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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of The Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2004
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number 1-13669
TAG-IT PACIFIC, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 95-4654481
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
21900 BURBANK BLVD., SUITE 270
WOODLAND HILLS, CALIFORNIA 91367
(Address of Principal Executive Offices) (Zip Code)
(818) 444-4100
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -------------------
COMMON STOCK, $.001 PAR VALUE AMERICAN STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2) Yes [_] No [X]
At June 30, 2004 the aggregate market value of the voting and
non-voting common stock held by non-affiliates of the registrant was
$65,632,028. At March 31, 2005 the issuer had 18,241,045 shares of Common Stock,
$.001 par value, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the issuer's proxy statement with respect to its 2005
annual meeting of stockholders are incorporated by reference into Part III of
this report.
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TAG-IT PACIFIC, INC.
INDEX TO FORM 10-K
PART I PAGE
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 7
Item 3. Legal Proceedings........................................... 7
Item 4. Submission of Matters to a Vote of Security Holders......... 8
PART II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securities........................................ 9
Item 6. Selected Financial Data..................................... 10
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 11
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk ............................................. 28
Item 8. Financial Statements and Supplementary Data:
Report of Independent Registered Public Accounting Firm..... 30
Consolidated Balance Sheets................................. 31
Consolidated Statements of Operations....................... 32
Consolidated Statements of Stockholders' Equity and
Convertible Redeemable Preferred Stock...................... 33
Consolidated Statements of Cash Flows....................... 34
Notes to Consolidated Financial Statements.................. 35
Independent Registered Public Accounting Firm's Report
on Schedule II........................................... 62
Schedule II - Valuation and Qualifying Accounts
and Reserves............................................. 63
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...................... 64
Item 9A. Controls and Procedures..................................... 64
Item 9B. Other Information........................................... 64
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 65
Item 11. Executive Compensation...................................... 65
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Shareholder Matters............... 65
Item 13. Certain Relationships and Related Transactions.............. 65
Item 14. Principal Accounting Fees and Services...................... 65
PART IV
Item 15. Exhibits and Financial Statement Schedules.................. 65
PART I
This Annual Report on Form 10-K contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. We use words
such as "believes", "intends", "expects", "anticipates", "plans", "may", "will"
and similar expressions to identify forward-looking statements. Discussions
containing forward-looking statements may be found in the material set forth
under "Business," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and in other sections of the report. All
forward-looking statements, including, but not limited to, projections or
estimates concerning our business, including demand for our products and
services, mix of revenue streams, ability to control and/or reduce operating
expenses, anticipated gross margins and operating results, cost savings, product
development efforts, general outlook of our business and industry, international
businesses, competitive position, adequate liquidity to fund our operations and
meet our other cash requirements, are inherently uncertain as they are based on
our expectations and assumptions concerning future events. These forward-looking
statements are subject to numerous known and unknown risks and uncertainties.
You should not place undue reliance on these forward-looking statements. Our
actual results could differ materially from those anticipated in the
forward-looking statements for many reasons, including the success of our
product offerings, our ability to expand our customer base, and all other risks
described below in the section entitled "Cautionary Statements and Risk Factors"
appearing in "Management's Discussion and Analysis of Financial Condition and
Risk of Operations" and elsewhere in this report. All forward-looking statements
in this document are made as of the date hereof, based on information available
to us as of the date hereof, and we assume no obligation to update any
forward-looking statement.
ITEM 1. BUSINESS
GENERAL
Tag-It Pacific, Inc. is an apparel company that specializes in the
distribution of a full range 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 of fashion apparel such as
Abercrombie & Fitch, Kellwood and Azteca Production International. We also serve
as a specified supplier of trim items to owners of specific brands, brand
licensees and retailers, including Levi Strauss & Co., Express, The Limited,
Lerner, Motherworks and Miller's Outpost, among others. In addition, we
manufacture and distribute zippers under our TALON brand name to manufacturers
for apparel brands and retailers such as Levi Strauss & Co., Wal-Mart and JC
Penny, among others. In 2002, we created a new division under the TEKFIT brand
name. This division develops and sells apparel components that utilize the
patented Pro-Fit technology, including a stretch waistband.
We were incorporated in Delaware in September 1997. We were formed to
serve as the parent holding company of Tag-It, Inc., a California corporation,
Tag-It Printing & Packaging Ltd., which changed its name in 1999 to Tag-It
Pacific (HK) LTD, a BVI corporation, Tagit de Mexico, S.A. de C.V., A.G.S.
Stationery, Inc., a California corporation, and Pacific Trim & Belt, Inc., a
California corporation. All of these companies were consolidated under a parent
limited liability company in October 1997. These companies became our wholly
owned subsidiaries immediately prior to the effective date of our initial public
offering in January 1998. In 2000, we formed two wholly owned subsidiaries of
Tag-It Pacific, Inc: Tag-It Pacific Limited, a Hong Kong corporation, and Talon
International, Inc., a Delaware corporation. Our website is
www.tagitpacific.com.
BUSINESS SUMMARY
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
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thread, zippers, stretch waistbands, 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, 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 manufacturer 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 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
also helps to eliminate a manufacturer's need to maintain a trim purchasing and
logistics department.
We manufacture and distribute zippers under our TALON trademark and
trade names to apparel brands and manufacturers. TALON enjoys tremendous brand
recognition and brand equity in the apparel industry worldwide. TALON is a
100-year-old brand, which is well known for quality and product innovation.
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. We have introduced a completely revised high quality line of
zippers, broadened distribution to Asia, Mexico and Central America and
initiated a new sales and marketing effort for this brand. We have also
developed, and are now implementing, what we refer to as our TALON franchise
strategy, whereby we appoint suitable distributors in various geographic
international regions to finish and sell zippers under the TALON brand name. Our
distributors purchase and install locally equipment for dying and producing
finished zippers. We expect this program to dramatically expand the geographic
footprint of our TALON division. To date, we have entered into six distribution
agreements for the sale of TALON zippers. TALON is promoted both within our trim
packages, as well as a stand-alone product line.
We also serve as a specified supplier for a variety of major retail
brand and private label oriented companies. A specified supplier is a supplier
that has been approved for quality and service by a major retail brand or
private label company. Contractors manufacturing for the major retail brand or
private label company must purchase their trim requirements from a supplier that
has been specified. 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. Becoming a specified supplier to
brand customers gives us an opportunity to become the preferred or sole vendor
of trim items for all manufacturers of apparel under that brand name.
Our team of sales representatives, program managers, creative design
personnel and global production and distribution coordinators at our facilities
located in the United States, Mexico, Hong Kong and the Caribbean enable us to
take advantage of and address the increasingly complicated requirements of the
large and expanding demand for complete trim packages. We plan to continue to
expand operations in Asia, Central and South America and the Caribbean to take
advantage of the large apparel manufacturing markets in these regions.
A significant portion of a typical trim package is comprised of zippers
and thread. In order to secure a stable high-quality source of supply for thread
products, we entered into a supply and co-marketing agreement with Coats
America, an affiliate of Coats, plc, which is a leading thread company in the
apparel
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industry and operates in more than 65 countries worldwide. The supply and
co-marketing agreement was accompanied by an equity investment by Coats North
America Consolidated, Inc., also an affiliate of Coats, plc, in the amount of $3
million.
PRODUCTS
COMPLETE TRIM PACKAGES. We market and supply our customers with
complete trim packages on a per-garment basis which we assemble on behalf of our
customers. Each trim package includes all items of trim that a customer will
need in the manufacture of a particular item of apparel. Our complete trim
packages include a variety of trim items including thread, zippers, labels,
buttons, rivets, polybags, packing cartons and hangers. We also provide in our
complete trim packages printed marketing materials including hang tags,
bar-coded hang tags, pocket flashers, waistband tickets and size stickers that
are attached to products to identify and promote the products, permit automated
data collection, provide brand identification and communicate consumer
information such as a product's retail price, size, fabric content and care
instructions.
We consider a high level of customer service essential to our success.
We combine our high level of customer service with our MANAGED TRIM SOLUTION to
offer our customers a complete trim service product. We believe this
full-service product gives us a competitive edge over companies that only offer
selected trim components because our MANAGED TRIM SOLUTION saves our customers
time and employee work hours in ordering and managing trim orders from several
different suppliers. Our MANAGED TRIM SOLUTION is a business-to-business
e-commerce system that allows us to provide our customers with a customized,
comprehensive system for the management of various aspects of their trim
programs. Our MANAGED TRIM SOLUTION is an Internet-based supply-chain management
system which provides customers with assistance in their ordering, production,
inventory management and just-in-time distribution of their trim and packaging
requirements.
The launch of TRIMNET, our Oracle based e-sourcing system has allowed
us to seamlessly supply complete trim packages to apparel brands, retailers and
manufacturers around the world, 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 allows us to provide
additional services to customers on a global platform.
SEPARATE TRIM COMPONENTS. Separate from our marketing of complete trim
packages, we also provide individual items of trim to certain of our customers
who only need to source a portion of their trim requirements from us. Further,
for selected customers, we also produce customized woven, leather, synthetic,
embroidered and novelty labels and tapes, which can be printed on or woven into
a wide range of fabrics and other materials using various types of high-speed
equipment. As an additional service, we lease to our customers the machinery
used to attach the buttons, rivets and snaps we distribute.
TALON BRAND ZIPPERS. We offer a full line of metal and synthetic
zippers bearing the TALON brand name. TALON zippers are used primarily by
manufacturers in the apparel industry and are distributed through our
distribution facilities in the United States, Mexico and Hong Kong and through
distributors, who we refer to as franchisees, in other international markets. We
have negotiated with distributors that service local markets in Asia and Africa
and have signed six franchise agreements to date. We are continuing to negotiate
with distributors that service local apparel manufacturing regions in the United
States and overseas. We offer manufacturers technologically advanced equipment
for efficiently handling TALON zippers and applying them into garments. The
branded apparel zipper market is dominated by one company; YKK (R). We are
positioning TALON to be a viable alternative to YKK (R), and to capture an
increased market share position. We also plan to leverage the brand equity in
the TALON name by branding other products in our line with the TALON name.
TEKFIT. We distribute a proprietary stretch waistband under our
Exclusive License and Intellectual Property Rights agreement with Pro-Fit
Holdings Limited. The agreement gives us the exclusive rights to sell or
sublicense stretch waistbands manufactured under the patented technology
developed by Pro-Fit for
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garments manufactured anywhere in the world for the U.S. market and all U.S.
brands, for the life of the patent and related know-how. We now offer apparel
manufacturers advanced, patented fabric technologies to utilize in their
garments under the TEKFIT name. This revolutionary technology allows fabrics to
be altered through the addition of stretch characteristics resulting in greatly
improved fit and comfort. Currently, we are supplying Levi Strauss & Co. with
TEKFIT waistbands for their Dockers(R) programs. Our exclusive supply
arrangement with Levi Strauss & Co. is for twill type pants only. This new
technology allows pant manufacturers to build in a stretch factor into standard
waistbands that does not alter the appearance of the garment, but will allow the
waist to stretch out and back by as much as two waist sizes.
We are presently in litigation with Pro-Fit relating to our rights
under the agreement, as described more fully elsewhere in this report. As we
derive a significant amount of revenue from the sale of products incorporating
the stretch waistband technology, our business, results of operations and
financial condition could be materially adversely affected if our dispute with
Pro-Fit is not resolved in a manner favorable to us.
DESIGN AND DEVELOPMENT
Our in-house creative team produces products with innovative technology
and designs that we believe distinguish our products from those of our
competitors. We support our skills and expertise in material procurement and
product-manufacturing coordination with product technology and designs intended
to meet fashion demands, as well as functional and cost parameters. Many
specialty design companies with which we compete have limited sourcing or
manufacturing experience. These companies create designs that often cannot be
implemented due to difficulties in the manufacturing process, the expenses of
required materials, or a lack of functionality in the resulting product. We
attempt to design products to function within the limitations imposed by the
applicable manufacturing framework. Using our manufacturing and sourcing
experience, we attempt to minimize the time-consuming delays that often arise in
coordinating the efforts of independent design houses and manufacturing
facilities. By supporting our material procurement and product manufacturing
services with design services, we believe that we reduce development and
production costs and deliver products to our customers sooner than many of our
competitors. Our development costs are low, most of which are borne by our
customers. Our design teams are based out of our California and Hong Kong
facilities.
CUSTOMERS
We have more than 300 active customers. Our customers include
well-known apparel manufacturers, such as Levi Strauss & Co., The Limited Group,
Motherworks, Kellwood, Azteca Production International and VF Corporation, among
others. Our customers also include contractors for specialty retailers such as
Miller's Outpost and mass merchant retailers such as Wal-Mart.
In July 2002, we entered into an exclusive supply contract with Levi
Strauss & Co. Under the terms of the supply agreement, Levi Strauss & Co. agreed
to purchase a minimum of $10 million of TEKFIT stretch waistbands, various other
trim products, garment components and services over the two-year term of the
agreement. On July 16, 2004, we amended our exclusive supply agreement with Levi
Strauss & Co. to provide for an additional two-year term through November 2006.
Levi Strauss & Co. also appointed TALON as an approved zipper supplier.
Two major customers accounted for approximately 21.9% of our net sales
on a consolidated basis for the year ended December 31, 2004. Three major
customers, two of which were related parties, accounted for approximately 64.1%
of our net sales on a consolidated basis for the year ended December 31, 2003.
Two major customers, both related parties, accounted for approximately 69.7% of
our net sales on a consolidated basis for the year ended December 31, 2002. Our
results of operations will depend to an extent upon the commercial success of
these customers. If these customers fail to purchase trim products at
anticipated levels, or the relationship terminates, it may have an adverse
affect on our results of operations.
4
If the financial condition of these customers were to deteriorate, resulting in
an impairment of their ability to purchase inventories or repay receivables, it
may also have an adverse affect on our results of operations.
SALES AND MARKETING
We sell our principal products through our own sales force based in Los
Angeles, various other cities in the United States, Hong Kong and Mexico. We
also employ customer service representatives who are assigned to key customers
and provide in-house customer service support. Our senior executives have
developed relationships with our major customers at senior levels. These
executives actively participate in marketing and sales functions and the
development of our overall marketing and sales strategies. When we become the
outsourcing vendor for a customer's packaging or trim requirements, we position
ourselves as if we are an in-house department of the customer's trim procurement
operation.
SOURCING AND ASSEMBLY
We have developed expertise in identifying high quality materials,
competitive prices and approved vendors for particular products and raw
materials. This expertise enables us to produce a broad range of packaging and
trim products at various price points. The majority of products that we procure
and distribute are purchased on a finished good basis. Raw materials, including
paper products and metals used to manufacture zippers, used in the assembly of
our trim kits are available from numerous sources and are in adequate supply. We
purchase products from several qualified material suppliers, including Coats
North America and its affiliates which accounted for 11.4% of our purchases in
2004.
We are able to create most product artwork and any necessary films,
dies and molds used to design and manufacture our products. All other products
that we design and sell are produced by third party vendors. We are confident in
our ability to secure high quality alternative manufacturing sources. We intend
to continue to outsource production to qualified vendors, particularly with
respect to manufacturing activities that require substantial investment in
capital equipment.
Through our Hong Kong facility, we distribute TALON zippers, trim items
and apparel packaging and coordinate the manufacture and distribution of the
full range of our products. Our Hong Kong facility supplies several significant
packaging programs, services customers located in Asia and the Pacific Rim and
sources products for our Los Angeles and Mexico based operations.
During 2004, we set up a TALON manufacturing facility in Kings
Mountain, North Carolina. This facility manufactures TALON zippers for use in
the Western Hemisphere and will reduce our reliance on our major zipper
supplier. The facility began production in January 2005.
INTELLECTUAL PROPERTY RIGHTS AND LICENSES
We have trademarks as well as copyrights, software copyrights and trade
names for which we rely on common law protection, including the TALON trademark.
Several of our other trademarks are the subject of applications for federal
trademark protection through registration with the United States Patent and
Trademark Office, including "Tag-It", "Managed Trim Solution" and "TekFit". We
also rely on our Exclusive License and Intellectual Property Rights agreement
with Pro-Fit Holdings Limited to sell our TEKFIT Stretch waistbands. The
agreement gives us the exclusive rights to sell or sublicense stretch waistbands
manufactured under the patented technology developed by Pro-Fit for garments
manufactured anywhere in the world for the U.S. market and all U.S. brands, for
an indefinite term that extends for the duration of the patent and trade secrets
licensed under the agreement.
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SEASONALITY
We typically experience 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. The apparel industry typically experiences higher
sales volume in the second quarter in preparation for back-to-school purchases,
and the third quarter in preparation for year-end holiday purchases.
INVENTORIES
In order to meet the rapid delivery requirements of our TRIMNET
customers, we may be required to carry a substantial amount of inventory on
their behalf. Included in inventories at December 31, 2004 are inventories that
are subject to buyback arrangements with some of these customers. 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, as provided by the buyback agreements, to purchase the
inventories from us under normal invoice and selling terms.
COMPETITION
We compete in highly competitive and fragmented industries that include
numerous local and regional companies that provide some or all of the products
we offer. We also compete with United States and international design companies,
distributors and manufacturers of tags, trim, packaging products and zippers.
Some of our competitors, including Paxar Corporation, YKK (R), Universal Button,
Inc., Avery Denison Corporation and Scovill Fasteners, Inc. have greater name
recognition, longer operating histories and, in many cases, substantially
greater financial and other resources.
Because of our integrated materials procurement and assembly
capabilities and our full service MANAGED TRIM SOLUTION, we believe that we are
able to effectively compete for our customers' business, particularly where our
customers require coordination of separately sourced production functions. We
believe that to successfully compete in our industry we must offer superior
product pricing, quality, customer service, design capabilities, delivery lead
times and complete supply-chain management. We also believe the TALON brand name
and the quality of our TALON brand zippers will allow us to gain market share in
the zipper industry. The unique stretch quality of our TEKFIT waistbands will
also allow us to compete effectively in the market for waistband components.
SEGMENT INFORMATION
We operate primarily in one industry segment, the distribution of a
full range of apparel trim products to manufacturers of fashion apparel,
specialty retailers and mass merchandisers. For information regarding the
revenues and assets associated with our geographic segments, see Note 18 of the
Notes to the Consolidated Financial Statements included in Item 8 of this
Report.
INTERNATIONAL
We sell the majority of our products to U.S. based brands, retailers
and manufacturers. The majority of these customers produce their products or
contract out the production of their products in manufacturing facilities
located outside of the U.S., primarily in Mexico, Asia, the Dominican Republic
and Central and South America.
A summary of our domestic and international net revenue and long-lived
assets is set forth in Note 18 of the Notes to the Consolidated Financial
Statements in Item 8 of this Report. Approximately 91% of
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our overall net revenue came from sales to U.S. based or contract manufacturers'
facilities located outside of the United States during the year ended December
31, 2004.
For a discussion of risks attendant to our foreign operations, see "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.", under Cautionary
Statements and Risk Factors in Item 7 of this Report, "Quantitative and
Qualitative Disclosure about Market Risk" in Item 7A of this Report and Note 18
of the Notes to the Consolidated Financial Statements in Item 8.
EMPLOYEES
As of December 31, 2004, we had approximately 206 full-time employees,
with approximately 43 employees in Los Angeles, 10 employees in North Carolina,
8 employees in various other cities, 60 employees in Asia, 7 employees in the
Dominican Republic, and 78 employees in Mexico and Central America. Our labor
forces in the United States and Hong Kong are non-union. The employees at our
Mexico facility are represented by a collective bargaining unit, the Federacion
De Trabajadores Del Estado de Tlaxcala. We believe that we have satisfactory
employee and labor relations.
