 15, 2001 and, generally, is to be applied
prospectively. The adoption of this Statement had no material impact on the
Company's financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This statement eliminates the current requirement that gains and
losses on debt extinguishment must be classified as extraordinary items in the
income statement. Instead, such gains and losses will be classified as
extraordinary items only if they are deemed to be unusual and infrequent, in
accordance with the current GAAP criteria for extraordinary classification. In
addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring
that modifications of capital leases that result in reclassification as
operating leases be accounted for consistent with sale-leaseback accounting
rules. The statement also contains other nonsubstantive corrections to
authoritative accounting literature. The changes related to debt extinguishment
will be effective for fiscal years beginning after May 15, 2002, and the changes
related to lease accounting will be effective for transactions occurring after
May 15, 2002. Adoption of this standard will not have any immediate effect on
the Company's consolidated financial statements.
In September 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which addresses accounting for
restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The
Company will adopt the provisions of SFAS No. 146 for restructuring activities
initiated after December 31, 2002. SFAS No. 146 requires that the liability for
costs associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF No. 94-3, a liability for an exit cost was
recognized at the date of a company's commitment to an exit plan. SFAS No. 146
also establishes that the liability should initially be measured and recorded at
fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing
future restructuring costs as well as the amount recognized.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read together with the
Consolidated Financial Statements of Tag-It Pacific, Inc. and the notes to the
Consolidated Financial Statements included elsewhere in this Form 10-Q.
This discussion summarizes the significant factors affecting the
consolidated operating results, financial condition and liquidity and cash flows
of Tag-It Pacific, Inc. for the three and nine months ended September 30, 2002
and 2001. Except for historical information, the matters discussed in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations are forward looking statements that involve risks and uncertainties
and are based upon judgments concerning various factors that are beyond our
control.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to our valuation of inventory and our allowance for uncollectable
accounts receivable. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
o Inventory is evaluated on a continual basis and reserve adjustments
are made based on management's estimate of future sales value, if any,
of specific inventory items. Reserve adjustments are made for the
difference between the cost of the inventory and the estimated market
value and charged to operations in the period in which the facts that
give rise to the adjustments become known. A substantial portion of
our total inventories is subject to buyback arrangements with our
customers. The buyback arrangements contain provisions related to the
inventory purchased on behalf of our customers. In the event that
inventories remain with us in excess of six to nine months from our
receipt of the goods from our vendors or the termination of production
of a product line, the customer is required to purchase the
inventories from us under normal invoice and selling terms. If the
financial condition of a customer were to deteriorate, resulting in an
impairment of its ability to purchase inventories, an additional
adjustment may be required. These buyback arrangements are considered
in management's estimate of future market value of inventories.
o Accounts receivable balances are evaluated on a continual basis and
allowances are provided for potentially uncollectable accounts based
on management's estimate of the collectability of customer accounts.
If the financial condition of a customer were to deteriorate,
resulting in an impairment of its ability to make payments, an
additional allowance may be required. Allowance adjustments are
charged to operations in the period in which the facts that give rise
to the adjustments become known.
o We record valuation allowances to reduce our deferred tax assets to an
amount that we believe is more likely than not to be realized. We
consider estimated future taxable income and ongoing prudent and
feasible tax planning strategies in accessing the need for a valuation
allowance. If we determine that we will not realize all or part of our
deferred tax assets in the future, we would make an adjustment to the
carrying value of the deferred tax asset, which would be reflected as
an
11
income tax expense. Conversely, if we determine that we will realize a
deferred tax asset, which currently has a valuation allowance, we
would be required to reverse the valuation allowance, which would be
reflected as an income tax benefit.
o Sales are recorded at the time of shipment, at which point title
transfers to the customer, and when collection is reasonably assured.
OVERVIEW
We specialize in the distribution of trim items to manufacturers of fashion
apparel, licensed consumer products, specialty retailers and mass merchandisers.
We act as a full service outsourced trim management department for manufacturers
of fashion apparel such as Tarrant Apparel Group and Azteca Production
International. We also serve as a supplier of trim items to specific brands,
brand licensees and retailers, including Levi Strauss & Co., Tommy Hilfiger, A/X
Armani, Express, The Limited, A&F, Lerner, among others. In addition, we
distribute zippers under our TALON brand name to apparel brands and
manufacturers such as VF Corporation, Savane International, Tropical Sportswear,
Target Stores, Abercrombie & Fitch, among others.
We have positioned ourselves as a fully integrated single-source supplier
of a full range of trim items for manufacturers of fashion apparel. Our business
focuses on servicing all of the trim requirements of our customers at the
manufacturing and retail brand level of the fashion apparel industry. Trim items
include thread, zippers, labels, buttons, rivets, printed marketing material,
polybags, packing cartons, and hangers. Trim items comprise a relatively small
part of the cost of most apparel products but comprise the vast majority of
components necessary to fabricate a typical apparel product. We offer customers
what we call our MANAGED TRIM SOLUTION(TM), which is an Internet-based
supply-chain management system covering the complete management of development,
ordering, production, inventory management and just-in-time distribution of
their trim and packaging requirements. Traditionally, manufacturers of apparel
products have been required to operate their own apparel trim departments,
requiring the manufacturers to maintain a significant amount of infrastructure
to coordinate the buying of trim products from a large number of vendors. By
acting as a single source provider of a full range of trim items, we allow
manufacturers using our MANAGED TRIM SOLUTION(TM) to eliminate the added
infrastructure, trim inventory positions, overhead costs and inefficiencies
created by in-house trim departments that deal with a large number of vendors
for the procurement of trim items. We also seek to leverage our position as a
single source supplier of trim items as well as our extensive expertise in the
field of trim distribution and procurement to more efficiently manage the trim
assembly process resulting in faster delivery times and fewer production delays
for our manufacturing customers. Our MANAGED TRIM SOLUTION(TM) also helps to
eliminate a manufacturer's need to maintain a trim purchasing and logistics
department.
We also serve as a specified supplier for a variety of major retail brand
and private label oriented companies. We seek to expand our services as a vendor
of select lines of trim items for such customers to being a preferred or single
source provider of all of such brand customer's authorized trim requirements.
Our ability to offer brand name and private label oriented customers a full
range of trim products is attractive because it enables our customers to address
their quality and supply needs for all of their trim requirements from a single
source, avoiding the time and expense necessary to monitor quality and supply
from multiple vendors and manufacturer sources. In addition, by becoming a
specified supplier to brand customers, we have an opportunity to become the
preferred or sole vendor of trim items for all contract manufacturers of apparel
under that brand name.
On July 12, 2002, we entered into an exclusive supply agreement with Levi
Strauss & Co. In accordance with the supply agreement, Levi is to purchase a
minimum of $10 million of various trim products, garment components and services
over the next two years. Certain proprietary products,
12
equipment and technological know-how will be supplied to Levi on an exclusive
basis during this period. The supply agreement also appoints Talon(R) as an
approved zipper supplier to Levi.
