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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 2004.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from ____________ to _______________.
Commission file number 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
(Registrant's Telephone Number, Including Area Code)
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 [_]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
Yes [_] No [X]
Indicate 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, 18,053,316 shares issued and outstanding as of May 15,
2004.
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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 March 31, 2004
(unaudited) and December 31, 2003....................................3
Consolidated Statements of Operations (unaudited)
for the Three Months Ended March 31, 2004 and 2003...................4
Consolidated Statements of Cash Flows (unaudited) for the
Three Months Ended March 31, 2004 and 2003...........................5
Notes to the Consolidated Financial Statements.......................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........25
Item 4. Controls and Procedures.............................................26
PART II OTHER INFORMATION
Item 1. Legal Proceedings...................................................26
Item 2. Changes in Securities and Use of Proceeds...........................26
Item 4. Submission of Matters to a Vote of Security Holders.................27
Item 6. Exhibits and Reports on Form 8-K....................................27
2
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
TAG-IT PACIFIC, INC.
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2004 2003
------------ ------------
(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents ...................... $ 7,106,130 $ 14,442,769
Due from factor ................................ 8,963 9,743
Trade accounts receivable, net ................. 10,324,965 7,531,079
Trade accounts receivable, related parties ..... 10,901,949 11,721,465
Inventories .................................... 18,800,461 17,096,879
Prepaid expenses and other current assets ...... 1,193,729 2,124,366
Deferred income taxes .......................... 2,800,000 2,800,000
------------ ------------
Total current assets ......................... 51,136,197 55,726,301
Property and equipment, net of accumulated
depreciation and amortization .................. 6,093,255 6,144,863
Tradename ......................................... 4,110,750 4,110,750
Goodwill .......................................... 450,000 450,000
License rights .................................... 367,500 375,375
Due from related parties .......................... 775,290 762,076
Other assets ...................................... 127,254 200,949
------------ ------------
Total assets ...................................... $ 63,060,246 $ 67,770,314
============ ============
LIABILITIES, CONVERTIBLE REDEEMABLE
PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Current Liabilities:
Line of credit ................................. $ 4,686,461 $ 7,095,514
Accounts payable and accrued expenses .......... 7,381,488 9,552,196
Subordinated notes payable to related parties .. 849,971 849,971
Current portion of capital lease obligations ... 560,402 562,742
Current portion of subordinated note payable ... 1,500,000 1,200,000
------------ ------------
Total current liabilities .................... 14,978,322 19,260,423
Capital lease obligations, less current portion ... 510,111 651,191
Subordinated note payable, less current portion ... 800,000 1,400,000
------------ ------------
Total liabilities ............................ 16,288,433 21,311,614
------------ ------------
Convertible redeemable preferred stock Series C,
$0.001 par value; 759,494 shares authorized;
no shares issued and outstanding at March 31,
2004; 759,494 shares issued and outstanding at
December 31, 2003 (stated value $3,000,000) .... -- 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 D, $0.001
par value; 572,818 shares authorized; no
shares issued or outstanding at March 31,
2004; 572,818 shares issued and outstanding
at December 31, 2003 ......................... -- 22,918,693
Common stock, $0.001 par value, 30,000,000
shares authorized; 18,035,316 shares issued
and outstanding at March 31, 2004; 11,508,201
at December 31, 2003 ......................... 18,037 11,510
Additional paid-in capital ..................... 50,593,171 23,890,356
Accumulated Deficit ............................ (3,839,395) (3,256,860)
------------ ------------
Total stockholders' equity ........................ 46,771,813 43,563,699
------------ ------------
Total liabilities, convertible redeemable
preferred stock and stockholders' equity ....... $ 63,060,246 $ 67,770,314
============ ============
See accompanying notes to consolidated financial statements.
3
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
------------------------------
2004 2003
------------ ------------
Net sales ................................... $ 10,160,298 $ 14,358,833
Cost of goods sold .......................... 7,168,248 10,059,252
------------ ------------
Gross profit ........................... 2,992,050 4,299,581
Selling expenses ............................ 772,116 829,144
General and administrative expenses ......... 2,857,140 2,698,504
------------ ------------
Total operating expenses ............... 3,629,256 3,527,648
(Loss) income from operations ............... (637,206) 771,933
Interest expense, net ....................... 186,719 320,848
------------ ------------
(Loss) income before income taxes ........... (823,925) 451,085
(Benefit) provision for income taxes ........ (271,895) 90,217
------------ ------------
Net (loss) income ...................... $ (552,030) $ 360,868
============ ============
Less: Preferred stock dividends ............ 30,505 47,100
------------ ------------
Net (loss) income available to common
shareholders .............................. $ (582,535) $ 313,768
============ ============
Basic (loss) earnings per share ............. $ (0.04) $ 0.03
============ ============
Diluted (loss) earnings per share ........... $ (0.04) $ 0.03
============ ============
Weighted average number of common shares
outstanding:
Basic .................................. 14,921,591 9,423,242
============ ============
Diluted ................................ 14,921,591 9,686,457
============ ============
See accompanying notes to consolidated financial statements.