ITEM 2. PROPERTIES
Our headquarters is located in Woodland Hills, California, where we
lease approximately 8,800 square feet of administrative and product development
space. In addition to our Woodland Hills facility, we lease 2,500 square feet of
warehouse space in Gardena, California, 2,175 square feet of office space in
Goleta, California, 675 square feet of office space in Columbus, Ohio, 54,000
square feet of warehouse space in Gastonia, North Carolina, 5,400 square feet of
office and warehouse space in Kwun Tong, Hong Kong, 4,100 square feet of
warehouse space in Santiago, Dominican Republic, and 22,000 square feet of
warehouse, distribution and administration space in Tlaxcala, Mexico. The lease
agreements related to these properties expire at various dates through October
2006. We also own a building with 41,650 square feet of manufacturing and
warehouse space in Kings Mountain, North Carolina.
ITEM 3. LEGAL PROCEEDINGS
We have filed suit against Pro-Fit Holdings Limited in the U.S.
District Court for the Central District of California -- TAG-IT PACIFIC, INC. V.
PRO-FIT HOLDINGS LIMITED, CV 04-2694 LGB (RCx) - based on various contractual
and tort claims relating to our exclusive license and intellectual property
agreement, seeking declaratory relief, injunctive relief and damages. Our
agreement with Pro-Fit gives us exclusive rights in certain geographic areas to
Pro-Fit's stretch and rigid waistband technology. Pro-Fit filed an answer
denying the material allegations of the complaint and filed a counterclaim
alleging various contractual and tort claims seeking injunctive relief and
damages. We filed a reply denying the material allegations of Pro-Fit's
pleading. Pro-Fit has since purported to terminate our exclusive license and
intellectual property agreement based on the same alleged breaches of the
agreement that are the subject of our existing litigation, as well as on an
additional basis unsupported by fact. In February 2005, we amended our pleadings
in the litigation to assert additional breaches by Pro-Fit of its obligations to
us under our agreement and under certain additional letter agreements, and for a
declaratory judgment that Pro-Fit's patent No. 5,987,721 is invalid and not
infringed by us. Discovery in this case has commenced. There have been ongoing
negotiations with Pro-Fit to attempt to resolve these disputes. We intend to
proceed with the lawsuit if these negotiations are not concluded in a manner
satisfactory to us. As we derive a significant amount of revenue from the sale
of products incorporating the stretch waistband technology, our business,
results of operations and financial condition could be materially adversely
affected if our dispute with Pro-Fit is not resolved in a manner favorable to
us.
We currently have pending a number of other claims, suits and
complaints that arise in the ordinary course of our business. We believe that we
have meritorious defenses to these claims and that the claims are
7
either 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 2004.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
COMMON STOCK
Tag-It Pacific's Common Stock is traded on the American Stock Exchange
under the symbol "TAG." The following table sets forth, for the periods
indicated, the high and low sales prices for the Common Stock as reported by the
American Stock Exchange.
HIGH LOW
------- --------
YEAR ENDED DECEMBER 31, 2004
First Quarter......................... $ 6.14 $ 4.30
Second Quarter........................ 5.99 4.20
Third Quarter......................... 4.35 3.09
Fourth Quarter........................ 4.58 2.81
YEAR ENDED DECEMBER 31, 2003
First Quarter......................... $ 3.79 $ 3.50
Second Quarter........................ 5.80 3.50
Third Quarter......................... 6.20 4.15
Fourth Quarter........................ 5.25 4.39
On March 30, 2005, the closing sales price of our Common Stock as
reported on the American Stock Exchange was $5.04 per share. As of March 30,
2005, there were 33 record holders of our Common Stock.
DIVIDENDS
We have never paid dividends on our Common Stock. We intend to retain
any future earnings for use in our business.
9
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data should be read in conjunction
with our consolidated financial statements. The information set forth below is
not necessarily indicative of results of future operations, and should be read
in conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and notes thereto included in Item 8, "Financial Statements and Supplementary
Data" of this Form 10-K in order to understand fully factors that may affect the
comparability of the financial data presented below.
TAG-IT PACIFIC, INC. AND SUBSIDIARIES
SELECTED FINANCIAL DATA
FISCAL YEARS ENDED DECEMBER 31,
(in thousands except per share information)
2000 2001(1) 2002 2003(2) 2004(2,3)
-------- -------- -------- -------- --------
OPERATIONS:
Total revenue ..................................... $ 49,362 $ 43,568 $ 60,073 $ 64,443 $ 55,109
Income (loss) from operations ..................... $ 2,547 $ (253) $ 3,044 $ (5,881) $(14,527)
Net income (loss) ................................. $ 1,539 $ (1,226) $ 1,496 $ (4,745) $(17,609)
Net income (loss) per share - basic ............... $ 0.23 $ (0.16) $ 0.14 $ (0.46) $ (1.02)
Net income (loss) per share - diluted ............. $ 0.21 $ (0.16) $ 0.14 $ (0.46) $ (1.02)
Weighted average shares outstanding - basic ....... 6,838 8,017 9,232 10,651 17,316
Weighted average shares outstanding - diluted ..... 7,283 8,017 9,531 10,651 17,316
FINANCIAL POSITION (AT PERIOD END):
Cash and cash equivalents ......................... $ 128 $ 47 $ 285 $ 14,443 $ 5,461
Total assets ...................................... $ 39,099 $ 40,794 $ 54,055 $ 67,770 $ 56,448
Capital lease obligations, line of credit and notes
payable ........................................... $ 13,828 $ 15,685 $ 21,263 $ 11,759 $ 18,792
Convertible redeemable preferred stock ............ $ -- $ 2,895 $ 2,895 $ 2,895 $ --
Stockholders' equity .............................. $ 14,791 $ 15,428 $ 18,467 $ 43,564 $ 30,195
Total liabilities and stockholders' equity ........ $ 39,099 $ 40,794 $ 54,055 $ 67,770 $ 56,448
PER SHARE DATA (AT END OF PERIOD):
Net book value per common share ................... $ 1.88 $ 1.76 $ 1.98 $ 3.79 $ 1.66
Common shares outstanding ......................... 7,863 8,770 9,320 11,508 18,171
- ----------
(1) We incurred restructuring charges of $1.6 million during the year ended
December 31, 2001.
(2) We incurred restructuring charges of $7.7 million during the year ended
December 31, 2003 and $414,675 during the year ended December 31, 2004.
See Note 22 of the Notes to the Consolidated Financial Statements
included in Item 8 of this Report.
(3) We incurred net charges of $4.3 million from the write-off of
obligations, primarily accounts receivable and inventories, due from a
former major customer (see Note 21 of the Notes to the Consolidated
Financial Statements included in Item 8 of this Report) and other
fourth quarter adjustments totaling $9.5 million during the year ended
December 31, 2004.
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
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 fiscal years ended December 31, 2004, 2003 and
2002. 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-K. 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 manufacturer and
distributor of zippers under our TALON brand name and a distributor of stretch
waistbands that utilize licensed patented technology under our TEKFIT brand
name.
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 has allowed
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 has allowed us
to provide additional services to customers on a global platform.
On November 10, 2004, we refinanced our working capital credit facility
with UPS Capital Global Trade Finance Corporation with a portion of the proceeds
received from a private placement of $12.5 million
11
Secured Convertible Notes Payable. See further discussion under the LIQUIDITY
AND CAPITAL RESOURCES section of this document.
We have developed, and are now implementing, what we refer to as our
TALON franchise strategy, whereby we appoint suitable distributors in various
geographic international regions to finish and sell zippers under the TALON
brand name. Our designated franchisees purchase and install locally equipment
for dying and producing finished zippers, thus minimizing our capital outlay.
The franchisee will then purchase from us large zipper rolls with other
materials such as sliders and produce finished zippers locally, according to
their customers' specifications, in markets around the world, becoming in
essence a local marketer and distributor of the TALON brand. This strategy is
expected to expand the geographic footprint of our TALON division.
We have entered into six franchise agreements for the sale of TALON
zippers. The agreements provide for minimum purchases of TALON zipper products
to be received over the term of the agreements as follows:
Agreement
Region Date Term
- ---------------------- ----------------- ---------
Central Asia October 21, 2004 42 Months
South East Asia November 10, 2004 42 Months
Southern Hemisphere December 21, 2004 66 Months
Asia December 28, 2004 42 Months
South East Asia January 7, 2005 42 Months
Middle East and Africa February 19, 2005 42 Months
During 2004, we set up a TALON manufacturing facility in Kings
Mountain, North Carolina. This facility manufactures TALON zippers for use in
the Western Hemisphere and will reduce our reliance on our current major zipper
supplier. The facility began production in January 2005.
On July 16, 2004, we amended our exclusive supply agreement with Levi
Strauss & Co. to provide for an additional two-year term through November 2006.
In accordance with the supply agreement, Levi is to purchase TEKFIT waistbands
for specific product categories over the term of the agreement. Certain
proprietary products, equipment and technological know-how will be supplied to
Levi on an exclusive basis for specific product categories during the extended
period.
As described more fully elsewhere in this report, we are presently in
litigation with Pro-Fit Holdings Limited relating to our exclusively licensed
rights to sell or sublicense stretch waistbands manufactured under Pro-Fit's
patented technology. We supply Levi with waistbands in reliance on our agreement
with Pro-Fit. As we derive a significant amount of revenue from the sale of
products incorporating the stretch waistband technology, our business, results
of operations and financial condition could be materially adversely affected if
our dispute with Pro-Fit is not resolved in a manner favorable to us.
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.
12
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, if lower, and
charged to operations in the period in which the facts that
give rise to the adjustments become known. A 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. See further discussion of inventory write-downs
recorded in the fourth quarter of 2004 below.
o Accounts receivable balances are evaluated on a continual
basis and allowances are provided for potentially
uncollectible accounts based on management's estimate of the
collectibility 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. See further discussion of
accounts receivable reserves recorded during the fourth
quarter of 2004 below.
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
assessing the need for a valuation allowance. If we determine
that we may not realize all or part of our deferred tax assets
in the future, we will 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.
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.
2004 WRITE-OFF OF ACCOUNTS RECEIVABLE AND INVENTORIES FROM A FORMER MAJOR
CUSTOMER
Following negotiations with United Apparel Ventures and its affiliate,
Tarrant Apparel Group, a former major customer of ours, we determined that a
significant portion of the obligations due from this
13
customer, primarily related to accounts receivable and inventories, was
uncollectable. As a result, we wrote-off a net of $4.3 million of obligations
due from this customer, with a remaining receivable balance due from UAV of $4.5
million. Included in general and administrative expenses for the year ended
December 31, 2004 are $4,289,436 of expenses related to the write-off of
obligations due from UAV and Tarrant. UAV agreed to pay the $4.5 million
receivable balance over a nine-month period beginning May 2005. We do not
anticipate any further charges as a result of this write-off.
2004 ALLOWANCE FOR DOUBTFUL ACCOUNTS
Our allowance for doubtful accounts as of December 31, 2004 includes a
reserve of $5.0 million recorded in the fourth quarter of 2004 based on
management's estimate of the collectability of accounts receivable primarily
related to two customers.
2004 RESERVE FOR INVENTORY OBSOLESCENCE
In the fourth quarter of 2004, we recorded inventory write-downs
totaling $2.7 million based on management's estimate of the net realizable value
of certain inventories.
2004 NET DEFERRED TAX ASSET
In 2004, we incurred additional net operating losses and, as a result,
increased our valuation allowance to $8.9 million from $1.1 million, which
reduced the carrying value of our net deferred tax asset to $1.0 million from
$2.8 million at December 31, 2003. The decrease in the net deferred tax asset
resulted in a charge of $1.8 million against the provision for income taxes in
the fourth quarter of 2004.
2003 RESTRUCTURING PLAN
During the fourth quarter of 2003, we implemented a plan to restructure
certain business operations. In accordance with the restructuring plan, we
incurred costs related to the reduction of our Mexico operations, including the
relocation of our Florida operations to North Carolina and the downsizing of our
corporate operations by eliminating certain corporate expenses related to
operations, sales and marketing and general and administrative expenses. The
reduction of our operations in Mexico was in response to the following:
o An anticipated reduction in sales volume from our larger
Mexico customers;
o Our efforts to decrease our reliance on our larger Mexico
customers; and
o 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 reduction of our operations in Mexico is estimated to reduce our
working capital requirements and improve our cash flow, among other things.
Total restructuring charges for the year ended 2003 amounted to
$7,700,047. Restructuring charges included approximately $4.3 million of
inventory write-downs, $1.6 million of additional reserves for doubtful accounts
receivable, $1 million of costs incurred related to the reduction of operations
in Mexico, including the relocation of inventory and facilities, $500,000 of
benefits paid to terminated employees and $300,000 of other costs. All
restructuring costs were incurred and paid for in the fourth quarter of 2003,
and we did not anticipate any further charges as a result of this restructuring
plan. Therefore, no liabilities related to restructuring charges were included
in the balance sheet at December 31, 2003. During the first quarter of 2004,
however, we incurred and recorded residual restructuring charges of $414,675.
14
Restructuring charges for the year ended December 31, 2003 related to
the following expense categories included in the Company's statement of
operations are as follows:
Amount
----------
Cost of goods sold ........................................ $4,931,218
Selling expenses .......................................... 143,442
General and administrative expenses ....................... 2,625,387
----------
Total restructuring charges ............................... $7,700,047
==========
RESULTS OF OPERATIONS
The following table sets forth for the years indicated selected
statements of operations data shown as a percentage of net sales:
YEAR ENDED
DECEMBER 31,
--------------------------------
2004(1) 2003 2002
----- ----- -----
Net sales ................................ 100.0 % 100.0 % 100.0%
Cost of goods sold ....................... 81.3 74.3 74.3
----- ----- -----
Gross profit ............................. 18.7 25.7 25.7
Selling expenses ......................... 5.3 5.8 3.5
General and administrative expenses ...... 39.0 17.1 17.1
Restructuring charges .................... .8 11.9 --
----- ----- -----
Operating (loss) income .................. (26.4)% (9.1)% 5.1%
===== ===== =====
- ----------
(1) Included in general and administrative expenses for the year ended
December 31, 2004 are $4,289,436 (7.8% of net sales) of expenses
related to the write-off of obligations due from United Apparel
Ventures and its affiliate, Tarrant Apparel Group. See further
discussion above and Notes 5 and 21 to the Consolidated Financial
Statements included in Item 8. Included in cost of sales and general
and administrative expenses for the year ended December 31, 2004 are
$2,746,000 (5.0% of net sales) and $5.0 million (9.1% of net sales) of
expenses related to fourth quarter inventory and accounts receivable
reserve adjustments.
The following table sets forth for the years indicated revenues
attributed to countries based on customer delivery locations as a percentage of
net sales:
Year Ended December 31,
---------------------------------
2004 2003 2002
----- ----- -----
United States ........................ 8.8% 13.7% 14.5%
Asia ................................. 23.2 15.0 9.0
Mexico ............................... 39.0 41.1 73.4
Dominican Republic ................... 17.6 22.1 3.1
Central and South America ............ 9.9 5.6 --
Other ................................ 1.5 2.5 --
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
Net sales decreased approximately $9,334,000 (or 14.5%) to $55,109,000
for the year ended December 31, 2004 from $64,443,000 for the year ended
December 31, 2003. The decrease in net sales for the year ended December 31,
2004 was primarily due to a decrease in trim-related sales of approximately
15
$19.1 million from our Tlaxcala, Mexico operations. 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,
Tarrant Apparel Group (and its affiliate United Apparel Ventures) and Azteca
Production International, which contributed approximately $25.9 million or 40.2%
of revenues for the year ended December 31, 2003. These customers contributed
approximately $6.8 million or 12.3% of revenues for the year ended December 31,
2004. We were able to replace in excess of 50% of the lost revenue from our
Tlaxcala, Mexico operations during the year ended December 31, 2004 with new
customers primarily in Mexico and Asia. The reduction of our operations in
Mexico was also in response to our efforts to decrease our reliance on our
larger Mexico customers. The decrease in net sales from our Tlaxcala, Mexico
operations was offset by an increase in sales from our TRIMNET programs related
to major U.S. retailers in our Hong Kong and Mexico facilities and an increase
in zipper sales under our TALON brand name in Asia. Fiscal 2004 has been a
transitional year as we experienced the effects of diversifying our customer
base.
Net sales increased approximately $4,370,000 (or 7.3%) to $64,443,000
for the year ended December 31, 2003 from $60,073,000 for the year ended
December 31, 2002. The increase in net sales was primarily due to the addition
of sales under our TEKFIT stretch waistband division. In late 2002, we created a
new division under the TEKFIT brand name. This division develops and sells
apparel components that utilize the patented Pro-Fit technology, including a
stretch waistband sold under our exclusive supply agreement with Levi Strauss &
Co. The increase in net sales was also attributable to 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 to our MANAGED TRIM
SOLUTION(TM) customers in Mexico and our other TALON customers in Mexico and
Asia. The increase in net sales was offset by a decrease in trim-related sales
from our Tlaxcala, Mexico operations under our MANAGED TRIM SOLUTION(TM) trim
package program. This decrease is due in part to our efforts to decrease our
reliance on certain customers and to further diversify our customer base.
Gross profit decreased approximately $6,257,000 (or 37.8%) to
$10,296,000 for the year ended December 31, 2004 from $16,553,000 for the year
ended December 31, 2003. Gross margin as a percentage of net sales decreased to
approximately 18.7% for the year ended December 31, 2004 as compared to 25.7%
for the year ended December 31, 2003. In the fourth quarter of 2004, we recorded
inventory write-downs totaling $2,746,000 (or 5.0% of net sales) based on
management's estimate of the net realizable value of certain inventory. The
decrease in gross profit as a percentage of net sales for the year ended
December 31, 2004 was also due to a change in our product mix during the year.
Gross profit increased approximately $1,113,000 (or 7.2%) to
$16,553,000 for the year ended December 31, 2003 from $15,440,000 for the year
ended December 31, 2002. Gross margin as a percentage of net sales remained
consistent at approximately 25.7% for the years ended December 31, 2003 and
2002. The increase in gross profit for the year ended December 31, 2004 resulted
from an increase in net sales during the year.
Selling expense decreased approximately $807,000 (or 21.8%) to
$2,899,000 for the year ended December 31, 2004 from $3,706,000 for the year
ended December 31, 2003. As a percentage of net sales, these expenses decreased
to 5.3% for the year ended December 31, 2004 compared to 5.8% for the year ended
December 31, 2003. The decrease in selling expenses during the period was due in
part to a contractual 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
$411,000 for the year ended December 31, 2004 compared to $780,000 for the year
ended December 31, 2003. Over the life of the contract, 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. Selling expenses also
decreased due to the implementation of our restructuring plan in the fourth
quarter of 2003.
Selling expense increased approximately $1,580,000 (or 74.3%) to
$3,706,000 for the year ended December 31, 2003 from $2,126,000 for the year
ended December 31, 2002. As a percentage of net sales,
16
these expenses increased to 5.8% for the year ended December 31, 2003 compared
to 3.5% for the year ended December 31, 2002. The increase in selling expenses
during the year was due primarily to royalty and other expenses related to our
exclusive license and intellectual property rights agreement with Pro-Fit
Holdings Limited incurred during the year, the addition of sales personnel in
our Hong Kong facility and increased marketing efforts to promote our updated
Oracle-based MANAGED TRIM SOLUTION(TM) system. We are in the process of
completing an update of our MANAGED TRIM SOLUTION(TM) system which will enable
us to further sell complete trim packages to new locations on a globAL basis.
Royalty expense related to our exclusive license and intellectual property
rights agreement with Pro-Fit Holdings Limited amounted to approximately
$780,000 for the year ended December 31, 2003. Royalties incurred for the year
ended December 31, 2002 amounted to approximately $110,000.