On April 2, 2002, we entered into an exclusive license and intellectual
property rights agreement with Pro-Fit Holdings Limited. This agreement gives us
the exclusive rights to sell or sublicense waistbands manufactured under
patented technology developed by Pro-Fit Holdings for garments manufactured
anywhere in the world for the United States market and for all United States
brands. The new technology allows pant manufacturers to build a stretch factor
into standard waistbands that does not alter the appearance of the garment, but
allows the waist to stretch out and back by as much as two waist sizes. Through
our trim package business, and our TALON line of zippers, we are already focused
on the North American bottoms market. This product compliments our existing
product line and we intend to integrate the production of the waistbands into
our existing infrastructure. The exclusive license and intellectual property
rights agreement has an indefinite term that extends for the duration of the
trade secrets licensed under the agreement.
On December 21, 2001, we entered into an asset purchase agreement with
Talon, Inc. and Grupo Industrial Cierres Ideal, S.A. de C.V. whereby we
purchased certain TALON zipper assets, including the TALON(R) zipper brand name,
trademarks, patents, technical field equipment and inventory. Since July 2000,
we have been the exclusive distributor of TALON brand zippers. TALON is an
American brand with significant name recognition and brand equity. TALON was the
original pioneer of the formed wire metal zipper for the jeans industry and is a
specified zipper brand for manufacturers in the sportswear and outerwear
markets. The TALON acquisition is an important step in our strategy to offer a
complete high quality trim package to apparel manufacturers. Our transition from
a distributor to an owner of the TALON brand name better positions us to
revitalize the TALON brand name and capture increased market share in the
industry. As the owner of the TALON brand name, we believe we will be able to
more effectively respond to customer needs and better maintain the quality and
value of the TALON products.
RELATED PARTY SUPPLY AGREEMENTS
On September 20, 2001, we entered into a ten-year co-marketing and supply
agreement with Coats American, Inc., an affiliate of Coats plc, as well as a
preferred stock purchase agreement with Coats North America Consolidated, Inc.,
also an affiliate of Coats plc. The co-marketing and supply agreement provides
for selected introductions into Coats' customer base and has the potential to
accelerate our growth plans and to introduce our MANAGED TRIM SOLUTION(TM) to
apparel manufacturers on a broader basis. Pursuant to the terms of the
co-marketing and supply agreement, our trim packages will exclusively offer
thread manufactured by Coats. Coats was selected for its quality, service, brand
recognition and global reach. Prior to entering into the co-marketing and supply
agreement, we were a long-time customer of Coats, distributing their thread to
sewing operations under our MANAGED TRIM SOLUTION(TM) program. This exclusive
agreement will allow Coats to offer its customer base of contractors in Mexico,
Central America and the Caribbean full-service trim management under our MANAGED
TRIM SOLUTION(TM) program.
Pursuant to the terms of the preferred stock purchase agreement, we
received a cash investment of $3 million from Coats North America Consolidated
in exchange for 759,494 shares of series C convertible redeemable preferred
stock. London-based Coats, plc is the world's largest manufacturer of industrial
thread and textile-related craft products. Coats has operations in 65 countries
and has a North American presence in the United States, Canada, Mexico, Central
America and the Caribbean.
We have entered into an exclusive supply agreement with Azteca Production
International, Inc., AZT International SA D RL and Commerce Investment Group,
LLC. Pursuant to this supply agreement, we provide all trim-related products for
certain programs manufactured by Azteca Production International. The agreement
provides for a minimum aggregate total of $10 million in annual purchases by
Azteca Production International and its affiliates during each year of the
three-year term of the agreement, if and to the extent, we are able to provide
trim products on a basis that is competitive in terms
13
of price and quality. Azteca Production International has been a significant
customer of ours for many years. This agreement is structured in a manner that
has allowed us to utilize our MANAGED TRIM SOLUTION(TM) system to supply Azteca
Production International with all of its trim program requirements. We have
expanded our facilities in Tlaxcala, Mexico, to service Azteca Production
International's trim requirements.
We also have an exclusive supply agreement with Tarrant Apparel Group and
have been supplying Tarrant Apparel Group with all of its trim requirements
under our MANAGED TRIM SOLUTION(TM) system since 1998.
Sales under our exclusive supply agreements with Azteca Production
International and Tarrant Apparel Group amounted to approximately 63% of our
total sales for the year ended December 2001. We will continue to rely on these
two customers for a significant amount of our sales for the year ended December
2002. Sales under these exclusive supply agreements as a percentage of total
sales for the year ended December 2002 are anticipated to be slightly higher
than the year ended December 2001. Our results of operations will depend to a
significant extent upon the commercial success of Azteca Production
International and Tarrant Apparel Group. If Azteca Production International and
Tarrant Apparel Group fail to purchase our trim products at anticipated levels,
or our relationship with Azteca Production International or Tarrant Apparel
Group terminates, it may have an adverse affect on our results of operations.
Included in trade accounts receivable, related parties at September 30, 2002, is
$15,899,000 due from Tarrant Apparel Group and Azteca Production International.
Included in inventories at September 30, 2002 are inventories that are
subject to buyback arrangements with Tarrant Apparel Group and Azteca Production
International. The buyback arrangements contain provisions related to the
inventory purchased on behalf of these customers. In the event that inventories
remain with us in excess of six to nine months from our receipt of the goods
from our vendors or the termination of production of a product line, the
customer is required to purchase the inventories from us under normal invoice
and selling terms. During the twelve months ended September 30, 2002, we sold
approximately $1.8 million in inventory to Tarrant Apparel Group and Azteca
Production International pursuant to these buyback arrangements. If the
financial condition of Tarrant Apparel Group and Azteca Production International
were to deteriorate, resulting in an impairment of their ability to purchase
inventories, it may have an adverse affect on our results of operations.
RESTRUCTURING PLAN
During the first quarter of 2001, we implemented a plan to restructure
certain of our business operations. In accordance with the restructuring plan,
we closed our Tijuana, Mexico, facilities and relocated our TALON brand
operations to Miami, Florida. In addition, we incurred costs related to the
reduction of our Hong Kong operations, the relocation of our corporate
headquarters from Los Angeles, California, to Woodland Hills, California, and
the downsizing of our corporate operations by eliminating certain corporate
expenses related to sales and marketing, customer service and general and
administrative expenses. Total restructuring charges for the first and fourth
quarters of 2001 amounted to $1,257,598 and $304,025, including $355,769 of
benefits paid to terminated employees.