4
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
2004 2003
------------ ------------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net (loss) income ............................. $ (552,030) $ 360,868
Adjustments to reconcile net (loss) income to net
cash (used) provided by operating activities:
Depreciation and amortization .................. 377,580 308,364
Increase in allowance for doubtful accounts .... 75,000 94,965
Stock issued for services ...................... 74,825 --
Changes in operating assets and liabilities:
Receivables, including related parties ...... (2,048,590) (249,213)
Inventories ................................. (1,703,582) (1,527,450)
Other assets ................................ 3,162 (2,592)
Prepaid expenses and other current assets ... 930,637 (283,948)
Accounts payable and accrued expenses ....... (1,308,107) 2,247,601
Income taxes payable ........................ (433,738) 298,879
------------ ------------
Net cash (used) provided by operating activities .. (4,584,843) 1,247,474
------------ ------------
Cash flows from investing activities:
Acquisition of property and equipment ......... (247,564) (681,818)
------------ ------------
Cash flows from financing activities:
Repayment of bank line of credit, net ......... (2,409,053) (778,575)
Proceeds from private placement transactions .. -- 900,000
Proceeds from exercise of stock options and
warrants .................................... 348,241 --
Repayment of capital leases ................... (143,420) (17,984)
Repayment of notes payable .................... (300,000) (800,000)
------------ ------------
Net cash used by financing activities ............. (2,504,232) (696,559)
------------ ------------
Net decrease in cash .............................. (7,336,639) (130,903)
Cash at beginning of period ....................... 14,442,769 285,464
------------ ------------
Cash at end of period ............................. $ 7,106,130 $ 154,561
============ ============
Supplemental disclosures of cash flow information:
Cash received (paid) during the period for:
Interest paid ............................... $ (189,949) $ (314,009)
Income taxes paid ........................... $ (170,016) $ (2,566)
Income taxes received ....................... $ -- $ 212,082
Non-cash financing activities:
Preferred Series D stock converted to common
stock ....................................... $ 22,918,693 $ --
Preferred Series C stock converted to common
stock ....................................... $ 2,895,001 $ --
Accrued dividends converted to common stock ... $ 458,707 $ --
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 accounting
principles generally accepted 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, 2003.
2. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations:
THREE MONTHS ENDED MARCH 31, 2004: (LOSS) INCOME SHARES PER SHARE
- --------------------------------- ------------- ------------ ---------
Basic loss per share:
Loss available to common stockholders $ (582,535) 14,921,591 $ (0.04)
Effect of Dilutive Securities:
Options -
Warrants -
----------- ----------- --------
Loss available to common stockholders $ (582,535) 14,921,591 $ (0.04)
=========== =========== ========
THREE MONTHS ENDED MARCH 31, 2003:
Basic earnings per share:
Income available to common stockholders $ 313,768 9,423,242 $ 0.03
Effect of Dilutive Securities:
Options 210,718
Warrants 52,497
----------- ----------- --------
Income available to common stockholders $ 313,768 9,686,457 $ 0.03
=========== =========== ========
Warrants to purchase 1,236,219 shares of common stock at between $0.71
and $5.06, options to purchase 1,927,000 shares of common stock at between $1.30
and $4.63 and convertible debt of $500,000 convertible at $4.50 per share were
outstanding for the three months ended March 31, 2004, but were not included in
the computation of diluted earnings per share because the effect of exercise or
conversion would have an antidilutive effect on earnings per share.
6
Warrants to purchase 683,332 shares of common stock at between $3.65
and $6.00, options to purchase 925,000 shares of common stock at between $3.75
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 months ended March 31, 2003, 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.
3. STOCK BASED COMPENSATION
All stock options issued to employees had an exercise price not less
than the fair market value of the Company's Common Stock on the date of grant,
and in accounting for such options utilizing the intrinsic value method there is
no related compensation expense recorded in the Company's financial statements
for the three months ended March 31, 2004 and 2003. If compensation cost for
stock-based compensation had been determined based on the fair market value of
the stock options on their dates of grant in accordance with SFAS 123, the
Company's net (loss) income and (loss) earnings per share for the three months
ended March 31, 2004 and 2003 would have amounted to the pro forma amounts
presented below:
THREE MONTHS ENDED MARCH 31,
--------------------------
2004 2003
----------- -----------
Net (loss) income, as reported ................... $ (552,030) $ 360,868
Add: Stock-based employee compensation expense
included in reported net (loss) income,
net of related tax effects .................. -- --
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects ......................... (39,556) (5,282)
----------- -----------
Pro forma net (loss) income ...................... $ (591,586) $ 355,586
=========== ===========
(Loss) earnings per share:
Basic - as reported ......................... $ (0.04) $ 0.03
Basic - pro forma ........................... $ (0.04) $ 0.03
Diluted - as reported ....................... $ (0.04) $ 0.03
Diluted - pro forma ......................... $ (0.04) $ 0.03
7
4. SERIES D PREFERRED STOCK
On December 18, 2003, the Company sold an aggregate of 572,818 shares
of non-voting Series D Convertible Preferred Stock, at a price of $44.00 per
share, to institutional investors and individual accredited investors in a
private placement transaction. The Company received net proceeds of $23,083,693
after commissions and other offering expenses. The Series D Convertible
Preferred Stock was convertible after approval at a special meeting of
stockholders at a rate of 10 common shares for each share of Series D
Convertible Preferred Stock. Except as required by law, the Preferred Shares had
no voting rights. The Preferred Shares would have accrued dividends, commencing
on June 1, 2004, at an annual rate of 5% of the initial stated value of $44.00
per share, payable quarterly. In the event of a liquidation, dissolution or
winding-up of the Company, the holders of the Preferred Shares would have been
entitled to receive, prior to any distribution on the common stock, a
distribution equal to the initial stated value of the Preferred Shares plus all
accrued and unpaid dividends.