General and administrative expenses increased approximately $10,481,000
(or 95.0%) to $21,509,000 for the year ended December 31, 2004 from $11,028,000
for the year ended December 31, 2003. Following negotiations with United Apparel
Ventures and its affiliate, Tarrant Apparel Group, a former customer of ours, we
determined that a significant portion of the obligations due from this customer
were uncollectable. Included in general and administrative expenses for the year
ended December 31, 2004 are charges of $4,289,000 (or 7.8% of net sales) related
primarily to the write-down of receivables due from UAV and Tarrant. We also
recorded an accounts receivable reserve of $5.0 million (or 9.1% of net sales)
in the fourth quarter of 2004 based on management's estimate of the
collectability of accounts receivable primarily related to two other customers.
The increase in general and administrative expenses was also due to the hiring
of additional employees related to the expansion of our Asian operations,
including our TALON franchising strategy. Additional administrative employees
were also hired for our new TALON manufacturing facility in North Carolina. This
facility began production in January 2005. In the first quarter of 2004, we
incurred additional restructuring charges of $414,675 (or .8% of net sales)
related to the final residual costs associated with our restructuring plan
implemented in the fourth quarter of 2003. This one-time charge was offset by a
decrease in salaries and related benefits and other costs 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 39.0% (22.2% before
customer write-offs and other fourth quarter charges) for the year ended
December 31, 2004 compared to 17.1% for the year ended December 31, 2003.
General and administrative expenses increased approximately $758,000
(or 7.4%) to $11,028,000 for the year ended December 31, 2003 from $10,270,000
for the year ended December 31, 2002. The increase in these expenses was due
primarily to expenses incurred related to our exclusive waistband license
agreement and the amortization of intangible assets incurred as a result of the
exclusive waistband technology license rights we acquired in April 2002. As a
percentage of net sales, these expenses remained consistent at 17.1% for the
years ended December 31, 2003 and 2002, because the rate of increase in net
sales did not exceed that of general and administrative expenses.
Interest expense decreased approximately $391,000 (or 32.7%) to
$805,000 for the year ended December 31, 2004 from $1,196,000 for the year ended
December 31, 2003. Borrowings under our UPS Capital credit facility decreased
during the year ended December 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 preferred stock. In
November 2004, we raised $12.5 million from the sale of 6% secured convertible
notes payable. Borrowings under our UPS credit facility were at prime plus 2%
and 4%.
Interest expense decreased approximately $73,000 (or 5.8%) to
$1,196,000 for the year ended December 31, 2003 from $1,269,000 for the year
ended December 31, 2002. Borrowings under our UPS Capital credit facility
decreased during the year ended December 31, 2003 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 preferred stock. The
decrease in borrowings under our UPS Capital credit facility was offset by
increased borrowings due to expanded operations in Asia and the Dominican
Republic.
17
The provision for income taxes amounted to approximately $2,277,000 for
the year ended December 31, 2004 as compared to a benefit for income taxes of
$2,333,000 for the year ended December 31, 2003. The income tax provision as a
percentage of loss before income taxes increased to 14.9% for the year ended
December 31, 2004 from an income tax benefit of 33.0% for the year ended
December 31, 2003 due primarily to the increase in the net deferred tax asset
valuation allowance related to net operating loss carryforwards to $8.9 million
at December 31, 2004 from $1.1 million at December 31, 2003,which reduced the
carrying value of our net deferred tax asset to $1.0 million from $2.8 million.
The decrease in the net deferred tax asset resulted in a charge of $1.8 million
against the provision for income taxes in 2004.
The benefit for income taxes amounted to approximately $2,333,000 for
the year ended December 31, 2003 as compared to a provision for income taxes of
$279,000 for the year ended December 31, 2002. Income taxes decreased for the
year ended December 31, 2003 primarily due to the decreased taxable income as a
result of the net loss incurred for the year ended December 31, 2003.
Net loss was $17,609,000 for the year ended December 31, 2004, as
compared to $4,745,000 for the year ended December 31, 2003, due primarily to
the write-off of obligations, primarily accounts receivable and inventories,
from a former major customer incurred during the fourth quarter of 2004 of $4.3
million, other fourth quarter losses of $7.7 million, a decrease in the net
deferred tax asset of $1.8 million and decreases in net sales, as discussed
above.
Net loss was $4,745,000 for the year ended December 31, 2003 as
compared to net income of $1,496,000 for the year ended December 31, 2002, due
primarily to the restructuring charges incurred during 2003 of $7.7 million and
increases in selling and general and administrative expenses, offset by an
increase in net sales of $4.4 million, as discussed above.
Preferred stock dividends amounted to approximately $31,000 for the
year ended December 31, 2004 as compared to $194,000 for the year ended December
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 stockholders amounted to $17,639,000 and $4,939,000 for the
years ended December 31, 2004 and 2003. Basic and diluted loss per share was
$1.02 and $0.46 for the years ended December 31, 2004 and 2003.
Preferred stock dividends amounted to approximately $194,000 for the
year ended December 31, 2003 as compared to $184,000 for the year ended December
31, 2002. Preferred stock dividends represent earned dividends at 6% of the
stated value per annum of the Series C convertible redeemable preferred stock.
Net loss available to common stockholders amounted to $4,939,000 for the year
ended December 31, 2003 compared to net income available to common stockholders
of $1,312,000 for the year ended December 31, 2002. Basic and diluted loss per
share was $0.46 for the year ended December 31, 2003. Basic and diluted earnings
per share was $0.14 for the year ended December 31, 2002.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased to $5,461,000 at December 31, 2004
from $14,443,000 at December 31, 2003. The decrease resulted from approximately
$11,382,000 of cash used by operating activities, $3,616,000 of cash used in
investing activities, partially offset by $6,016,000 of cash provided by
financing activities.
Net cash used in operating activities was approximately $11,382,000,
$2,086,000 and $5,440,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. Cash used in operating activities for the year ended December 31,
2004 resulted primarily from a net loss of approximately $17.6 million, which
includes $4.3 million in charges related to the write-off of obligations,
primarily accounts receivable and
18
inventories, from a former major customer incurred in the fourth quarter of
2004, $7.7 million of fourth quarter adjustments related to accounts receivable
and inventories and increased accounts receivable of $7.6 million, offset by
decreased inventories of $7.8 million, depreciation and amortization of $1.5
million, a $1.8 million decrease in the net deferred tax asset, increased
allowance for doubtful accounts of $4.0 million and accounts payable and accrued
expenses of $1.6 million. The increase in accounts receivable during the period
was due primarily to slower customer collections of non-related party
receivables during the year. Non-related party trade receivables increased by an
additional $6.6 million due to the inclusion of receivables that were previously
classified as related party trade receivables. Cash used by operating activities
for the year ended December 31, 2003 resulted primarily from a net loss of
approximately $4,745,000, offset by depreciation and amortization expense of
approximately $1,280,000, a write-down in inventory of approximately $4,266,000
and an increase in allowance for doubtful accounts of approximately $1,642,000,
both related to our corporate restructuring. Cash used by operating activities
further resulted from the realization of deferred income of approximately
$1,028,000 due to advances made by a customer in 2002, an increase in deferred
income taxes of approximately $2,709,000 due primarily to current year losses,
and a reduction in accounts payable and accrued expenses of approximately
$1,139,000, offset by a further decrease in inventory of $1,742,000. Cash used
in operating activities for the year ended December 31, 2002 resulted primarily
from increased inventories and receivables, which was partially offset by
increases in accounts payable and accrued expenses and net income.
Net cash used in investing activities was approximately $3,616,000,
$2,516,000 and $1,268,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. Net cash used in investing activities for the year ended December
31, 2004 consisted primarily of capital expenditures for computer equipment, the
purchase of additional TALON zipper equipment and building, land and leasehold
improvements related to our new TALON manufacturing facility in North Carolina.
The building and land purchase of the TALON manufacturing facility was treated
as a non-cash financing transaction. Net cash used in investing activities for
the year ended December 31, 2003 consisted primarily of capital expenditures for
equipment related to the exclusive supply agreement we entered into with Levi
Strauss & Co. and the purchase of additional TALON zipper equipment. During the
period, we also purchased computer equipment and software for the implementation
of a new Oracle-based computer system. This purchase was treated as a non-cash
capital lease obligation. Net cash used in investing activities for the year
ended December 31, 2002 consisted primarily of capital expenditures for
machinery and equipment.
Net cash provided by financing activities was approximately $6,016,000,
$18,759,000 and $6,947,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. Net cash provided by financing activities for the year ended
December 31, 2004 primarily reflects funds raised from secured convertible
promissory notes of $12.5 million, the exercise of stock options and warrants,
proceeds from notes payable and a capital lease obligation, offset by the
repayment of borrowings under our credit facility and notes payable. Net cash
provided by financing activities for the year ended December 31, 2003 primarily
reflects funds raised from private placement transactions of approximately $29.4
million, offset by decreased borrowings under our credit facility and the
repayment of notes payable. Net cash provided by financing activities for the
year ended December 31, 2002 primarily reflects increased borrowings under our
credit facility and funds raised from private placement transactions, offset by
the repayment of notes payable.
We currently satisfy our working capital requirements primarily through
cash flows generated from operations, sales of equity securities and borrowings
from institutional investors and individual accredited investors. On November
10, 2004, we paid off our working capital credit facility with UPS Capital
Global Trade Finance Corporation with a portion of the proceeds received from a
private placement of $12.5 million of Secured Convertible Promissory Notes. The
Secured Convertible Promissory Notes are convertible into common stock at a
price of $3.65 per share, bear interest at 6% payable quarterly, are due
November 9, 2007 and are secured by the TALON trademarks. The Notes are
convertible at the option of the holder at any time after closing. We may repay
the Notes at any time after one year from the closing date with a 15% prepayment
penalty. At maturity, we may repay the Notes in cash or require conversion if
certain conditions
19
are met. In connection with the issuance of the Notes, we issued to the Note
holders warrants to purchase up to 171,235 shares of common stock. The warrants
have a term of five years, an exercise price of $3.65 per share and vested 30
days after closing. We have registered with the SEC, the resale by the holders
of the shares issuable upon conversion of the options and exercise of the
warrants.
At December 31, 2004, there were no outstanding borrowings under our
UPS Capital credit facility which was terminated in November 2004. Amounts
borrowed under our foreign factoring agreement as of December 31, 2004 amounted
to approximately $615,000. At December 31, 2003, outstanding borrowings under
our UPS Capital credit facility, including amounts borrowed under our foreign
factoring agreement, amounted to approximately $7,096,000. There were no open
letters of credit at December 31, 2004 and 2003.
Pursuant to the terms of a foreign factoring agreement under our UPS
Capital credit facility, UPS Capital purchased our eligible accounts receivable
and assumed the credit risk with respect to those foreign accounts for which UPS
Capital had given its prior approval. If UPS Capital did not assume the credit
risk for a receivable, the collection risk associated with the receivable
remained with us. We paid a fixed commission rate and borrowed up to 85% of
eligible accounts receivable under our credit facility. Included in due from
factor as of December 31, 2003 are trade accounts receivable factored without
recourse of approximately $65,000. Included in due from factor are outstanding
advances due to UPS Capital under this factoring arrangement amounting to
approximately $55,000 at December 31, 2003. There were no factored accounts
receivable of advances from factor under the UPS credit facility as of December
31, 2004.
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 December 31, 2004 and 2003, the amount factored with
recourse and included in trade accounts receivable was approximately $1,559,000
and $316,000. Outstanding advances as of December 31, 2004 and 2003 amounted to
approximately $615,000 and $411,000 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 borrowings 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, net of allowance for doubtful accounts,
increased to $22,390,000 at December 31, 2004 from $19,253,000 at December 31,
2003. This increase was due primarily to increased non-related party receivables
of approximately $3.7 million due to increased sales to non-related party
customers and slower collections. This increase is net of a $5.0 million reserve
for bad debts provided in the fourth quarter of 2004, based on management's
estimate of the collectability of our customer accounts. Non-related party trade
receivables increased by an additional $6.6 million due to the inclusion of
receivables that were previously classified as related party trade receivables.
As a result of the sale of its ownership in our common stock, Azteca Production
International is no longer considered a related party customer. The increase in
non-related party receivables was offset by a decrease in related party trade
receivables of approximately $7.2 million resulting from decreased sales to
related parties during the year and the write-off of outstanding accounts
receivable obligations due from United Apparel Ventures and its affiliate,
Tarrant Apparel Group. Following negotiations with United Apparel Ventures and
its affiliate, Tarrant Apparel Group, a former major customer of ours, we
determined that a significant portion of the obligations due from this customer
were uncollectable. This resulted in a write-off of $6.9 million of accounts
receivable due from Tarrant and
20
UAV and a net receivable balance due from UAV of $4.5 million at December 31,
2004. UAV agreed to pay the $4.5 million receivable balance over a nine-month
period beginning May 2005.
Our net deferred tax asset at December 31, 2004 amounted to $1.0
million compared to $2.8 million at December 31, 2003. Our deferred tax asset
valuation allowance increased to $8.9 million at December 31, 2004 from $1.1
million at December 31, 2003. The decrease in the net deferred tax asset
resulted in a charge of $1.8 million against the provision for income taxes in
the fourth quarter of 2004. At December 31, 2004, we had Federal and state net
operating loss carryforwards of approximately $21.6 million and $12.9 million,
respectively, available to offset future taxable income. Our net operating
losses may be limited in future periods if the ownership of the Company changes
by more than 50% within a three-year period. As of December 31, 2004, none of
our net operating losses have been limited.
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. 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 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 operations in the Asian, Central and
South American 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 December 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
- ------------------------- ----------- ----------- ----------- ----------- -----------
Note payable ............ $ 1,501,500 $ 1,501,500 $ -- $ -- $ --
Capital lease obligations $ 2,454,068 $ 1,023,793 $ 1,251,263 $ 179,012 $ --
Notes payable to related
parties (1) ............. $ 734,021 $ 734,021 $ -- $ -- $ --
Operating leases ........ $ 1,145,827 $ 724,009 $ 421,818 $ -- $ --
Line of credit .......... $ 654,449 $ 654,449 $ -- $ -- $ --
Note payable ............ $ 27,720 $ 27,720 $ -- $ -- $ --
Notes payable ........... $ 2,060,326 $ 276,009 $ 828,027 $ 956,290 $ --
Convertible notes payable $14,645,205 $ 750,000 $13,895,205 $ -- $ --
- ----------
(1) The majority of 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.
At December 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.
21
RELATED PARTY TRANSACTIONS
For a description of transactions to which we were or will be a party,
and in which any director, executive officer, shareholder of more than 5% of our
common stock or any member of their immediate family had or will have a direct
or indirect material interest, see Note 20 of the Notes to the Consolidated
Financial Statements included in Item 8 of this Report.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123R "Share Based Payment." This statement is a revision
of SFAS Statement No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
its related implementation guidance. SFAS 123R addresses all forms of share
based payment ("SBP") awards including shares issued under employee stock
purchase plans, stock options, restricted stock and stock appreciation rights.
Under SFAS 123R, SBP awards result in a cost that will be measured at fair value
on the awards' grant date, based on the estimated number of awards that are
expected to vest. This statement is effective as of the beginning of the first
interim or annual reporting period that begins after December 15, 2005. We have
evaluated the effects of the adoption of this pronouncement and have determined
it will not have a material impact on our financial statements.
In November 2004, the FASB issued SFAS No. 151 "Inventory Costs" (SFAS
151). This statement amends the guidance in ARB No. 43, Chapter 4, "Inventory
Pricing," to clarify the accounting for abnormal amounts of idle facility
expense, freight, handling costs, and wasted material (spoilage). SFAS 151
requires that those items be recognized as current-period charges. In addition,
this Statement requires that allocation of fixed production overheads to costs
of conversion be based upon the normal capacity of the production facilities.
The provisions of SFAS 151 are effective for inventory cost incurred in fiscal
years beginning after June 15, 2005. As such, we are required to adopt these
provisions at the beginning of fiscal 2006. The adoption of this pronouncement
is not expected to have material effect on our financial statements.
In December 2004, the FASB issued Statement Accounting Standard
("SFAS") No. 153 "Exchanges of Nonmonetary Assets." This Statement amends
Opinion 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Earlier application is permitted for
nonmonetary asset exchanges occurring in fiscal periods beginning after December
16, 2004. The provisions of this Statement should be applied prospectively. The
adoption of this pronouncement is not expected to have material effect on our
financial statements.
In October 2004, the American Jobs Creation Act of 2004 (Act) became
effective in the U.S. Two provisions of the Act may impact the provision
(benefit) for income taxes in future periods, namely those related to the
Qualified Production Activities Deduction (QPA) and Foreign Earnings
Repatriation (FER).
The QPA will be effective for our U.S. federal tax return year
beginning after December 31, 2004. In summary, the Act provides for a percentage
deduction of earnings from qualified production activities, as defined,
commencing with an initial deduction of 3 percent for tax years beginning in
2005 and increasing to 9 percent for tax years beginning after 2009, with the
result that the Statutory federal tax rate currently applicable to our qualified
production activities of 35 percent could be reduced initially to 33.95 percent
and ultimately to 31.85 percent. However, the Act also provides for the phased
elimination of the Extraterritorial Income Exclusion provisions of the Internal
Revenue Code, which have previously resulted in tax benefits to both CCN and
IMC. Due to the interaction of the law provisions noted above as well as the
particulars of our tax position, the ultimate effect of the QPA on our future
provision (benefit) for income taxes has not
22
been determined at this time. The FASB issued FASB Staff Position FAS 109-1,
Application of FASB Statement No.109, Accounting for Income Taxes, to the Tax
Deduction on Qualified Production Activities Provided by the American Jobs
Creation Act of 2004, (FSP 109-1) in December 2004. FSP 109-1 requires that tax
benefits resulting from the QPA should be recognized no earlier than the year in
which they are reported in the entity's tax return, and that there is to be no
revaluation of recorded deferred tax assets and liabilities as would be the case
had there been a change in an applicable statutory rate.
The FER provision of the Act provides generally for a one-time 85
percent dividends received deduction for qualifying repatriations of foreign
earnings to the U.S. Qualified repatriated funds must be reinvested in the U.S.
in certain qualifying activities and expenditures, as defined by the Act. In
December 2004, the FASB issued FASB Staff Position FAS 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004 (FSP 109-2). FSP 109-2 allows additional time
for entities potentially impacted by the FER provision to determine whether any
foreign earnings will be repatriated under said provisions. At this time, we
have not undertaken an evaluation of the application of the FER provision and
any potential benefits of effecting repatriations under said provision. Numerous
factors, including previous actual and deemed repatriations under federal tax
law provisions, are factors impacting the availability of the FER provision and
its potential benefit to the us, if any. We intend to examine the issue and will
provide updates in subsequent periods.
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.
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. Pro-Fit filed an answer denying the material allegations of the
complaint and filed a counterclaim alleging various contractual and tort claims
seeking injunctive relief and damages. We filed a reply denying the material
allegations of Pro-Fit's pleading. Pro-Fit has since purported to terminate our
exclusive license and intellectual property agreement based on the same alleged
breaches of the agreement that are the subject of our existing litigation, as
well as on an additional basis unsupported by fact. In February 2005, we amended
our pleadings in the litigation to assert additional breaches by Pro-Fit of its
obligations to us under our agreement and under certain additional letter
agreements, and for a declaratory judgment that Pro-Fit's patent No. 5,987,721
is invalid and not infringed by us. Discovery in this case has commenced. There
have been ongoing negotiations with Pro-Fit to attempt to resolve these
disputes. We intend to proceed with the lawsuit if these negotiations are not
concluded in a manner satisfactory to us.
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 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
23
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.