14
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated, selected
statements of operations data shown as a percentage of net sales.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------- -----------------
2002 2001 2002 2001
------- ------- ------- -------
Net sales ............................ 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ................... 76.0 74.0 74.6 72.9
------- ------- ------- -------
Gross profit ......................... 24.0 26.0 25.4 27.1
Selling expenses ..................... 2.9 3.3 3.2 3.5
General and administrative expenses .. 16.2 22.1 15.9 19.1
Restructuring Charges ................ -- -- -- 3.5
------- ------- ------- -------
Operating Income ..................... 4.9% 0.6% 6.3% 1.0%
======= ======= ======= =======
Net sales increased approximately $5,311,000, or 48.1%, to $16,350,000 for
the three months ended September 30, 2002 from $11,039,000 for the three months
ended September 30, 2001. The increase in net sales was primarily due to an
increase in trim-related sales from our Tlaxcala, Mexico operations under our
MANAGED TRIM SOLUTION(TM) trim package program. The increase in net sales was
also attributable to an increase in zipper sales under our TALON brand name to
our MANAGED TRIM SOLUTION(TM) customers in Mexico and our other Talon customers
in Mexico and Asia. TALON has been successful in becoming an approved zipper
vendor for major brands and retailers which has allowed us to increase our sales
to these customers. Our purchase of the TALON brand name and trademarks in
December 2001 has enabled us to better control our product offerings, selling
prices and profit margins.
Net sales increased approximately $9,671,000, or 27.0%, to $45,468,000 for
the nine months ended September 30, 2002 from $35,797,000 for the nine months
ended September 30, 2001. The increase in net sales was primarily due to an
increase in trim-related sales from our Tlaxcala, Mexico operations under our
MANAGED TRIM SOLUTION(TM) trim package program. The increase in net sales was
also attributable, for the reasons discussed above, to an increase in zipper
sales under our TALON brand name to our MANAGED TRIM SOLUTION(TM) customers in
Mexico and our other Talon customers in Mexico and Asia.
Gross profit increased approximately $1,061,000, or 37.0%, to $3,926,000
for the three months ended September 30, 2002 from $2,865,000 for the three
months ended September 30, 2001. Gross margin as a percentage of net sales
decreased to approximately 24.0% for the three months ended September 30, 2002
as compared to 26.0% for the three months ended September 30, 2001. The decrease
in gross profit as a percentage of net sales for the three months ended
September 30, 2002 was primarily due to an increase in zipper sales under our
TALON brand name to our MANAGED TRIM SOLUTION(TM) customers in Mexico during the
quarter. Talon products have a lower gross margin than other products included
within the complete trim packages we offer to our customers through our MANAGED
TRIM SOLUTION(TM).
Gross profit increased approximately $1,824,000, or 18.8%, to $11,537,000
for the nine months ended September 30, 2002 from $9,713,000 for the nine months
ended September 30, 2001. Gross margin as a percentage of net sales decreased to
approximately 25.4% for the nine months ended September 30, 2002 as compared to
27.1% for the nine months ended September 30, 2001. The decrease in gross profit
as a percentage of net sales for the nine months ended September 30, 2002 was
primarily
15
due to an increase in zipper sales under our TALON brand name to our MANAGED
TRIM SOLUTION(TM) customers in Mexico during the period. Talon products have a
lower gross margin than other products included within the complete trim
packages we offer to our customers through our MANAGED TRIM SOLUTION(TM). The
decrease in gross margin as a percentage of net sales for the nine months ended
September 30, 2002 was offset by a further reduction of manufacturing and
facility costs which was a direct result of the implementation of our
restructuring plan in the first quarter of 2001.
Selling expenses increased approximately $106,000, or 28.9%, to $473,000
for the three months ended September 30, 2002 from $367,000 for the three months
ended September 30, 2001. As a percentage of net sales, these expenses decreased
to 2.9% for the three months ended September 30, 2002 compared to 3.3% for the
three months ended September 30, 2001. This increase was due to our efforts to
obtain approval from major brands and retailers of the TALON brand zipper and
the implementation of our new sales and marketing plan for the TALON brand. In
addition, we hired additional personnel to support the exclusive waistband
license agreement we entered into in April 2002. For the period, selling
expenses increased at a slower rate than the increase in net sales, resulting in
a decrease in selling expenses as a percentage of net sales.
Selling expenses increased approximately $198,000, or 15.9%, to $1,446,000
for the nine months ended September 30, 2002 from $1,248,000 for the nine months
ended September 30, 2001. As a percentage of net sales, these expenses decreased
to 3.2% for the nine months ended September 30, 2002 compared to 3.5% for the
nine months ended September 30, 2001. The increase in selling expenses during
the period was due to our efforts to obtain approval from major brands and
retailers of the TALON brand zipper and the implementation of our new sales and
marketing plan for the TALON brand. The increase in these selling expenses was
partially offset by a reduction of our sales force under our MANAGED TRIM
SOLUTION(TM) program, which was part of our restructuring plan that we
implemented in the first quarter of 2001. For the period, selling expenses
increased at a slower rate than the increase in net sales, resulting in a
decrease in selling expenses as a percentage of net sales.
General and administrative expenses increased approximately $209,000, or
8.6%, to $2,649,000 for the three months ended September 30, 2002 from
$2,440,000 for the three months ended September 30, 2001. The increase in these
expenses was due primarily to additional staffing and other expenses incurred
related to our Tlaxcala, Mexico operations and the amortization of intangible
assets acquired under the exclusive waistband license agreement we entered into
in April 2002. As a percentage of net sales, these expenses decreased to 16.2%
for the three months ended September 30, 2002 compared to 22.1% for the three
months ended September 30, 2001, because the rate of increase in net sales
exceeded that of general and administrative expenses.
General and administrative expenses increased approximately $398,000, or
5.8%, to $7,246,000 for the nine months ended September 30, 2002 from $6,848,000
for the nine months ended September 30, 2001. The increase in these expenses was
due primarily to additional staffing and other expenses incurred related to our
Tlaxcala, Mexico operations and the amortization of intangible assets acquired
under the exclusive waistband license agreement we entered into in April 2002.
As a percentage of net sales, these expenses decreased to 15.9% for the nine
months ended September 30, 2002 compared to 19.1% for the nine months ended
September 30, 2001, because the rate of increase in net sales exceeded that of
general and administrative expenses.
Interest expense increased approximately $37,000, or 12.0%, to $345,000 for
the three months ended September 30, 2002 from $308,000 for the three months
ended September 30, 2001. On May 30, 2001, we replaced our credit facility with
a new facility with UPS Capital Global Trade Finance Corporation, which provides
for increased borrowing availability of up to $20,000,000 and a more favorable
interest rate of prime plus 2%. We incurred financing charges of approximately
$570,000, including legal, consulting and closing costs, in the first two
quarters of 2001 related to our efforts to replace our existing credit facility.