At a special meeting of stockholders held on February 11, 2004, the
stockholders of the Company approved the issuance of 5,728,180 shares of common
stock upon conversion of the Series D Preferred Stock. At the conclusion of the
meeting, all of the shares of the Series D Convertible Preferred Stock
automatically converted into common shares.
The Company has registered the common shares issued upon conversion of
the Series D Convertible Preferred Stock with the Securities and Exchange
Commission for resale by the investors. In conjunction with the private
placement transaction, the Company issued a warrant to purchase 572,818 common
shares to the placement agent. The warrant is exercisable beginning June 18,
2004 through December 18, 2008. The fair value of the warrant was estimated at
approximately $165,000 utilizing the Black-Scholes option-pricing model.
5. SERIES C PREFERRED STOCK
On February 25, 2004, the holders of the Series C Preferred Stock
converted all 759,494 shares of Series C Preferred Stock, plus $458,707 of
accrued dividends, into 700,144 shares of common stock.
6. GUARANTEES AND CONTINGENCIES
In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others - and interpretation of FASB Statements No. 5, 57 and 107
and rescission of FIN 34." The following is a summary of the Company's
agreements that it has determined are within the scope of FIN 45:
In accordance with the bylaws of the Company, officers and directors
are indemnified for certain events or occurrences arising as a result of the
officer or director's serving in such capacity. The term of the indemnification
period is for the lifetime of the officer or director. The maximum potential
amount of future payments the Company could be required to make under the
indemnification provisions of its bylaws is unlimited. However, the Company has
a director and officer liability insurance policy that reduces its exposure and
enables it to recover a portion of any future amounts paid. As a result of its
insurance policy coverage, the Company believes the estimated fair value of the
indemnification provisions of its bylaws is minimal and therefore, the Company
has not recorded any related liabilities.
8
The Company enters into indemnification provisions under its agreements
with investors and its agreements with other parties in the normal course of
business, typically with suppliers, customers and landlords. Under these
provisions, the Company generally indemnifies and holds harmless the indemnified
party for losses suffered or incurred by the indemnified party as a result of
the Company's activities or, in some cases, as a result of the indemnified
party's activities under the agreement. These indemnification provisions often
include indemnifications relating to representations made by the Company with
regard to intellectual property rights. These indemnification provisions
generally survive termination of the underlying agreement. The maximum potential
amount of future payments the Company could be required to make under these
indemnification provisions is unlimited. The Company has not incurred material
costs to defend lawsuits or settle claims related to these indemnification
agreements. As a result, the Company believes the estimated fair value of these
agreements is minimal. Accordingly, the Company has not recorded any related
liabilities.
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.
7. NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 104 (SAB No. 104), "REVENUE RECOGNITION," which
codifies, revises and rescinds certain sections of SAB No. 101, "REVENUE
RECOGNITION," in order to make this interpretive guidance consistent with
current authoritative accounting and auditing guidance and SEC rules and
regulations. The changes noted in SAB No. 104 did not have a material effect on
our consolidated results of operations, consolidated financial position or
consolidated cash flows.
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150, ACCOUNTING FOR CERTAIN
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("FAS 150"),
which establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. FAS 150
requires an issuer to classify a financial instrument that is within its scope,
which may have previously been reported as equity, as a liability. This
Statement is effective at the beginning of the first interim period beginning
after June 15, 2003 for public companies. The Company adopted this Statement as
of July 1, 2003 and it had no material impact on its financial statements.
In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT
133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("FAS No. 149"). FAS No.
149 amends and clarifies the accounting guidance on derivative instruments
(including certain derivative instruments embedded in other contracts) and
hedging activities that fall within the scope of FAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." FAS No. 149 also amends certain
other existing pronouncements, which will result in more consistent reporting of
contracts that are derivatives in their entirety or that contain embedded
derivatives that warrant separate accounting. This Statement is effective for
contracts entered into or modified after June 30, 2003, with certain exceptions,
and for hedging relationships designated after June 30, 2003. The Company
adopted this Statement as of July 1, 2003 and it had no material impact on its
financial statements.
9
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 months ended March 31, 2004 and 2003.
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.
OVERVIEW
Tag-It Pacific, Inc. is an apparel company that specializes in the
distribution of trim items to manufacturers of fashion apparel, specialty
retailers and mass merchandisers. We act as a full service outsourced trim
management department for manufacturers, a specified supplier of trim items to
owners of specific brands, brand licensees and retailers, a distributor of
zippers under our TALON brand name and a distributor of stretch waistbands that
utilize licensed patented technology.
The global apparel industry served by our company continues to undergo
dramatic change within its traditional supply chain. Large retail brands such as
Levi Strauss & Co. and other major brands have largely moved away from owning
their manufacturing operations and have increasingly embraced an outsourced
production model. These brands today are primarily focused on design, marketing
and sourcing. As sourcing has gained prominence in these organizations, they
have become increasingly adept at responding to changing market conditions with
respect to labor costs, trade policies and other areas, and are more capable of
shifting production to new geographic areas.