WE MAY NOT BE ABLE TO ENFORCE THE MINIMUM PURCHASE REQUIREMENTS AND
OTHER OBLIGATIONS OF OUR TALON DISTRIBUTORS. Expansion of our TALON zipper
business depends in a large part on what we refer to as our TALON franchise
strategy. We appoint distributors in various geographic international regions to
finish and sell zippers under the TALON brand name. In return for the exclusive
right to finish and sell zippers in selected territories, each distributor
agrees to purchase a minimum quantity of zipper components from us over the term
of our agreement. These distributors are foreign entities located primarily in
emerging markets in Asia, Latin America, the Middle East and Africa. Despite a
distributor's contractual commitments to us, we may be unable to enforce the
distributor's minimum purchase guarantee or recover damages or other relief
following a default, which could result in lower than projected revenues for our
TALON division.
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 a borrowing base credit agreement, 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, the lender 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.
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, some of
our customers are required to purchase 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 or
insists on markdowns, we may incur a charge in connection with our holding
significant amounts of unsalable inventory and this would have a negative impact
on our income.
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.
24
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.
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.
25
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.
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.
26
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.
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 currently do not have
any plans to pursue any potential 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 9, 2005, our officers and directors and their affiliates beneficially
owned approximately 15.1% 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 17.6% of the
outstanding shares of our common stock at March 9, 2005. As a result,
27
our officers and directors and the Dyne family 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.
ITEM 7A. 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. During 2004, we
purchased forward exchange contracts for British Pounds to hedge the payments of
product purchases. We intend to purchase additional contracts to hedge the
British Pound exposure for future product purchases. There were no hedging
contracts outstanding as of December 31, 2004. 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 December 31 2004, we had approximately $1.0 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.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TABLE OF CONTENTS
PAGE
----
Report of Independent Registered Public Accounting Firm................... 30
Consolidated Balance Sheets............................................... 31
Consolidated Statements of Operations..................................... 32
Consolidated Statements of Stockholders' Equity and Convertible
Redeemable Preferred Stock............................................. 33
Consolidated Statements of Cash Flows..................................... 34
Notes to Consolidated Financial Statements................................ 35
Independent Registered Public Accounting Firm's Report on Schedule II..... 62
Schedule II - Valuation and Qualifying Accounts and Reserves.............. 63
29
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Tag-It Pacific, Inc.
Los Angeles, California
We have audited the accompanying consolidated balance sheets of Tag-It
Pacific, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of operations, stockholders' equity and convertible
redeemable preferred stock and cash flows for each of the three years in the
period ended December 31, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Tag-It
Pacific, Inc. and subsidiaries at December 31, 2004 and 2003, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.
/s/ BDO Seidman, LLP
--------------------
Los Angeles, California
March 31, 2005
30
TAG-IT PACIFIC, INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2004 2003
------------ ------------
Assets
Current assets:
Cash and cash equivalents ....................... $ 5,460,662 $ 14,442,769
Due from factor ................................. -- 9,743
Trade accounts receivable, net .................. 17,890,044 7,531,079
Trade accounts receivable, related parties, net . 4,500,000 11,721,465
Inventories, net ................................ 9,305,819 17,096,879
Prepaid expenses and other current assets ....... 2,326,245 2,124,366
Deferred income taxes ........................... 1,000,000 2,800,000
------------ ------------
Total current assets ............................... 40,482,770 55,726,301
Property and equipment, net of accumulated
depreciation and amortization ................... 9,380,026 6,144,863
Due from related parties ........................... 556,550 762,076
Tradename .......................................... 4,110,750 4,110,750
Goodwill ........................................... 450,000 450,000
License rights ..................................... 259,875 375,375
Other assets ....................................... 1,207,885 200,949
------------ ------------
Total assets ....................................... $ 56,447,856 $ 67,770,314
============ ============
Liabilities, Convertible Redeemable Preferred
Stock and Stockholders' Equity
Current liabilities:
Line of credit ................................... $ 614,506 $ 7,095,514
Accounts payable and accrued expenses ............ 7,460,916 9,552,196
Demand notes payable to related parties .......... 664,971 849,971
Current portion of capital lease obligations ..... 859,799 562,742
Current portion of notes payable ................. 174,975 --
Note payable ..................................... 1,400,000 1,200,000
------------ ------------
Total current liabilities .......................... 11,175,167 19,260,423
Capital lease obligations, less current portion .... 1,220,969 651,191
Notes payable, less current portion ................ 1,447,855 --
Note payable, less current portion ................. -- 1,400,000
Secured convertible promissory notes ............... 12,408,623 --
------------ ------------
Total liabilities .................................. 26,252,614 21,311,614
------------ ------------
Commitments and contingencies (Note 17)
Convertible redeemable preferred stock Series
C, $0.001 par value; 759,494 shares authorized;
no shares issued and outstanding at December 31,
2004; 759,494 shares issued and outstanding at
December 31, 2003 (stated value $3,000,001) ...... -- 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 D, $0.001
par value; 572,818 shares authorized; no
shares issued and outstanding at December 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; 18,171,301 shares issued
and outstanding at December 31, 2004;
11,508,201 at December 31, 2003 ............... 18,173 11,510
Additional paid-in capital ....................... 51,073,402 23,890,356
Accumulated deficit .............................. (20,896,333) (3,256,860)
------------ ------------
Total stockholders' equity ......................... 30,195,242 43,563,699
------------ ------------
Total liabilities, convertible redeemable
preferred stock and stockholders' equity ......... $ 56,447,856 $ 67,770,314
============ ============
See accompanying notes to consolidated financial statements.
31
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2004 2003 2002
------------ ------------ ------------
Net sales to unrelated parties ................... $ 54,351,108 $ 38,560,045 $ 18,179,970
Net sales to related parties ..................... 758,373 25,882,770 41,893,200
------------ ------------ ------------
Total net sales .................................. 55,109,481 64,442,815 60,073,170
Cost of goods sold ............................... 44,813,736 47,889,762 44,633,195
------------ ------------ ------------
Gross profit ..................................... 10,295,745 16,553,053 15,439,975
Selling expenses ................................. 2,899,329 3,706,143 2,126,227
General and administrative expenses (Note 21) .... 21,508,607 11,028,291 10,269,672
Restructuring charges (Note 22) .................. 414,675 7,700,047 --
------------ ------------ ------------
Total operating expenses ......................... 24,822,611 22,434,481 12,395,899
(Loss) income from operations .................... (14,526,866) (5,881,428) 3,044,076
Interest expense, net ............................ 804,888 1,196,110 1,269,365
------------ ------------ ------------
(Loss) income before income taxes ................ (15,331,754) (7,077,538) 1,774,711
Provision (benefit) for income taxes ............. 2,277,214 (2,332,880) 278,685
------------ ------------ ------------
Net (loss) income ................................ $(17,608,968) $ (4,744,658) $ 1,496,026
============ ============ ============
Less: Preferred stock dividends .................. (30,505) (194,052) (184,200)
------------ ------------ ------------
Net (loss) income available to common shareholders $(17,639,473) $ (4,938,710) $ 1,311,826
============ ============ ============
Basic (loss) earnings per share .................. $ (1.02) $ (0.46) $ 0.14
============ ============ ============
Diluted (loss) earnings per share ................ $ (1.02) $ (0.46) $ 0.14
============ ============ ============
Basic weighted average shares outstanding ........ 17,316,202 10,650,684 9,232,405
============ ============ ============
Diluted weighted average shares outstanding ...... 17,316,202 10,650,684 9,531,301
============ ============ ============
See accompanying notes to consolidated financial statements.
32
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
CONVERTIBLE REDEEMABLE PREFERRED STOCK
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Preferred Stock Preferred Stock
Common Stock Series A Series D
---------------------------- --------------------------- ----------------------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, JANUARY 1, 2002 ... 8,769,910 $ 8,771 -- $ -- -- $ --
Common stock issued upon
exercise of options ... 50,000 50 -- -- -- --
Acquisition of license
rights ................ 150,000 150 -- -- -- --
Common stock issued in
private placement
transactions .......... 349,999 350 -- -- -- --
Tax benefit from exercise
of stock options ...... -- -- -- -- -- --
Preferred stock dividends -- -- -- -- -- --
Net income .............. -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2002 . 9,319,909 9,321 -- -- -- --
Preferred stock issued in
private placement
transaction ........... -- -- -- -- 572,818 22,918,693
Common stock cancelled in
settlement agreement .. (5,208) (5) -- -- -- --
Common stock issued upon
exercise of options ... 126,500 127 -- -- -- --
Common stock issued in
private placement
transactions .......... 2,025,000 2,025 -- -- -- --
Common stock issued for
services .............. 42,000 42 -- -- -- --
Tax benefit from exercise
of stock options ...... -- -- -- -- -- --
Preferred stock dividends -- -- -- -- -- --
Net loss ................ -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2003 . 11,508,201 11,510 -- -- 572,818 22,918,693
Conversion of preferred
stock Series C and
accrued dividends ..... 700,144 700 -- -- -- --
Conversion of preferred
stock Series D ........ 5,728,180 5,728 -- -- (572,818) (22,918,693)
Warrants issued in
private placement
transaction ........... -- -- -- -- -- --
Common stock issued upon
exercise of options and
warrants .............. 214,276 214 -- -- -- --
Common stock and warrants
issued for services ... 20,500 21 -- -- -- --
Tax benefit from exercise
of stock options ...... -- -- -- -- -- --
Preferred stock dividends -- -- -- -- -- --
Net loss ................ -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2004 . 18,171,301 $ 18,173 -- $ -- -- $ --
============ ============ ============ ============ ============ ============
Preferred Stock
Additional Retained Series C
Paid-In Earnings ----------------------------
Capital (Deficit) Total Shares Amount
------------ ------------ ------------ ------------ ------------
BALANCE, JANUARY 1, 2002 ... $ 15,048,971 $ 370,024 $ 15,427,766 759,494 $ 2,895,001
Common stock issued upon
exercise of options ... 64,948 -- 64,998 -- --
Acquisition of license
rights ................ 577,350 -- 577,500 -- --
Common stock issued in
private placement
transactions .......... 1,029,647 -- 1,029,997 -- --
Tax benefit from exercise
of stock options ...... 55,096 -- 55,096 -- --
Preferred stock dividends -- (184,200) (184,200) -- --
Net income .............. -- 1,496,026 1,496,026 -- --
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2002 . 16,776,012 1,681,850 18,467,183 759,494 2,895,001
Preferred stock issued in
private placement
transaction ........... 165,000 -- 23,083,693 -- --
Common stock cancelled in
settlement agreement .. (31,712) -- (31,717) -- --
Common stock issued upon
exercise of options ... 317,823 -- 317,950 -- --
Common stock issued in
private placement
transactions .......... 6,333,475 -- 6,335,500 -- --
Common stock issued for
services .............. 166,698 -- 166,740 -- --
Tax benefit from exercise
of stock options ...... 163,060 -- 163,060 -- --
Preferred stock dividends -- (194,052) (194,052) -- --
Net loss ................ -- (4,744,658) (4,744,658) -- --
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2003 . 23,890,356 (3,256,860) 43,563,699 759,494 2,895,001
Conversion of preferred
stock Series C and
accrued dividends ..... 3,353,008 -- 3,353,708 (759,494) (2,895,001)
Conversion of preferred
stock Series D ........ 22,912,965 -- -- -- --
Warrants issued in
private placement
transaction ........... 189,815 -- 189,815 -- --
Common stock issued upon
exercise of options and
warrants .............. 557,514 -- 557,728 -- --
Common stock and warrants
issued for services ... 85,710 -- 85,731 -- --
Tax benefit from exercise
of stock options ...... 84,034 -- 84,034 -- --
Preferred stock dividends -- (30,505) (30,505) -- --
Net loss ................ -- (17,608,968) (17,608,968) -- --
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2004 . $ 51,073,402 $(20,896,333) $ 30,195,242 -- $ --
============ ============ ============ ============ ============
See accompanying notes to consolidated financial statements.
33
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2004 2003 2002
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net (loss) income .................................... $(17,608,968) $ (4,744,658) $ 1,496,026
Adjustments to reconcile net (loss) income to net
cash used in operating activities:
Depreciation and amortization ...................... 1,547,223 1,280,380 1,169,247
Decrease (increase) in deferred income taxes ....... 1,800,000 (2,709,072) 16,671
Loss on sale of assets ............................. -- -- 20,804
Common stock and warrants issued for services ...... 85,731 135,023 --
Increase (decrease) in allowance for doubtful
accounts ......................................... 4,042,428 1,642,086 (167,140)
Changes in operating assets and liabilities:
Receivables, including related parties ............. (7,640,984) (392,522) (9,534,894)
Inventories ........................................ 7,791,060 6,008,388 (2,654,527)
Prepaid expenses and other current assets .......... 13,121 (1,524,823) (191,396)
Other assets ....................................... 147,046 (24,976) (75,580)
Accounts payable and accrued expenses .............. (1,570,550) (1,138,946) 3,197,895
Deferred income .................................... -- (1,027,984) 1,027,984
Income taxes payable ............................... 12,032 411,420 254,663
------------ ------------ ------------
Net cash used in operating activities ................... (11,381,861) (2,085,684) (5,440,247)
------------ ------------ ------------
Cash flows from investing activities:
Decrease in loans to related parties ................. -- 167,801 --
Acquisition of property and equipment ................ (3,615,899) (2,683,857) (1,290,087)
Proceeds from sale of equipment ...................... -- -- 22,312
------------ ------------ ------------
Net cash used in investing activities ................... (3,615,899) (2,516,056) (1,267,775)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from secured convertible promissory notes ... 11,663,685 -- --
Proceeds from preferred stock issuance ............... -- 23,083,693 --
Proceeds from common stock issuance .................. -- 6,335,500 1,029,997
Proceeds from exercise of stock options and warrants . 557,728 317,950 64,998
(Repayment) proceeds from bank line of credit, net ... (6,481,007) (8,838,743) 6,521,480
Proceeds from capital lease obligation ............... 950,000 -- 125,000
Payment of capital lease obligations ................. (332,583) (439,355) (194,937)
Proceeds from notes payable .......................... 880,000 -- 500,000
Repayment of notes payable ........................... (1,222,170) (1,700,000) (1,100,000)
------------ ------------ ------------
Net cash provided by financing activities ............... 6,015,653 18,759,045 6,946,538
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents .... (8,982,107) 14,157,305 238,516
Cash and cash equivalents, beginning of year ............ 14,442,769 285,464 46,948
------------ ------------ ------------
Cash and cash equivalents, end of year .................. $ 5,460,662 $ 14,442,769 $ 285,464
============ ============ ============
Supplemental disclosures of cash flow information:
Cash paid (received) during the year for:
Interest paid ...................................... $ 693,045 $ 1,149,357 $ 1,203,663
Interest received .................................. $ (32,340) $ (179) $ (180)
Income taxes paid .................................. $ 495,345 $ 177,455 $ 7,984
Income taxes received .............................. $ (17,903) $ (212,082) $ --
Non-cash financing activity:
Common stock issued in acquisition of license rights $ -- $ -- $ 577,500
Capital lease obligation ........................... $ 249,418 $ 1,474,053 $ --
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 $ -- $ --
Mortgage note payable .............................. $ 765,000 $ -- $ --
Warrants issued to placement agent ................. $ 93,815 $ -- $ --
Accounts receivable converted to notes receivable .. $ 470,799 $ -- $ --
See accompanying notes to consolidated financial statements.
34
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
Tag-It Pacific, Inc. (the "Company") is the parent holding company of
Tag-It, Inc., a California corporation, Tag-It Pacific (HK) Ltd., a BVI
corporation, Tag-It de Mexico, S.A. de C.V., A.G.S. Stationery, Inc., a
California corporation and Pacific Trim & Belt, Inc., a California corporation
(collectively, the "Subsidiaries"), all of which were consolidated under a
parent limited liability company on October 17, 1997 and became wholly-owned
subsidiaries of the Company immediately prior to the effective date of the
Company's initial public offering in January 1998. Immediately prior to the
initial public offering, the outstanding membership units of Tag-It Pacific LLC
were converted to 2,470,001 shares of Common Stock of the Company. In November
1998, the Company formed a wholly-owned subsidiary, Pacific Trim, SA de CV
located in Tlaxcala, Mexico (now included in "Subsidiaries"). All the activities
of this company were merged into Tag-It de Mexico, SA de CV, in 1999. In January
2000, the Company formed Tag-It Pacific Limited, a Hong Kong corporation, and in
April 2000, the Company formed Talon International, Inc., a Delaware
corporation. All newly formed corporations are 100% wholly-owned Subsidiaries of
Tag-It Pacific, Inc. Pacific Trim & Belt, Inc. was dissolved during 2000.
All significant intercompany accounts and transactions have been
eliminated in consolidation. Assets and liabilities of foreign subsidiaries are
translated at rates of exchange in effect at the close of the period. Revenues
and expenses are translated at the weighted average of exchange rates in effect
during the year. The resulting translation gains and losses are deferred and are
shown as a separate component of stockholders' equity and transaction gains and
losses are recorded in the consolidated statement of income in the period
incurred. During 2004, 2003 and 2002, foreign currency translation and
transaction gains and losses were not material.
NATURE OF BUSINESS
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. The Company acts 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 manufacturer and
distributor of zippers under the TALON brand name and a distributor of stretch
waistbands that utilize licensed patented technology under the TEKFIT brand
name.
REVENUE RECOGNITION
The Company generates revenue primarily from two sources:
o Trim product sales, including zippers and waistbands, and
o Complete trim package sales under TRIMNET.
Trim product and trim package sales are recorded at the time of
shipment, at which point title transfers to the customer, and when collection is
reasonably assured. Our customers are not given extended terms or dating and
have return rights with proper prior authorization.
COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Standard No. 130,
"Reporting Comprehensive Income" ("SFAS 130"), issued by the FASB and effective
for financial statements with fiscal years beginning after December 15, 1997.
SFAS 130 establishes standards for reporting and display of comprehensive
35
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
income and its components in a full set of general-purpose financial statements.
There were no material other comprehensive income items for the years ended
December 31, 2004, 2003 and 2002.
CLASSIFICATION OF EXPENSES
COST OF SALES - Cost of good sold includes expenses primarily related
to inventory purchases, customs, duty, freight and overhead expenses. Overhead
expenses primarily consist of warehouse and operations salaries, and warehouse
expenses.
SELLING EXPENSE - Selling expenses primarily include royalty expense,
selling salaries, commissions, marketing and other selling expenses, including
travel and entertainment.
GENERAL AND ADMINISTRATIVE EXPENSES - General and administrative
expenses primarily include administrative salaries, employee benefits,
professional service fees, facility expenses, information technology, investor
relations, travel and entertainment, depreciation and amortization, bad debts
and other general corporate expenses.
SHIPPING AND HANDLING COSTS
In accordance with Emerging Issues Task Force (EITF) 00-10, Accounting
for Shipping and Handling Fees and Costs, the Company records shipping and
handling costs billed to customers as a component of revenue, and shipping and
handling costs incurred by the Company for inbound and outbound freight are
recorded as a component of cost of sales. Total shipping and handling costs
included as component of revenue for the years ended December 31, 2004, 2003 and
2002 amounted to $194,000, $428,000 and $245,000. Total shipping and handling
costs included as a component of cost of sales amounted to $1,002,000, $827,000
and $813,000.
SEGMENTS OF AN ENTERPRISE
The Company has adopted Statement of Financial Standard No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"), issued by the FASB and effective for financial statements with fiscal
years beginning after December 15, 1997. SFAS 131 requires that public companies
report certain information about operating segments, products, services and
geographical areas in which they operate and their major customers. The Company
believes that it operates within one segment as there is not enough difference
between the types of products developed and distributed by the Company to
justify segmented reporting by product type. Management decisions regarding the
allocation of resources and the assessment of performance are made on a
company-wide basis and are not specific to the type of product. Adoption of SFAS
131 resulted in expanded disclosures regarding geographical regions (Note 18).