Our borrowings under the new UPS Capital credit facility increased
16
during the third quarter of 2002 due to increased sales and expanded operations
in Mexico and Asia. The increase in interest expense due to increased borrowings
during the quarter was offset by decreases in the prime rate from prior periods.
Interest expense decreased approximately $235,000, or 20.5%, to $913,000
for the nine months ended September 30, 2002 from $1,148,000 for the nine months
ended September 30, 2001. As discussed above, we incurred financing charges and
were charged less favorable interest rates during the first two quarters of 2001
under our former credit facility.
The provision for income taxes for the three months ended September 30,
2002 amounted to approximately $115,000 compared to an income tax benefit of
$51,000 for the three months ended September 30, 2001. Income taxes increased
for the three months ended September 30, 2002 primarily due to increased taxable
income.
The provision for income taxes for the nine months ended September 30, 2002
amounted to approximately $488,000 compared to an income tax benefit of $155,000
for the nine months ended September 30, 2001. Income taxes increased for the
nine months ended September 30, 2002 primarily due to increased taxable income.
Net income was approximately $344,000 for the three months ended September
30, 2002 as compared to a net loss of $199,000 for the three months ended
September 30, 2001, due primarily to increased net sales during the quarter.
Net income was approximately $1,444,000 for the nine months ended September
30, 2002 as compared to a net loss of $634,000 for the nine months ended
September 30, 2001, due primarily to increased net sales during the period and
restructuring charges incurred during the first quarter of 2001 of approximately
$1.3 million.
LIQUIDITY AND CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS
Cash and cash equivalents increased to $242,000 at September 30, 2002 from
$47,000 at December 31, 2001. The increase resulted from $6,710,000 of cash
provided by financing activities, offset by $6,078,000 and $438,000 of cash used
in operating and investing activities, respectively.
Net cash used in operating activities was approximately $6,078,000 and
$2,215,000 for the nine months ended September 30, 2002 and 2001, respectively.
The increase in cash used by operating activities for the nine months ended
September 30, 2002 resulted primarily from increases in inventories and
receivables, which was partially offset by increases in accounts payable and
accrued expenses, deferred revenue and net income. The increase in inventories
during the period was due primarily to increased customer orders for future
sales. The increase in accounts receivable during the period was due primarily
to increased sales and slower customer collections. Cash used in operating
activities for the nine months ended September 30, 2001 resulted primarily from
increased accounts receivable, inventories, other assets and net losses, and
decreased accounts payable and accrued expenses.
Net cash used in investing activities was approximately $438,000 and
$531,000 for the nine months ended September 30, 2002 and 2001, respectively.
Net cash used in investing activities for the nine months ended September 30,
2002 consisted primarily of capital expenditures for machinery and equipment.
Net cash used in investing activities for the nine months ended September 30,
2001 consisted primarily of capital expenditures for computer equipment and
upgrades and additional loans to related parties.
Net cash provided by financing activities was approximately $6,710,000 and
$2,756,000 for the nine months ended September 30, 2002 and 2001, respectively.
Net cash provided by financing activities for the nine months ended September
30, 2002 primarily reflects increased borrowings under our credit facility and
funds raised from private placement transactions, offset by the repayment of
notes payable. The increase in borrowings under our credit facility during the
period was due primarily to working
17
capital requirements related to increases in accounts receivable and
inventories. Net cash provided by financing activities for the nine months ended
September 30, 2001 primarily reflects increased borrowings under our credit
facility and proceeds from the issuance of Series C Convertible Redeemable
preferred stock, offset by the repayment of a bank overdraft.
We currently satisfy our working capital requirements primarily through
cash flows generated from operations and borrowings under our credit facility
with UPS Capital. Our maximum availability under the credit facility is $20
million. At September 30, 2002 and 2001, outstanding borrowings under our UPS
Capital credit facility amounted to approximately $16,039,000 and $10,410,000,
respectively. Open letters of credit amounted to approximately $1,080,000 at
September 30, 2002. There were no open letters of credit at September 30, 2001.
The initial term of our agreement with UPS Capital is three years and the
facility is secured by substantially all of our assets. The interest rate of the
credit facility is at the prime rate plus 2%. The credit facility requires that
we comply with certain financial covenants including net worth, fixed charge
ratio and capital expenditures. At September 30, 2002, we were in compliance
with all applicable financial covenants. The amount we can borrow under the
credit facility is determined based on a defined borrowing base formula related
to eligible accounts receivable and inventories. Our borrowing base availability
ranged from approximately $9,921,000 to $18,126,000 from October 1, 2001 to
September 30, 2002. A significant decrease in eligible accounts receivable and
inventories due to customer concentration levels and the aging of inventories,
among other factors, can have an adverse effect on our borrowing capabilities
under our credit facility, which thereafter, may not be adequate to satisfy our
working capital requirements. Eligible accounts receivable are reduced if our
accounts receivable customer balances are concentrated in excess of the
percentages allowed under our agreement with UPS Capital. In addition, we have
typically experienced seasonal fluctuations in sales volume. These seasonal
fluctuations result in sales volume decreases in the first and fourth quarters
of each year due to the seasonal fluctuations experienced by the majority of our
customers. During these quarters, borrowing availability under our credit
facility may decrease as a result of decreases in eligible accounts receivables
generated from our sales. As a result of our concentration of business with
Tarrant Apparel Group and Azteca Production International, our eligible
receivables have been limited under the UPS Capital facility to various degrees
over the prior nine months. If our business becomes further dependant on one or
a limited number of customers or if we experience future significant seasonal
reductions in receivables, our availability under the UPS Capital credit
facility would be correspondingly reduced. If this were to occur, we would be
required to seek additional financing which may not be available on attractive
terms and, if such financing is unavailable, we may be unable to meet our
working capital requirements.
Pursuant to the terms of a foreign factoring agreement under our UPS
Capital credit facility, UPS Capital purchases our eligible accounts receivable
and assumes the credit risk with respect to those foreign accounts for which UPS
Capital has given its prior approval. If UPS Capital does not assume the credit
risk for a receivable, the collection risk associated with the receivable
remains with us. We pay a fixed commission rate and may borrow up to 85% of
eligible accounts receivable under our credit facility. As of September 30,
2002, the amount factored without recourse was approximately $552,000. There
were no receivables factored with UPS Capital at September 30, 2001.
The UPS Capital credit facility contains customary covenants restricting
our activities as well as those of our subsidiaries, including limitations on
certain transactions related to the disposition of assets; mergers; entering
into operating leases or capital leases; entering into transactions involving
subsidiaries and related parties outside of the ordinary course of business;
incurring indebtedness or granting liens or negative pledges on our assets;
making loans or other investments; paying dividends or repurchasing stock or
other securities; guarantying third party obligations; repaying subordinated
debt; and making changes in our corporate structure.