As the separation of the retail brands and apparel production has
grown, the disintermediation of the retail brands and the underlying suppliers
of apparel component products such as trim has become substantially more
pronounced. The management of trim procurement, including ordering, production,
inventory management and just-in-time distribution to a brand's manufacturers,
has become an increasingly cumbersome task given (i) the proliferation of
brands, styles and divisions within the major retail brands and (ii) the growing
pace of globalization within the apparel manufacturing industry.
While the global apparel industry is in the midst of restructuring its
supply chain, the trim product industry has not evolved and remains highly
fragmented, with no single player providing the global scope, integrated product
set or service focus required for the broader industry evolution to succeed. We
believe these trends present an attractive opportunity for a fully-integrated
single source supplier of trim products to successfully interface between the
retail brands, their manufacturing partners and other underlying trim component
suppliers. Our objective is to provide the global apparel industry with
innovative products and distribution solutions that improve both the quality of
fashion apparel and the efficiency of the industry itself.
The launch of TRIMNET, our Oracle based e-sourcing system will allow us
to seamlessly supply complete trim packages to apparel brands, retailers and
manufacturers around the world, greatly expanding upon our success in offering
complete trim packages to customers in Mexico over the past several years.
TRIMNET is an upgrade of our MANAGED TRIM SOLUTION software and will allow us to
provide additional services to customers on a global platform.
10
APPLICATION OF 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 we purchase and warehouse 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
customer's product line related to the inventories, 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 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.
11
o Intangible assets are evaluated on a continual basis and
impairment adjustments are made based on management's
valuation of identified reporting units related to goodwill,
the valuation of intangible assets with indefinite lives and
the reassessment of the useful lives related to other
intangible assets with definite useful lives. Impairment
adjustments are made for the difference between the carrying
value of the intangible asset and the estimated valuation and
charged to operations in the period in which the facts that
give rise to the adjustments become known.
o Sales are recorded at the time of shipment, at which point
title transfers to the customer, and when collection is
reasonably assured.
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
MARCH 31,
-----------------------------
2004 2003
----------- -----------
Net sales........................................ 100.0 % 100.0 %
Cost of goods sold............................... 70.6 70.1
----------- -----------
Gross profit..................................... 29.4 29.9
Selling expenses................................. 7.6 5.7
General and administrative expenses.............. 28.1 18.8
----------- -----------
Operating (loss) income.......................... (6.3)% 5.4 %
=========== ===========
The following table sets forth for the periods indicated revenues
attributed to geographical regions based on the location of the customer as a
percentage of net sales:
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2004 2003
----------- -----------
United States............................... 8.2 % 12.3 %
Asia 20.3 19.1
Mexico...................................... 36.0 44.7
Dominican Republic.......................... 21.3 23.9
Central and South America................... 14.0 -
Other....................................... 0.2 -
----------- -----------
100.0 % 100.0 %
=========== ===========
12
Net sales decreased approximately $4,199,000, or 29.2%, to $10,160,000
for the three months ended March 31, 2004 from $14,359,000 for the three months
ended March 31, 2003. The decrease in net sales was primarily due to a decrease
in trim-related sales of approximately $6.1 million from our Tlaxcala, Mexico,
operations under our MANAGED TRIM SOLUTION(TM) trim package program. During the
fourth quarter of 2003, we implemented a plan to restructure certain business
operations, including the reduction of our reliance on two significant customers
in Mexico, which contributed approximately 51.4% of revenues in the first
quarter of 2003. These customers contributed approximately 6.0% of revenues in
the first quarter of 2004. The reduction of our operations in Mexico was in
response to an anticipated reduction in sales volume from our larger Mexico
customers, our efforts to decrease our reliance on our larger Mexico customers,
and our difficulty obtaining financing in Mexico due to the location of assets
outside the U.S. and customer concentration and other limits imposed by
financial institutions. The first quarter of 2004 was a transitional quarter as
we experienced the effects of diversifying our customer base. We are no longer
reliant on Tarrant Apparel Group for the majority of our sales. The decrease in
net sales was offset by an increase in sales under our TEKFIT stretch waistband
division. The decrease in net sales was also offset by an increase in sales from
our Hong Kong subsidiary for programs related to major U.S. retailers and an
increase in zipper sales under our TALON brand name in Asia.
Gross profit decreased approximately $1,308,000, or 30.4%, to
$2,992,000 for the three months ended March 31, 2004 from $4,300,000 for the
three months ended March 31, 2003. Gross margin as a percentage of net sales
decreased to approximately 29.4% for the three months ended March 31, 2004 as
compared to 29.9% for the three months ended March 31, 2003. The decrease in
gross profit as a percentage of net sales for the three months ended March 31,
2004 was due to a change in our product mix during the current quarter.