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
initial maturity of three months or less to be cash equivalents. The Company had
approximately $5.4 million at financial institutions in excess of federally
insured limits.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or
market (net realizable value).
36
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Maintenance and repairs are
charged to expense as incurred. Upon retirement or other disposition of property
and equipment, applicable cost and accumulated depreciation and amortization are
removed from the accounts and any gains or losses are included in results of
operations. The Company capitalizes the cost of films, dies, molds and art
designs. The costs capitalized include direct material and direct labor costs.
Depreciation of property and equipment is computed using the
straight-line method based on estimated useful lives as follows:
Furniture and fixtures 5 years
Machinery and equipment 5 to 10 years
Computer equipment 5 years
Leasehold improvements Term of the
lease or the estimated life
of the related improvements,
whichever is shorter.
Films, dies, molds and art designs 3 to 5 years
Building 39 years
IMPAIRMENT OF LONG-LIVED ASSETS
On January 1, 2002, the Company adopted SFAS 142 which requires, among
other things, that the Company 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 lives of other existing
recognized intangible assets, and cease amortization of intangible assets with
an indefinite useful life. The Company's previous business combinations were
accounted for using the purchase method. As of December 31, 2004, the net
carrying amount of goodwill is $450,000, tradename is $4,110,750 and other
intangible assets is $259,875 (Note 8). Management has determined that goodwill
and tradename have indefinite lives. Amortization expense related to other
intangibles amounted to $115,500 for the years ended December 31, 2004 and 2003.
RECLASSIFICATION
Certain reclassifications have been made to the prior year financial
statements to conform to 2004 presentation.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and tax benefit carry-forwards. Deferred tax liabilities and assets at the
end of each period are determined using enacted tax rates. We record deferred
tax assets arising from temporary timing differences between recorded net income
and taxable net income when and if we believe that future earnings will be
sufficient to realize the tax benefit. For those jurisdictions where the
expiration date of tax benefit carry-forwards or the projected taxable earnings
indicate that realization is not likely, a valuation allowance is provided.
37
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The provisions of SFAS No. 109, "Accounting for Income Taxes," require
the establishment of a valuation allowance when, based on currently available
information and other factors, it is more likely than not that all or a portion
of a deferred tax asset will not be realized. SFAS No. 109 provides that an
important factor in determining whether a deferred tax asset will be realized is
whether there has been sufficient income in recent years and whether sufficient
income is expected in future years in order to utilize the deferred tax asset.
The Company believes that its estimate of deferred tax assets and
determination to record a valuation allowance against such assets are critical
accounting estimates because they are subject to, among other things, an
estimate of future taxable income, which is susceptible to change and dependent
upon events that may or may not occur, and because the impact of recording a
valuation allowance may be material to the assets reported on the balance sheet
and results of operations.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), establishes a fair value method of
accounting for stock-based compensation plans and for transactions in which a
company acquires goods or services from non-employees in exchange for equity
instruments. SFAS 123 also gives the option to account for employee stock-based
compensation in accordance with Accounting Principles Board Opinion No. 25 ("APB
25"), "Accounting for Stock issued to Employees," or SFAS 123. The Company has
chosen to account for stock-based compensation for employees utilizing the
intrinsic value method prescribed in APB 25 and not the fair value method
established by SFAS 123. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the fair market price of the Company's stock
at the measurement date over the amount an employee must pay to acquire stock.
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 years ended December 31, 2004, 2003 and 2002.
Under SFAS 123, the Company presents in a footnote the effect of
measuring the cost of stock-based employee compensation at the grant date based
on the fair value of the award and recognizes this cost over the service period.
The value of the stock-based award is determined using a pricing model whereby
compensation cost is the fair value of the option as determined by the model at
grant date or other measurement date.
38
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 years ended December 31, 2004, 2003 and 2002. 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) income per share for the years ended
December 31, 2004, 2003 and 2002 would have amounted to the pro forma amounts
presented below:
2004 2003 2002
-------------- -------------- --------------
Net (loss) income, as reported ................ $ (17,608,968) $ (4,744,658) $ 1,496,026
Add: Stock-based employee compensation expense
included in reported net income, net of
related tax effects ...................... -- -- --
Deduct: Total stock-based employee
compensation expense determined under fair
value based methods for all awards, net of
related tax effects ...................... (55,228) (139,796) (121,073)
-------------- -------------- --------------
Pro forma net (loss) income ................... $ (17,664,196) $ (4,884,454) $ 1,374,953
============== ============== ==============
(Loss) earnings per share:
Basic - as reported ...................... $ (1.02) $ (0.46) $ 0.14
Basic - pro forma ........................ $ (1.02) $ (0.48) $ 0.13
Diluted - as reported .................... $ (1.02) $ (0.46) $ 0.14
Diluted - pro forma ...................... $ (1.02) $ (0.48) $ 0.13
The fair value of option grants is estimated on the date of grant
utilizing the Black-Scholes option-pricing model with the following weighted
average assumptions for options granted during 2003 and 2002; expected life of
option of 1.5 years, expected volatility of 19%, risk free interest rate of 3%
and a 0% dividend yield. The weighted average fair value at the grant date for
such options is $.37 and $.38 per option for the years ended December 31, 2003
and 2002. There were no options granted during the year ended December 31, 2004.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the year.
Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INFORMATION
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value. ACCOUNTS RECEIVABLE AND DUE FROM FACTOR: Due to the
short-term nature of the receivables, the fair value approximates the carrying
value. DUE FROM RELATED PARTIES AND NOTES PAYABLE TO RELATED PARTIES: Due to the
short-term nature and current market borrowing rates of the loans and notes, the
fair value approximates the carrying value. LINE OF CREDIT AND NOTES PAYABLE:
Estimated to approximate fair value based upon current market borrowing rates
for loans with similar terms and maturities.
39
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RESTRUCTURING CHARGES
Upon approval of a restructuring plan by management, the Company
records restructuring reserves for certain costs associated with facility
closures and business reorganization activities as they are incurred or when
they become probable and estimable. Such costs are recorded as a current
liability. Restructuring costs associated with initiatives commenced prior to
January 1, 2003 were recorded in compliance with Emerging Issues Task Force No.
94-3 as a current liability.
For initiatives after December 31, 2002, the Company recorded
restructuring reserves in compliance with SFAS 146, resulting in the recognition
of employee severance and related termination benefits for recurring
arrangements when they became probable and estimable and on the accrual basis
for one-time benefit arrangements. The Company records other costs associated
with exit activities as they are incurred. Employee severance and termination
benefits are estimates based on agreements with the relevant union
representatives or plans adopted by the Company that are applicable to employees
not affiliated with unions. These costs are not associated with nor do they
benefit continuing activities. Inherent in the estimation of these costs are
assessments related to the most likely expected outcome of the significant
actions to accomplish the restructuring. Changing business conditions may affect
the assumptions related to the timing and extent of facility closure activities.
The Company reviews the status of restructuring activities on a quarterly basis
and, if appropriate, records changes based on updated estimates.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123R "Share Based Payment." This statement is a revision
of SFAS Statement No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
its related implementation guidance. SFAS 123R addresses all forms of share
based payment ("SBP") awards including shares issued under employee stock
purchase plans, stock options, restricted stock and stock appreciation rights.
Under SFAS 123R, SBP awards result in a cost that will be measured at fair value
on the awards' grant date, based on the estimated number of awards that are
expected to vest. This statement is effective as of the beginning of the first
interim or annual reporting period that begins after December 15, 2005. The
Company has evaluated the effects of the adoption of this pronouncement and has
determined it will not have a material impact on the Company's financial
statements.
In November 2004, the FASB issued SFAS No. 151 "Inventory Costs" (SFAS
151). This statement amends the guidance in ARB No. 43, Chapter 4, "Inventory
Pricing," to clarify the accounting for abnormal amounts of idle facility
expense, freight, handling costs, and wasted material (spoilage). SFAS 151
requires that those items be recognized as current-period charges. In addition,
this Statement requires that allocation of fixed production overheads to costs
of conversion be based upon the normal capacity of the production facilities.
The provisions of SFAS 151 are effective for inventory cost incurred in fiscal
years beginning after June 15, 2005. As such, the Company is required to adopt
these provisions at the beginning of fiscal 2006. The adoption of this
pronouncement is not expected to have material effect on the Company's financial
statements.
In December 2004, the FASB issued Statement Accounting Standard
("SFAS") No. 153 "Exchanges of Nonmonetary Assets." This Statement amends
Opinion 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Earlier application is permitted for
nonmonetary asset exchanges occurring in fiscal periods beginning after December
16, 2004. The provisions of this Statement should be
40
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
applied prospectively. The adoption of this pronouncement is not expected to
have material effect on the Company's financial statements.
In October 2004, the American Jobs Creation Act of 2004 (Act) became
effective in the U.S. Two provisions of the Act may impact the provision
(benefit) for income taxes in future periods, namely those related to the
Qualified Production Activities Deduction (QPA) and Foreign Earnings
Repatriation (FER).
The QPA will be effective for the U.S. federal tax return year
beginning after December 31, 2004. In summary, the Act provides for a percentage
deduction of earnings from qualified production activities, as defined,
commencing with an initial deduction of 3 percent for tax years beginning in
2005 and increasing to 9 percent for tax years beginning after 2009, with the
result that the Statutory federal tax rate currently applicable to our qualified
production activities of 35 percent could be reduced initially to 33.95 percent
and ultimately to 31.85 percent. However, the Act also provides for the phased
elimination of the Extraterritorial Income Exclusion provisions of the Internal
Revenue Code, which have previously resulted in tax benefits to both CCN and
IMC. Due to the interaction of the law provisions noted above as well as the
particulars of the Company's tax position, the ultimate effect of the QPA on the
Company's future provision (benefit) for income taxes has not been determined at
this time. The FASB issued FASB Staff Position FAS 109-1, Application of FASB
Statement No.109, Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of 2004, (FSP
109-1) in December 2004. FSP 109-1 requires that tax benefits resulting from the
QPA should be recognized no earlier than the year in which they are reported in
the entity's tax return, and that there is to be no revaluation of recorded
deferred tax assets and liabilities as would be the case had there been a change
in an applicable statutory rate.
The FER provision of the Act provides generally for a one-time 85
percent dividends received deduction for qualifying repatriations of foreign
earnings to the U.S. Qualified repatriated funds must be reinvested in the U.S.
in certain qualifying activities and expenditures, as defined by the Act. In
December 2004, the FASB issued FASB Staff Position FAS 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004 (FSP 109-2). FSP 109-2 allows additional time
for entities potentially impacted by the FER provision to determine whether any
foreign earnings will be repatriated under said provisions. At this time, the
Company has not undertaken an evaluation of the application of the FER provision
and any potential benefits of effecting repatriations under said provision.
Numerous factors, including previous actual and deemed repatriations under
federal tax law provisions, are factors impacting the availability of the FER
provision and its potential benefit to the Company, if any. The Company intends
to examine the issue and will provide updates in subsequent periods.
NOTE 2--EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations:
December 31, 2004 December 31, 2003
------------------------------------------ ------------------------------------------
Loss Shares Per Share Loss Shares Per Share
Years ended: (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
- ------------------ ------------ ------------ ----------- ------------ ------------ -----------
Basic earnings per
share:
(Loss) income
available
to common
stockholders .. $(17,639,473) 17,316,202 $ (1.02) $ (4,938,710) 10,650,684 $ (0.46)
Effect of dilutive
securities:
Options ....... -- --
Warrants ...... -- --
------------ ------------ ----------- ------------ ------------ -----------
(Loss) income
available to common
stockholders ...... $(17,639,473) 17,316,202 $ (1.02) $ (4,938,710) 10,650,684 $ (0.46)
============ ============ =========== ============ ============ ===========
December 31, 2002
------------------------------------------
Income Shares Per Share
Years ended: (Numerator) (Denominator Amount
- ------------------ ------------- ------------ -----------
Basic earnings per
share:
(Loss) income
available
to common
stockholders .. $ 1,311,826 9,232,405 $ 0.14
Effect of dilutive
securities:
Options ....... 244,706
Warrants ...... 54,190
------------ ------------ -----------
(Loss) income
available to common
stockholders ...... $ 1,311,826 9,531,301 $ 0.14
============ ============ ===========
41
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warrants to purchase 1,578,973 shares of common stock at between $3.50
and $5.06, options to purchase 1,742,000 shares of common stock at between $1.30
and $4.63, convertible debt of $12,500,000 convertible at $3.65 per share, and
other convertible debt of $500,000 convertible at $4.50 per share were
outstanding for the year ended December 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.
Warrants to purchase 1,277,885 shares of common stock at between $0.71
and $5.06, options to purchase 1,978,000 shares of common stock at between $1.30
and $4.63, 759,494 shares of preferred Series C stock convertible at $4.94 per
share, and convertible debt of $500,000 convertible at $4.50 per share were
outstanding for the year ended December 31, 2003, 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. For the year
ended December 31, 2003, 572,818 shares of preferred Series D stock, convertible
into 5,728,180 shares of common stock after shareholder approval on February 11,
2004, were not included in the computation of diluted earnings per share because
the conversion contingency related to the preferred shares was not met.
Warrants to purchase 523,332 shares of common stock at between $4.34
and $6.00, options to purchase 643,000 shares of common stock at between $4.00
and $4.63, 759,494 shares of preferred Series C stock convertible at $4.94 per
share, and convertible debt of $500,000 convertible at $4.50 per share were
outstanding for the year ended December 31, 2002, 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.
NOTE 3--DUE FROM FACTOR
The Company has entered into a factoring agreement with East Asia
Heller for the purchase of eligible receivables from its Hong Kong subsidiary,
Tag-It Pacific Limited. The Company's factor purchases eligible accounts
receivable and assumes the credit risk with respect to those accounts for which
they have given their prior approval. If the factor does not assume the credit
risk for a receivable, the collection risk associated with the receivable
remains with the Company. The Company pays a fixed commission rate and may
borrow up to 80% of its eligible accounts receivable. Interest is charged at
1.5% over the Hong Kong Dollar prime rate (6.5% at December 31, 2004 and 2003).
As of December 31, 2004 and 2003, the amount factored with recourse and included
in trade accounts receivable was approximately $1,559,000 and $316,000.
Outstanding advances as of December 31, 2004 and 2003 amounted to approximately
$615,000 and $411,000 and are included in the line of credit balance.
The Company also had a factoring agreement with UPS Capital Global
Trade Finance Corporation, whereby UPS Capital purchased eligible accounts
receivable and assumed the credit risk with respect to those foreign accounts
for which UPS Capital had given its prior approval. If UPS Capital did not
assume the credit risk for a receivable, the collection risk associated with the
receivable remained with the Company. The Company paid a fixed commission rate
and borrowed up to 85% of eligible accounts receivable under the credit
facility. Included in due from factor as of December 31, 2003 are trade accounts
receivable factored without recourse of approximately $65,000. Included in due
from factor are outstanding advances due to UPS Capital under this factoring
arrangement amounting to approximately $55,000 at December 31, 2003. The UPS
Capital factoring agreement was cancelled in November 2004 as a result of the
Company's debt refinancing. There were no outstanding obligations due under this
agreement as of December 31, 2004.
The Company measures the value of its retained interest in receivables
factored without recourse based on the fair value of the factored receivable at
the time the sale is initiated. Fair value is determined based on management's
estimate of the expected amount to be collected from the factored receivable.
Adjustments to the fair value of the Company's retained interest in the factored
receivable are made when
42
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
management becomes aware of factors that could result in a reduction of the
amount paid by the customer. Adjustments are charged to operations in the period
in which the facts that give rise to the adjustments become known. The Company
has not recorded any adjustments to reduce the carrying amount of its retained
interest in factored receivables for the years ended December 31, 2004 and 2003.
NOTE 4--TRADE ACCOUNTS RECEIVABLE
Trade accounts receivable are net of an allowance for doubtful accounts
and subsequent returns. At December 31, 2004 and 2003, the total allowance for
doubtful accounts and subsequent returns was $6,085,999 and $2,043,571.
NOTE 5--TRADE ACCOUNTS RECEIVABLE RELATED PARTY
Following negotiations with United Apparel Ventures and its affiliate,
Tarrant Apparel Group, a former major customer, the Company determined that a
significant portion of the obligations due from this customer, primarily related
to accounts receivable and inventories, was uncollectable. As a result, the
Company wrote-off a net of $4.3 million of obligations due from this customer,
with a remaining receivable balance due from UAV of $4.5 million (Note 21).
Included in trade accounts receivable, related parties at December 31, 2004 is
$4.5 million due from this customer. UAV agreed to pay the $4.5 million
receivable balance over a nine-month period beginning May 2005. Trade accounts
receivable, related party at December 31, 2003 included amounts due from Tarrant
Apparel Group and its affiliate, United Apparel Ventures, and Azteca Production
International (a former related party) totaling $11,721,465.
NOTE 6--INVENTORIES
Inventories consist of the following:
Year Ended December 31,
--------------------------------
2004 2003
----------- -----------
Raw materials ........................ $ 127,270 $ 11,210
Work-in-process ...................... 11,439 --
Finished goods ....................... 9,167,110 17,085,669
----------- -----------
Total inventories .................... $ 9,305,819 $17,096,879
=========== ===========
Inventories at December 31, 2004 and 2003 include goods that are
subject to buy back agreements with some of the Company's customers. The buyback
agreements contain provisions related to the inventory purchased on behalf of
the Company's customers. In the event that inventories remain with the Company
in excess of six to nine months from the Company's receipt of the goods from its
vendors, the customer is required to purchase, as provided by the buyback
agreement, the inventories from the Company under normal invoice and selling
terms. Included in inventories at December 31, 2004 are inventories of
approximately $3.2 million that are subject to buyback arrangements with Levi
Strauss & Co., Azteca Production International and other customers.
43
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7--PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Year Ended December 31,
---------------------------
2004 2003
----------- -----------
Furniture and fixtures ......................... $ 670,988 $ 627,826
Machinery and equipment ........................ 7,981,012 5,032,427
Computer equipment ............................. 3,337,986 2,861,459
Leasehold improvements ......................... 292,273 259,789
Films, dies, molds and art designs ............. 2,163,627 1,958,883
Land ........................................... 81,000 --
Building ....................................... 748,859 --
----------- -----------
15,275,745 10,740,384
Accumulated depreciation and amortization ...... 5,895,719 4,595,521
----------- -----------
Net property and equipment ..................... $ 9,380,026 $ 6,144,863
=========== ===========
NOTE 8--GOODWILL AND OTHER INTANGIBLE ASSETS
Intangible assets consist of goodwill, tradename and exclusive license
and intellectual property rights. In accordance with SFAS No. 142, all of the
Company's intangible assets that have definite lives are being amortized on a
straight-line basis over their estimated useful lives. Goodwill and other
intangible assets with indefinite lives are evaluated to determine if the fair
value of the asset has decreased below its carrying value. At December 31, 2004,
the Company evaluated its goodwill and tradename assets and determined that no
impairment adjustment was necessary.
Goodwill and other intangible assets as of December 31, 2004 and 2003
are as follows:
Year Ended December 31,
-----------------------------
2004 2003
----------- -----------
Goodwill ................................... $ 500,000 $ 500,000
Accumulated amortization ................... (50,000) (50,000)
----------- -----------
Goodwill, net .............................. 450,000 450,000
----------- -----------
Tradename .................................. 4,110,750 4,110,750
Accumulated amortization ................... -- --
----------- -----------
Tradename, net ............................. 4,110,750 4,110,750
----------- -----------
Exclusive license and intellectual
property rights ......................... 577,500 577,500
Accumulated amortization ................... (317,625) (202,125)
----------- -----------
Exclusive license and intellectual
property rights, net .................... 259,875 375,375
----------- -----------
Intangible assets, net ..................... $ 4,820,625 $ 4,936,125
=========== ===========
There were no changes in the net carrying amounts of goodwill and
tradename for the years ended December 31, 2004 and 2003.