18
In a series of sales on December 28, 2001, January 7, 2002 and January 8,
2002, we entered into stock and warrant purchase agreements with three private
investors, including Mark Dyne, the chairman of our board of directors. Pursuant
to the stock and warrant purchase agreements, we issued an aggregate of 516,665
shares of common stock at a price per share of $3.00 for aggregate proceeds of
$1,549,995. The stock and warrant purchase agreements also include a commitment
by one of the private investors to purchase an additional 400,000 shares of
common stock at a price per share of $3.00 at second closings (subject of
certain conditions) on or prior to October 1, 2002 for additional proceeds of
$1,200,000. In March 2002, this private investor purchased 100,000 shares of
common stock at a price per share of $3.00 pursuant to the second closing
provisions of the stock and warrant purchase agreement for total proceeds of
$300,000. The remaining commitment under the stock and warrant purchase
agreement is for an additional 300,000 shares with aggregate proceeds of
$900,000. Pursuant to the second closing provisions of the stock and warrant
purchase agreement, 50,000 warrants were issued to the investor. On October 1,
2002, the second closing provisions of one of the Stock and Warrant Purchase
Agreements were amended to provide for an extension to exercise the purchase of
the remaining commitment due under the agreement of 300,000 shares for total
aggregate proceeds of $900,000 until March 1, 2003.
In accordance with the series C preferred stock purchase agreement entered
into by us and Coats North America Consolidated, Inc. on September 20, 2001, we
issued 759,494 shares of series C convertible redeemable preferred stock to
Coats North America Consolidated, Inc. in exchange for an equity investment from
Coats North America Consolidated of $3 million cash. The series C preferred
shares are convertible at the option of the holder after one year at the rate
$4.94 per share. The series C preferred shares are redeemable at the option of
the holder after four years. If the holders elect to redeem the series C
preferred shares, we have the option to redeem for cash at the stated value of
$3 million or in the form of the our common stock at 85% of the market price of
our common stock on the date of redemption. If the market price of our common
stock on the date of redemption is less than $2.75 per share, we must redeem for
cash at the stated value of the series C preferred shares. We can elect to
redeem the series C preferred shares at any time for cash at the stated value.
The preferred stock purchase agreement provides for cumulative dividends at a
rate of 6% of the stated value per annum, payable in cash or our common stock.
Each holder of the series C preferred shares has the right to vote with our
common stock based on the number of our common shares that the series C
preferred shares could then be converted into on the record date.
Pursuant to the terms of a factoring agreement for our Hong Kong
subsidiary, Tag-It Pacific Limited, the factor purchases our eligible accounts
receivable and assumes the credit risk with respect to those accounts for which
the factor has given its prior approval. If the factor does not assume the
credit risk for a receivable, the collection risk associated with the receivable
remains with us. We pay a fixed commission rate and may borrow up to 80% of
eligible accounts receivable. Interest is charged at 1.5% over the Hong Kong
Dollar prime rate. As of September 30, 2002 and 2001, the amount factored
without recourse was approximately $223,000 and $30,000 and the amount due from
the factor and recorded as a current asset was approximately $223,000 and
$30,000. There were no outstanding advances from the factor as of September 30,
2002 and 2001.
As of September 30, 2002, we had outstanding related-party debt of
approximately $850,000 at a weighted average interest rate of 10.5%, and
additional non-related-party debt of $25,200 at an interest rate of 10%. The
majority of related-party debt is due on demand, with the remainder due and
payable on the fifteenth day following the date of delivery of written demand
for payment. On October 4, 2002, we entered into a note payable agreement with a
related party in the amount of $500,000 to fund additional working capital
requirements. The note payable is unsecured, due on demand, bears interest at 4%
and is subordinated to UPS Capital. As of September 30, 2001, we had outstanding
related-party debt, of approximately $3,620,000 at a weighted average interest
rate of between 0% and 11%, and additional non-related-party debt of $25,200 at
an interest rate of 10%. The majority of related-party debt was
19
cancelled in connection with the TALON trademark purchase agreement dated
December 21, 2001, with the remainder due on the fifteenth day following the
date of delivery of written demand for payment.
Our receivables increased to $20,649,000 at September 30, 2002 from
$13,773,000 at September 30, 2001. This increase was due primarily to increased
related-party trade receivables of approximately $6.3 million resulting from
increased related party sales during the nine months ended September 30, 2002.
In October 1998, we entered into a supply agreement with Tarrant Apparel
Group. In accordance with the supply agreement, we issued 2,390,000 shares of
our common stock to KG Investment, LLC. KG Investment is owned by Gerard Guez
and Todd Kay, executive officers and significant shareholders of Tarrant Apparel
Group. Commencing in December 1998, we began to provide trim products to Tarrant
Apparel Group for its operations in Mexico. Pricing and terms are consistent
with competitive vendors.
On December 22, 2000, we entered into a supply agreement with Azteca
Production International, Inc., AZT International SA D RL and Commerce
Investment Group, LLC. The term of the supply agreement is three years, with
automatic renewals of consecutive three-year terms, and provides for a minimum
of $10 million in sales for each contract year beginning April 1, 2001. In
accordance with the supply agreement, we issued 1,000,000 shares of our common
stock to Commerce Investment Group, LLC. Commencing in December 2000, we began
to provide trim products to Azteca Production International, Inc for its
operations in Mexico. Pricing and terms are consistent with competitive vendors.
We believe that our existing cash and cash equivalents and anticipated cash
flows from our operating activities and available financing will be sufficient
to fund our minimum working capital and capital expenditure needs for the next
twelve months. In addition, we expect to receive quarterly cash payments of a
minimum of $1.25 million under our supply agreement with Levi Strauss & Co.
through August 2004 and additional funds of $900,000 by March 1, 2003 pursuant
to the remaining commitment due under the stock warrant and purchase agreement
we entered into with a private investor. If our cash from operations is less
than anticipated or our working capital requirements and capital expenditures
are greater than we expect, we will need to raise additional debt or equity
financing in order to provide for our operations. We are continually evaluating
various financing strategies to be used to expand our business and fund future
growth or acquisitions. The extent of our future capital requirements will
depend, however, on many factors, including our results of operations, future
demand for our products, the size and timing of future acquisitions, our
borrowing base availability limitations related to eligible accounts receivable
and inventories and our expansion into foreign markets. There can be no
assurance that additional debt or equity financing will be available on
acceptable terms or at all. If we are unable to secure additional financing, we
may not be able to execute our plans for expansion, including expansion into
foreign markets to promote our TALON brand tradename, and we may need to
implement additional cost savings initiatives.
Our need for additional long-term financing includes the integration and
expansion of our operations to exploit our rights under our TALON trade name,
the expansion of our operations in the Asian, Caribbean and Central American
markets and the further development of our waistband technology.