Selling expenses decreased approximately $57,000, or 6.9%, to $772,000
for the three months ended March 31, 2004 from $829,000 for the three months
ended March 31, 2003. As a percentage of net sales, these expenses increased to
7.6% for the three months ended March 31, 2004 compared to 5.7% for the three
months ended March 31, 2003. The decrease in selling expenses during the period
was due primarily to a decrease in the royalty rate related to our exclusive
license and intellectual property rights agreement with Pro-Fit Holdings
Limited. We incurred royalties related to this agreement of approximately
$115,000 for the three months ended March 31, 2004 compared to $155,000 for the
three months ended March 31, 2003. We pay royalties of 6% on related sales of up
to $10 million, 4% of related sales from $10-20 million and 3% on related sales
in excess of $20 million. The majority of our sales force is on a non-commission
basis, which accounts for the increase in selling expenses as a percentage of
net sales during the period ended March 31, 2004.
General and administrative expenses increased approximately $158,000,
or 5.9%, to $2,857,000 for the three months ended March 31, 2004 from $2,699,000
for the three months ended March 31, 2003. The increase in these expenses was
due primarily to a one-time charge of approximately $400,000 related to the
final residual costs associated with our restructuring plan implemented in the
fourth quarter of 2003. This on-time charge was offset by a decrease in salaries
and related benefits as a result of the implementation of our restructuring plan
in the fourth quarter of 2003. As a percentage of net sales, these expenses
increased to 28.1% for the three months ended March 31, 2004 compared to 18.8%
for the three months ended March 31, 2003, due to the decrease in net sales.
Interest expense decreased approximately $134,000, or 41.7%, to
$187,000 for the three months ended March 31, 2004 from $321,000 for the three
months ended March 31, 2003. Borrowings under our UPS Capital credit facility
decreased during the period ended March 31, 2004 due to proceeds received from
our private placement transactions in May and December 2003 in which we raised
approximately $29 million from the sale of common and convertible preferred
stock.
13
The income tax benefit for the three months ended March 31, 2004
amounted to approximately $272,000 compared to a provision for income taxes of
$90,000 for the three months ended March 31, 2003. Income taxes decreased for
the three months ended March 31, 2004 primarily due to decreased taxable income.
Net loss was approximately $552,000 for the three months ended March
31, 2004 as compared to net income of $361,000 for the three months ended March
31, 2003, due primarily to a decrease in net sales and an increase in general
and administrative expenses, as discussed above.
Preferred stock dividends amounted to $31,000 for the three months
ended March 31, 2004 as compared to $47,000 for the three months ended March 31,
2003. Preferred stock dividends represent earned dividends at 6% of the stated
value per annum of the Series C convertible redeemable preferred stock. In
February 2004, the holders of the Series C convertible redeemable preferred
stock converted all 759,494 shares of the Series C Preferred Stock, plus
$458,707 of accrued dividends, into 700,144 shares of our common stock. Net loss
available to common shareholders amounted to $583,000 for the three months ended
March 31, 2004 compared to net income available to common shareholders of
$314,000 for the three months ended March 31, 2003. Basic and diluted loss per
share were $0.04 for the three months ended March 31, 2004 and basic and diluted
earnings per share were $0.03 for the three months ended March 31, 2003.
LIQUIDITY AND CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS
Cash and cash equivalents decreased to $7,106,000 at March 31, 2004
from $14,443,000 at December 31, 2003. The decrease resulted from approximately
$4,585,000 of cash used by operating activities, $248,000 of cash used in
investing activities and $2,504,000 of cash used in financing activities.
Net cash used in operating activities was approximately $4,585,000 for
the three months ended March 31, 2004 as compared to net cash provided by
operating activities of approximately $1,247,000 for the three months ended
March 31, 2003. Cash used in operating activities for the three months ended
March 31, 2004 resulted primarily from increased accounts receivable and
inventories and decreased accounts payable and accrued expenses. 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 slower customer collections. Cash provided by operating activities
for the three months ended March 31, 2003 resulted primarily from increases in
accounts payable and accrued expenses, which were partially offset by increases
in inventories and receivables.
Net cash used in investing activities was approximately $248,000 and
$682,000 for the three months ended March 31, 2004 and 2003, respectively. Net
cash used in investing activities for the three months ended March 31, 2004
consisted primarily of capital expenditures for computer equipment and the
purchase of additional TALON zipper equipment. Net cash used in investing
activities for the three months ended March 31, 2003 consisted primarily of
capital expenditures for equipment related to the exclusive supply agreement we
entered into with Levi Strauss & Co.
14
Net cash used in financing activities was approximately $2,504,000 and
$697,000 for the three months ended March 31, 2004 and 2003, respectively. Net
cash used in financing activities for the three months ended March 31, 2004
primarily reflects the repayment of borrowings under our credit facility and
subordinated notes payable, offset by funds raised from the exercise of stock
options and warrants. Net cash provided by financing activities for the three
months ended March 31, 2003 primarily reflects the repayment of borrowings under
our credit facility and subordinated notes payable, offset by funds raised from
a private placement transaction.
We currently satisfy our working capital requirements primarily through
cash flows generated from operations, sales of equity securities and borrowings
under our credit facility with UPS Capital. Our maximum availability under the
credit facility is $7 million. At March 31, 2004 and 2003, outstanding
borrowings under our UPS Capital credit facility, including amounts borrowed
under our foreign factoring agreement, amounted to approximately $4,686,000 and
$15,250,000, respectively. Open letters of credit under our UPS Capital credit
facility amounted to approximately $110,000 and $500,000 at March 31, 2004 and
2003.