44
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Amortization expense amounted to $115,500, $115,500 and $86,625 for the
years ended December 31, 2004, 2003 and 2002. The weighted average amortization
period for intangible assets with definite lives is five years.
The following table shows the estimated amortization expense for these
assets for each of the succeeding years:
YEARS ENDING DECEMBER 31, AMOUNT
- ----------------------------------------------------------- --------
2005 ...................................................... $115,500
2006 ...................................................... 115,500
2007 ...................................................... 28,875
--------
Total amortization expense ................................ $259,875
========
NOTE 9--LINE OF CREDIT
On May 30, 2001, the Company entered into a loan and security agreement
with UPS Capital Global Trade Finance Corporation, providing for a working
capital credit facility with a maximum available amount of $13 million. On
November 10, 2004, the Company refinanced its working capital credit facility
with UPS Capital Global Trade Finance Corporation with a portion of the proceeds
received from a private placement of $12.5 million of Secured Convertible
Promissory Notes (Note 12). The initial term of the loan and security agreement
with UPS Capital was three years and the facility was secured by all assets of
the Company. The interest rate for the credit facility was at the prime rate
plus 2%. The credit facility required the compliance with certain financial
covenants including net worth, fixed charge coverage ratio and capital
expenditures. At December 31, 2003, the Company was in compliance with these
financial covenants. Availability under the UPS Capital credit facility was
determined based on a defined formula related to eligible accounts receivable
and inventory. There were no open letters of credit at December 31, 2003.
45
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10--DEMAND NOTES PAYABLE TO RELATED PARTIES
Demand notes payable to related parties consist of the following:
Year Ended December 31,
-------------------------------
2004 2003
------------- ------------
Six notes payable issued in 1996, four notes
payable issued in 1997, and two notes
payable issued in 1998 to officers and
directors of the Company with no monthly
payments and interest rates ranging from
7.5% to 10% annually, due and payable on the
fifteenth day following delivery of written
demand for payment.......................... $ 85,176 $ 85,176
Convertible secured note payable to the
Company's Chairman bears interest at 11%,
payable quarterly, is due on demand and
convertible into common stock at the
election of the holder at a rate of $4.50
per share, the market value of the Company's
common stock on the date of approval by the
Company's Board of Directors. The note is
secured by substantially all of the
Company's assets............................ 500,000 500,000
Unsecured notes payable to shareholders,
directors and officers of the Company accrue
interest at 7% and 8.5% per annum, principal
and interest due on demand and fifteen days
from demand................................. 79,795 264,795
------------- ------------
$ 664,971 $ 849,971
============= ============
As of December 31, 2003, the demand notes were subordinated to UPS
Capital Global Trade Finance Corporation under the Company's former line of
credit facility. Interest expense related to the demand notes payable to related
parties for the years ended December 31, 2004, 2003 and 2002 amounted to
$81,628, $88,102 and $88,102. Included in accrued expenses at December 31, 2004
and 2003 was $380,233 and $373,530 of accrued interest related to these demand
notes. There was no interest paid on the demand notes for the years ended
December 31, 2004 and 2003.
On February 28, 2003, the Company repaid an unsecured note payable to a
shareholder in the amount of $500,000.
46
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11--CAPITAL LEASE OBLIGATIONS
The Company financed equipment purchases through various capital lease
obligations expiring through August 2009. These obligations bear interest at
various rates ranging from 6.3% to 15% per annum. Future minimum annual payments
under these capital lease obligations are as follows:
YEARS ENDING DECEMBER 31, AMOUNT
- --------------------------------------------------------- -----------
2005 .................................................... $ 1,023,793
2006 .................................................... 592,938
2007 .................................................... 371,878
2008 .................................................... 286,447
2009 .................................................... 179,012
-----------
Total payments .......................................... 2,454,068
Less amount representing interest ....................... (373,300)
-----------
Balance at December 31, 2004 ............................ 2,080,768
Less current portion .................................... 859,799
-----------
Long-term portion ....................................... $ 1,220,969
===========
At December 31, 2004, total equipment, included in property and
equipment (Note 7), under capital lease obligations and related accumulated
depreciation amounted to $3,258,589 and $316,826. At December 31, 2003, total
equipment, included in property and equipment, under capital lease obligations
and related accumulated depreciation amounted to $2,198,390 and $650,878.
NOTE 12--NOTES PAYABLE
The Company financed building, land and equipment purchases through
note payable obligations expiring through June 2011. These obligations bear
interest at rates of 6.5% and 6.6% per annum. Future minimum annual payments
under these note payable obligations are as follows:
YEARS ENDING DECEMBER 31, AMOUNT
- -------------------------------------------------------- ----------
2005 ................................................... $ 174,975
2006 ................................................... 186,837
2007 ................................................... 199,504
2008 ................................................... 213,030
2009 ................................................... 210,218
2010 and thereafter .................................... 638,266
----------
Total payments ......................................... 1,622,830
Less current portion ................................... 174,975
----------
Long-term portion ...................................... $1,447,855
==========
NOTE 13--SECURED CONVERTIBLE PROMISSORY NOTES
On November 10, 2004, the Company raised $12.5 million from the sale of
Secured Convertible Promissory Notes (the "Notes") to existing shareholders. The
Notes are convertible into common stock at a price of $3.65 per share, bear
interest at 6% payable quarterly, are due November 9, 2007 and are secured by
the TALON trademarks. The Notes are convertible at the option of the holder at
any time after closing. The Company may repay the Notes at any time after one
year from the closing date with a 15% prepayment
47
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
penalty. At maturity, the Company may repay the Notes in cash or require
conversion if certain conditions are met. In connection with the issuance of the
Notes, the Company issued to the Note holders, warrants to purchase up to
171,235 shares of common stock. The warrants have a term of five years, an
exercise price of $3.65 per share and vested 30 days after closing. The fair
value of the warrants was estimated at approximately $96,000 utilizing the
Black-Scholes option-pricing model and recorded as a discount against the face
value of the Notes. The discount will be amortized over the three-year term of
the Notes on a straight-line basis. The Company has registered with the SEC the
resale by the holders of the shares issuable upon conversion of the Notes and
exercise of the warrants. In connection with this financing, the Company paid
the placement agent $704,000 in cash, and issued the placement agent a warrant
to purchase 215,754 common shares at an exercise price of $3.65 per share. The
warrant is exercisable beginning May 10, 2005 through November 10, 2009. The
fair value of the warrant was estimated at $93,815 utilizing the Black-Scholes
option-pricing model and recorded as deferred financing costs which are
amortized over the three- year term of the Notes.
A portion of the proceeds from the Secured Convertible Notes Payable
was used to pay off all existing indebtedness under our credit facility with UPS
Capital Global Trade Finance Corporation (Note 9). The Company has determined
that this transaction did not result in a beneficial conversion feature.
NOTE 14--STOCKHOLDERS' EQUITY AND CONVERTIBLE REDEEMABLE PREFERRED STOCK
PREFERRED STOCK
SERIES D PREFERRED STOCK PRIVATE PLACEMENT TRANSACTION
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 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 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 and was
recorded as a reduction of the proceeds from the placement of the Series D
Convertible Preferred Stock. The Company has determined that this transaction
did not result in a beneficial conversion feature.
48
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SERIES C PREFERRED STOCK PURCHASE AGREEMENT AND CO-MARKETING AND SUPPLY
AGREEMENT
In accordance with the Series C Preferred Stock Purchase Agreement
entered into by the Company and Coats North America Consolidated, Inc. ("Coats")
on September 20, 2001, the Company issued 759,494 shares of Series C Convertible
Redeemable Preferred Stock (the "Shares") to Coats North America Consolidated,
Inc. in exchange for an equity investment from Coats of $3,000,001 cash. The
Shares were convertible at the option of the holder after one year at the rate
of the closing price multiplied by 125% of the ten-day average closing price
prior to closing. The Shares were redeemable at the option of the holder after
four years. If the holders elected to redeem the Shares, the Company had the
option to redeem for cash at the stated value of $3,000,001 or in the form of
the Company's common stock at 85% of the market price of the Company's common
stock on the date of redemption. If the market price of the Company's common
stock on the date of redemption was less than $2.75 per share, the Company was
required to redeem for cash at the stated value of the Shares. The Company could
elect to redeem the Shares at any time for cash at the stated value. The
Preferred Stock Purchase Agreement provided for cumulative dividends at a rate
of 6% of the stated value per annum, payable in cash or the Company's common
stock. The dividends were payable at the earlier of the declaration of the
Board, conversion or redemption. Each Preferred Share had the right to vote for
each of the Company's common shares that the Shares could then be converted into
on the record date. Total legal and other costs associated with this transaction
of $105,000 were netted against the $3,000,001 proceeds received from Coats.
Dividends accrued but unpaid at December 31, 2003 and 2002 amounted to $428,202
and $234,150.
In connection with the Series C Preferred Stock Purchase Agreement, the
Company also entered into a 10-year Co-Marketing and Supply Agreement with
Coats. The Co-Marketing and Supply Agreement provides for selected introductions
into Coats' customer base and the Company's trim packages will exclusively offer
thread manufactured by Coats.
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.
SERIES B PREFERRED STOCK PURCHASE AGREEMENT, DISTRIBUTION AGREEMENT AND
TRADENAME PURCHASE AGREEMENT
On April 3, 2000, the Company entered into a ten-year exclusive license
and distribution agreement with Talon, Inc. and its parent company, Grupo
Industrial Cierres Ideal, S.A. de C.V. ("GICISA"). Under this agreement, Tag-It
Pacific, Inc. was the exclusive sales, marketing, distribution and e-commerce
arm for "Talon" products for all customers in the United States, Mexico-based
maquiladores, Canada and the Pacific Rim and had the exclusive license to market
trim products under the "Talon" brand name. In exchange for these exclusive
distribution rights, the Company issued 850,000 shares of Series B Convertible
Preferred stock to GICISA. After a period of 30 months, the shares were
convertible into the Company's common stock once the average price per share of
the Company's common stock reached or exceeded $8.00 for a 30-day consecutive
period. The preferred stock was automatically convertible into shares of the
Company's common stock based on a rate of one minus the fraction of $2.50 over
the average per share closing price of the Company's common stock for the 30-day
period preceding the conversion.
The Series B Convertible Preferred stock had a liquidation preference
of $.001 per share, and was entitled to receive non-cumulative dividends on an
as converted basis, if and when, such dividends were declared on the Company's
common stock and was redeemable by the Company under certain conditions as
outlined in the agreement.
The estimated fair value of the Series B Convertible Preferred stock on
April 3, 2000 was $1,400,000. The Company recorded the value of the license and
distribution rights as a long-term asset, which was being amortized over the
ten-year period of the agreement. The unamortized balance of the long-term asset
at December 21, 2001 was $1,166,667.
49
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On September 30, 2000, the Company purchased inventory from GICISA in
exchange for an unsecured note payable in the amount of $2,830,024. The note
payable was non-interest bearing and was due April 1, 2002. The Company imputed
interest for the holding period of the note amounting to $272,000. The note was
subordinate to the obligations due under the credit facility with UPS Capital.
The note payable balance at December 21, 2001 was $2,767,182, net of imputed
interest of $62,842.
On December 21, 2001, the Company entered into an Asset Purchase
Agreement with Talon, Inc. and GICISA. Pursuant to the Asset Purchase Agreement,
the Company acquired from Talon, Inc. and GICISA: (1) certain inventory and
equipment, (2) all patent rights held by Talon, Inc. and (3) all of Talon's
rights to its trade names and trademarks bearing the TALON (R) name. In
addition, the Asset Purchase Agreement terminated the exclusive 10-year license
and distribution agreement, dated as of April 3, 2000 by and among the Company,
GICISA and Talon, Inc.
Under the Asset Purchase Agreement, the Company issued to Talon, Inc.
500,000 shares of common stock, par value $0.001 per share, a promissory note in
the amount of $4,900,000 and $100,000 in cash held in escrow. The Asset Purchase
Agreement required Talon, Inc. to place 50,000 shares of the Company's common
stock and $100,000 in escrow for a period of 12 months to satisfy any
indemnification claims the Company may have under the Asset Purchase Agreement.
The common stock was valued at the market value of the Company's stock on the
date of closing. The promissory note is unsecured, bears interest at prime plus
2% (7.25% at December 31, 2004). In connection with the Asset Purchase
Agreement, the Company also entered into a mutual release with Talon, Inc. and
GICISA pursuant to which Talon, Inc. and GICISA released the Company from its
obligations under the unsecured note payable of $2,830,024 dated September 30,
2000 and other current liabilities under the Exclusive License and Distribution
Agreement. Further, 850,000 shares of the Company's series B convertible
preferred stock held by GICISA were cancelled at the closing of the Asset
Purchase Agreement.
Future minimum payments under the note payable amount to $1,400,000
through June 1, 2005.
COMMON STOCK
2003 PRIVATE PLACEMENT
On May 30, 2003, the Company raised approximately $6,037,500 in a
private placement transaction with five institutional investors. Pursuant to a
securities purchase agreement with these institutional investors, the Company
sold 1,725,000 shares of its common stock at a price per share of $3.50. After
commissions and expenses, the Company received net proceeds of approximately
$5.5 million. The Company has registered the shares issued in the private
placement with the Securities and Exchange Commission for resale by the
investors. In conjunction with the private placement transaction, the Company
issued warrants to purchase 172,500 shares of common stock to the placement
agent. The warrants are exercisable beginning August 30, 2003 through May 30,
2008 and have a per share exercise price of $5.06.
STOCK GRANT AGREEMENTS
Pursuant to Stock Grant Agreements between the Company and Herman Roup,
dated December 1, 2001, January 1, 2002 and July 17, 2002, the Company issued to
Mr. Roup an aggregate of 42,000 shares of common stock during the year ended
December 31, 2003 and 20,500 shares of common stock in 2004 for services
provided to the Company valued at $166,740 and $74,825 in 2003 and 2004,
respectively.
50
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. The Company is currently in
litigation with this supplier (Note 17).
2002 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 included a commitment by one of the two non-related
investors to purchase an additional 400,000 shares of common stock at a price
per share of $3.00 at a second closing (subject of certain conditions) on or
prior to March 1, 2003, as amended, 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 closing. 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 our 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.
In March 2002 and February 2003, one of the non-related investors
purchased an additional 100,000 and 300,000 shares, respectively, 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 $1,200,000. Pursuant to the second
closing provisions of the Stock and Warrant Purchase Agreement, 50,000 and
150,000 warrants were issued to the investor in March 2002 and February 2003,
respectively. There are no remaining commitments due under the stock and warrant
purchase agreements.
NOTE 15--STOCK OPTION INCENTIVE PLAN AND WARRANTS
STOCK OPTION INCENTIVE PLAN
On October 1, 1997, the Company adopted the 1997 Stock Incentive Plan
("the 1997 Plan"), which authorized the granting of a variety of stock-based
incentive awards. The 1997 Plan is administered by the Board of Directors, or a
committee appointed by the Board of Directors, which determine the recipients
and terms of the awards granted
In 2002, the Company's Board of Directors amended its 1997 Stock
Incentive Plan to provide for a total of 2,277,500 shares of common stock to be
reserved for issuance under the Plan. During the year
51
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ended December 31, 2002, the Company granted 270,000 options to purchase common
stock at an exercise price of $3.63 per share, the closing price of the
Company's common stock on the date of grant.
In 2003, the Company's Board of Directors further amended its 1997
Stock Incentive Plan to provide for a total of 2,577,500 shares of common stock
to be reserved for issuance under the Plan. During the year ended December 31,
2004, the Company granted 510,000 options to purchase common stock at exercise
prices of $3.50 and $3.70 per share, the closing price of the Company's common
stock on the date of grants.
In 2004, the Company's Board of Directors further amended its 1997
Stock Incentive Plan to provide for a total of 3,077,500 shares of common stock
to be reserved for issuance under the Plan. There were no options granted during
the year ended December 31, 2004.
The following table summarizes the activity in the 1997 Plan:
Weighted
Average
Number of Exercise
Shares Price
--------- --------
Options outstanding - January 1, 2002 ........ 1,546,000 $ 3.39
Granted ................................. 270,000 3.63
Exercised ............................... (50,000) 1.30
Canceled ................................ (32,500) 3.40
---------
Options outstanding - December 31, 2002 ...... 1,733,500 3.48
Granted ................................. 510,000 3.59
Exercised ............................... (126,500) 2.51
Canceled ................................ (139,000) 3.84
---------
Options outstanding - December 31, 2003 ...... 1,978,000 3.55
Granted ................................. -- --
Exercised ............................... (115,375) 3.36
Canceled ................................ (120,625) 4.00
---------
Options outstanding - December 31, 2004 ...... 1,742,000 $ 3.53
=========
52
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Additional information relating to stock options and warrants
outstanding and exercisable at December 31, 2004, summarized by exercise price
is as follows:
Exercisable
Outstanding Weighted Average Weighted Average
---------------------------------------- --------------------------
Life Exercise Exercise
Exercise Price Per Share Shares (years) Price Shares Price
- ------------------------ ----------- --------- ------------ ----------- -----------
$ 1.30 235,000 3.5 $ 1.30 235,000 $ 1.30
$ 4.31 292,000 5.0 $ 4.31 292,000 $ 4.31
$ 4.63 90,000 5.0 $ 4.63 90,000 $ 4.63
$ 3.78 126,000 6.5 $ 3.78 126,000 $ 3.78
$ 4.25 118,000 5.5 $ 4.25 117,063 $ 4.25
$ 3.75 120,000 6.0 $ 3.75 120,000 $ 3.75
$ 3.63 166,250 8.0 $ 3.63 166,250 $ 3.63
$ 3.64 141,000 7.0 $ 3.64 141,000 $ 3.64
$ 3.50 285,000 8.3 $ 3.50 285,000 $ 3.50
$ 3.70 168,750 8.3 $ 3.70 148,250 $ 3.70
----------- -----------
1,742,000 1,720,563
----------- -----------
$ 3.65 (warrants) 386,989 9.9 $ 3.65 386,989 $ 3.65
$ 4.29 (warrants) 30,000 2.5 $ 4.29 30,000 $ 4.29
$ 3.50 (warrants) (1) 150,000 2.1 $ 3.50 150,000 $ 3.50
$ 4.34 (warrants) (1) 133,333 1.3 $ 4.34 133,333 $ 4.34
$ 4.73 (warrants) (1) 133,333 1.3 $ 4.73 133,333 $ 4.73
$ 4.74 (warrants) 572,818 4.0 $ 4.74 572,818 $ 4.74
$ 5.06 (warrants) 172,500 3.5 $ 5.06 172,500 $ 5.06
----------- -----------
1,578,973 1,578,973
----------- -----------
3,320,973 5.6 $ 3.92 3,299,536 $ 3.91
=========== ===========
- ----------
(1) The exercise price of these warrants includes an upward adjustment of
25% of the amount, if any, that the market price of the Company's
common stock on the exercise date exceeds the stated exercise price, up
to a maximum of $5.25.