20
CONTRACTUAL OBLIGATIONS
The following summarizes our contractual obligations at September 30, 2002
and the effects such obligations are expected to have on liquidity and cash flow
in future periods:
PAYMENTS DUE BY PERIOD
------------------------------------------------------
LESS THAN 1-3 4-5 AFTER
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
- ----------------------- ----------- ----------- ---------- ------ -------
Subordinated notes
payable ............ $ 4,200,000 $ 1,300,000 $2,900,000 $ -- $ --
Capital lease
obligations ........ $ 192,862 $ 71,121 $ 121,741 $ -- $ --
Subordinated notes
payable to related
parties (1) ........ $ 849,971 $ 849,971 $ -- $ -- $ --
Operating leases ...... $ 1,708,425 $ 644,272 $1,064,153 $ -- $ --
Line of credit ........ $16,039,467 $16,039,467 $ -- $ -- $ --
Note payable .......... $ 25,200 $ 25,200 $ -- $ -- $ --
Royalty payments ...... $ 950,000 $ 100,000 $ 850,000 $ -- $ --
- --------------------------------------------------------------------------------
(1) The majority of subordinated notes payable to related parties are due
on demand with the remainder due and payable on the fifteenth day following
the date of delivery of written demand for payment.
NEW ACCOUNTING PRONOUNCEMENT
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 requires the fair value of a liability for
an asset retirement obligation to be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated
asset retirement costs are capitalized as part of the carrying amount of the
long-lived asset. SFAS No. 143 is effective for fiscal years beginning after
September 15, 2002. We believe the adoption of this Statement will have no
material impact on our financial statements.
In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS 144 requires that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not yet
occurred. SFAS 144 is effective for financial statements issued for fiscal years
beginning after December 15, 2001 and, generally, are to be applied
prospectively. The adoption of this Statement had no material impact on the
Company's financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This statement eliminates the current requirement that gains and
losses on debt extinguishment must be classified as extraordinary items in the
income statement. Instead, such gains and losses will be classified as
extraordinary items only if they are deemed to be unusual and infrequent, in
accordance with the current GAAP criteria for extraordinary classification. In
addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring
that modifications of capital leases that result in reclassification as
operating leases be accounted for consistent with sale-leaseback accounting
rules. The statement also contains other nonsubstantive corrections to
authoritative accounting literature. The changes related to debt
21
extinguishment will be effective for fiscal years beginning after May 15, 2002,
and the changes related to lease accounting will be effective for transactions
occurring after May 15, 2002. Adoption of this standard will not have any
immediate effect on the Company's consolidated financial statements.
In September 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which addresses accounting for
restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The
Company will adopt the provisions of SFAS No. 146 for restructuring activities
initiated after December 31, 2002. SFAS No. 146 requires that the liability for
costs associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF No. 94-3, a liability for an exit cost was
recognized at the date of a company's commitment to an exit plan. SFAS No. 146
also establishes that the liability should initially be measured and recorded at
fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing
future restructuring costs as well as the amount recognized.
CAUTIONARY STATEMENTS AND RISK FACTORS
Several of the matters discussed in this document contain forward-looking
statements that involve risks and uncertainties. Factors associated with the
forward-looking statements that could cause actual results to differ from those
projected or forecast are included in the statements below. In addition to other
information contained in this report, readers should carefully consider the
following cautionary statements and risk factors.
IF WE LOSE OUR LARGEST CUSTOMERS OR THEY FAIL TO PURCHASE AT ANTICIPATED
LEVELS, OUR SALES AND OPERATING RESULTS WILL BE ADVERSELY AFFECTED. Our largest
customer, Tarrant Apparel Group, accounted for approximately 42.0% and 48.1% of
our net sales, on a consolidated basis, for the years ended December 31, 2001
and 2000, and 32.1% for the nine months ended September 2002. In December 2000,
we entered into an exclusive supply agreement with Azteca Production
International, AZT International SA D RL, and Commerce Investment Group, LLC
that provides for a minimum of $10,000,000 in total annual purchases by Azteca
Production International and its affiliates during each year of the three-year
term of the agreement. Azteca Production International is required to purchase
from us only if we are able to provide trim products on a competitive basis in
terms of price and quality.
Our results of operations will depend to a significant extent upon the
commercial success of Azteca Production International and Tarrant Apparel Group.
If Azteca and Tarrant fail to purchase our trim products at anticipated levels,
or our relationship with Azteca or Tarrant terminates, it may have an adverse
affect on our results because:
o We will lose a primary source of revenue if either of Tarrant or
Azteca choose not to purchase our products or services;
o We may not be able to reduce fixed costs incurred in developing the
relationship with Azteca and Tarrant in a timely manner;
o We may not be able to recoup setup and inventory costs;
o We may be left holding inventory that cannot be sold to other
customers; and
o We may not be able to collect our receivables from them.
CONCENTRATION OF RECEIVABLES FROM OUR LARGEST CUSTOMERS MAKES RECEIVABLE
BASED FINANCING DIFFICULT AND INCREASES THE RISK THAT IF OUR LARGEST CUSTOMERS
FAIL TO PAY US, OUR CASH FLOW WOULD BE SEVERELY AFFECTED. Our business relies
heavily on a relatively small number of customers, including Tarrant Apparel
Group and Azteca Production International. This concentration of our business
adversely affects our ability to obtain receivable based financing due to
customer concentration limitations customarily
22
applied by financial institutions, including UPS Capital and factors. Further,
if we are unable to collect any large receivables due us, our cash flow would be
severely impacted.
OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS CONTINUE TO
WORSEN. Our revenues depend on the health of the economy and the growth of our
customers and potential future customers. When economic conditions weaken,
certain apparel manufacturers and retailers, including some of our customers,
have experienced in the past, and may experience in the future, financial
difficulties which increase the risk of extending credit to such customers.
Customers adversely affected by economic conditions have also attempted to
improve their own operating efficiencies by concentrating their purchasing power
among a narrowing group of vendors. There can be no assurance that we will
remain a preferred vendor to our existing customers. A decrease in business from
or loss of a major customer could have a material adverse effect on our results
of operations. Further, if the economic conditions in the United States worsen
or if a wider or global economic slowdown occurs, we may experience a material
adverse impact on our business, operating results, and financial condition.
IF WE ARE NOT ABLE TO MANAGE OUR RAPID EXPANSION AND GROWTH, WE COULD INCUR
UNFORESEEN COSTS OR DELAYS AND OUR REPUTATION AND RELIABILITY IN THE MARKETPLACE
AND OUR REVENUES WILL BE ADVERSELY AFFECTED. The growth of our operations and
activities has placed and will continue to place a significant strain on our
management, operational, financial and accounting resources. If we cannot
implement and improve our financial and management information and reporting
systems, we may not be able to implement our growth strategies successfully and
our revenues will be adversely affected. In addition, if we cannot hire, train,
motivate and manage new employees, including management and operating personnel
in sufficient numbers, and integrate them into our overall operations and
culture, our ability to manage future growth, increase production levels and
effectively market and distribute our products may be significantly impaired.
WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS IN
OPERATING RESULTS THAT MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND STOCK
PRICE VOLATILITY. We operate in an industry that is subject to significant
fluctuations in operating results from quarter to quarter, which may lead to
unexpected reductions in revenues and stock price volatility. Factors that may
influence our quarterly operating results include:
o The volume and timing of customer orders received during the quarter;
o The timing and magnitude of customers' marketing campaigns;
o The loss or addition of a major customer;
o The availability and pricing of materials for our products;
o The increased expenses incurred in connection with the introduction of
new products;
o Currency fluctuations;
o Delays caused by third parties; and
o Changes in our product mix or in the relative contribution to sales of
our subsidiaries.
Due to these factors, it is possible that in some quarters our operating
results may be below our stockholders' expectations and those of public market
analysts. If this occurs, the price of our common stock would likely be
adversely affected.
OUR CUSTOMERS HAVE CYCLICAL BUYING PATTERNS WHICH MAY CAUSE US TO HAVE
PERIODS OF LOW SALES VOLUME. Most of our customers are in the apparel industry.
The apparel industry historically has been subject to substantial cyclical
variations. Our business has experienced, and we expect our business to continue
to experience, significant cyclical fluctuations due, in part, to customer
buying patterns, which may result in periods of low sales usually in the first
and fourth quarters of our financial year.
23
OUR BUSINESS MODEL IS DEPENDENT ON INTEGRATION OF INFORMATION SYSTEMS ON A
GLOBAL BASIS AND, TO THE EXTENT THAT WE FAIL TO MAINTAIN AND SUPPORT OUR
INFORMATION SYSTEMS, IT CAN RESULT IN LOST REVENUES. We must consolidate and
centralize the management of our subsidiaries and significantly expand and
improve our financial and operating controls. Additionally, we must effectively
integrate the information systems of our Mexican and Caribbean facilities with
the information systems of our principal offices in California and Florida. Our
failure to do so could result in lost revenues, delay financial reporting or
adversely affect availability of funds under our credit facilities.
THE LOSS OF KEY MANAGEMENT AND SALES PERSONNEL COULD ADVERSELY AFFECT OUR
BUSINESS, INCLUDING OUR ABILITY TO OBTAIN AND SECURE ACCOUNTS AND GENERATE
SALES. Our success has and will continue to depend to a significant extent upon
key management and sales personnel, many of whom would be difficult to replace,
particularly Colin Dyne, our Chief Executive Officer. Colin Dyne is not bound by
an employment agreement. The loss of the services of Colin Dyne or the services
of other key employees could have a material adverse effect on our business,
including our ability to establish and maintain client relationships. Our future
success will depend in large part upon our ability to attract and retain
personnel with a variety of sales, operating and managerial skills.
IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL NOT
BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently, we
do not operate duplicate facilities in different geographic areas. Therefore, in
the event of a regional disruption where we maintain one or more of our
facilities, it is unlikely that we could shift our operations to a different
geographic region and we may have to cease or curtail our operations. This may
cause us to lose sales and customers. The types of disruptions that may occur
include:
o Foreign trade disruptions;
o Import restrictions;
o Labor disruptions;
o Embargoes;
o Government intervention; and
o Natural disasters.
INTERNET-BASED SYSTEMS THAT HOST OUR MANAGED TRIM SOLUTION MAY EXPERIENCE
DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. Our MANAGED TRIM
SOLUTION is an Internet-based business-to-business e-commerce system. To the
extent that we fail to adequately continue to update and maintain the hardware
and software implementing the MANAGED TRIM SOLUTION, our customers may
experience interruptions in service due to defects in our hardware or our source
code. In addition, since our MANAGED TRIM SOLUTION is Internet-based,
interruptions in Internet service generally can negatively impact our customers'
ability to use the MANAGED TRIM SOLUTION to monitor and manage various aspects
of their trim needs. Such defects or interruptions could result in lost revenues
and lost customers.
THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors,
including Paxar Corporation, YKK, Universal Button, Inc., Avery Dennison
Corporation and Scovill Fasteners, Inc., have greater name recognition, longer
operating histories and, in many cases, substantially greater financial and
other resources than we do.
IF CUSTOMERS DEFAULT ON BUYBACK AGREEMENTS WITH US, WE WILL BE LEFT HOLDING
UNSALABLE INVENTORY. Inventories include goods that are subject to buyback
agreements with our customers. Under these
24
buyback agreements, the customer must purchase the inventories from us under
normal invoice and selling terms, if any inventory which we purchase on their
behalf remains in our hands longer than agreed by the customer from the time we
received the goods from our vendors. If any customer defaults on these buyback
provisions, we may incur a charge in connection with our holding significant
amounts of unsalable inventory.
UNAUTHORIZED USE OF OUR PROPRIETARY TECHNOLOGY MAY INCREASE OUR LITIGATION
COSTS AND ADVERSELY AFFECT OUR SALES. We rely on trademark, trade secret and
copyright laws to protect our designs and other proprietary property worldwide.
We cannot be certain that these laws will be sufficient to protect our property.
In particular, the laws of some countries in which our products are distributed
or may be distributed in the future may not protect our products and
intellectual rights to the same extent as the laws of the United States. If
litigation is necessary in the future to enforce our intellectual property
rights, to protect our trade secrets or to determine the validity and scope of
the proprietary rights of others, such litigation could result in substantial
costs and diversion of resources. This could have a material adverse effect on
our operating results and financial condition. Ultimately, we may be unable, for
financial or other reasons, to enforce our rights under intellectual property
laws, which could result in lost sales.
IF OUR PRODUCTS INFRINGE ANY OTHER PERSON'S PROPRIETARY RIGHTS, WE MAY BE
SUED AND HAVE TO PAY LARGE LEGAL EXPENSES AND JUDGMENTS AND REDESIGN OR
DISCONTINUE SELLING OUR PRODUCTS. From time to time in our industry, third
parties allege infringement of their proprietary rights. Any infringement
claims, whether or not meritorious, could result in costly litigation or require
us to enter into royalty or licensing agreements as a means of settlement. If we
are found to have infringed the proprietary rights of others, we could be
required to pay damages, cease sales of the infringing products and redesign the
products or discontinue their sale. Any of these outcomes, individually or
collectively, could have a material adverse effect on our operating results and
financial condition.
OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS AND
CAUSE OUR STOCKHOLDERS TO SUFFER SIGNIFICANT LOSSES. The following factors could
cause the market price of our common stock to decrease, perhaps substantially:
o The failure of our quarterly operating results to meet expectations of
investors or securities analysts;
o Adverse developments in the financial markets, the apparel industry
and the worldwide or regional economies;
o Interest rates;
o Changes in accounting principles;
o Sales of common stock by existing shareholders or holders of options;
o Announcements of key developments by our competitors; and
o The reaction of markets and securities analysts to announcements and
developments involving our company.
IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED. Our business strategy may
include expansion through internal growth, by acquiring complementary businesses
or by establishing strategic relationships with targeted customers and
suppliers. In order to do so or to fund our other activities, we may issue
additional equity securities that could dilute our stockholders' stock
ownership. We may also assume additional debt and incur impairment losses
related to goodwill and other tangible assets if we acquire another company and
this could negatively impact our results of operations.
25
WE MAY NOT BE ABLE TO REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS. We
may consider strategic acquisitions as opportunities arise, subject to the
obtaining of any necessary financing. Acquisitions involve numerous risks,
including diversion of our management's attention away from our operating
activities. We cannot assure our stockholders that we will not encounter
unanticipated problems or liabilities relating to the integration of an acquired
company's operations, nor can we assure our stockholders that we will realize
the anticipated benefits of any future acquisitions.
WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE OF OUR COMMON STOCK. Our stockholders' rights plan, our ability to issue
additional shares of preferred stock and some provisions of our certificate of
incorporation and bylaws and of Delaware law could make it more difficult for a
third party to make an unsolicited takeover attempt of us. These anti-takeover
measures may depress the price of our common stock by making it more difficult
for third parties to acquire us by offering to purchase shares of our stock at a
premium to its market price.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT
OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As of
December 31, 2001, our officers and directors and their affiliates owned
approximately 42.4% of the outstanding shares of our common stock. The Dyne
family, which includes Mark Dyne, Colin Dyne, Larry Dyne, Jonathan Burstein and
the estate of Harold Dyne, beneficially owned approximately 40.4% of the
outstanding shares of our common stock. The number of shares beneficially owned
by the Dyne family includes the shares of common stock held by Azteca Production
International, which are voted by Colin Dyne pursuant to a voting agreement. The
Azteca Production International shares constitute approximately 11.4% of the
outstanding shares of common stock at December 31, 2001. KG Investment, LLC, a
significant stockholder, owns approximately 27.2% of the outstanding shares of
our common stock at December 31, 2001. As a result, our officers and directors,
the Dyne family and KG Investment, LLC are able to exert considerable influence
over the outcome of any matters submitted to a vote of the holders of our common
stock, including the election of our Board of Directors. The voting power of
these stockholders could also discourage others from seeking to acquire control
of us through the purchase of our common stock, which might depress the price of
our common stock.
WE MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED
SECURITY MEASURES IN RESPONSE TO TERRORISM. Our business depends on the free
flow of products and services through the channels of commerce. Recently, in
response to terrorists' activities and threats aimed at the United States,
transportation, mail, financial and other services have been slowed or stopped
altogether. Further delays or stoppages in transportation, mail, financial or
other services could have a material adverse effect on our business, results of
operations and financial condition. Furthermore, we may experience an increase
in operating costs, such as costs for transportation, insurance and security as
a result of the activities and potential activities. We may also experience
delays in receiving payments from payers that have been affected by the
terrorist activities and potential activities. The United States economy in
general is being adversely affected by the terrorist activities and potential
activities and any economic downturn could adversely impact our results of
operations, impair our ability to raise capital or otherwise adversely affect
our ability to grow our business.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All of our sales are denominated in United States dollars or the currency
of the country in which our products originate and, accordingly, we do not enter
into hedging transactions with regard to any foreign currencies. Currency
fluctuations can, however, increase the price of our products to foreign
customers which can adversely impact the level of our export sales from time to
time. The majority of our cash equivalents are held in United States bank
accounts and we do not believe we have significant market risk exposure with
regard to our investments.
We are also exposed to the impact of interest rate changes on our
outstanding borrowings. At September 30, 2002, we had approximately $20.2
million of indebtedness subject to interest rate fluctuations. These
fluctuations may increase our interest expense and decrease our cash flows from
time to time. For example, based on average bank borrowings of $10 million
during a three-month period, if the interest rate indices on which our bank
borrowing rates are based were to increase 100 basis points in the three-month
period, interest incurred would increase and cash flows would decrease by
$25,000.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures, which we have designed to
ensure that material information related to Tag-it Pacific, Inc., including our
consolidated subsidiaries, is disclosed in our public filings on a regular
basis. In response to recent legislation and proposed regulations, we reviewed
our internal control structure and our disclosure controls and procedures. We
believe our pre-existing disclosure controls and procedures are adequate to
enable us to comply with our disclosure obligations.
Within 90 days prior to the filing of this report, members of the Company's
management, including the Company's Chief Executive Officer, Colin Dyne, and
Chief Financial Officer, Ronda Sallmen, evaluated the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
upon that evaluation, Mr. Dyne and Ms. Sallmen concluded that the Company's
disclosure controls and procedures are effective in causing material information
to be recorded, processed, summarized and reported by management of the Company
on a timely basis and to ensure that the quality and timeliness of the Company's
public disclosures complies with its SEC disclosure obligations.
CHANGES IN CONTROLS AND PROCEDURES
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these internal controls after the
date of our most recent evaluation.
27
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We currently have pending claims, suits and complaints that arise in the
ordinary course of our business. We believe that we have meritorious defenses to
these claims and the claims are covered by insurance or, after taking into
account the insurance in place, would not have a material effect on our
consolidated financial condition if adversely determined against us.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.68 Exclusive supply agreement, dated July 12, 2002, among
Tag-it Pacific, Inc. and Levi Strauss & Co.*
99.1 Certification Pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
* Certain portions of this agreement have been omitted and filed
separately with the Securities and Exchange Commission pursuant
to a request for an order granting confidential treatment
pursuant to Rule 406 of the General Rules and Regulations under
the Securities Act of 1933, as amended.
(b) Report on Form 8-K:
None.
28
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.
Date: November 14, 2002 TAG-IT PACIFIC, INC.
` /s/ Ronda Sallmen
--------------------------------
By: Ronda Sallmen
Its: Chief Financial Officer
29
Certification of CEO Pursuant to
Securities Exchange Act Rules 13a-14 and 15d-14
as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Colin Dyne, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Tag-It
Pacific, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Colin Dyne
-----------------------
Colin Dyne
Chief Executive Officer
30
Certification of CFO Pursuant to
Securities Exchange Act Rules 13a-14 and 15d-14
as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Ronda Sallmen, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Tag-It
Pacific, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Ronda Sallmen
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Ronda Sallmen
Chief Financial Officer
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