The initial term of our agreement with UPS Capital is three years,
expiring May 30, 2004, 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% on
advances and the prime rate plus 4% on the term loan. On November 17, 2003, the
credit facility was amended to provide for a term loan of $6 million in addition
to the revolving credit facility with a maximum availability of $7 million. The
term loan provided for monthly payments beginning December 15, 2003 through
March 1, 2004 and has been paid in full as of March 31, 2004. On May 14, 2004,
the credit facility was further amended to provide for an additional term
expiring August 28, 2004 and an increased interest rate of prime plus 2.75% on
advances. We are currently pursuing alternative working capital credit
arrangements to replace the UPS Capital credit facility upon its expiration.
The credit facility requires that we comply with certain financial
covenants including net worth, fixed charge ratio and capital expenditures. We
were not in compliance with one of the financial covenants at March 31, 2004.
The non-compliance was subsequently waived by the bank. 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 $3,434,000 to $4,560,000 from
January 1, 2004 to March 31, 2004. 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 with a
particular customer 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.
If our business becomes dependent 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.
15
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.
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. Included in due from
factor as of March 31, 2004 and 2003 are trade accounts receivable factored
without recourse of approximately $60,000 and $399,000. Included in due from
factor are outstanding advances due to UPS Capital under this factoring
arrangement amounting to approximately $51,000 and $339,000 at March 31, 2004
and 2003.
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 March 31, 2004 and 2003, the amount factored with
recourse and included in trade accounts receivable was approximately $375,000
and $257,000. Outstanding advances as of March 31, 2004 and 2003 amounted to
approximately $164,000 and $185,000 and are included in the line of credit
balance.
As we continue to respond to the current industry trend of large retail
brands to outsource apparel manufacturing to offshore locations, our foreign
customers, though backed by U.S. brands and retailers, are increasing. This
makes receivables based financing with traditional U.S. banks more difficult.
Our current credit facility may not provide the level of financing we may need
to expand into additional foreign markets. As a result, we are continuing to
evaluate non-traditional financing of our foreign assets.
Our trade receivables increased to $21,227,000 at March 31, 2004 from
$20,515,000 at March 31, 2003. This increase was due primarily to increased
non-related party receivables of approximately $3.2 million due to increased
sales to non-related party customers. The increase in non-related party
receivables was offset by a decrease in related party trade receivables of
approximately $2.5 million resulting from decreased sales to related parties
during the period, offset by slower collections.
Our net deferred tax asset increased to $2,800,000 at March 31, 2004
from $91,000 at March 31, 2003. The increase in our net deferred tax asset
results primarily from 2003 losses. At December 31, 2003, we had Federal and
state net operating loss carryforwards of approximately $9.2 million and $5.1
million, respectively, available to offset future taxable income.
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
at least the next twelve months. 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. The extent of our future capital requirements will depend
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. 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
16
operations in the Asian, Central American, South America and Caribbean markets
and the further development of our waistband technology. If our cash from
operations is less than anticipated or our working capital requirements and
capital expenditures are greater than we expect, we may 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. 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.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The following summarizes our contractual obligations at March 31, 2004
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 note payable $ 2,300,000 $ 1,500,000 $ 800,000 $ -- $ --
Capital lease obligations $ 1,070,513 $ 560,402 $ 510,111 $ -- $ --
Subordinated notes payable to
related parties (1) $ 849,971 $ 849,971 $ -- $ -- $ --
Operating leases $ 1,397,627 $ 635,925 $ 761,702 $ -- $ --
Line of credit $ 4,686,461 $ 4,686,461 $ -- $ -- $ --
Note payable $ 25,200 $ 25,200 $ -- $ -- $ --
Royalty Payments $ 369,315 $ -- $ 369,315 $ -- $ --
- -------------------------------------------------------------------------------------------------------
(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.
As of March 31, 2003, we indirectly guaranteed the indebtedness of two
of our suppliers through the issuance by a related party of letters of credit to
purchase goods and equipment totaling $3.3 million. Financing costs due to the
related party amounted to approximately $328,000. The letters of credit expired
on various dates through July 2003. There were no outstanding letters of credit
at March 31, 2004.
At March 31, 2004 and 2003, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, we are not exposed
to any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.
17
RELATED PARTY TRANSACTIONS
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) and TRIMNET 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. 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. In February 2004, Coats converted all
759,494 shares of Series C Preferred Stock, plus $458,707 of accrued dividends,
into 700,144 shares of our common stock.
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. In accordance with the supply agreement, we issued 1,000,000
shares of our common stock to Commerce Investment Group, LLC.
We also have a 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. The exclusive supply agreement with
Tarrant Apparel Group has an indefinite term. Pricing and terms are consistent
with competitive vendors. At the time we entered into this supply agreement, we
also sold 2,390,000 shares of our common stock to KG Investment, LLC, an entity
then owned by Gerard Guez and Todd Kay, executive officers and significant
shareholders of Tarrant Apparel Group.