NOTE 16--INCOME TAXES
The components of the provision (benefit) for income taxes included in
the consolidated statements of operations are as follows:
Year Ended December 31,
---------------------------------------------------
2004 2003 2002
----------- ----------- -----------
Current:
Federal ........ $ 405,632 $ 360,000 $ 222,713
State .......... 71,582 16,193 39,301
----------- ----------- -----------
477,214 376,193 262,014
Deferred:
Federal ........ 1,530,000 (2,302,711) 14,170
State .......... 270,000 (406,362) 2,501
----------- ----------- -----------
1,800,000 (2,709,073) 16,671
----------- ----------- -----------
$ 2,277,214 $(2,332,880) $ 278,685
=========== =========== ===========
53
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of the statutory Federal income tax rate with the
Company's effective income tax rate is as follows:
Year Ended December 31,
-----------------------------
2004 2003 2002
----- ----- -----
Current:
Federal statutory rate ................. (34.0)% (34.0)% 34.0%
State taxes net of Federal benefit ..... (6.0) (6.0) 6.0
Income earned from foreign subsidiaries 3.1 6.4 (18.2)
Net operating loss valuation allowance . 51.3 2.3 (3.1)
Other .................................. 0.5 (1.7) (3.0)
----- ----- -----
14.9% (33.0)% 15.7%
===== ===== =====
(Loss) income before income taxes are as follows:
Year Ended December 31,
--------------------------------------------------------
2004 2003 2002
------------ ------------ ------------
Domestic ...... $(17,574,926) $ (9,303,639) $ 428,473
Foreign ....... 2,243,172 2,226,101 1,346,238
------------ ------------ ------------
$(15,331,754) $ (7,077,538) $ 1,774,711
============ ============ ============
The primary components of temporary differences which give rise to the
Company's deferred tax assets and deferred tax liabilities are as follows:
Year Ended December 31,
------------------------------
2004 2003
----------- -----------
Net deferred tax asset:
Net operating loss carryforwards .... $ 8,110,000 $ 3,447,744
Dies, film and art library .......... (103,894) (22,959)
Depreciation and amortization ....... 83,078 199,629
Intangible assets .................. (494,193) (347,240)
Bad debt reserve ................... 2,198,402 584,481
Related party interest ............. 105,824 72,165
Other ............................... 783 (14,820)
----------- -----------
9,900,000 3,919,000
Less: Valuation Allowance .......... (8,900,000) (1,119,000)
----------- -----------
$ 1,000,000 $ 2,800,000
=========== ===========
At December 31, 2004, Tag-It Pacific, Inc. had Federal and state NOL
carryforwards of approximately $21.6 and $12.9 million, respectively. The
Federal NOL is available to offset future taxable income through 2024, and the
state NOL expires in 2014. Section 382 ("Section 382") of the Internal Revenue
Code of 1986, as amended (the "Code"), places a limitation on the realizability
of net operating losses in future periods if the ownership of the Company has
changed more than 50% within a three-year period. As of December 31, 2004, some
of our net operating losses may be limited by the Section 382 rules. The amount
of such limitations, if any, has not yet been determined.
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and tax benefit
54
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
carry-forwards. Deferred tax liabilities and assets at the end of each period
are determined using enacted tax rates. The Company records deferred tax assets
arising from temporary timing differences between recorded net income and
taxable net income when and if it believes that future earnings will be
sufficient to realize the tax benefit. For those jurisdictions where the
expiration date of tax benefit carry-forwards or the projected taxable earnings
indicate that realization is not likely, a valuation allowance is provided.
The provisions of SFAS No. 109, "Accounting for Income Taxes," require
the establishment of a valuation allowance when, based on currently available
information and other factors, it is more likely than not that all or a portion
of a deferred tax asset will not be realized. SFAS No. 109 provides that an
important factor in determining whether a deferred tax asset will be realized is
whether there has been sufficient income in recent years and whether sufficient
income is expected in future years in order to utilize the deferred tax asset.
In 2003, the Company determined, based upon its operating loss, that it
was more likely than not that it would not be in a position to fully realize all
of its deferred tax assets in future years. Accordingly, in 2003, the Company
recorded a valuation allowance of $1.1 million, which reduced the carrying value
of its net deferred tax assets to $2.8 million. In 2004, the Company incurred
additional net operating losses and, as a result, increased its valuation
allowance to $8.9 million, which reduced the carrying value of its net deferred
tax asset to $1.0 million. The Company intends to maintain a valuation allowance
for its deferred tax assets until sufficient evidence exists to support the
reversal or reduction of the allowance. At the end of each quarter, the Company
will review supporting evidence, including the performance against sales and
income projections, to determine if a release of the valuation allowance is
warranted. If in future periods it is determined that it is more likely than not
that the Company will be able to recognize all or a greater portion of its
deferred tax assets, the Company will at that time reverse or reduce the
valuation allowance.
The Company believes that its estimate of deferred tax assets and
determination to record a valuation allowance against such assets are critical
accounting estimates because they are subject to, among other things, an
estimate of future taxable income, which is susceptible to change and dependent
upon events that may or may not occur, and because the impact of recording a
valuation allowance may be material to the assets reported on its balance sheet
and results of operations.
The Company has not provided withholding and U.S. federal income taxes
on undistributed earnings of its foreign subsidiaries because the Company
intends to reinvest those earnings indefinitely or any taxes on these earnings
will be offset by the approximate credits for foreign taxes paid. It is not
practical to determine the U.S. federal tax liability, if any, which would be
payable if such earnings were not invested indefinitely.
NOTE 17--COMMITMENTS AND CONTINGENCIES
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 stretch waistbands, various other
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 stretch waistbands, various other trim products,
garment components and services from the Company of $10 million over the
two-year period. On July 16, 2004, the Company amended its exclusive supply
agreement with Levi to provide for an additional two-year term through November
2006. The supply agreement also appoints Talon as an approved zipper supplier to
Levi.
55
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FRANCHISE AGREEMENTS
The Company has entered into six franchise agreements for the sale of
TALON zippers. The agreements provides for minimum purchases from the Company of
TALON zipper products to be received over the term of the agreements as follows:
Agreement
Region Date Term
- ---------------------- ------------------ ----------
Central Asia October 21, 2004 42 Months
South East Asia November 10, 2004 42 Months
Southern Hemisphere December 21, 2004 66 Months
Asia December 28, 2004 42 Months
South East Asia January 7, 2005 42 Months
Middle East and Africa February 19, 2005 42 Months
LEASES
The Company is a party to a number of non-cancelable operating lease
agreements involving buildings and equipment which expire at various dates
through November 2008. The Company accounts for its leases in accordance with
SFAS No. 13, whereby step provisions, escalation clauses, tenant improvement
allowances, increases based on an existing index or rate, and other lease
concessions are accounted for in the minimum lease payments and are charged to
the income statement on a straight line basis over the related lease term.
The future minimum lease commitments as of December 31, 2004 are as
follows:
Years Ending December 31, Amount
----------------------------------------- ----------
2005 .................................... $ 724,009
2006 .................................... 362,058
2007 .................................... 37,760
2008 .................................... 22,000
----------
Total minimum payments ............... $1,145,827
==========
Total rental expense for the years ended December 31, 2004, 2003 and
2002 aggregated $696,590, $966,867 and $820,194, respectively.
PROFIT SHARING PLAN
In October 1999, the Company established a 401(k) profit-sharing plan
for the benefit of eligible employees. The Company may make annual contributions
to the plan as determined by the Board of Directors. There were no contributions
made during the years ended December 31, 2004, 2003 and 2002.
CONTINGENCIES
The Company has filed suit against Pro-Fit Holdings Limited in the U.S.
District Court for the Central District of California -- TAG-IT PACIFIC, INC. V.
PRO-FIT HOLDINGS LIMITED, CV 04-2694 LGB (RCx) - based on various contractual
and tort claims relating to the Company's exclusive license and intellectual
property agreement, seeking declaratory relief, injunctive relief and damages.
The agreement with Pro-Fit gives the Company exclusive rights in certain
geographic areas to Pro-Fit's stretch and rigid waistband technology. Pro-Fit
filed an answer denying the material allegations of the complaint and filed a
counterclaim
56
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
alleging various contractual and tort claims seeking injunctive relief and
damages. The Company filed a reply denying the material allegations of Pro-Fit's
pleading. Pro-Fit has since purported to terminate the exclusive license and
intellectual property agreement based on the same alleged breaches of the
agreement that are the subject of the parties' existing litigation, as well as
on an additional basis unsupported by fact. In February 2005, the Company
amended its pleadings in the litigation to assert additional breaches by Pro-Fit
of its obligations to the Company under the agreement and under certain
additional letter agreements, and for a declaratory judgment that Pro-Fit's
patent No. 5,987,721 is invalid and not infringed by the Company. Discovery in
this case has commenced. There have been ongoing negotiations with Pro-Fit to
attempt to resolve these disputes. The Company intends to proceed with the
lawsuit if these negotiations are not concluded in a manner satisfactory to it.
The Company is subject to certain other 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.
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.
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.
NOTE 18--GEOGRAPHIC INFORMATION
The Company specializes in the distribution of a full range of trim
items to manufacturers of fashion apparel, specialty retailers and mass
merchandisers. There is not enough difference between the types of products
developed and distributed by the Company to account for these products
separately or to justify segmented reporting by product type.
57
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company distributes its products internationally and has reporting
requirements based on geographic regions. Long-lived assets are attributed to
countries based on the location of the assets and revenues are attributed to
countries based on customer delivery locations, as follows:
Year Ended December 31,
-----------------------------------------
2004 2003 2002
----------- ----------- -----------
Sales:
United States ................ $ 4,822,935 $ 8,836,546 $ 8,709,833
Asia ......................... 12,785,977 9,637,268 5,436,927
Mexico ....................... 21,452,805 26,472,044 44,087,714
Dominican Republic ........... 9,678,078 14,219,236 1,838,696
Central and South America .... 5,504,761 3,620,848 --
Other ........................ 864,925 1,656,873 --
----------- ----------- -----------
$55,109,481 $64,442,815 $60,073,170
=========== =========== ===========
Long-lived Assets:
United States ................ $12,911,377 $ 8,594,804 $ 6,998,595
Asia ......................... 234,746 1,243,388 117,534
Mexico ....................... 187,721 267,704 308,671
Dominican Republic ........... 866,807 975,092 580,526
----------- ----------- -----------
$14,200,651 $11,080,988 $ 8,005,326
=========== =========== ===========
NOTE 19--MAJOR CUSTOMERS AND VENDORS
Two major customers accounted for approximately 21.9% of the Company's
net sales on a consolidated basis for the year ended December 31, 2004. Three
major customers, two of which were related parties, accounted for approximately
64.1% of the Company's net sales on a consolidated basis for the year ended
December 31, 2003. Two major customers, both related parties, accounted for
approximately 69.7% of the Company's net sales on a consolidated basis for the
year ended December 31, 2002. Included in trade accounts receivable at December
31, 2004 is $8,133,471 due from these customers. Included in trade accounts
receivable and accounts receivable related parties at December 31, 2003 is
$1,524,211 and $11,721,465 due from these customers. Terms are net 30 and 60
days. The Company holds inventories of approximately $3.2 million at December
31, 2004 that are subject to buyback arrangements with its customers. The
Company's results of operations will depend to an extent upon the commercial
success of these customers. If these customers fail to purchase trim products at
anticipated levels, or the relationship terminates, it may have an adverse
affect on the Company's results of operations. If the financial condition of
these customers were to deteriorate, resulting in an impairment of their ability
to purchase inventories or repay receivables, it may also have an adverse affect
on the Company's results of operations.
Four major vendors accounted for approximately 70.0% of the Company's
purchases for the year ended December 31, 2004. Two major vendors, one a related
party, accounted for approximately 43.2% of the Company's purchases for the year
ended December 31, 2003. One major vendor, a related party, accounted for
approximately 30.6% of the Company's purchases for the year ended December 31,
2002. Included in accounts payable and accrued expenses at December 31, 2004 and
2003 is $2,547,809 and $607,179 due to these vendors. Terms are sight and 60
days.
NOTE 20--RELATED PARTY TRANSACTIONS
In October 1998, the Company sold 2,390,000 shares of Common Stock at a
purchase price per share of $1.125 to KG Investment, LLC. KG Investment is owned
by Gerard Guez and Todd Kay, executive officers and significant shareholders of
Tarrant Apparel Group ("Tarrant"). KG Investment agreed that it would not seek
to dispose of its shares prior to October 16, 2000, except to certain affiliated
parties, without the Company's prior written consent. KG Investment also agreed
to certain additional
58
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
restrictions on the transfer and voting of the shares it purchased and has been
granted piggyback registration rights.
Commencing in December 1998, the Company began to provide trim products
to Tarrant for its operations in Mexico. In connection therewith, the Company
purchased $2.25 million of Tarrant's existing inventory in December 1998 for
resale to Tarrant. The Company has terminated its supply relationship with
Tarrant. In December 2004, the Company wrote-off the remaining obligations due
from Tarrant, see Notes 5 and 21 to the financial statements.
Commencing in December 2000, the Company began to provide trim products
to Azteca Production International, Inc. for its operations in Mexico. In
connection therewith, the Company purchased $4.0 million of Azteca's existing
inventory in December 2000 for resale to Azteca. As a result of the sale of its
ownership in the Company's common stock, Azteca Production International is no
longer considered a related party customer for the year ended December 31, 2004.
Total sales to Tarrant and Azteca and their affiliates for the years
ended December 31, 2004, 2003 and 2002 amounted to approximately $6,784,000,
$25,883,000 and $41,893,000. As of December 31, 2004, accounts receivable
included approximately $6,596,000 due from Azteca and its affiliates. As of
December 31, 2004, accounts receivable, related party included $4.5 million due
from Tarrant's affiliate, Untied Apparel Ventures. As of December 31, 2003,
accounts receivable related parties included approximately $11,721,000 due from
Tarrant and Azteca and their affiliates. Terms are net 60 days.
Transportation fees paid to a company that has common ownership with
Azteca for the years ended December 31, 2004, 2003 and 2002 amounted to
$200,000, $210,000 and $225,000.
Included in due from related parties at December 31, 2004 and 2003 is
$556,550 and $762,076, respectively, of unsecured notes and advances from an
officer and stockholder of the Company. The notes and advances bear interest at
8.5% and prime and are due on demand.
In August 1999, Mark Dyne, Chairman of the Board of Directors, loaned
the Company $160,000. This indebtedness is evidenced by an unsecured promissory
note dated August 17, 1999. The principal, that bears an interest rate at 7% per
annum, and interest are due and payable on demand. The Company repaid $95,205 of
the principal balance during the year ended December 31, 2001.
Transportation fees paid to or on behalf of a company that has common
ownership with Mark Dyne, Chairman of the Board of Directors, and Colin Dyne,
Chief Executive Officer of the Company, for the years ended December 31, 2004
and 2003 amounted to $211,000 and $20,000.
Consulting fees paid to Diversified Investments, a company owned by a
member of the Board of Directors of the Company, amounted to $150,000, $137,000
and $150,000 for the years ended December 31, 2004, 2003 and 2002.
Consulting fees paid for services provided by a member of the Board of
Directors amounted to $40,700, $41,300 and $70,800 for the years ended December
31, 2004, 2003 and 2002. Consulting fees paid for services provided by another
member of the Board of Directors amounted to $57,375 for the year ended December
31, 2004.
In October 1998, the Company adopted a stockholder's rights plan. Under
the rights plan the Company distributed one preferred share purchase right for
each outstanding share of Common Stock outstanding on November 6, 1998. Upon the
occurrence of certain triggering events related to an unsolicited takeover
attempt of the Company, each purchase right not owned by the party or parties
making the unsolicited takeover attempt will entitle its holder to purchase
shares of the Company's Series A Preferred
59
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock at a value below the then market value of the Series A Preferred Stock.
The rights of holders of the Common Stock will be subject to, and may be
adversely affected by, the rights of holders of the share purchase rights, the
Series A Preferred Stock and any other preferred stock that may be issued in the
future. The issuance of preferred stock, while providing desirable flexibility
in connection with possible acquisitions and other corporate purposes, could
make it more difficult for a third party to acquire a majority of the Company's
outstanding voting stock.
NOTE 21 -WRITE-OFF OF ACCOUNTS RECEIVABLE AND INVENTORIES FROM A FORMER MAJOR
CUSTOMER
Following negotiations with United Apparel Ventures and its affiliate,
Tarrant Apparel Group, a former major customer, the Company determined that a
significant portion of the obligations due from this customer, primarily related
to accounts receivable and inventories, was uncollectable. As a result, the
Company wrote-off a net $4.3 million of obligations due from this customer with
a remaining receivable balance due from UAV of $4.5 million. Included in general
and administrative expenses for the year ended December 31, 2004 are $4,289,436
of expenses related to the write-off of obligations due from United Apparel
Ventures and its affiliate, Tarrant Apparel Group. UAV agreed to pay the $4.5
million receivable over a nine-month period beginning May 2005. The Company does
not anticipate any further charges as a result of this write-off.
NOTE 22 -RESTRUCTURING CHARGES
During the fourth quarter of 2003, the Company implemented a plan to
restructure certain business operations. In accordance with the restructuring
plan, the Company incurred costs related to the reduction of its Mexico
operations, including the relocation of its Florida operations to North Carolina
and the downsizing of its corporate operations by eliminating certain corporate
expenses related to operations, sales and marketing and general and
administrative expenses. The reduction of operations in Mexico was in response
to the following:
o An anticipated reduction in sales volume from the Company's
larger Mexico customers;
o The Company's efforts to decrease its reliance on its larger
Mexico customers;
o The difficulty in obtaining financing in Mexico due to the
location of assets outside the U.S. and customer concentration
and other limits imposed by financial institutions.
Total restructuring charges for the year ended 2003 amounted to
$7,700,047. Restructuring charges include approximately $4.3 million of
inventory write-downs, $1.6 million of additional reserves for doubtful accounts
receivable, $1 million of costs incurred related to the reduction of operations
in Mexico, including the relocation of inventory and facilities, $500,000 of
benefits paid to terminated employees and $300,000 of other costs. All
restructuring costs were incurred and paid for in the fourth quarter of 2003,
and we did not anticipate any further charges as a result of this restructuring
plan. Therefore, no liabilities related to restructuring charges were included
in the balance sheet at December 31, 2003. During the first quarter of 2004,
however, we incurred residual restructuring charges of $414,675.
Restructuring charges for the year ended December 31, 2003 related to
the following expense categories included in the Company's statement of
operations are as follows:
60
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Amount
----------
Cost of goods sold ........................................ $4,931,218
Selling expenses .......................................... 143,442
General and administrative expenses ....................... 2,625,387
----------
Total restructuring charges ............................... $7,700,047
==========
NOTE 23 - QUARTERLY RESULTS (UNAUDITED)
Quarterly results for the years ended December 31, 2004 and 2003 are
reflected below:
FOURTH THIRD SECOND FIRST
- ----------------------------------------------------------------------------------------------
2004
- ----
Revenue ......................... $ 13,021,287 $ 17,004,775 $ 14,923,121 $ 10,160,298
Operating (loss) income (1,2) ... $(14,761,124) $ 472,901 $ 398,563 $ (637,206)
Net (loss) income (2) ........... $(17,438,261) 211,004 170,319 $ (552,030)
Basic (loss) earnings per share . $ (0.96) $ 0.01 $ 0.01 $ (0.04)
Diluted (loss) earnings per share $ (0.96) $ 0.01 $ 0.01 $ (0.04)
2003
- ----
Revenue ......................... $ 12,884,512 $ 16,467,896 $ 20,731,573 $ 14,358,834
Operating (loss) income (1) ..... $ (8,363,491) $ 431,311 $ 1,278,819 $ 771,933
Net (loss) income ............... $ (5,949,360) $ 95,170 $ 748,664 $ 360,868
Basic (loss) earnings per share . $ (0.52) $ 0.00 $ 0.07 $ 0.03
Diluted (loss) earnings per share $ (0.52) $ 0.00 $ 0.07 $ 0.03
- ----------
(1) The Company recorded restructuring charges of $7.7 million during the
fourth quarter of 2003 and $414,675 during the first quarter of 2004
(Note 22).