Sales under our supply agreements with Azteca Production International
and Tarrant Apparel Group, and their affiliates, amounted to approximately 40.2%
and 69.7% of our total sales for the years ended December 2003 and 2002,
respectively, and 6.0% and 51.4% of our total sales for the three months ended
March 31, 2004 and 2003. Sales under these supply agreements as a percentage of
total sales for the year ending December 2004 are anticipated to be
significantly lower than the year ended December 2003. This decrease is due in
part to our efforts to decrease our reliance on these customers and to further
diversify our customer base. Our results of operations will depend, to a lesser
extent than in prior periods, upon the commercial success of Azteca Production
International and Tarrant Apparel Group. If 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 March 31, 2004 and 2003 and December 31, 2003, is
approximately $10.9, $13.4 and $11.7 million due from Tarrant Apparel Group and
Azteca Production International, and their affiliates. As of May 12, 2004,
outstanding receivables due from Tarrant Apparel Group and Azteca Production
International, and their affiliates, amounted to $10.7.
Included in inventories at March 31, 2004 are inventories of
approximately $6.8 million that are subject to buyback arrangements with Tarrant
Apparel Group, Azteca Production International and others. 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 customer's product line related to the inventories, the
customer is required to purchase the inventories from us under normal invoice
and selling terms. During the three months ended March 31, 2004 and 2003, we
sold approximately $100,000 and $700,000 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 or pay receivables, it may have an adverse affect on our
results of operations.
18
As of March 31, 2004 and 2003, we had outstanding related-party debt of
approximately $850,000, at interest rates ranging from 7% to 11%, 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 was unsecured, due on demand, accrued interest at 4% and was
subordinated to UPS Capital. This note was re-paid on February 28, 2003.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 104 (SAB No. 104), "REVENUE RECOGNITION," which
codifies, revises and rescinds certain sections of SAB No. 101, "REVENUE
RECOGNITION," in order to make this interpretive guidance consistent with
current authoritative accounting and auditing guidance and SEC rules and
regulations. The changes noted in SAB No. 104 did not have a material effect on
our consolidated results of operations, consolidated financial position or
consolidated cash flows.
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150, ACCOUNTING FOR CERTAIN
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("FAS 150"),
which establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. FAS 150
requires an issuer to classify a financial instrument that is within its scope,
which may have previously been reported as equity, as a liability. This
Statement is effective at the beginning of the first interim period beginning
after June 15, 2003 for public companies. We adopted this Statement as of July
1, 2003 and it had no material impact on our financial statements.
In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT
133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("FAS No. 149"). FAS No.
149 amends and clarifies the accounting guidance on derivative instruments
(including certain derivative instruments embedded in other contracts) and
hedging activities that fall within the scope of FAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." FAS No. 149 also amends certain
other existing pronouncements, which will result in more consistent reporting of
contracts that are derivatives in their entirety or that contain embedded
derivatives that warrant separate accounting. This Statement is effective for
contracts entered into or modified after June 30, 2003, with certain exceptions,
and for hedging relationships designated after June 30, 2003. We adopted this
Statement as of July 1, 2003 and it had no material impact on our financial
statements.
19
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 LARGER CUSTOMERS OR THEY FAIL TO PURCHASE AT ANTICIPATED
LEVELS, OUR SALES AND OPERATING RESULTS WILL BE ADVERSELY AFFECTED. Our results
of operations will depend to a significant extent upon the commercial success of
our larger customers. If these customers fail to purchase our trim products at
anticipated levels, or our relationship with these customers terminates, it may
have an adverse affect on our results because:
o We will lose a primary source of revenue if these customers
choose not to purchase our products or services;
o We may not be able to reduce fixed costs incurred in
developing the relationship with these customers 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 LARGER CUSTOMERS MAKES RECEIVABLE
BASED FINANCING DIFFICULT AND INCREASES THE RISK THAT IF OUR LARGER CUSTOMERS
FAIL TO PAY US, OUR CASH FLOW WOULD BE SEVERELY AFFECTED. Our business relies
heavily on a relatively small number of customers. This concentration of our
business reduces the amount we can borrow from our lenders under receivables
based financing agreements. Under our credit agreement with UPS Capital, for
instance, if accounts receivable due us from a particular customer exceed a
specified percentage of the total eligible accounts receivable against which we
can borrower, UPS Capital will not lend against the receivables that exceed the
specified percentage. If we are unable to collect any large receivables due us,
our cash flow would be severely impacted.
OUR GROWTH AND OPERATING RESULTS COULD BE MATERIALLY, ADVERSELY
EFFECTED IF WE ARE UNSUCCESSFUL IN RESOLVING A DISPUTE THAT NOW EXISTS REGARDING
OUR RIGHTS UNDER OUR EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY AGREEMENT
("AGREEMENT") WITH PRO-FIT HOLDINGS. Pursuant to our Agreement with Pro-Fit
Holdings Limited, we have exclusive rights in certain geographic areas to
Pro-Fit's stretch and rigid waistband technology. By letter dated April 6, 2004,
Pro-Fit alleged various breaches of the Agreement which we dispute. To prevent
Pro-Fit in the future from terminating the Agreement based on alleged breaches
that we do not regard as meritorious, we filed a lawsuit against Pro-Fit in the
U.S. District Court for the Central District of California, based on various
contractual and tort claims seeking declaratory relief, injunctive relief and
damages. Representatives of Pro-Fit and our representatives have met to resolve
the dispute. We and Pro-Fit have mutually expressed general terms to be
incorporated into an amendment to the Agreement to resolve the dispute. On April
30, 2004 we signed a letter agreement with Pro-Fit continuing discussions to
resolve the dispute assuring that no party takes any act to disturb the status
quo and the existence and enforceability of the Agreement while discussions were
ongoing to conclude an amendment to the Agreement. The parties have agreed in
writing to conclude and execute an agreement during the month of May 2004. We
intend to proceed with the lawsuit if these negotiations are not concluded in a
manner satisfactory to us.
20
We derive a significant amount of revenues from the sale of products
incorporating the stretch waistband technology. Our business, results of
operations and financial condition could be materially adversely affected if we
are unable to conclude our present negotiations in a manner acceptable to us and
ensuing litigation is not resolved in a manner favorable to us.
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 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.
OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS 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.
BECAUSE WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS, WE MAY NOT BE ABLE
TO ALWAYS OBTAIN MATERIALS WHEN WE NEED THEM AND WE MAY LOSE SALES AND
CUSTOMERS. Lead times for materials we order can vary significantly and depend
on many factors, including the specific supplier, the contract terms and the
demand for particular materials at a given time. From time to time, we may
experience fluctuations in the prices, and disruptions in the supply, of
materials. Shortages or disruptions in the supply of materials, or our inability
to procure materials from alternate sources at acceptable prices in a timely
manner, could lead us to miss deadlines for orders and lose sales and customers.
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.
21
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.
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 Hong Kong, Mexico and Caribbean
facilities with the information systems of our principal offices in California.
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.
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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.
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.
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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.
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 March 1, 2004, our officers and directors and their affiliates beneficially
owned approximately 19.1% 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 21.2% of the
outstanding shares of our common stock at March 1, 2004. 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 3.3% of the outstanding shares of common stock at March 1, 2004.
Gerard Guez and Todd Kay, significant stockholders of Tarrant Apparel Group, own
approximately 5.6% of the outstanding shares of our common stock at March 1,
2004. As a result, our officers and directors, the Dyne family, Gerard Guez and
Todd Kay 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
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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.
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. We are exposed to
market risk for fluctuations in the foreign currency exchange rates for certain
product purchases that are denominated in British Pounds. At March 31, 2004, we
purchased forward exchange contracts for British Pounds to hedge the payments of
product purchases through June 30, 2004. These contracts have an aggregate
notional amount of $565,000. The market value of these contracts approximated
their carrying value at March 31, 2004. The Company intends to purchase
additional contracts to hedge the British Pound exposure for future product
purchases. Currency fluctuations can 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 March 31 2004, we had approximately $7.8 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.
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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.
Members of the Company's management, including the Company's Chief
Executive Officer, Colin Dyne, and Chief Financial Officer, Ronda Ferguson, have
evaluated the effectiveness of the design and operation of the Company's
disclosure controls and procedures as of March 31, 2004, the end of the period
covered by this report. Based upon that evaluation, Mr. Dyne and Ms. Ferguson
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 INTERNAL CONTROLS OVER FINANCIAL REPORTING
There were no significant changes in the Company's internal controls
over financial reporting or in other factors that could significantly affect
these internal controls over financial reporting after the date of our most
recent evaluation.
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 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES.
On December 18, 2003, we sold an aggregate of 572,818 shares of
non-voting Series D Convertible Preferred Stock, at a price of $44.00 per share,
to institutional investors and individual accredited investors in a private
placement transaction. We received net proceeds of $23,083,693 after commissions
and other offering expenses. Each share of Series D Convertible Preferred Stock
was automatically converted into 10 shares of common stock, for an aggregate of
5,728,180 shares of common stock, following approval of the conversion by our
stockholders at a special meeting held on February 11, 2004. We have registered
the common shares issued upon conversion of the Series D Convertible Preferred
Stock with the Securities and Exchange Commission for resale by the investors.
In conjunction with the private placement transaction, we issued 572,818
warrants to the placement agent. The warrants are exercisable beginning June 18,
2004 through December 18, 2008 and have a per share exercise price of $4.74.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At Special Meeting of Stockholders held on February 11, 2004, our
stockholders approved the issuance of 5,728,180 shares of common stock issuable
upon conversion of the outstanding shares of Series D Preferred Stock. At the
special meeting, 8,797,569 shares were voted in favor of, 88,450 shares were
voted against, and 200 shares abstained from voting on the approval of the
issuance of 5,728,180 shares of common stock issuable upon conversion of the
outstanding shares of Series D Preferred Stock. There were no broker non-votes
at the special meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
31.1 Certificate of Chief Executive Officer pursuant to
Rule 13a-14(a) under the Securities and Exchange Act
of 1934, as amended
31.2 Certificate of Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities and Exchange Act
of 1934, as amended
32.1 Certificate of Chief Executive Officer and Chief
Financial Officer pursuant to Rule 13a-14(b) under
the Securities and Exchange Act of 1934, as amended.
(b) Reports on Form 8-K:
Current Report on Form 8-K dated February 11, 2004, reporting
Item 5, as filed on February 13, 2004.
Current Report on Form 8-K dated March 30, 2004, reporting
Items 7 and 12, as filed on March 30, 2004.
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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.
Dated: May 17, 2004 TAG-IT PACIFIC, INC.
` /S/ RONDA FERGUSON
---------------------------------------
By: Ronda Ferguson
Its: Chief Financial Officer
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