(2) The Company recorded net charges of $4.3 million from the write-off of
obligations, primarily accounts receivable and inventories, due from a
former major customer (Note 21), an additional allowance for bad debts
of $5.0 million, inventory write-downs of $2.7 million and a decrease
in net deferred tax asset resulting in a charge to the provision for
income taxes of $1.8 million during the fourth quarter of 2004.
Quarterly and year-to-date computations of per share amounts are made
independently. Therefore, the sum of per share amounts for the quarters may not
agree with the per share amounts for the year.
61
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S REPORT ON SCHEDULE II
To the Board of Directors
Tag-It Pacific, Inc.
Los Angeles, California
The audits referred to in our report, dated March 31, 2005, included the related
financial statement schedule as of December 31, 2004, and for each of the three
years in the period ended December 31, 2004, included in the annual report on
Form 10-K of Tag-It Pacific, Inc. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement schedule based on our audits. In our
opinion, such financial statement schedule presents fairly, in all material
respects, the information set forth therein.
/s/ BDO Seidman, LLP
-------------------------
Los Angeles, California
March 31, 2005
62
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ---------- ---------- ---------- ----------
Balance at Balance at
Beginning End of
DESCRIPTION of Year Additions Deductions Year
- ---------------------------------------- ---------- ---------- ---------- ----------
2004
- ----
Allowance for doubtful accounts deducted
from accounts receivable in the balance
sheet .................................. $2,043,571 $5,500,000 $1,457,572 $6,085,999
Reserve for obsolescence deducted from
inventories on the balance sheet ....... -- 2,240,000 1,945,884 294,116
---------- ---------- ---------- ----------
$2,043,571 $7,740,000 $3,403,456 $6,380,115
========== ========== ========== ==========
2003
- ----
Allowance for doubtful accounts deducted
from accounts receivable in the balance
sheet .................................. $ 401,485 $1,822,116 $ 180,030 $2,043,571
Reserve for obsolescence deducted from
inventories on the balance sheet ....... 155,500 4,665,000 4,820,500 --
---------- ---------- ---------- ----------
$ 556,985 $6,487,116 $5,000,530 $2,043,571
========== ========== ========== ==========
2002
- ----
Allowance for doubtful accounts deducted
from accounts receivable in the balance
sheet .................................. $ 568,625 $ 743,113 $ 910,253 $ 401,485
Reserve for obsolescence deducted from
inventories on the balance sheet ....... -- 155,500 -- 155,500
---------- ---------- ---------- ----------
$ 568,625 $ 898,613 $ 910,253 $ 556,985
========== ========== ========== ==========
63
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. 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 have identified a material weakness in the controls related to the
identification of approximately $1.0 million of our inventory located in a third
party warehouse. We have taken steps and will continue to take additional steps
to remedy this material weakness and believe the risk as to the existence of
this inventory at December 31, 2004 has been sufficiently mitigated.
We recorded fourth quarter post-closing adjustments related to the
allowance for doubtful accounts and deferred tax asset in our financial
statements for the year ended December 31, 2004 which is considered a material
weakness surrounding the controls related to our financial reporting.
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 December 31, 2004, the end of the
period covered by this report. Based upon that evaluation, with the exceptions
discussed above, Mr. Dyne and Ms. Ferguson concluded that the Company's
disclosure controls and procedures are effective.
CHANGES IN CONTROLS AND PROCEDURES
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.
ITEM 9B. OTHER INFORMATION.
NONE.
64
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this Item 10 will appear in the proxy statement
for the 2005 Annual Meeting of Stockholders, and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION.
Information regarding executive compensation will appear in the proxy
statement for the 2005 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
Information regarding security ownership of certain beneficial owners
and management and related stockholder matters will appear in the proxy
statement for the 2005 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding certain relationships and related transactions
will appear in the proxy statement for the 2005 Annual Meeting of Stockholders,
and is incorporated by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Information regarding principal accounting fees and services will
appear in the proxy statement for the 2005 Annual Meeting of Stockholders, and
is incorporated by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) FINANCIAL STATEMENTS AND SCHEDULES - See Item 8 of this Form
10-K Annual Report.
(b) Exhibits:
See Exhibit Index attached to this Form 10-K Annual Report.
65
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TAG-IT PACIFIC, INC.
/S/ RONDA FERGUSON
--------------------------------
By: Ronda Ferguson
Its: Chief Financial Officer
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints
Colin Dyne and Ronda Ferguson, and each of them, as his true and lawful
attorneys-in-fact and agents with full power of substitution and resubstitution,
for him and his name, place and stead, in any and all capacities, to sign any or
all amendments to this Annual Report on Form 10-K and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
foregoing, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or either of them, or their substitutes, may lawfully do or cause to be
done by virtue hereof.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/S/ MARK DYNE Chairman of the Board March 31, 2005
- --------------------------- of Directors
Mark Dyne
/S/ COLIN DYNE Chief Executive Officer March 31, 2005
- --------------------------- and Director
Colin Dyne (Principal Executive Officer)
/S/ RONDA FERGUSON Chief Financial Officer March 31, 2005
- --------------------------- (Principal Accounting
Ronda Ferguson and Financial Officer)
/S/ KEVIN BERMEISTER Director March 31, 2005
- ---------------------------
Kevin Bermeister
/S/MICHAEL KATZ Director March 31, 2005
- ---------------------------
Michael Katz
/S/JONATHAN BURSTEIN Director,Vice President of March 31, 2005
- --------------------------- Operations and Secretary
Jonathan Burstein
/S/ BRENT COHEN Director March 31, 2005
- ---------------------------
Brent Cohen
66
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
3.1 Certificate of Incorporation of Registrant. Incorporated by
reference to Exhibit 3.1 to Form SB-2 filed on October 21, 1997,
and the amendments thereto.
3.2 Bylaws of Registrant. Incorporated by reference to Exhibit 3.2 to
Form SB-2 filed on October 21, 1997, and the amendments thereto.
3.3 Certificate of Designation of Rights, Preferences and Privileges
of Series A Preferred Stock. Incorporated by reference to Exhibit
A to the Rights Agreement filed as Exhibit 4.1 to Current Report
on Form 8-K filed as of November 4, 1998.
3.4 Certificate of Amendment of Certificate of Incorporation of
Registrant. Incorporated by reference to Exhibit 3.4 to Annual
Report on Form 10-KSB, filed March 28, 2000.
4.1 Specimen Stock Certificate of Common Stock of Registrant.
Incorporated by reference to Exhibit 4.1to Form SB-2 filed on
October 21, 1997, and the amendments thereto.
4.2 Rights Agreement, dated as of November 4, 1998, between Registrant
and American Stock Transfer and Trust Company as Rights Agent.
Incorporated by reference to Exhibit 4.1 to Current Report on Form
8-K filed as of November 4, 1998.
4.3 Form of Rights Certificate. Incorporated by reference to Exhibit B
to the Rights Agreement filed as Exhibit 4.1 to Current Report on
Form 8-K filed as of November 4, 1998.
10.1 Form of Indemnification Agreement. Incorporated by reference to
Exhibit 10.1to Form SB-2 filed on October 21, 1997, and the
amendments thereto.
10.2 Promissory Note, dated September 30, 1996, provided by Tag-It,
Inc. to Harold Dyne. Incorporated by reference to Exhibit 10.21 to
Form SB-2 filed on October 21, 1997, and the amendments thereto.
10.3 Promissory Note, dated June 30, 1991, provided by Tag-It, Inc. to
Harold Dyne. Incorporated by reference to Exhibit 10.23 to Form
SB-2 filed on October 21, 1997, and the amendments thereto.
10.4 Promissory Note, dated January 31, 1997, provided by Tag-It Inc.
to Mark Dyne. Incorporated by reference to Exhibit 10.24 to Form
SB-2 filed on October 21, 1997, and the amendments thereto.
10.5 Promissory Note, dated February 29, 1996, provided by A.G.S.
Stationary, Inc. to Monto Holdings Pty. Ltd. Incorporated by
reference to Exhibit 10.25 of Form SB-2 filed on October 21, 1997,
and the amendments thereto.
10.6 Promissory Note, dated January 19, 1995, provided by Pacific Trim
& Belt, Inc. to Monto Holdings Pty. Ltd. Incorporated by reference
to Exhibit 10.26 to Form SB-2 filed on October 21, 1997, and the
amendments thereto.
10.7 Registrant's 1997 Stock Incentive Plan, as amended. (2)
Incorporated by reference to Exhibit 10.1 to Form 10-Q filed on
August 16, 2004.
67
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
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10.8 Form of Non-statutory Stock Option Agreement. (2) Incorporated by
reference to Exhibit 10.30 to Form SB-2 filed on October 21, 1997,
and the amendments thereto.
10.9 Promissory Note, dated August 31, 1997, provided by Harold Dyne to
Pacific Trim & Belt, Inc. Incorporated by reference to Exhibit
10.32 to Form SB-2 filed on October 21, 1997, and the amendments
thereto.
10.10 Promissory Note, dated October 15, 1997, provided by Harold Dyne
to Pacific Trim & Belt, Inc. Incorporated by reference to Exhibit
10.34 to Form SB-2 filed on October 21, 1997, and the amendments
thereto.
10.11 Warrant Agreement, dated June 1, 1994, between Jonathan Markiles
and Tag-It, Inc. Incorporated by reference to Exhibit 10.39 to
Form SB-2 filed on October 21, 1997, and the amendments thereto.
10.12 Contract for Manufacturing Services between USA and Mexico,
between Tag-It, Inc. and Tagit de Mexico, S.A. de C.V.
Incorporated by reference to Exhibit 10.44 to Form SB-2 filed on
October 21, 1997, and the amendments thereto.
10.13 Promissory Note, dated October 15, 1997, provided by A.G.S.
Stationary Inc. to Monto Holdings Pty. Ltd. Incorporated by
reference to Exhibit 10.48 to Form SB-2 filed on October 21, 1997,
and the amendments thereto.
10.14 Promissory Note, dated November 4, 1997, provided by Pacific Trim
& Belt, Inc. to Monto Holdings Pty. Ltd. Incorporated by reference
to Exhibit 10.49 to Form SB-2 filed on October 21, 1997, and the
amendments thereto.
10.15 Binding Letter of Understanding, dated October 14, 1998.
Incorporated by reference to Exhibit 99.3 to Current Report on
Form 8-K filed as of October 29, 1998.
10.16 Side Letter Agreement, dated October 14, 1998. Incorporated by
reference to Exhibit 99.4 to Current Report Form 8-K filed as of
October 29, 1998.
10.17 Guaranty, dated as of October 4, 2000, by A.G.S. Stationery, Inc.
in favor or Mark I. Dyne. Incorporated by reference to Exhibit
10.40 to Form 10-K filed on April 4, 2001.
10.18 Guaranty, dated as of October 4, 2000, by Tag-It, Inc. in favor of
Mark I. Dyne. Incorporated by reference to Exhibit 10.41 to Form
10-K filed on April 4, 2001.
10.19 Guaranty, dated as of October 4, 2000, by Talon International,
Inc. in favor of Mark I. Dyne. Incorporated by reference to
Exhibit 10.42 to Form 10-K filed on April 4, 2001.
10.20 Intercreditor Agreement, dated as of October 4, 2000, by and among
Mark I. Dyne, Sanwa Bank California, the Registrant, Tag-It, Inc.,
Talon International, Inc. and A.G.S. Stationery, Inc. Incorporated
by reference to Exhibit 10.43 to Form 10-K filed on April 4, 2001.
10.21 Security Agreement, dated as of October 4, 2000, between A.G.S.
Stationery, Inc. and Mark I. Dyne. Incorporated by reference to
Exhibit 10.44 to Form 10-K filed on April 4, 2001. Incorporated by
reference to Exhibit 10.44 to Form 10-K filed on April 4, 2001.
10.22 Security Agreement, dated as of October 4, 2000, between Tag-It,
Inc. and Mark I. Dyne. Incorporated by reference to Exhibit 10.45
to Form 10-K filed on April 4, 2001.
68
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
10.23 Security Agreement, dated as of October 4, 2000, between Talon
International Inc. and Mark I. Dyne. Incorporated by reference to
Exhibit 10.46 to Form 10-K filed on April 4, 2001.
10.24 Security Agreement, dated as of October 4, 2000, between Tag-It
Pacific, Inc. and Mark I. Dyne. Incorporated by reference to
Exhibit 10.47 to Form 10-K filed on April 4, 2001.
10.25 Convertible Secured Subordinated Promissory Note, dated October 4,
2000, provided by Mark I. Dyne to the Registrant. Incorporated by
reference to Exhibit 10.48 to Form 10-K filed on April 4, 2001.
10.26 Trim Handling Agreement, dated as of December 29, 1999, among the
Registrant, Tarrant Apparel Group, Inc. & Tagmex and Tag-It de
Mexico S.A. Incorporated by reference to Exhibit 10.51 to Form
10-K filed on April 4, 2001.
10.27 Supply Agreement entered into on December 22, 2000, by and between
the Company, Hubert Guez, Paul Guez and Azteca Production
International, Inc., AZT International SA D RL, and Commerce
Investment Group, LLC. (1) Incorporated by reference to Exhibit
10.53 to Form 10-K filed on April 4, 2001.
10.28 Investor Rights Agreement entered into on December 22, 2000, by
and between the Company and Commerce Investment Group, LLC.
Incorporated by reference to Exhibit 10.54 to Form 10-K filed on
April 4, 2001.
10.29 Voting Agreement entered into on December 22, 2000, by and between
the Company, Hubert Guez, Paul Guez and Azteca Production
International, Inc., AZT International SA D RL, Commerce
Investment Group, LLC, and Colin Dyne. Incorporated by reference
to Exhibit 10.55 to Form 10-K filed on April 4, 2001.
10.30 Right of First Refusal and Sale Agreement entered into on December
22, 2000, by and between the Company, Hubert Guez, Paul Guez and
Azteca Production International, Inc., AZT International SA D RL,
Commerce Investment Group, LLC, and Colin Dyne. Incorporated by
reference to Exhibit 10.56 to Form 10-K filed on April 4, 2001.
10.31 Co-Marketing and Supply Agreement, dated as of September 20, 2001,
between Tag-It Pacific, Inc. and Coats America, Inc. Incorporated
by reference to Exhibit 99.3 to Form 8-K filed on October 15,
2001.
10.32 Purchase Money Security Agreement, dated as of September 20, 2001,
between Tag-It Pacific, Inc. and Coats America, Inc. Incorporated
by reference to Exhibit 99.4 to Form 8-K filed on October 15,
2001.
10.33 Promissory Note, dated as of December 21, 2001, by Tag-It Pacific,
Inc. for the benefit of Talon, Inc. Incorporated by reference to
Exhibit 99.2 to Form 8-K filed on January 7, 2002.
10.34 Form of Warrant to Purchase Common Stock Agreements dated December
28, 2001. Incorporated by reference to Exhibit 99.2 to Form 8-K
filed on January 23, 2002.
10.35 Form of Stockholders Agreements dated December 28, 2001.
Incorporated by reference to Exhibit 99.3 to Form 8-K filed on
January 23, 2002.
69
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
10.36 Form of Investor Rights Agreements dated December 28, 2001.
Incorporated by reference to Exhibit 99.4 to Form 8-K filed on
January 23, 2002.
10.37 Exclusive Supply Agreement dated July 12, 2002, among Tag-It
Pacific, Inc. and Levi Strauss & Co. (1) Incorporated by reference
to Exhibit 10.68 to Form 10-Q filed on November 15, 2002.
10.37.1 Amendment to Exclusive Supply Agreement, dated July 12, 2002,
between Tag-It Pacific, Inc. and Levi Strauss & Co. (1)
Incorporated by reference to Exhibit 10.70 to Form 10-K filed on
March 28, 2003.
10.37.2 Amendment, dated June 29, 2004, to Exclusive Supply Agreement,
dated July 12, 2002, between Tag-It Pacific, Inc. and Levi Strauss
& Co.
10.38 Intellectual Property Rights Agreement, dated April 2, 2002,
between the Company and Pro-Fit Holdings, Ltd. (1) Incorporated by
reference to Exhibit 10.69 to Form 10-K/A filed on October 1,
2003.
10.39 Securities Purchase Agreement dated May 23, 2003, by and among the
Company and the Purchasers identified on the signature pages
thereto. Incorporated by reference to Exhibit 99.2 to Form 8-K
filed on June 4, 2003.
10.40 Registration Rights Agreement dated May 23, 2003, by and among the
Company and the Purchasers identified on the signature pages
thereto. Incorporated by reference to Exhibit 99.3 to Form 8-K
filed on June 4, 2003.
10.41 Common Stock Purchase Warrant dated May 30, 2003 between the
Company and Roth Capital Partners LLC. Incorporated by reference
to Exhibit 10.15 to Form S-3 Registration Statement filed on June
25, 2003.
10.42 Form of Subscription Agreement between the Company and the
Purchaser to be identified therein dated December 18, 2003.
Incorporated by reference to Exhibit 99.1 to Form 8-K filed on
December 22, 2003.
10.43 Form of Registration Rights Agreement dated December 18, 2003
among the Company and the Purchasers identified therein.
Incorporated by reference to Exhibit 99.2 to Form 8-K filed on
December 22, 2003.
10.44 Placement Agent Agreement dated December 18, 2003 between the
Company and Sanders Morris Harris Inc. Incorporated by reference
to Exhibit 99.3 to Form 8-K filed on December 22, 2003.
10.45 Common Stock Purchase Warrant dated December 18, 2003 between the
Company and Sanders Morris Harris Inc. Incorporated by reference
to Exhibit 99.4 to Form 8-K filed on December 22, 2003.
10.46 Form of Subscription Agreement, dated as of November 9, 2004,
between the Company and the Purchaser identified therein.
Incorporated by reference to Exhibit 10.1 to Form S-3 filed on
December 9, 2004.
70
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
10.47 Form of Secured Convertible Promissory Note, dated as of November
9, 2004. Incorporated by reference to Exhibit 10.2 to Form S-3
filed on December 9, 2004.
10.48 Form of Common Stock Purchase Warrant, dated as of November 9,
2004. Incorporated by reference to Exhibit 10.3 to Form S-3 filed
on December 9, 2004.
10.49 Trademark Security Agreement, dated as of November 9, 2004, among
the Registrant and the Secured Parties identified on the signature
page thereto. Incorporated by reference to Exhibit 10.4 to Form
S-3 filed on December 9, 2004.
10.50 Registration Rights Agreement, dated as of November 9, 2004, among
the Registrant, Sanders Morris Harris Inc. and the Purchasers
identified therein. Incorporated by reference to Exhibit 10.5 to
Form S-3 filed on December 9, 2004.
10.51 Placement Agent Agreement, dated as of November 9, 2004, between
the Registrant and Sanders Morris Harris Inc. Incorporated by
reference to Exhibit 10.6 to Form S-3 filed on December 9, 2004.
10.52 Common Stock Purchase Warrant dated as of November 9, 2004, issued
by the Registrant in favor of Sanders Morris Harris Inc.
Incorporated by reference to Exhibit 10.7 to Form S-3 filed on
December 9, 2004.
14.1 Code of Ethics. Incorporated by reference to Exhibit 14.1 to Form
10-K filed on March 30, 2004.
21.1 Subsidiaries. Incorporated by reference to Exhibit 14.1 to Form
10-K filed on March 30, 2004.
23.1 Consent of BDO Seidman, LLP.
24.1 Power of Attorney (included on signature page).
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.
(1) 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.
(2) Indicates a management contract or compensatory plan.
71